CHAPTER 21
UNDERSTANDING THE ISSUES
1. Given a restructuring that is not under
bankruptcy law, the gain on restructuring is
measured as the amount by which the book
value of the debt, including accrued inter-
est, exceeds the total of all restructured
principal and interest payments. If the total
the restructured consideration received.
The value of the consideration received is
the net present value of the restructured
payments.
2. A corporate reorganization is a legal remedy
designed to restructure the debt and/or eq-
uity of a troubled company so that the
company may continue to operate and
3. If a creditor is fully secured, by definition no
portion of their claim will become unse-
cured. However, if the value of the assets
securing their claim exceeds the amount of
the claim, such excess amounts will
become available to unsecured creditors.
of priority.
4. The statement of realization and liquidation
serves several purposes. First, it provides a
reporting of the activities of the trustee in
liquidation and helps discharge the fidu-
ciary responsibility. The statement also
documents that available assets are being
distributed properly among the various
Ch. 21—Exercises 21–2
EXERCISES
Note: Some calculations may vary due to rounding or method of calculation. Answers presented
have been determined using Excel.
EXERCISE 21-1
Alternative A—Income Statement Impact
First Month:
Gain on land:
Fair market value ………………………………………………………………. $ 380,000.00
the net present value of the restructured loan is $183,306 determined as follows:
Where: The number of payments is …………………………………… 40
The periodic payment is ……………………………………….. $5,067.60
The future value is ………………………………………………. $ —
Periodic interest rate is ………………………………………… 0.50%
21–3 Ch. 21—Exercises
Exercise 21-1, Continued
Second Month:
Interest expense:
Current carrying value ……………………………………………………….. $ 182,654.73
where n = 39, interest rate = 0.40%,
Using the original loan’s effective of interest rate of 0.5% (6% divided by 12 months),
the net present value of the restructured loan is $155,177 determined as follows:
Where: The number of payments is …………………………………… 60
The periodic payment is ……………………………………….. $3,000.00
The future value is ………………………………………………. $ —
Interest expense:
The implicit interest rate on the new debt is 0.39% per month determined as follows:
Where: The number of payments is …………………………………… 60
The periodic payment is ……………………………………….. $ 3,000.00
The future value is ………………………………………………. $ —
Exercise 21-1, Concluded
Second Month:
EXERCISE 21-2
Interest Bearing Debt ……………………………………………………………. 300,000
Preferred Stock (at par) …………………………………………………… 50,000
Paid-In Capital in Excess of Par ……………………………………….. 200,000
Gain on Restructuring ……………………………………………………… 50,000
To record extinguishment of debt.
EXERCISE 21-3
(1) The impact on the ratios is directly related to how each of the actions taken by manage-
ment impacts the financial statements. The recognition of impairment losses will decrease
long-lived assets and decrease net income and corresponding shareholders’ equity. Future
periods will base depreciation/amortization on the long-lived assets on the lower impaired
value, which will increase future income. The restructuring of the long-term debt will result
in a restructuring gain. However, since the future cash payments are less than the carrying
basis of the original debt, no interest expense will be recognized in future periods. The
adjustment of the par value of common stock in order to eliminate the deficit in retained
earnings will have no impact on net income nor will it change the total amount of share-
(2) Net income in future periods would be affected by lower depreciation/amortization expense
EXERCISE 21-4
Outstanding Debt
A B C D
Total amount due ………………………… $ 84,000 $ 520,000 $328,000 $350,000
Less amounts applied against debt:
Value of assets transferred ……… (80,000) (120,000) — (48,339)
Value of stock transferred ……….. (380,000) —
Remaining debt …………………………… $ 4,000 $ 20,000 $328,000 $301,661
Regarding Debt C: Because the total of the periodic payments is less than the remaining debt,
there would be a gain of restructuring in the amount of $28,000. Furthermore, because the pe-
riodic payments are less than the remaining debt, no interest expense would be recognized. All
periodic payments are considered to be a reduction of the revised principal amount due of
$300,000.
EXERCISE 21-5
July 1 Quarter 3 Quarter 4 Total
Debt A (see note 1):
Gain on transfer of land……..……
…
$175,000
$
175,000
Gain on restructuring………………
…
64,000 64,000
$
Gain on restructuring …………………………………………………………. $ 64,000
Because the sum of the restructured payments equal the restructured carry value of
the debt, there is no recognized interest expense.
Note 2 Original carrying value of debt …………………………………………….. $2,152,500.00
Less: Fair value of stock …………………………………………………….. (500,000.00)
Remaining carry value ……………………………………………………….. $1,652,500.00
Sum of restructured payments (7 × $193,553.02 plus $400,000) $1,754,871.14
Payment Interest Principal Balance
Beginning balance $1,652,500.00
Payment 1 $193,553.02 $21,482.50 $172,070.52 1,480,429.48
Payment 2 193,553.02 19,245.59 174,307.43 1,306,122.05
Payment 3 193,553.02 16,979.59 176,573.43 1,129,548.62
Payment 4 193,553.02 14,684.14 178,868.88 950,679.74
EXERCISE 21-6
(1) Quarterly
Item Cash Outflows
Loan A restructuring:
$3,580,000 restructured at 10%, 8 years, and monthly
installments. The monthly payment is $50,000 ………………………………. $150,000
Loan B restructuring:
(2) Effect on Net Income If
Part of a Not Part of a
Item Formal Filing Formal Filing
Loan A restructuring:
Gain on forgiveness of debt ………………………………………… … $500,000 $500,000
Gain on restructuring of remaining debt:
Total payments = $4,800,000 (96 × $50,000). Net present
value of payments at 10% is $3,295,074 vs. carrying basis of
$3,580,000 ……………………………………………………………… 284,926 —
The effective interest rate on the restructured note (0.64% per month) is less than the ef-
fective interest rate of the original note (1% per month). Therefore, the lender has made a
concession.
EXERCISE 21-7
Liabilities
Unsecured
Fully Partially With Without
Secured Secured Priority Priority Total
Accounts payable …………………….. $130,000 $150,000 $ 280,000
Note payable—A ……………………… $560,000 40,000 600,000
Realizable
Value
Assets to be applied against
the liabilities:
Inventory $ 150,000 $130,000 $ 20,000 $ 150,000
Inventory ……………………………… 200,000 $200,000 200,000
Receivables …………………………. 360,000 360,000 360,000
Equipment ……………………………. 300,000 300,000 300,000
Total consideration to be received by Note B:
Received toward partially secured portion ……………………….. $300,000
EXERCISE 21-8
Unsecured
Fully Partially With Without
Claims against the bankrupt estate: Secured Secured Priority Priority Total
Bank loan balance and accrued interest …………………… $ 85,000 $ — $ — $ — $ 85,000
Dealer-financed vehicle loan …………………………………… — 18,000 18,000
Accounts payable due vendors ……………………………….. — 21,000 21,000
Line of credit due…………………………………………………… 30,000 30,000
Payroll and taxes due …………………………………………….. — 23,000 23,000
Unsecured
Fully Partially With Without
Amounts received by each major class of creditor: Secured Secured Priority Priority Total
Amounts received:
Secured amount received …………………………………… $115,000 $29,000 $144,000
Unsecured amount received:
100% Dividend on $39,200 …………………………….. $39,200 39,200
EXERCISE 21-9
(1) The Rodak Corporation
Statement of Realization and Liquidation
For Period July 1, 2014, to August 12, 2014
Liabilities
Unsecured
Assets
Fully Partially With Without Owners’
Cash
Noncash Secured Secured Priority Priority Equity
Beginning balances, assigned
July 1, 2014 ……………………….. $ 12,000 $590,000 $200,000 $175,000 $54,000 $150,000 $ 23,000
Cash receipts:
Sale of inventory ………………… 30,000 (25,000) 5,000
Collection on receivables …….. 39,000 (54,000) (15,000)
(2) Estimated assets available:
Cash ……………………………………………………………………………………….. $ 66,500
Estimated value of noncash assets ……………………………………………… 410,000
Ch. 21—Problems 21–12
PROBLEMS
PROBLEM 21-1
Jan. 1, 2014 Cash …………………………………………………………………….. 4,915,562
Deferred Debt Issuance Costs ………………………………….. 84,438
June 30, 2014 Interest Expense …………………………………………………… 157,298
Deferred Debt Issuance Costs …………………………….. 7,298
Cash ………………………………………………………………… 150,000
To record semi-annual interest at the effective interest rate of 3.20% per six
months. Where, PV = $4,915,562, FV = $5,000,000, interest = $150,000, and
n = 10.
Effective interest rate per six months ……………………….. 3.20%
Interest Deferred Debt Interest NPV of
Payment Issuance Expense Debt
Jan. 1, 2014 84,438 4,915,562
June 30, 2014 (150,000) (7,298) 157,298 4,922,860
Dec. 31, 2014 Interest Expense ……………………………………………………. 157,532
Deferred Debt Issuance Costs …………………………….. 7,532
Cash ………………………………………………………………… 150,000
To record semi-annual interest at the effective rate of 3.2%.
June 30, 2015 Interest Expense …………………………………………………… 157,773
The effective interest rate on the original debt prior to restructuring was 3.11% semiannual
Where: Number of periods is……….… 7
Periodic payment is…………… $ 150,000
Future value is………………… $5,150,000 ($5,000,000 + $150,000 unpaid interest)
Net present value is…………… $5,088,164 ($4,938,164 + $150,000 unpaid interest)
The effective interest rate on the restructured debt is ………………………. 3.09% semiannual
Where: Number of periods is……….… 10