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PRACTICAL ACCOUNTING 1 – REVIEW

NOTES PAYABLE & DEBT RESTRUCTURING

PROF. U.C. VALLADOLID

Multiple Choice
Identify the letter of the choice that best completes the statement or answers the question.

1. Jeffrey Company is indebted to Apex under a P5,000,000, 12% three-year note date December 31,
2016. Because of Jeffrey’s financial difficulties developing in 2018, Jeffrey owed accrued interest of
P600,000 on the note at December 31, 2018. Under a debt restructuring on December 31, 2018,
Apex agreed to settle the note and accrued interest for a tract of land having a fair value of
P4,500,000. Jeffrey’s acquisition cost of the land is P3,600,000. Ignoring income tax, in its 2018
income statement, what amount of gain on extinguishment should Jeffrey report as component of
income from continuing operations?
a. 2,000,000 b. 1,400,000
c. 1,100,000 d. 900,000

Notes payable 5,000,000

Interest payable 600,000
Land 3,600,000
Gain 2,000,000
#

2. The following information pertains to the transfer of real estate pursuant to a debt restructuring by
Kaila Company to Mene Company in full liquidation of Kaila’s liability to Mene:

Carrying amount of liability liquidated 1,500,000

Carrying amount of real estate transferred 1,000,000
Fair value of real estate transferred 1,200,000

What amount of pretax gain should Kaila report as component of income from continuing
operations?
a. 300,000 b. 500,000
c. 200,000 d. 0

3. Kaila Company is experiencing financial difficulty and is negotiating debt restructuring with its
creditors to relieve ifs financial stress. Kaila has a P2,500,000 note payable to United Bank. The
bank is considering acceptance of an equity interest in Kaila Company in the form of 200,000
shares of common stock valued at P12 per share. The par value of the common is P10 per share.

How much additional paid in capital should be recognized from the debt restructuring?
a. 500,000 b. 100,000
c. 400,000 d. 0

Notes payable 2,500,000

Ordinary shares 2,000,000
Share premium 400,000
Gain 100,000
#

4. Due to extreme financial difficulties, Kaila Company has negotiated a restructuring of its 10%
P5,000,000 note payable due on December 31, 2017. The unpaid interest on the note on such date
is P500,000. The creditor has agreed to reduce the face value to P4,000,000, forgive the unpaid
interest, reduce the interest rate to 8% and extend the due date three years from December 31,
2017. The present value of 1 at 10% for three periods is 0.75 and the present value of an ordinary
annuity of 1 at 10% for three periods is 2.49.
Kaila Company should report gain on extinguishment of debt in its 2017 income statement at
a. 1,703,200 b. 1,203,200
c. 2,000,000 d. 540,000

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Notes payable (old) 5,000,000

Interest payable 500,000
Discount on notes payable 203,200
Notes payable (new) 4,000,000
Gain 1,703,200
#

5. Giselle Company has an overdue 8% note payable to First Bank at P8,000,000 and accrued
interest of P640,000. As a result of a restructuring agreement on January 1, 2017, First Bank
agreed to the following provisions:

 The principal obligation is reduced to P7,000,000.

 The accrued interest of P640,000 is forgiven
 The date of maturity is extended to December 31, 2020
 Annual interest of 10% is to be paid for 4 years every December 31.

The present value of 1 at 8% for 4 periods is 0.735 and the present value of an ordinary annuity of 1
at 8% for 4 periods is 3.31.

What is the gain on extinguishment to be recognized for the year 2017?

a. 1,000,000 b. 1,178,000
c. 1,640,000 d. 538,000

Notes payable (old) 8,000,000

Interest payable 640,000
Notes payable (new) 7,000,000
Gain 1,178,000
Premium on notes payable 462,000
#

6. Due to adverse economic circumstances and poor management, Giselle Highlands Company has
negotiated a restructuring of its 9% P6,000,000 note payable to Second Bank due on January 1,
2017. There is no accrued interest on the note.

The bank has reduced the principal obligation from P6,000,000 to P5,000,000 and extend the
maturity to 3 years or on December 31, 2017. However, the new interest rate is 13% payable
annually every December 31. The present value of 1 at 9% for three periods is .77 and the present
value of an ordinary annuity of 1 at 9% for three periods is 2.53.

What is the gain on extinguishment to be recognized for 2017?

a. 1,000,000 b. 350,000
c. 505,500 d. 0

7. During 2017, Joseph Company experienced financial difficulties and is likely to default on a
P5,000,000, 15% three-year note date January 1, 2013, payable to Summit Bank. On December
31, 2017, the bank agreed to settle the note and unpaid interest of P750,000 for P4,100,000 cash
payable on January 31, 2018.

What amount should Joseph report as gain from debt extinguishment in its 2017 income statement?
a. 1,650,000 b. 900,000
c. 750,000 d. 0

8. On December 31, 2015, Melvin Company acquired a piece of equipment from Mary Company by
issuing a P1,200,000 note, payable in full on December 31, 2019. Melvin’s credit rating permits it to
borrow funds from several lines of credit at 10%. The equipment is expected to have a 5-year life
and a P150,000 salvage value. The present value of 1 at 10% for 4 periods is 0.68301.

1. What is the equipment’s book value on December 31, 2017?

a. P551,767 c. P491,767
b. P630,000 d. P341,767

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2. What is the carrying value of the note at December 31, 2017?

a. P1,090,903 c. P1,200,000
b. P991,730 d. P819,612

9. Kris Company purchased machinery on December 31, 2017, paying P80,000 down and agreeing to
pay the balance in four equal installments of P60,000 payable each December 31. Implicit in the
purchase price is an assumed interest of 12%.
The following data are abstracted from the present value tables:

Present value of 1 at 12% for 4 periods 0.63552

Present value of an ordinary annuity of 1 at 12%
for 4 periods 3.03735

1. What is the cost of the machinery purchased on December 31, 2017?

a. P233,083 c. P262,241
b. P320,000 d. P290,842

2. How much interest expense should be reported on Kris’s income statement for the year
ended December 31, 2018?
a. P38,131 c. P17,293
b. P21,869 d. P42,707

3. What is the carrying value of the note at December 31, 2019?

a. P120,000 c. P99,310
b. P144,110 d. P101,403

10. On December 31, 2019, Nolte Co. is in financial difficulty and cannot pay a note due that day. It is a
600,000 note with 60,000 accrued interest payable to Piper, Inc. Piper agrees to accept from Nolte
a building that has a fair value of 590,000, an original cost of 530,000, and accumulated
depreciation of 130,000.

Nolte should recognize a gain on the settlement of the debt of

a. 0. b. 10,000.
c. 60,000. d. 260,000.

11. Colt, Inc. is indebted to Kent under an 800,000, 10%, four-year note dated December 31, year 1.
Annual interest of 80,000 was paid on December 31, year 2 and year 3. During year 4, Colt
experienced financial difficulties and is likely to default unless concessions are made. On December
31, year 4, Kent agreed to restructure the debt as follows:

 Interest of 80,000 for year 4, due December 31, year 4, was made payable December 31,
year 5.
 Interest for year 5 was waived.
 The principal amount was reduced to 700,000.

How much should Colt report as a gain in its income statement for the year ended December 31,
year 4?
a. 0 b. 100,000
c. 60,000 d. 120,000

12. On December 31, year 1, Marsh Company entered into a debt restructuring agreement with Saxe
Company, which was experiencing financial difficulties. Marsh restructured a 100,000 notes
receivable as follows:

 Reduced the principal obligation to 70,000.

 Forgave 12,000 of accrued interest.
 Extend the maturity date from December 31, year 1 to December 31, year 3.
 Reduced the interest rate from 12% to 8%.
 Interest is payable annually on December 31, year 2 and year 3.

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Present value factors:

Single sum, two years @ 8% .85734
Single sum, two years @ 12% .79719
Ordinary annuity, two years @ 8% 1.78326
Ordinary annuity, two years @ 12% 1.69006

In accordance with the agreement, Saxe made payments to Marsh on December 31, year 2 and
year 3. Marsh does not elect the fair value option for reporting the modification of debt.

How much interest income should Marsh report for the year ended December 31, year 3?
a. 0
b. 5,600
c. 8,100
d. 11,200

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