Question

Vargo Corp. owes \(270,000 to First Trust. The debt is a 10-year, 12% note due December 31, 2017. Because Vargo Corp. is in financial trouble, First Trust agrees to extend the maturity date to December 31, 2019, reduce the principal to \)220,000, and reduce the interest rate to 5%, payable annually on December 31.

Instructions

1. Prepare the journal entries on Vargo’s books on December 31, 2017, 2018, 2019.
2. Prepare the journal entries on First Trust’s books on December 31, 2017, 2018, 2019.

Short answer

1. The total debit and credit side of Journal is $270,000.
2. The total debit and credit side of the Journal is $394,054.

Step-by-step solution

Meaning of Journal Entry

A journal entry is a financial transaction recordthat is preserved in an organization's books of accounts.Debit and credit columns, as well as a description of each transaction, are included.

(a) Preparing journal entry

Becausethe carrying amount of the loan, $270,000, is more than the total anticipated cash flows, $242,000 [$220,000 + ($11,000 X 2)], a gain and a loss are recognized, and the debtor does not record interest.

Vargo Corp.’s entries

Date	Particulars	Debit ($)	Credit ($)
2017	Notes payable	28,000
	Gain on the restructuring of debt		28,000
2018	Notes payable	11,000
	Cash$\left(5\%\times \$220,000\right)$		11,000
2019	Notes payable	231,000
	Cash $\left[\$220,000+\left(5\%\times \$220,000\right)\right]$		231,000
		$270,000	$270,000

(b) Preparing journal entry

First Trust’s entries

Date	Particulars	Debit ($)	Credit ($)
Dec. 31, 2017	Bad debt expense	76,027
	Allowances for doubtful accounts		76,027
Dec. 31, 2018	Cash	11,000
	Allowance for doubtful accounts	12,277
	Interest revenue		23,277
Dec. 31, 2019	Cash	11,000
	Allowances for doubtful accounts	13,750
	Interest revenue		24,750
Dec. 31, 2019	Cash	220,000
	Allowance for doubtful accounts	50,000
	Notes receivable		270,000
		$394,054	$394,054

Working notes:

Calculation of creditors’ loss due to restructuring of debt

Pre-restructure carrying amount	$270,000
Present value of restructured cash flows:
Present value of $220,000 due in 2 years At 12%, interest payable annually (Table 6-2); $\left(\$220,000\times 0.79719\right)$$175,382
Present value of $11,000 interest payable Annually for 2 years at 12 % (Table 6-4); $\left(\$11,000\times 1.69005\right)$18,591	193,973
Creditor’s loss on restructuring of debt	$(76,027)

Preparing interest payment schedule

Date	Cash interest	Effective interest	Increase in Carrying Amount	Carrying Amount of Note
12/31/17				$193,973
12/31/18	$11,000 $\left(\$220,000\times 0.05\right)$	$23,277 $\left(\$193,973\times 12\%\right)$	$12,277 $\left(\$23,277-\$11,000\right)$	206,250
12/31/19	11,000	24,750	13,750	220,000