Question

Using the same information as in E14-22 and E14-24, answer the following questions related to American Bank (creditor).

Instructions

1. Compute the loss American Bank will suffer under this new term modification. Prepare the journal entry to record the loss on American’s books.
2. Prepare the interest receipt schedule for American Bank after the debt restructuring.
3. Prepare the interest receipt entry for American Bank on December 31, 2018, 2019, and 2020.
4. What entry should American Bank make on January 1, 2021?

Short answer

1. Loss on the restructuring of debt is $1,191,270
2. The total cash paid is$570,000
3. The total amount of debit and credit side of the journal is$661,270
4. Allowance for doubtful accounts is$1,100,000

Step-by-step solution

 Meaning of Debt restructuring

The company facing cash flow issues can avoid bankruptcy by agreeing with lenders to renegotiate favorable or flexible conditions. We call this procedure "debt restructuring."

(a) Computing loss and Preparing journal entry

The loss can be calculated as follows:

The pre-restructuring carrying amount of note	$3,000,000
Less: Present value of restructured future cash flows:
Present value of principal $1,900,000 due in 3 years at 12% $1,352,382
Present value of interest $190,000 Paid annually for 3 years at 12% 456,348	1,808,730
Loss on the restructuring of debt	$1,191,270

Working note:

Calculation of Present value of principal $1,900,000 due in 3 years at 12%

$\begin{array}{rcl}\mathit{P}\mathit{r}\mathit{e}\mathit{s}\mathit{e}\mathit{n}\mathit{t}\mathbf{}\mathit{v}\mathit{a}\mathit{l}\mathit{u}\mathit{e}& \mathbf{=}& \mathit{P}\mathit{r}\mathit{i}\mathit{n}\mathit{c}\mathit{i}\mathit{p}\mathit{a}\mathit{l}\mathbf{}\mathit{v}\mathit{a}\mathit{l}\mathit{u}\mathit{e}\mathbf{\times }\mathit{P}\mathit{V}\mathbf{}\mathit{f}\mathit{a}\mathit{c}\mathit{t}\mathit{o}\mathit{r}\\ & \mathbf{=}& \mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{900}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{0}\mathbf{.}\mathbf{71178}\\ & \mathbf{=}& \mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{352}\mathbf{,}\mathbf{382}\\ & & \end{array}$

Calculation of Present value of interest $190,000 Paid annually for 3 years at 12%

$\begin{array}{rcl}\mathit{P}\mathit{r}\mathit{e}\mathit{s}\mathit{e}\mathit{n}\mathit{t}\mathbf{}\mathit{v}\mathit{a}\mathit{l}\mathit{u}\mathit{e}& \mathbf{=}& \mathit{P}\mathit{r}\mathit{i}\mathit{n}\mathit{c}\mathit{i}\mathit{p}\mathit{a}\mathit{l}\mathbf{}\mathit{v}\mathit{a}\mathit{l}\mathit{u}\mathit{e}\mathbf{}\mathit{i}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{t}\mathit{e}\mathit{s}\mathit{t}\mathbf{\times }\mathit{P}\mathit{V}\mathbf{}\mathit{f}\mathit{a}\mathit{c}\mathit{t}\mathit{o}\mathit{r}\\ & \mathbf{=}& \mathbf{\$}\mathbf{190}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{2}\mathbf{.}\mathbf{40183}\\ & \mathbf{=}& \mathbf{\$}\mathbf{456}\mathbf{,}\mathbf{348}\\ & & \end{array}$

Journal entry in American’s books

Date	Particulars	Debit ($)	Credit ($)
Dec. 31, 2017	Bad debt expense	1,191,270
	Allowance for doubtful accounts		1,191,270

(b) Preparing interest receipt schedule

AMERICAN BANK Interest Receipt Schedule After Debt Restructuring Effective Interest Rate 12%
Date	Cash received (10%)	Interest Revenue (12%)	Increase In Carrying Amount	Carrying Amount of Note
12/31/17				$1,808,730
12/31/18	$190,000	$217,048	$27,048	1,835,778
12/31/19	190,000	220,293	30,293	1,866,071
12/31/20	190,000	223,929	33,929	1,900,000
Total	$570,000	$661,270	$91,270

Calculation of Cash paid on 12/31/18

$\begin{array}{rcl}\mathit{C}\mathit{a}\mathit{s}\mathit{h}\mathbf{}\mathit{p}\mathit{a}\mathit{i}\mathit{d}& \mathbf{=}& \mathit{P}\mathit{r}\mathit{i}\mathit{n}\mathit{c}\mathit{i}\mathit{p}\mathit{a}\mathit{l}\mathbf{}\mathit{o}\mathit{b}\mathit{l}\mathit{i}\mathit{g}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathit{n}\mathbf{\times }\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{r}\mathit{a}\mathit{t}\mathit{e}\\ & \mathbf{=}& \mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{900}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{10}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{190}\mathbf{,}\mathbf{000}\\ & & \end{array}$

Calculation of interest revenue on 12/31/18

$\begin{array}{rcl}\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{r}\mathit{e}\mathit{v}\mathit{e}\mathit{n}\mathit{u}\mathit{e}& \mathbf{=}& \mathit{P}\mathit{r}\mathit{i}\mathit{n}\mathit{c}\mathit{i}\mathit{p}\mathit{a}\mathit{l}\mathbf{}\mathit{o}\mathit{b}\mathit{l}\mathit{i}\mathit{g}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathit{n}\mathbf{\times }\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{ }\mathit{r}\mathit{a}\mathit{t}\mathit{e}\\ & \mathbf{=}& \mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{808}\mathbf{,}\mathbf{730}\mathbf{\times }\mathbf{12}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{217}\mathbf{,}\mathbf{048}\\ & & \end{array}$

Calculation of increase in carrying amount on 12/31/18

$\begin{array}{rcl}\mathit{I}\mathit{n}\mathit{c}\mathit{r}\mathit{e}\mathit{a}\mathit{s}\mathit{e}\mathit{}\mathit{i}\mathit{n}\mathit{}\mathit{c}\mathit{a}\mathit{r}\mathit{r}\mathit{y}\mathit{i}\mathit{n}\mathit{g}\mathit{}\mathit{a}\mathit{m}\mathit{o}\mathit{u}\mathit{n}\mathit{t}& \mathit{=}& \mathit{C}\mathit{a}\mathit{s}\mathit{h}\mathit{}\mathit{p}\mathit{a}\mathit{i}\mathit{d}\mathit{-}\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathit{}\mathit{e}\mathit{x}\mathit{p}\mathit{e}\mathit{n}\mathit{s}\mathit{e}\\ & \mathit{=}& \mathit{\$}\mathit{217}\mathit{,}\mathit{048}\mathit{-}\mathit{\$}\mathit{190}\mathit{,}\mathit{000}\\ & \mathit{=}& \mathit{\$}\mathit{27}\mathit{,}\mathit{048}\\ & & \end{array}$

(c) Preparing interest receipt entry

Date	Particulars	Debit ($)	Credit ($)
Dec. 31, 2018	Cash	190,000
	Allowance for doubtful accounts	27,048
	Interest Revenue		217,048
Dec. 31, 2019	Cash	190,000
	Allowance for doubtful accounts	30,293
	Interest Revenue		220,293
Dec. 31, 2020	Cash	190,000
	Allowance for doubtful accounts	33,929
	Interest Revenue		223,929
		$661,270	$661,270

(d) Preparing journal entryThe receipt at maturity is:

Date	Particulars	Debit ($)	Credit ($)
Jan. 1, 2021	Cash	1,900,000
	Allowance for doubtful accounts	1,100,000
	Notes Receivable		3,000,000