Solutions Guide: Please reword the answers to essay type parts so as to guarantee that your answer is an original. Do not submit as is

*E14-21 (Term Modification without Gain—Debtor’s Entries) On December 31, 2007, the Firstar Bank enters into a debt restructuring agreement with Nicole Bradtke Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $2,000,000 note receivable by the following modifications: 1. Reducing the principal obligation from $2,000,000 to $1,600,000. 2. Extending the maturity date from December 31, 2007, to December 31, 2010. 3. Reducing the interest rate from 12% to 10%. Bradtke pays interest at the end of each year. On January 1, 2011, Bradtke Company pays $1,600,000 in cash to Firstar Bank. Instructions (a) Based on FASB Statement No. 114, will the gain recorded by Bradtke be equal to the loss recorded by Firstar Bank under the debt restructuring? (b) Can Bradtke Company record a gain under the term modification mentioned above? Explain. (c) Assuming that the interest rate Bradtke should use to compute interest expense in future periods is 1.4276%, prepare the interest payment schedule of the note for Bradtke Company after the debt restructuring. (d) Prepare the interest payment entry for Bradtke Company on December 31, 2009. (e) What entry should Bradtke make on January 1, 2011?

(a) No. The gain recorded by Barkley is not equal to the loss recorded by American Bank under the debt restructuring agreement. (You will see why this happens in the following four exercises.) In response to this “accounting asymmetry” treatment, GAAP did not address debtor accounting because the FASB was concerned that expansion of the scope of its pronouncement would delay issuance of GAAP for the creditor.

(b) No. There is no gain under the modified terms because the total future cash flows after restructuring exceed the total pre-restructuring carrying amount of the note (principal):

Total future cash flows after restructuring are:
Principal / $2,400,000
Interest ($2,400,000 X 10% X 3) / 720,000
$3,120,000
Total pre-restructuring carrying amount of note
(principal): /
$3,000,000

(c) The interest payment schedule is prepared as follows:

BARKLEY COMPANY
Interest Payment Schedule After Debt Restructuring
Effective-Interest Rate 1.4276%
Date / Cash Paid (10%) / Interest Expense (1.4276%) / Reduction
of Carrying Amount / Carrying Amount of Note
12/31/10 / $3,000,000
12/31/11 / $240,000a / $ 42,828b / $197,172c / 2,802,828
12/31/12 / 240,000 / 40,013 / 199,987 / 2,602,841
12/31/13 / 240,000 / 37,159d / 202,841 / 2,400,000
Total / $720,000 / $120,000 / $600,000

a$2,400,000 X 10% = $240,000.

b$3,000,000 X 1.4276% = $42,828.

c$240,000 – $42,828 = $197,172.

dAdjusts $1 due to rounding.

(d) / Interest payment entry for Barkley Company is:
December 31, 2012
Note Payable / 199,987
Interest Expense / 40,013
Cash / 240,000
(e) / The payment entry at maturity is:
January 1, 2014
Note Payable / 2,400,000
Cash / 2,400,000