Question

Question: (Restructure of Note under Different Circumstances) Halvor Corporation is having financial difficulty and therefore has asked Frontenac National Bank to restructure its \(5 million note outstanding. The present note has 3 years remaining and pays a current rate of interest of 10%. The present market rate for a loan of this nature is 12%. The note was issued at its face value.

Instructions

The following are four independent situations. Prepare the journal entry that Halvor and Frontenac National Bank would make for each of these restructurings.

(a) Frontenac National Bank agrees to take an equity interest in Halvor by accepting common stock valued at \)3,700,000 in exchange for relinquishing its claim on this note. The common stock has a par value of \(1,700,000.

(b) Frontenac National Bank agrees to accept land in exchange for relinquishing its claim on this note. The land has a book value of \)3,250,000 and a fair value of \(4,000,000.

(c) Frontenac National Bank agrees to modify the terms of the note, indicating that Halvor does not have to pay any interest on the note over the 3-year period.

(d) Frontenac National Bank agrees to reduce the principal balance due to \)4,166,667 and require interest only in the second and third year at a rate of 10%.

Short answer

Answer

1. Halvor corporation generates a gain of$1,300,000 on restructuring.
2. Halvor corporation generates a gain of disposal of$750,000 and gains on the restructuring of$1,000,000.
3. Modification in terms of the loan does not require any entry to be made in the books of Halvor, because there is no difference between the aggregate cash flow and the carrying amount.
4. Frontenac national bank will report$1,212,083 as bad debt expenses.

Step-by-step solution

Definition of Restructuring Loan

The process adopted by the corporates and the government to avoid default over loans by generating new terms of loans is known as restructuring of loans. Under this process, they negotiate upon the interest charged on the loan.

Journal entries when Frontenac national bank takes an equity interest in Halvor

Date	Accounts and Explanation	Debit ($)	Credit ($)
In the books of Halvor corporation
	Note payable	5,000,000
	Common stock		1,700,000
	Gain on restructuring		1,300,000
	Paid-in-capital in excess of par – common stock		2,000,000
In the books of Frontenac national bank
	Equity investment – Halvor corporation	3,700,000
	Allowance for bad debts	1,300,000
	Note receivable		5,000,000

Working note:

Calculation of gain on restructuring:

Particular	Amount $
Carrying amount of debt	$5,000,000
Less: Fair value of the equity exchanged	(3,700,000)
Gain on restructuring	$1,300,000

Journal entries when the Frontenac national bank agrees to accept land

Date	Accounts and Explanation	Debit ($)	Credit ($)
In the books of Halvor corporation
	Note payable	5,000,000
	Land		3,250,000
	Gain on disposal of land		750,000
	Gain on restructuring		1,000,000
In the books of Frontenac national bank
	Land	4,000,000
	Allowance for bad debts	1,000,000
	Note receivable		5,000,000

Working note:

Calculation of gain on disposal of land:

Particular	Amount $
Fair value of land	$4,000,000
Less: book value of land	(3,250,000)
Gain on disposal of land	$750,000

Calculation of gain on restructuring:

Particular	Amount $
Note payable	$5,000,000
Less: fair value of land	(4,000,000)
Gain on restructuring debt	$1,000,000

Journal entries when the Frontenac national bank agrees to modify the term of note

Date	Accounts and Explanation	Debit ($)	Credit ($0
On the book of Halvor
	No journal entry is required for Halvor Corporation because the aggregate cash flow is same as the carrying amount of the note payable.
In the books of Frontenac national bank
	Bad debt expenses	1,245,000
	Allowance for doubtful accounts		1,245,000

Working note:

Calculation of bad debt expenses:

Particular	Amount $
Carrying amount of loan before restricting	$5,000,000
Less: Present value of the restructured cash flow $5,000,000 (n=3, r=10%) (0.751)	(3,755,000)
Loss on restructuring debt	$1,245,000

Journal entries when the Frontenac national bank agrees to reduce the principal balance

Date	Accounts and Explanation	Debit ($)	Credit ($)
In the books of Halvor
	No journal entry is required because the aggregate cash flow is same as the carrying amount of the note payable
In the books of Frontenac national bank
	Bad debt expenses	1,212,083
	Allowance for doubtful accounts		1,212,083

Working note:

Calculation of aggregate cash flow and carrying amount:

Particular	Amount $
Principal	$4,166,667
Add: Interest	833,333
Aggregate cash flow	$5,000,000

Calculation of creditor loss on restructuring:

Particular	Amount $
Carrying amount before restructuring	$5,000,000
Less: Present value of restructured loan
Present value of $4,166,667 (n=3, r=10%) (0.751)	(3,129,167)
Present value of interest payable annually $416,667 (n=3, r=10%) (PVOAF: 2.49)	(1,037,500)
Present value of interest due in first year (n=3, r=10%) (0.909)	378,750
Loss due to restructuring	$1,212,083