1. January 1, 2011
Accrued interest payable (10% x $12,000,000) 1,200,000 Note payable ($13 million – 12 million)* 1,000,000 Gain on troubled debt restructuring 200,000
* Establishes a balance in the note account equal to the total cash payments under the new agreement.
2. December 31, 2012
Note payable 1,000,000 Cash(revised “interest” amount) 1,000,000
Note: No interest should be recorded after the restructuring. All subsequent cash payments result in reductions of principal.
3. December 31, 2013
Note payable 1,000,000 Cash(revised “interest” amount) 1,000,000
Note payable 11,000,000 Cash(revised principal amount) 11,000,000
Exercise 14-33
Analysis: Carrying amount: $240,000 + (10% x $240,000) = $264,000 Future payments: ($11,555 x 3) + $240,000 = (274,665) Interest $ 10,665
The discount rate that “equates” the present value of the debt ($264,000) and its future value ($274,665) is the effective rate of interest:
$264,000 ÷ $274,665 = .961 – the Table 2 value for n= 2,i=?
In row 2 of Table 2, the value .961 is in the 2% column. So, this is the neweffective interest rate. A financial calculator will produce the same rate.
1. January 1, 2011
no entry needed
2. December 31, 2011
Interest expense (2% x $264,000) 5,280 Accrued interest payable 5,280
[Unpaid interest is accrued at the effective rate times the carrying amount of the debt.]
3. December 31, 2012
Interest expense (2% x [$264,000 + 5,280]) 5,385* Accrued interest payable 5,385
*rounded
Note payable (balance) 240,000
Accrued interest payable ($24,000 + 5,280 + 5,385) 34,665 Cash([$11,555 x 3] + $240,000) 274,665
Exercise 14-34
Requirement 2
The specific citation that specifies the accounting treatment of legal fees and other direct costs incurred by a creditor to effect a troubled debt restructuring is FASB ASC 310–40–25–1: “Receivables–Troubled Debt Restructurings by Creditors –Recognition–Legal Fees.”
Requirement 3
Legal fees and other direct costs incurred by a creditor to effect a troubled debt restructuringshould be recorded as an expense when incurred.
CPA / CMA REVIEW QUESTIONS
CPA Exam Questions
1. c. At issuance, a bond is valued at the present value of the principal and interest payments, discounted at the prevailing market rate of interest at the date of issuance of the bond.
2. d. The interest expense is for the time the bonds were outstanding during the reporting period – 7 months in this case.
3. d. Six months interest revenue at stated rate.
Since no yield rate was given, the $1,800 amortization must be accepted. Note that the amortization is added to the stated revenue amount since the bonds were acquired at a discount.
4. b. Present value of payments:.
a. A bond issued at a discount reflects that the market rate is greater than the contract rate.
CPA Exam Questions (continued)
6. a. The interest payable at September 30, 2011, will be for the three month's interest that has accrued since the last interest was paid on June 30, 2011 ($300,000 × 12% × 3/12 = $9,000).
7. a. Must determine carrying value at time of extinguishment:
Bond premium at issue $ 40,000
Amortization of premium 1/1/2006 through 7/1/2011:
$40,000/20 = $2,000 per period
$2,000 x 11 periods 22,000
Unamortized premium 7/1/2011 $ 18,000
Face Value 1,000,000
Carrying value 7/1/2011 $1,018,000
Call (redemption) price 1,010,000
$1,000,000 x 1.01
Gain on extinguishment $ 8,000
a. Using the book value method, no gain or loss is recognized. The journal entry for the conversion would be:
Bonds payable 1,000,000
Discount on bonds payable 30,000
Common stock (par) 800,000
Paid-in capital – excess of par 170,000
9. b. Carrying value of bonds at 6/30/2011 is $4,980,000 ($5,000,000 + $30,000 – $50,000).
CPA Exam Questions (concluded)
10. b. The discount on the bonds is $800:
Amount allocated to bonds:
.83 x $240,000= $199,200
Face amount 200,000
Discount on bonds $ 800
CMA Exam Questions
1, a. Because the bonds sold for more than their face value, they were sold at a premium. The premium adjusted the yield of the bonds to the effective rate (presumably, the market rate).
2. d. The annual interest cash outlay is $70,000 (7% nominal rate x $1,000,000), or $35,000 each semiannual period. Interest expense is less than $35,000, however, because the bonds were originally issued at a premium. That premium should be amortized over the life of the bond. Thus, interest expense for the first 6 months is $31,884 [$1,062,809 x 6% x (6 months / 12 months)], and premium amortization is $3,116 ($35,000 – $31,884).
b. A bond liability is shown at its face value (maturity value), minus any related discount, or plus any related premium. Thus, a bond issued at a premium is shown at its maturity value plus the unamortized portion of the premium.
PROBLEMS
Problem 14-1
Requirement 1
Interest $2,500,000¥ x 15.04630 * = $37,615,750 Principal $50,000,000 x 0.09722 ** = 4,861,000 Present value (price) of the bond s $42,476,750
¥ 5% x $50,000,000
* present value of an ordinary annuity of $1: n=40, i=6% (Table 4)
** present value of $1: n=40, i=6% (Table 2)
Cash(price determined above) 42,476,750 Discount on bonds (difference) 7,523,250 Bonds payable (face amount) 50,000,000
Requirement 2
Interest $ 2,500,000 x 18.40158 * = $46,003,950 Principal $50,000,000 x 0.17193 ** = 8,596,500 Present value (price) of the bonds $54,600,450
* present value of an ordinary annuity of $1: n=40, i=4.5% (Table 4)
** present value of $1: n=40, i=4.5% (Table 2)
Cash(price determined above) 54,600,450 Premium on bonds (difference) 4,600,450 Bonds payable (face amount) 50,000,000
Requirement 3
Investment in bonds (face amount) 50,000,000 Premium on bond investment 4,600,450 Cash(price calculated above) 54,600,450
Problem 14-2