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Chapter 14: Long-term liabilities

consists of probable future sacrifices of economic benefits arising from present


obligations that are NOT payable within a year or the operating cycle of the company,
whichever is longer.

Learning Objectives:

Bonds Payable
Issuing bonds
Types and ratings
Valuation
Effective-interest
method
Costs of issuing
Extinguishment

Long-Term Notes
Payable
Notes issued at face
value
Notes not issued at
face value
Special situations
Mortgage notes
payable

Reporting and
Analyzing
Long-Term Debt
Presentation and
analysis

Learning Objective :
Bonds Payable

Issuing bonds
Types and ratings
Valuation
Effective-interest method
Costs of issuing
Extinguishment

Bonds Payable= Bond


indenture
Represents a promise to pay:
(1) sum of money at designated maturity date

+
(2) periodic interest at a specified rate on the maturity
amount (face value). Interest payments usually made
semiannually.

Paper certificate, typically a $1,000 or a $5,000 face


value. Price of bonds stated at 100s.

The Process of Bond Issuance

Underwriters are usually investment banks

The issuing company may sell the bonds directly to a


large institution without the aid of an underwriter ( private placement).

Types of Bonds: On the basis


of

Bond Ratings
Investments, Ltd)
Moody's S & P

(Source: BestVest
Meaning

Aaa

Best quality, with the smallest amount of risk.


AAA
Issuers are extremely stable and dependable.

Aa

High quality, with a slightly higher degree of


AA
long-term risk.

Baa

BBB

High to medium quality, with many strong


attributes but with some risk exposure to
changing economic conditions.
Medium quality, currently adequate but with
significant risk possible over the long term.

Bond Ratings (contd.)


Ba

BB

Caa

Some speculative element, with moderate security but not


well safeguarded for the long haul.
Able to pay now but with a significant risk of default in the
future.

CCC Poor quality with a clear danger of default.

Ca

CC

High speculative nature, often in or near default.

Lowest rated, poor prospects of payment going forward but


may be current in payments.

--

In default.

Valuation of Bonds

Discount and

Premium

Selling price of a bond issue is set by the

supply and demand of buyers and sellers,

relative risk,

market conditions, and

state of the economy.

The investment community values a bond at the present


value of its expected future cash flows, which consist of
(1) interest and (2) principal.

Valuation of Bonds

Discount and

Premium
Interest Rates
Stated, coupon, or nominal rate =
The interest rate written in the terms of the bond indenture.
Market rate, discount rate, effective rate or yield rate =
rate that provides an acceptable return on an investment
commensurate with the issuers risk characteristics.
Rate of interest actually earned by the bondholders.

Valuation of Bonds

Discount and

Premium

Between the time the company sets the terms


and the time it issues the bonds, the market
conditions and the financial position of the
issuing corporation may change significantly.

Such changes affect the marketability of the


bonds and thus their selling price.

Valuation of Bonds

Discount and

Premium
Assume Stated Rate of 8%
Market Interest

Bonds Sold At

6%

Premium

8%

Face Value

10%

Discount

Valuation of Bonds

Discount and

Premium
Classification of Discount and Premium
Discount on bonds payable is a liability valuation account,
that reduces the face amount of the related liability (contraaccount).
Balance Sheet (in thousands)

Assets

Premium on bonds payable


is a liability valuation account,
that adds to the face amount of
the related liability (adjunct

account).

Cash
Inventories
Plant assets, net
Total assets

40,000
95,000
280,000
$ 415,000

Liabilities and Equity


Accounts payable
$
Bonds payable
Disount on bonds payable
Common stock, $1 par
Retained earnings
Total liabilities and equity $

80,000
140,000
(15,000)
150,000
60,000
415,000

Valuation of Bonds

Discount and

Premium
How do you calculate the amount of interest that is actually
paid to the bondholder each period?

(Stated rate x Face Value of the bond)


How do you calculate the amount of interest that is actually
recorded as interest expense by the issuer of the bonds?

(Market rate x Carrying Value of the bond)

Valuation of Bonds

Discount and

Premium
Calculating the Selling Price of a Bond
1- Use Market Rate of interest ( Discount rate)
2- Computation of selling price:
- PV of maturity value, plus
- PV of interest payments
3- Semi-annual interest paying bonds:
- Require doubling the periods
- Halving the interest rate

Accounting for Bonds Payable


Discount and Premium

This discount or premium would be amortized over the


life of the bond.

Amortization methods:
1. Straight-Line: the Discount or premium would be
amortized equally over the life of the bond.
2. Effective Interest Method

Interest Expense = Carrying value of Bond at the


beginning of the period effective rate
15

Accounting for Bonds Payable

APB Opinion 21 requires the use of the effective


interest method for the amortization of premium or
discount when two amortization methods generate
significant different result.

However, the effective interest rate is usually changing


from period to period during the life of a bond.

As a result, the book value of bonds, very often, does


not equal the present value of bonds.

16

Valuation of Bonds
Effective-Interest Method
Produces a periodic interest expense
equal to a constant percentage of
the carrying value of the bonds.
Illustration 14-3

Bonds Issued at Par


Illustration: Three year bonds are issued at face value of $100,000
on Jan. 1, 2014, with a stated interest rate of 8%. Interest paid
annually on Dec. 31. Calculate the issue price of the bonds,
market interest rate of 8%.
Market Rate 8% (PV for 3 periods at 8%)

Solution on notes
page

Bonds Issued at Par


Illustration: Three year bonds are issued at face value of
$100,000 on Jan. 1, 2011, a stated interest rate of 8%, and
market rate of 8%.
Journal entries?

Bonds Issued at a Discount


Illustration: Three year bonds are issued at face value of
$100,000 on Jan. 1, 2011, and a stated interest rate of 8%.
Calculate the issue price of the bonds assuming a market interest
rate of 10%.
Market Rate 10% (PV for 3 periods at 10%)
Principal
Interest

Solution on notes
page

$100,000 x 0.75132 = $ 75,132


8,000 x 2.48685 =
19,895
Present value
95,027
Face value
100,000

Discount

(4,973)

Amortize Discount via

Effective Interest method


Illustration: Three year bonds are issued at face value of
$100,000 on Jan. 1, 2011, a stated interest rate of 8%, and
market rate of 10%.

*
* rounding

Amortize Discount via

Effective Interest method


Illustration: Stated rate = 8%. Market rate = 10%.
Journal entries for 2011:
1/1/11

Cash
Discount on bonds payable

95,027
4,973

Bonds payable
12/31/11

Interest expense

100,000
9,503

Discount on bonds payable

1,503

Cash

8,000

Amortize Discount via

Straight-line method
Illustration: Stated rate = 8%. Market rate = 10%.
Total discount:
100,000-95,027= 4,973
4,973 / 3= 1,658 per period
12/31/11

Interest expense

9,658

Discount on bonds payable

1,658

Cash

8,000

Bonds Issued at a Premium


Illustration: Three year bonds are issued at face value of
$100,000 on Jan. 1, 2011, and a stated interest rate of 8%.
Calculate the issue price of the bonds assuming a market interest
rate of 6%.
Market Rate 6% (PV for 3 periods at 6%)
Principal
Interest

$100,000 x 0.83962 = $ 83,962


8,000 x 2.67301 =
21,384
Present value
105,346
Face value
100,000

Premium
Solution on notes
page

5,346

Amortize Premium via

Effective Interest method

Illustration: Three year bonds are issued at face value of


$100,000 on Jan. 1, 2011, a stated interest rate of 8%, and
market rate of 6%.

Unamortized bond issue costs are treated as a deferred charge and amortized
over the life of the debt.

Amortize Premium via

Effective Interest method


Illustration: Stated rate = 8%. Market rate = 6%.
Journal entries for 2011:
1/1/11

Cash

105,346

Premium on bonds payable

5,346

Bonds payable
12/31/11

100,000

Interest expense

6,321

Premium on bonds payable

1,679

Cash

8,000

Amortize Premium via

Straight Line method


Total Premium: 105,346 100,000=5,346
5,346/3=1,782
Journal entries for 2011:
12/31/11

Interest expense

6,218

Premium on bonds payable

1,782

Cash

8,000

Bonds Issued between Interest Dates


Consider: Prorate Interest and Discount or Premium.

1/1: Interest payment date ($600)


The first payment starts on 7/1 of the issuing year

3/1: Date of Issue.


Buyers will pay the seller the
interest accrued from the last
interest payment date to the
date of issue.
( Pay $200)

7/1: Interest payment date ($600)

On the next semiannual


interest payment date,
purchasers will receive
the full six months
interest payment

Bonds Issued at Par between Interest Dates


( Use the Straight-line method to count for Interest)
Illustration: On March 1, 2010, KC Corporation issues 10-year
bonds, dated January 1, 2010, with a par value of $800,000. These
bonds have an annual interest rate of 6 percent, payable
semiannually on January 1 and July 1. Prepare the journal entry to
record the bond issuance at par plus accrued interest.
($800,000 x .06 x 2/12)

Cash
Bonds Payable
Bond Interest Expense

= $8,000

808,000
800,000
8,000

Bonds Issued at Par between Interest Dates


(Straight-line method)
Illustration: On July 1, 2010, four months after the
date of purchase, KC pays the purchaser six months interest.
KC makes the following entry on July 1, 2010.

Bond Interest Expense

24,000

Cash
($800,000 x .06 x 6/12)

24,000
= $24,000

Bond Interest Expense


Debit / Dr.

Credit / Cr.

$24,000

$8,000

$16,000

Debt issued between Interest Payment Dates at

a Discount
Present value of the bond at 1/1/2015 based on yield of 10%
for a term of 2 years. The stated interest rate is 8%.
The interest is paid semiannually. The Face value of the bond
is $200,000. The bond was issued on March 1, 2015.
How much should be the issue price?
P.V. of the principal
P.V. of Interest
P.V. on 1/1/2015

200,000(given) x .8227 = 164,540


8,000(given) x 3.5460 = 28,368

$192,908

Debt issued between Interest


Payment Dates at a Discount

From the 1/1~3/1/2015:

192,908 x 0.05 = 9,645


Prorated amortization:
9,645 - 8,000 =1,645
1,645*2/6= 548 in which $548 was for the period

of 1/1 - 3/1/2015

Debt issued between Interest


Payment Dates at A Discount

The P.V. of the bonds on 3/1/2015 =>


(PV0 + Discount Amortized for 2 months) =>
192,908x 0.05 (9,645) 8,000 = $1,645.
PV on 3/1/2015= $192,908 + 1,645 x 2/6
= 192,908 + 548
= 193,456

Accrued interest from 1/1~ 3/1/2015:

= 200,000 x 4% x 2/6=2,667

Debt issued between Interest


Payment Dates at A Discount

Therefore, the issue price on 3/1/2015 =>


193,456 + 2,667 = $196,123 (including the 2-month
accrued interest)
Cash

196,123

Dis. On B/P
B/P

6,544**

200,000

Interest Expense

2,667

** (200,000 - 193,456) or {(200,000 - 192,908) 548}

Debt issued between Interest


Payment Dates at A Discount
or A Premium

Debt issued between Interest


Payment Dates at A Discount or A
Premium
7/1/2015
Interest Expense
9,097
Discount on B/P*
Cash

1,097
8,000

* 1,645-548=1,097
12/31/2015 Interest Expense

Cash
Discount on B/P

9,728
8,000
1,728

Extinguishment of Debt
Extinguishment before Maturity Date
Reacquisition price > Net carrying amount = Loss
Net carrying amount > Reacquisition price = Gain
At time of reacquisition, unamortized premium or discount,
and any costs of issue applicable to the bonds, must be
amortized up to the reacquisition date.

Extinguishment of Debt
Illustration: Three year 8% bonds of $100,000 issued on Jan. 1, 2011,
are recalled at 105 on Dec. 31, 2012. Expenses of recall are $2,000.
Market interest on issue date was 10%.

Account Balances at Dec. 31, 2012:


Bonds payable =
Discount on bonds payable ($4,9731,503-1,653) =

$98,183
1,817

Extinguishment of Debt
Illustration: Three year 8% bonds of $100,000 issued on Jan. 1,
2011, are recalled at 105 on Dec. 31, 2012. Expenses of recall
are $2,000. Market interest on issue date was 8%.
Journal entry at Dec. 31, 2012:
Bonds payable
Loss on extinguishment

100,000
8,817

Cash
Discount on bonds payable
Reacquisition price = $105,000 + 2,000 = $107,000

107,000
1,817

Valuation of Bonds
Cost of Issuing Bonds
Unamortized bond issue costs are treated as a deferred
charge and amortized over the life of the debt.
Illustration: Microchip Corporation sold $20,000,000 of 10-year
debenture bonds for $20,795,000 on January 1, 2014 (also the
date of the bonds). Costs of issuing the bonds were $245,000.
Microchip records the issuance of the bonds and amortization of
the bond issue costs as follows.

Cost of Issuing Bonds


Illustration: Microchip Corporation sold $20,000,000 of 10-year
debenture bonds for $20,795,000 on January 1, 2014 (also the
date of the bonds). Costs of issuing the bonds were $245,000.
Jan. 1,
2014

Cash

20,550,000

Unamortized Bond Issue Costs

245,000

Premium on Bonds Payable

795,000

Bonds Payable
Dec. 1,
2014

Bond Issue Expense


Unamortized Bond Issue Costs

20,000,000
24,500
24,500

Extinguishment of Debt
Illustration: On January 1, 2007, General Bell Corp. issued at 97
bonds with a par value of $800,000, due in 20 years. It incurred
bond issue costs totaling $16,000. Eight years after the issue date,
General Bell calls the entire issue at 101 and cancels it. General
Bell computes the loss on redemption (extinguishment).
Illustration 14-10

Extinguishment of Debt
General Bell records the reacquisition and cancellation of the
bonds as follows:
Bonds Payable
Loss on Redemption of Bonds
Discount on Bonds Payable
Unamortized Bond Issue Costs
Cash

800,000
32,000
14,400
9,600
808,000

Learning Objective :
Long-Term Notes Payable
Notes issued at face value
Notes not issued at face value
Special situations
Mortgage notes payable

Long-Term Notes Payable


Notes issued at face value
Notes NOT issued at face value

1.
2.

Zero-interest-bearing notes:
It measures the notes present value by the cash
received. The implicit interest rate is the rate that
equals the cash received with the amounts to be
paid in the future.
Interest bearing notes

Zero-Interest-Bearing Notes
BE14-13: Samson Corporation issued a 4-year, $75,000, zero-interestbearing note to Brown Company on January 1, 2011, and received
cash of $47,663. The implicit interest rate is 12%. Prepare Samsons
journal entries for (a) the Jan. 1 issuance and (b) the Dec. 31
recognition of interest.

Zero-Interest-Bearing Notes
BE14-13: Samson Corporation issued a 4-year, $75,000, zero-interestbearing note to Brown Company on January 1, 2011, and received
cash of $47,663. The implicit interest rate is 12%. Prepare Samsons
journal entries for (a) the Jan. 1 issuance and (b) the Dec. 31
recognition of interest.
(a)

(b)

Cash
Discount on notes payable
Notes payable
Interest expense
Discount on notes payable
($47,663 x 12%)

47,663
27,337
75,000
5,720
5,720

Interest-Bearing Notes
BE14-14: McCormick Corporation issued a 4-year, $40,000, 5% note to
Greenbush Company on Jan. 1, 2011, and received a computer that
normally sells for $31,495. The note requires annual interest payments
each Dec. 31. The market rate of interest is 12%. Prepare McCormicks
journal entries for (a) the Jan. 1 issuance and (b) the Dec. 31 interest.

Interest-Bearing Notes

(a) Computer
Discount on notes payable
Notes payable
(b) Interest expense
Cash
Discount on notes payable

31,495
8,505
40,000
3,779
2,000
1,779

Special Notes Payable


Situations
Notes Issued for Property, Goods, and Services
When exchanging the debt instrument for property, goods, or
services in a bargained transaction, the stated interest rate is
presumed to be fair unless:
(1) No interest rate is stated, or
(2) The stated interest rate is unreasonable, or
(3) The face amount is materially different from the current cash

price for the same or similar items or from the market value
of the debt instrument.

Special Notes Payable


Choice of Interest Rates
Situations
If a company cannot determine the fair value of the property,
goods, services, or other rights, and if the note has no ready
market, the company must impute an interest rate.
The process of interest rate approximation is called Imputation .

The choice of imputed interest rate is affected by:


prevailing rates for similar instruments
factors such as restrictive covenants, collateral, payment
schedule, and the existing prime interest rate.

Special Notes Payable Situations


Illustration: On December 31, 2014, Wunderlich Company issued a
promissory note to Brown Interiors Company for architectural
services. The note has a face value of $550,000, a due date of
December 31, 2019, and bears a stated interest rate of 2 percent,
payable at the end of each year. Wunderlich cannot readily determine
the fair value of the architectural services, nor is the note readily
marketable. On the basis of Wunderlichs credit rating, the absence of
collateral, the prime interest rate at that date, and the prevailing
interest on Wunderlichs other outstanding debt, the company imputes
an 8 percent interest rate as appropriate in this circumstance.

Special Notes Payable Situations


Illustration 14-15

Illustration 14-16

Special Notes Payable Situations


Wunderlich records issuance of the note on Dec. 31, 2014, in
payment for the architectural services as follows.
Building (or Construction in Process)

418,239

Discount on notes payable

131,761

Notes Payable

550,000

Special Notes Payable Situations


Illustration 14-17

Payment of first years interest and amortization of the discount.


Interest Expense

33,459

Discount on Notes Payable

22,459

Cash

11,000
LO 6

Presentation and Analysis of


Long-Term Debt
Presentation of Long-Term Debt
Note disclosures generally indicate the nature of the liabilities,
maturity dates, interest rates, call provisions, conversion
privileges, restrictions imposed by the creditors, and assets
designated or pledged as security.
Must disclose future payments for sinking fund requirements
and maturity amounts of long-term debt during each of the
next five years.

Presentation and Analysis of


Long-Term Debt
Analysis of Long-Term Debt
Two ratios that provide information about debt-paying
ability and long-run solvency are:
1.

Debt to total
assets

Total debt
=

Total assets

The higher the percentage of debt to total assets, the greater


the risk that the company may be unable to meet its
maturing obligations.

Presentation and Analysis of


Long-Term Debt
Analysis of Long-Term Debt

Two ratios that provide information about debt-paying


ability and long-run solvency are:
2. Times interest
earned

Income before income taxes and interest


expense
=

Interest expense

Indicates the companys ability to meet interest payments as


they come due.

The Fair Value Option for Bonds


SFAS No. 159

The book value is computed by historical


effective interest rate at date of issue.
The present value (fair value) of bonds is
computed by the current effective interest rate.
SFAS 159 allows companies to have the option
to report the fair value of the bond on the
balance sheet.

59

The Fair Value Option SFAS


No. 159

The difference between the fair value of bonds


and the book value is calculated at the end of
each period .

This difference is reported

as unrealized losses (i.e., fair value > book value)


or unrealized gains (i.e., fair value < book value) in the
income statement.

60

SFAS 159 (contd.)

Fair value option is an irrevocable decision:


This reporting method can only be adopted at the
issuance (origination) of a bond (loan).

Companies can choose the fair value option for


one, a few or all of their financial liabilities.

Pension and lease liabilities are excluded from the


fair value option.

61

The Fair Value Option


Fair Value Measurement
Non-current liabilities are recorded at fair value, with unrealized
holding gains or losses reported as part of net income.
Illustrations: Edmonds Company has issued $500,000 of 6 percent
bonds at face value on May 1, 2012. Edmonds chooses the fair
value option for these bonds. At December 31, 2012, the value of
the bonds is now $480,000 because interest rates in the market
have increased to 8 percent.
Bonds Payable
Unrealized Holding Gain or LossIncome
14-62

20,000
20,000

A troubled debt restructurings occurs when a creditor for economic or


legal reasons related to the debtors financial difficulties grants a
concession to the debtor that it would not otherwise consider .
Usual Progression in Troubled-Debt Situations

A troubled-debt restructuring involves one of two basic types of transactions:


1. Settlement of debt at less than its carrying amount.
2. Continuation of debt with a modification of terms.

1. Settlement of Debt
Can involve either a
transfer of noncash assets (real estate, receivables, or other
assets) or
the issuance of the debtors stock.
Creditor should account for the noncash assets or equity interest
received at their fair value.

1. Settlement of Debt (Transfer of Assets):


Illustration : American City Bank loaned $20,000,000 to Union
Mortgage Company. Union Mortgage cannot meet its loan obligations.
American City Bank agrees to accept from Union Mortgage real estate
with a fair value of $16,000,000 in full settlement of the $20,000,000
loan obligation. The real estate has a carrying value of $21,000,000 on
the books of Union Mortgage.
American City Bank (creditor) records this transaction as follows.
Land
Allowance for Doubtful Accounts
Note Receivable from Union Mortgage

14-65

16,000,000
4,000,000
20,000,000

1. Settlement of Debt (Transfer of Assets):


Illustration : The bank records the real estate at fair value. Further, it
makes a charge to the Allowance
for Doubtful Accounts to reflect the bad debt write-off.
Union Mortgage (debtor) records this transaction as follows.
Note Payable to American City Bank
Loss on Disposal of Land
Land
Gain on Restructuring of Debt

14-66

20,000,000
5,000,000
21,000,000
4,000,000

1. Settlement of Debt (Granting an Equity Interest):


Illustration: American City Bank agrees to accept from Union Mortgage
320,000 shares of common stock ($10 par) that has a fair value of
$16,000,000, in full settlement of the $20,000,000 loan obligation.
American City Bank (creditor) records this transaction as follows.

Investment
Allowance for Doubtful Accounts
Note Receivable from Union Mortgage

14-67

16,000,000
4,000,000
20,000,000

1. Settlement of Debt (Granting an Equity Interest):


Illustration: It records the stock as an investment at the fair value at
the date of restructure.
Union Mortgage (debtor) records this transaction as follows.
Note Payable to American City Bank
Common Stock
Additional Paid-in Capital
Gain on Restructuring of Debt

14-68

20,000,000
3,200,000
12,800,000
4,000,000

2. Modification of Terms
A debtors serious short-run cash flow problems will lead it to
request one or a combination of the following modifications:
1.

Reduction of the stated interest rate.

2.

Extension of the maturity date of the face amount of the debt.

3.

Reduction of the face amount of the debt.

4.

Reduction or deferral of any accrued interest.

(Example 1No Gain for Debtor):


On December 31, 2013, Morgan National Bank enters into a debt restructuring
agreement with Resorts Development Company, which is experiencing
financial difficulties. The bank restructures a $10,500,000 loan receivable
issued at par (interest paid to date) by:
1.

Reducing the principal obligation from $10,500,000 to $9,000,000;

2.

Extending the maturity date from December 31, 2013, to December 31,
2017 ( 4 more years) ; and

3.

Reducing the interest rate from 12% to 8% (Stated interest rate).

No Gain for debtor:


Pre-restructuring carrying value ( $10,500,000) < after restructuring of $11,880,000*

*11,880,000= $9,000,000 ( new principal) +$2,880,000 (interest: 9,000,000*8%*4)

(Example 1No Gain for Debtor):


Schedule Showing Reduction of Carrying Amount of Note
Debtors Calculations:
New effective interest rate

11,880,000-10,500,000=1,380,000

Dec. 31, Notes Payable


2014
Interest Expense
Cash

356,056
363,944
720,000

(Example 1No Gain for Debtor): Debtors Computation


Debtor must compute a new effective interest rate ( indicates by i in the formula)
to record interest expense in the future period.
The rate necessary to discount the total future cash flows ( $11,880,000) to
a present value equal to the remaining balance ($10,500,000)
$10,500,000 = 1/(1+i)4 * $9,000,000 +
{1-(1/(1+i) 4 )/i }*$720,000
Calculator: N=4 PV=10,500,000
PMT=-720,000
FV= -9,000,000
1/YR= 3.466 ( New effective interest)

Maturity
date:
Dec. 31,
2017

Notes Payable

9,000,000

Cash
9,000,000

(Example 1No Gain for Debtor): Creditors Computation


Morgan National Bank (creditor)

Market
Interest rate:
12%

Morgan National Bank records bad debt expense as follows


Bad Debt Expense
Allowance for Doubtful Accounts

2,593,428
2,593,428

(Example 1No Gain for Debtor): Creditors Computation


Creditor Calculations
In subsequent periods, Morgan National Bank reports interest
revenue based on the historical effective rate.
b. 7,906,572*12%=948,789
c. 948,789-720,000=228,789
d. 28 adjustment to
compensate for rounding

Illustration 14A-4

Dec. 31, 2010


Cash

720,000

Allowance for Doubtful Accounts

228,789

Interest Revenue

948,789

(Example 1No Gain for Debtor): Creditors


Computation
Creditor Calculations
The creditor makes a similar entry (except for different amounts
debited to Allowance for Doubtful Accounts and credited to Interest
Revenue) each year until maturity.
At maturity, the company makes the following entry.
Dec. 10, 2017
Cash

9,000,000

Allowance for Doubtful Accounts

1,500,000

Notes receivable

10,500,000

(Example 2Gain for Debtor):


Illustration: Assume the facts in the previous example except that Morgan
National Bank reduces the principal to $7,000,000 (and extends the maturity
date to December 31, 2017 and reduces the interest from 12% to 8%).
The total future cash flow is now $9,240,000 ($7,000,000 of principal plus
$2,240,000 of interest) < $10,500,000 ( difference is $1,260,000)
Under these circumstances, Resorts Development (debtor) reduces the carrying
amount of its payable $1,260,000 and records a gain of $1,260,000.
Debtor Accounting

Note Payable carrying value after restructuring: 10,500,000-1,260,000=9,240,000 ( Equal the


sum of the undiscounted cash flows) ---Imputed interest rate is 0 %.

(Example 2Gain for Debtor):


Morgan National Bank (creditor) debits its Bad Debt Expense for $4,350,444.

Creditor Accounting

(Example 2 Gain for Debtor):


Creditor Calculations
Morgan National reports interest revenue the same as the previous
example

(Example 2 Gain for Debtor):


Accounting for periodic interest payments and final principal payment.
Recognize no
interest expense

7,000,000*8%