Acct 414
Prof. Teresa Gordon
Troubled Debt Restructuring
Example 1
1.
Viola Vacations signed a note to Empire Airways in the amount of
$50,000. The terms specified annual 10% interest payments on the
unpaid balance. The note is due today. Viola Vacations has not paid the
interest for the last year and is unable to pay anything on the principal
due.
2.
Empire has agreed to a concession which involves the transfer of noncash
items with a market value of less than the $55,000 amount of the pastdue debt ($50,000 principal, $5,000 accrued interest already debited to
interest expense and credited to interest payable).
3.
Viola Vacations will transfer a parcel of real estate to Empire. The fair
market value of the land (per the appraisal) is $30,000. Viola Vacations
had purchased the land several years ago for $10,000.
Creditor’s Books
Land
Notes receivable
Interest receivable
Allow for bad debts
Debit
30,000
Credit
25,000
Comparison to IFRS:
Is
50,000 revaluation possible?
5,000
Is this "fair value" accounting?
Loan Impairment wip 9Sep10.xlsx
Example 1
Page 1
Acct 414
Prof. Teresa Gordon
Troubled Debt Restructuring
Example 2
1.
Viola Vacations signed a note to Empire Airways in the amount of
$50,000. The terms specified annual 10% interest payments on the
unpaid balance. The note is due today. Viola Vacations has not paid the
interest for the last year and is unable to pay anything on the principal
due.
2.
Empire has agreed to a concession which involves the transfer of noncash
items with a market value of less than the $55,000 amount of the pastdue debt ($50,000 principal, $5,000 accrued interest already debited to
interest expense and credited to interest payable).
3.
Viola Vacations will issue to Empire Airways 4,000 shares (a 10%
ownership interest) of its common stock which has a par value of $10 and
has been estimated to be worth $12 per share. In return, Empire Airways
will accept the stock in full settlement of the debt principal and accrued
interest (i.e., $55,000).
Creditor’s Books
Debit
Investment Portfolio
48,000
Notes receivable
Interest receivable
Allow for bad debts
7,000
Loss on troubled debt
restructuring
4000
12
48000
55000
7000
Credit
What type of investment?
Trading
50,000 Available for sale
5,000 Equity method
Cost method
Is this "fair value" accounting?
Loan Impairment wip 9Sep10.xlsx
Example 2
Page 1
Acct 414
Prof. Teresa Gordon
Troubled Debt - Example 3 - CREDITOR
TROUBLED DEBT RESTRUCTURING DEMONSTRATION PROBLEM #3 - DEBTOR
1.
2.
Farview Farms had signed a $40,000 note to Idaho First Bank and Trust. The
note specified annual payments of $10,000 per year plus 12% interest on the
unpaid balance. Unseasonable weather two years in a row has ruined the
crops which Farview intended to sell to make its loan payments. The bank
has agreed to restructure the terms of the loan. [Assume that Farview has
already recorded as interest expense the $4,800 unpaid accrued interest.]
Carry9ng value of old debt
PV of fitire cash flows
loss
The new loan agreement specifies an immediate payment of $4,000 which
represents 10% interest on the balance which was outstanding during the
year. Farview will then pay interest only for three years at a 10% rate on a
reduced principal amount of $25,000. Four years from now, the balloon
payment of $27,500 (principal + interest) will come due.
Creditor’s Books
At date of restructure:
Cash
Accrued Interest Receivable
Note Receivable (old)
Note Receivable (restructured)
Allowance for doubtful accounts
Alt: Loss on TDR
End of year 1
Cash
Interest revenue
Notes receivable (restructured)
End of year 2
Cash
Interest revenue
Notes receivable (restructured)
Loan Impairment wip 9Sep10.xlsx
Debit
$
$
$
$
Find present value of cash flows
using historical interest rate
i=
12%
n=
4
pmt=
2500
FV=
25000
$
23,481
PV=
ADD
$
4,000 Immediate payment (pv of $1 now is $1)
PV=
$
27,481 before payment of interest
Creditor’s New Amortization Table:
Cash
Interest
Difference
Carrying
Flows
Revenue
Value
Credit
4,000
$
$
23,481
17,319
44,800
$
4,800
40,000
44,800
Period
0
0
1
2
$
2,500
$
318
$
2,500
$
356
$
2,818
$
2,856
Ex 3 - Creditor
$ 44,800.00
$
27,481
$ (17,319)
3
4
12%
4,000
2,500
2,500
2,500
2,500
25,000
2,818
2,856
2,899
2,946
318
356
399
446
27,481
23,481
23,799
24,155
24,554
25,000
0
Page 1
Acct 414
Prof. Teresa Gordon
Example 3 - creditor (continued)
Cost Recovery Method (FAS 118 Amendment to FAS 114)
Under FAS 114 troubled debt accounting required creditors to use the interest method to recognize interest income on
the restructured debt. Many financial institutions objected to this procedure because it caused them to recognize
revenue that would later have to be written off as a loss if the debtor was unable to meet the terms of the restructured
debt. Under the amendment, creditors are permitted to use other revenue recognition methods such as the cost
recovery method. This method assumes that all cash collected goes toward principle until the entire amount has been
recovered.
If the creditors in the demonstration problems used cost recovery method instead, they would recognize revenue as
shown below -- no interest income would ever be recorded.
Troubled Debt Demonstration Problem #3
Creditor’s Books
Debit
Credit
Period
At date of restructure:
Cash
Accrued Interest Receivable
Note Receivable (old)
Note Receivable (restructured)
Allowance for doubtful accounts
same as effecive interest method
End of year 1, 2 and 3
Cash
Notes receivable (restructured)
End of year 4
Cash
Notes receivable (restructured)
Income realized on impaired loans
$
0
1
23,481
17,319
2
3
4
$
$
Loan Impairment wip 9Sep10.xlsx
4,800
40,000
Totals
$
Revenue
Recognized
Principal
Received
4,000
$
$
$
$
Cash Rec'd
PV
2,500
$
2,500
$
$
$
15,981
11,519
74,800
4,000
2,500
2,500
2,500
27,500
39,000
0 2,500
0 2,500
0 2,500
11,519 15,981
11,519 23,481
Carrying
Value
27,481
23,481
20,981
18,481
15,981
0
27,481
11,519
27,500
74,800
Ex 3 - Creditor
Page 2
Acct 414
Prof. Teresa Gordon
Troubled Debt Example 4 - CREDITOR
1.
Farview Farms had signed a $40,000 note to Idaho First Bank and Trust. The
note specified annual payments of $10,000 per year plus 12% interest on the
unpaid balance. Unseasonable weather two years in a row has ruined the
crops upon which Farview intended to sell to makes it loan payments. The
bank has agreed to restructure the terms of the loan. [Assume that Farview
has already recorded as interest expense the $4,800 unpaid accrued interest.]
2.
The new loan agreement specifies no immediate payments. Farview will pay
interest only for three years at a 11% rate on a reduced principal amount of
$35,000. Four years from now, the balloon payment will come due, i.e.,
$38,850 principal plus interest.
Creditor’s Books
At date of restructure:
Cash
Accrued Interest Receivable
Note Receivable (old)
Note Receivable (restructured)
Allowance for doubtful accounts
Effective interest method:
End of year 1
Cash
Interest revenue
Notes receivable (restructured)
Debit
$
Credit
-
$
$
33,937
10,863
$
3,850
$
222
$
48,872
Cash
N/R restructured
Creditor’s New Amortization Table:
effective in
Cash Flows Interest
Difference Carrying
Revenue
Value
Period
$
$
4,800
40,000
$
4,072
0
0
1
2
3
4
4
total interest=
Period
$
48,872
What if we used cost recovery method?
Yr 1
Find present value of cash flows
using historical interest rate
i=
12% ALWAYS USE HISTORICAL RATE
n=
4
pmt=
3850
35000
11%
3850
FV=
35000
$ (33,937)
PV=
ADD
$
Immediate pymt (pv of $1 now = $1)
PV=
before payment of interest
3850
3850
0
0
1
2
3
4
4
12%
3,850
3,850
3,850
3,850
35,000
4,072
4,099
4,129
4,163
Ex 4 - Creditor
33,937
34,159
34,408
34,688
35,000
0
16,463
Creditor’s New Amortization Table:
cost recove
Cash Flows Interest
Difference Carrying
Revenue
Value
12%
3,850
3,850
3,850
3,850
35,000
0
0
0
0
16,463
Add total cash flows
PV of the cash flows
Revenue to recognize
Loan Impairment wip 9Sep10.xlsx
222
249
279
313
-3,850
-3,850
-3,850
-3,850
18,537
33,937
30,087
26,237
22,387
18,537
0
50400
33,937
16,463
Page 1
Acct 414
Prof. Teresa Gordon
Troubled Debt - Example 5 - CREDITOR
new
Troubled Debt (Question from F06 Exam 1). Bobs Brakes Inc. is a major
creditor of Adam’s Auto Repair Inc. Adam’s Auto Repair Inc. is experiencing
substantial financial difficulties. Its original note with Bobs Brakes Inc. was
dated August 1, 2005 and has a face value of $100,000 and specified a 10%
interest rate. The interest for the year ending August 1, 2006 has not been
paid. On August 1, 2006, the debtor persuaded Bobs Brakes to reduce the
principal from $100,000 to $70,000 and to reduce interest payments to
$3,500 per year for the remaining 3-year life of the debt. The modified
terms also waive payment of the accrued interest currently due. Both debtor
and creditor have fiscal years that coincide with the calendar year.
Find present value of cash flows
using historical interest rate
i=
10%
n=
3
pmt=
-3500
FV=
-70000
$
61,296
PV=
ADD
$
Immediate payment (pv of $1 now = $1)
PV=
$
61,296 before payment of interest
$ 110,000 carrying value
$ (48,704) loss
Assume accrued interest receivable has already been booked.
Creditor’s Books
8/1/2006 Note receivable (old)
Acc'd Interest Receivable
Restructured note receivable (NEW)
Allowance for bad loans (OR LOSS ON
RESTRUCTURING)
effective interest method
5 monthsto accrue
12/31/2006 Interest receivable (5/12 * 3500)
Interest revenue 5/12 * 6130
Note receivable (5/12 * 2630)
8/1/2007 Cash
Interest receivable
Interst revenues (7/12 * 6130)
Note receivable (plug)
Loan Impairment wip 9Sep10.xlsx
Debit
$
$
$
$
Credit
100,000
10,000
61,296
48,704
$
1,458
$
1,096
$
3,500
$
1,534
$
117,588
Period
$
2,554
$
$
1,458
3,576
$
117,588
0
0
1
2
3
4
4
10%
Creditor’s New Amortization Table:
Cash Flows
Interest
Difference
Carrying
Revenue
Value
3,500
3,500
3,500
70,000
6,130
6,393
6,682
2,630
2,893
3,182
61,296
63,926
66,818
70,000
spread between 06 & 07
TRUE
Ex 5 - Creditor
Page 1
Acct 414
Prof. Teresa Gordon
IFRS vs. US GAAP - Loan Impairment (creditor)
6-9. On December 31, 2006, Jones Company sold manufacturing equipment to Steel
Corporation. Steel Corporation gave Jones Company a 5 year $200,000, zero interest note. The
market rate of interest for a note with similar risks is 10%. At December 31, 2008 Jones
Company reviews its financial assets for impairment. Jones Company concludes that the value of
the note is impaired and it only expects to collect $150,000 of the principal at maturity. By
December 31, 2009 Jones Company has determined they will probably collect $160,000 on the
manufacturing equipment. Prepare the appropriate journal entries for December 31, 2008 and
December 31, 2009 according to a) IFRS b) US GAAP. Explain why the journal entries differ
under the two sets of standards.
Creditor’s Books
12/31/2006
12/31/2007
12/31/2008
12/31/2008
US GAAP
IFRS
Initiation of loan
Note receivable
Sales
COGS
Inventory
[SAME UNDER IFRS & US GAAP]
Recognition of interest revenue
Interest revenue
Notes receivable
Recognition of interest revenue
Interest revenue
Notes receivable
Recognition of impairment
Note receivable (new)
Allowance for doubtful accounts
Notes receivable (old)
Notes receivable (new)
Provision for bad and doubtful debts
Note receivable (old)
Loan Impairment wip 9Sep10.xlsx
Debit
$
Credit
124,184
xx
12,418
$
124,184
xx
Table 1
12/31/2006
12/31/2007
12/31/2008
12/31/2009
12/31/2010
12/31/2011
12/31/2012
At loan initiation, record sales at PV of cash flows
i=
10%
n=
5
pmt=
0 0% rate
FV=
$ (200,000)
PV= $ 124,184
US GAAP & IFRS
At origination of loan
12/31/2006
Creditor’s Original Amortization Table:
Period
Cash Flows
Interest
Difference
Carrying
Revenue
Value
0
10%
124,184
1
0
12,418
12,418
136,602
2
0
13,660
13,660
150,263
3
0
15,026
15,026
165,289
4
0
16,529
16,529
181,818
5
0
18,182
18,182
200,000
6
12,418
13,660
13,660
112,697
37,565
150,263
112,697
37,565
12/31/2008
Loan impairment recognized
i=
10%
n=
3
pmt=
0
FV=
$ (150,000)
12/31/2008 PV= $
112,697
$
150,263 carrying value
$
(37,565) impairment loss
IFRS and US GAAP
At date of impairment
12/31/2008
150,263
Ex 6 IFRS Example
Page 1
Acct 414
Prof. Teresa Gordon
12/31/2009 Change in expectations
US GAAP
No change - we don't recognize recoveries of
impairments previously recorded
12/31/2009 Note receivable
11,270
12/31/2010 Note receivable
12,397
Interest revenue
Interest revenue
11,270
12,397
12/31/2011 Assuming $160,000 is collected
Cash
Interest revenue
Note receivable
Bad debt expense (reduction)
or "recovery of impaired loan"
12/31/2009 Change in expectations
IFRS
Recovery of impairments ARE acceptable
Note receivable
Interest revenue
12/31/2009 Notes receivable (new)
Provision for bad and doubtful debts
Notes receivable (old)
160,000
13,636
13,636
150,000
10,000
648,089
648,091
11,270
132,231
Creditor’s NEW Amortization Table after impairment:
Interest
Difference Book Value
Period
Cash Flows
Table 2
Revenue
0
10%
12/31/2006
1
12/31/2007
2
112,697
12/31/2008
3
0
11,270
11,270
123,967
12/31/2009
4
0
12,397
12,397
136,363
12/31/2010
5
0
13,636
13,636
150,000
12/31/2011
FALSE
Under IFRS, partial recovery recognized
i=
10%
n=
2 PV=
$ 132,231
pmt=
0 carrying
123,967 Table 2
FV=
160000
8,265 loss recovey
PV= $ 132,231
11,270
8,265
123,967
To adjust N/R for improved expectations
Change in estimated value
At this point, the carrying value = new present
value of expected cash flows at original interest
rate.
12/31/2010 Note receivable
Interest revenue
13,223
Table 3
13,223 12/31/2006
12/31/2011 Assuming $160,000 is collected
Cash
Interest revenue
Note receivable
Loan Impairment wip 9Sep10.xlsx
160,000
14,545
14,545
160,000
12/31/2007
12/31/2008
12/31/2009
12/31/2010
12/31/2011
Ex 6 IFRS Example
IFRS ONLY
12/31/2009
IFRS ONLY - Creditor’s NEW Amortization Table:
Period
Cash Flows
Interest
Difference
Carrying
Revenue
Value
0
10%
1
2
3
132,231
4
0
13,223
13,223
145,455
5
0
14,545
14,545
160,000
Page 2