On December 31, 2003, the Merchants Bank enters into a debt restructuring agreem

Question

On December 31, 2003, the Merchants Bank enters into a debt restructuring agreement with River Company, which is now experiencing financial trouble. The bank agrees to restructure a 10%, issued at par, $1,000,000 note receivable by the following modifications:

1. Reducing the principal obligation to $800,000

2. Extending the maturity date to 12/31/05

3. Reducing the interest rate to 6%

Prepare all entries from 12-31-03 to 12-31-05 for both parties (debtor and creditor), and explain the interest rate assumed by the debtor and creditor after the restructuring. Show all your work.

Explanation / Answer

In the books of bank

Pre-structuring carrying amount of note= 1,000,000$

present value of principal to be recieved at maturity= 8,00,000*DCF@6% for 2 years=800000*0.8899=711920$

present value of interest =8,00,000*6%*PVF@6% for 2 years= 48000*1.8334=88003$

Loss on Debt restructuring= 1,000,000-711920-88003=200077

Journal entry:

Bad debt expensesA/c Dr 200077

to Allowance for doubtful debtsA/c 200077

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