Appendix

G-1
 Warfield
Wyegandt
Kieso

APPENDIX F
ACCOUNTING FOR TROUBLED
DEBT

INTERMEDIATE ACCOUNTING
Principles and Analysis
2nd Edition
Appendix
G-2
 Troubled
Troubled Debt
Debt

Two situations result with troubled debt:

1. Impairments.
2. Restructurings:
a. Settlements.
b. Modification of terms
Illustration G-1
Usual Progression

Appendix
G-3
 Troubled
Troubled Debt
Debt

Impairments
A loan is impaired when it is probable the creditor will
not collect all amounts due (both principal and interest).

Appendix
G-4 O 1 Describe the accounting for a loan impairment.
 Troubled
Troubled Debt
Debt

Impairments
If considering a loan impaired, the creditor should measure
the loss due to the impairment as the difference between
the investment in the loan (generally the principal plus
accrued interest) and the expected future cash flows
discounted at the loan’s historical effective interest rate.

Appendix
G-5 O 1 Describe the accounting for a loan impairment.
 Troubled
Troubled Debt
Debt -- Impairments
Impairments

Example of Loss on Impairment

On December 31, 2008, Prospect Inc. issued a $500,000,
five-year, zero-interest-bearing note to Community Bank.
Prospect issued the note to yield 10% annual interest. As a
result, Prospect received, and Community Bank paid,
$310,460 ($500,000 x .62092) on December 31, 2008.
Illustration G-2

Appendix
G-6 O 1 Describe the accounting for a loan impairment.
 Troubled
Troubled Debt
Debt -- Impairments
Impairments
Show how Community Bank (creditor) and Prospect (debtor)
record these transactions on December 31, 2008
Illustration G-3

Appendix
G-7 O 1 Describe the accounting for a loan impairment.
 Troubled
Troubled Debt
Debt -- Impairments
Impairments
Schedule of Interest and Discount Amortization (Before
Impairment) Illustration G-4

Illustration G-3

Appendix
G-8 O 1 Describe the accounting for a loan impairment.
 Troubled
Troubled Debt
Debt -- Impairments
Impairments
Assume Community Bank determines that Prospect will
probably pay back only $300,000 of the principal at
maturity. Community Bank declares the loan impaired.

Determine the loss due to impairment.

Illustration G-5

Appendix
G-9 O 1 Describe the accounting for a loan impairment.
 Troubled
Troubled Debt
Debt -- Impairments
Impairments
The loss due to impairment is the difference between the
present value of the expected future cash flows and the
recorded carrying amount of the investment in the loan.
Illustration G-6

Illustration G-7

Appendix
G-10 O 1 Describe the accounting for a loan impairment.
 Troubled
Troubled Debt
Debt

Restructurings
A troubled-debt restructuring occurs when a creditor “for
economic or legal reasons related to the debtor’s financial
difficulties grants a concession to the debtor that it would
not otherwise consider.”

Two basic types of transactions:

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

Appendix
G-11 O 2 Describe the accounting for debt restructuring.
 Troubled-Debt
Troubled-Debt Restructuring
Restructuring

Settlement of Debt
Involve either a:
Transfer of noncash assets (real estate,
receivables, or other assets) or
Issuance of the debtor’s stock.

Creditor should account for noncash assets or

equity interest received at their fair value.

Appendix
G-12 O 2 Describe the accounting for debt restructuring.
 Troubled-Debt
Troubled-Debt Restructuring
Restructuring

EG-1 (Settlement of Debt) Larisa Nieland Company

owes $200,000 plus $18,000 of accrued interest to
First State Bank. The debt is a 10-year, 10% note.
During 2008, Larisa Nieland’s business deteriorated
due to a faltering regional economy. On December 31,
2008, First State Bank agrees to accept an old
machine and cancel the entire debt. The machine has
a cost of $390,000, accumulated depreciation of
$221,000, and a fair market value of $190,000.

Appendix
G-13 O 2 Describe the accounting for debt restructuring.
 Troubled-Debt
Troubled-Debt Restructuring
Restructuring
EG-1 Prepare journal entries for Larisa Nieland
Company and First State Bank to record this debt
settlement.
Larisa Nieland Company (Debtor):
Notes Payable 200,000
Interest Payable 18,000
Accumulated Depreciation 221,000
Machine 390,000
Gain on Disposition of Machine 21,000 a
Gain on Debt Restructuring 28,000 b
a $190,000 – ($390,000 – $221,000) = $21,000.
b ($200,000 + $18,000) – $190,000 = $28,000.
Appendix
G-14 O 2 Describe the accounting for debt restructuring.
 Troubled-Debt
Troubled-Debt Restructuring
Restructuring
EG-1 Prepare journal entries for Larisa Nieland
Company and First State Bank to record this debt
settlement.
First State Bank (Creditor):
Machine 190,000
Allowance for Doubtful Accounts 28,000
Notes Receivable 200,000
Interest Receivable 18,000

Appendix
G-15 O 2 Describe the accounting for debt restructuring.
 Troubled-Debt
Troubled-Debt Restructuring
Restructuring
EG-1 Assume instead that Larisa Nieland decides to grant
15,000 shares of its common stock ($10 par) which has a
fair value of $190,000 in full settlement of the loan
obligation. If First State Bank treats Larisa Nieland’s
stock as a trading investment, prepare the entries to
record the transaction for both parties.

Larisa Nieland Company (Debtor):

Notes Payable 200,000
Interest Payable 18,000
Common Stock 150,000
Additional Paid-in Capital 40,000
Gain on Debt Restructuring 28,000
Appendix
G-16 O 2 Describe the accounting for debt restructuring.
 Troubled-Debt
Troubled-Debt Restructuring
Restructuring
EG-1 Assume instead that Larisa Nieland decides to grant
15,000 shares of its common stock ($10 par) which has a
fair value of $190,000 in full settlement of the loan
obligation. If First State Bank treats Larisa Nieland’s
stock as a trading investment, prepare the entries to
record the transaction for both parties.

First State Bank (Creditor):

Investment (Trading) 190,000
Allowance for Doubtful Accounts 28,000
Notes Receivable 200,000
Interest Receivable 18,000

Appendix
G-17 O 2 Describe the accounting for debt restructuring.
 Troubled-Debt
Troubled-Debt Restructuring
Restructuring

Modification of Terms
1. Reduction of the interest rate.
2. Extension of maturity date of the face amount of debt.
3. Reduction of the face amount of the debt.
4. Reduction or deferral of any accrued interest.

Two examples demonstrate troubled-debt restructuring by

debtors and creditors:
1. No gain for debtor.
2. Gain for debtor.

Appendix
G-18 O 2 Describe the accounting for debt restructuring.
 Debtor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring No Gain

EG-2 (Term Modification without Gain — Debtor’s Entries)

On December 31, 2008, 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. Reduce principal obligation from $2,000,000 to $1,600,000.
2. Extend the maturity date from December 31, 2008, to
December 31, 2011.
3. Reduce the interest rate from 12% to 10%.

Bradtke pays interest at the end of each year. On January 1,

2012, Bradtke Company pays $1,600,000 in cash to Firstar.
Appendix
G-19 O 2 Describe the accounting for debt restructuring.
 Debtor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring No Gain

EG-2 Can Bradtke Company record a gain under the term

modification mentioned above? Explain.

No. Total future cash flows after restructuring exceed

total pre-restructuring carrying amount of the note
(principal):

Total future cash flows after restructuring:

Principal $1,600,000
Interest ($1,600,000 X 10% X 3) 480,000
$2,080,000
Total pre-restructuring carrying amount
of note (principal): $2,000,000
Appendix
G-20 O 2 Describe the accounting for debt restructuring.
 Debtor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring No Gain

EG-2 Assuming the interest rate Bradtke should use to

compute interest expense is 1.4276%, prepare the interest
payment schedule of the note after the debt restructuring.

a. $1,600,000 x 10% = $160,000. b. $2,000,000 x 1.4276% = $28,552.

Appendix
c. $160,000–$28,552 = $131,448. d. Adjusts $1 due to rounding.
G-21
 Debtor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring No Gain

EG-2 Prepare the interest payment entry for Bradtke

Company on December 31, 2010.

Note Payable 133,325

Interest Expense 26,675
Cash 160,000

EG-2 What entry should Bradtke make on January 1, 2012?

Note Payable 1,600,000

Cash 1,600,000

Appendix
G-22 O 2 Describe the accounting for debt restructuring.
 Creditor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring No Gain

EG-3 (Term Modification without Gain — Creditor’s Entries)

On December 31, 2008, 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. Reduce principal obligation from $2,000,000 to $1,600,000.
2. Extend the maturity date from December 31, 2008, to
December 31, 2011.
3. Reduce the interest rate from 12% to 10%.
Bradtke pays interest at the end of each year. On January 1,
2012, Bradtke Company pays $1,600,000 in cash to Firstar.

Appendix
G-23 O 2 Describe the accounting for debt restructuring.
 Creditor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring No Gain

EG-3 Compute the loss that Firstar Bank will suffer from
the debt restructuring. Prepare the journal entry to record
the loss.

Bad Debt Expense 476,859

Allowance for Doubtful Accounts 476,859

a$1,600,000 X .71178 = $1,138,848. b$160,000 X 2.40183 = $384,293.

Appendix
G-24 O 2 Describe the accounting for debt restructuring.
 Creditor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring No Gain

EG-3 Prepare the interest receipt schedule for Firstar

Bank after the debt restructuring.

Appendix
G-25 O 2 Describe the accounting for debt restructuring.
 Creditor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring No Gain

EG-3 Prepare the interest receipt entry for Firstar Bank

on December 31, 2010.

Cash 160,000
Allowance for Doubtful Accounts 25,510
Interest Revenue 185,510

EG-3 What entry should Firstar make on Jan. 1, 2012?

Cash 1,600,000
Allowance for Doubtful Accounts 400,000
Note Receivable 2,000,000
Appendix
G-26 O 2 Describe the accounting for debt restructuring.
 Debtor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring Gain

EG-2 - Modified (Term Modification with Gain — Debtor’s

Entries) On December 31, 2008, 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. Reduce principal obligation from $2,000,000 to $1,300,000.
2. Extend the maturity date from December 31, 2008, to
December 31, 2011.
3. Reduce the interest rate from 12% to 10%.
Bradtke pays interest at the end of each year. On January 1,
2012, Bradtke Company pays $1,300,000 in cash to Firstar.

Appendix
G-27 O 2 Describe the accounting for debt restructuring.
 Debtor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring Gain

EG-2 – Modified Can Bradtke Company record a gain under the

term modification mentioned above? If yes, record the gain.

Total future cash flows after restructuring:

Principal $1,300,000
Interest ($1,300,000 X 10% X 3) 390,000
$1,690,000
Total pre-restructuring carrying amount
of note (principal): $2,000,000
Gain = $2,000,000 – $1,690,000 = $310,000

Journal December 31, 2008:

Note Payable 310,000
Gain on Debt Restructuring 310,000
Appendix
G-28 O 2 Describe the accounting for debt restructuring.
 Debtor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring Gain

EG-2 - Modified Prepare the interest payment schedule of

the note for Bradtke after the debt restructuring.

Appendix
G-29 O 2 Describe the accounting for debt restructuring.
 Debtor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring Gain

EG-2 - Modified Prepare the interest payment entry for

Bradtke Company on December 31, 2009, 2010, and 2011.

Note Payable 130,000

Cash 130,000

EG-2 What entry should Bradtke make on January 1, 2012?

Note Payable 1,300,000

Cash 1,300,000

Appendix
G-30 O 2 Describe the accounting for debt restructuring.
 Creditor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring Gain

EG-3 - Modified (Term Modification with Gain — Creditor’s

Entries) On December 31, 2008, 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. Reduce principal obligation from $2,000,000 to $1,300,000.
2. Extend the maturity date from December 31, 2008, to
December 31, 2011.
3. Reduce the interest rate from 12% to 10%.
Bradtke pays interest at the end of each year. On January 1,
2012, Bradtke Company pays $1,300,000 in cash to Firstar.

Appendix
G-31 O 2 Describe the accounting for debt restructuring.
 Creditor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring Gain

EG-3 - Modified Compute the loss that Firstar Bank will

suffer from the debt restructuring. Prepare the journal
entry to record the loss on Firstar’s books.

Bad Debt Expense 762,448

Allowance for Doubtful Accounts 762,448
a$1,300,000 X .71178 = $925,314 b$130,000 X 2.40183 = $312,238
Appendix
G-32 O 2 Describe the accounting for debt restructuring.
 Creditor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring Gain

EG-3 - Modified Prepare the interest receipt schedule

for Firstar Bank after the debt restructuring.

Appendix
G-33 O 2 Describe the accounting for debt restructuring.
 Creditor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring Gain

EG-3 - Modified Prepare the interest receipt entry for

Firstar Bank on December 31, 2009, 2010, and 2011.
2009 Cash 130,000
Allowance for Doubtful Accounts 18,506
Interest Revenue 148,506

2010 Cash 130,000

Allowance for Doubtful Accounts 20,727
Interest Revenue 150,727

2011 Cash 130,000

Allowance for Doubtful Accounts 23,215
Interest Revenue 153,215
Appendix
G-34 O 2 Describe the accounting for debt restructuring.
 Creditor
Troubled-Debt
Troubled-Debt Restructuring
Restructuring Gain

EG-3 - Modified What entry should Firstar make on Jan.

1, 2012?
Cash 1,300,000
Allowance for Doubtful Accounts 700,000
Notes Receivable 2,000,000

Appendix
G-35 O 2 Describe the accounting for debt restructuring.
 Copyright
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Appendix
G-36