Question

Question: (Debtor/Creditor Entries for Continuation of Troubled Debt with New Effective Interest)

Crocker Corp. owes D. Yaeger Corp. a 10-year, 10% note in the amount of \(330,000 plus \)33,000 of accrued interest. The note is due today, December 31, 2017. Because Crocker Corp. is in financial trouble, D. Yaeger Corp. agrees to forgive the accrued interest, \(30,000 of the principal, and to extend the maturity date to December 31, 2020. Interest at 10% of revised principal will continue to be due on 12/31 each year.

Assume the following present value factors for 3 periods.

Single sum	0.93543	0.93201	0.92589	0.92521	0.92184	0.91514
Ordinary annuity of 1	2.86989	2.86295	2.85602	2.84913	2.84226	2.82861

Instructions

(a) Compute the new effective-interest rate for Crocker Corp. following restructure. (Hint: Find the interest rate that establishes approximately \)363,000 as the present value of the total future cash flows.)

(b) Prepare a schedule of debt reduction and interest expense for the years 2017 through 2020.

(c) Compute the gain or loss for D. Yaeger Corp. and prepare a schedule of receivable reduction and interest revenue for the years 2017 through 2020.

(d) Prepare all the necessary journal entries on the books of Crocker Corp. for the years 2017, 2018, and 2019.

(e) Prepare all the necessary journal entries on the books of D. Yaeger Corp. for the years 2017, 2018, and 2019.

Short answer

Answer

1. The effective interest rate will be.
2. Difference between the cash paid and the interest expenses is reported as amortized premium.
3. Creditor will incur a loss of$63,000due to restructuring.
4. Both sides of the journal total$93,000.
5. Journal entries will include one entry for reporting bad debt expenses and two entries for interest revenue.

Step-by-step solution

Definition of Interest Revenue

Interest revenue can be defined as all the benefits the business entity generates by charging fees against the loan granted to the customers or any other individual. It is the primary source of revenue for financial institutions.

Calculation of new effective interest rate

Particular
Present value of $300,000	$277,767	$276,552	$277,563
Present value of the interest $30,000	$85,681	$85,268	$85,474
Total	$363,448	$361,820	$363,037

The effective interest rate will fall aroundbecause it provides the value nearest to $363,000$\left(\$330,000+\$33,000\right)$.

Schedule debt reduction and interest expenses

Date	Cash paid	Interest expenses (using an effective interest rate 2.625%)	Premium amortized	Unamortized premium	Stated value	Carrying amount
31 Dec 17				$63,000	$300,000	$363,000
31 Dec 18	$30,000	$9,529	$20,471	$42,529	$300,000	$342,529
31 Dec 19	$30,000	$8,991	$21,009	$21,520	$300,000	$321,520
31 Dec 20	$30,000	$8,440	$21,560	$0	$300,000	$300,000

Calculation of gain or loss for D. Yaeger Corp

Particular	Amount $
Carrying amount before restructuring	$363,000
Less: Present value of restructured cash flow
Present value of $300,000 (n=3, r=10%) (0.751)	(225,300)
Present value of interest payable annually of $30,000 (n=3, r=10%) (2.49)	(74,700)
Loss on restructuring	$63,000

Journal entries in the books of Crocker Corp

Date	Accounts and Explanation	Debit ($)	Credit ($)
31 Dec 2017	Interest payable	33,000
	Note payable		33,000
31 Dec 2018	Interest expenses	9,529
	Note payable	20,471
	Cash		30,000
31 Dec 2019	Interest expenses	8,991
	Note payable	21,009
	Cash		30,000
		$93,000	$93,000

Journal entries in the books of D. Yaeger Corp

Date	Accounts and Explanation	Debit ($)	Credit ($)
31 Dec 2017	Bad debt expenses	63,000
	Allowance for doubtful accounts		63,000
31 Dec 2018	Cash	30,000
	Interest revenue		30,000
31 Dec 2019	Cash	30,000
	Interest revenue		30,000
		$123,000	$123,000