14 Long-Term Liabilities EXERCISES 14.2
E14-17 (L03) (Imputation of Interest) Presented below are two independent situations.
(a) On January 1, 2017, Robin Wright Inc. purchased land that had an assessed value of $350,000 at the time of purchase. A $550,000, zero-interest-bearing note due January 1, 2020, was given in exchange. There was no established exchange price for the land, nor a ready fair value for the note. The interest rate charged on a note of this type is 12%. Determine at what amount the land should be recorded at January 1, 2017, and the interest expense to be reported in 2017 related to this transaction.
(b) On January 1, 2017, Field Furniture Co. borrowed $5,000,000 (face value) from Gary Sinise Co., a major customer, through a zero-interest-bearing note due in 4 years. Because the note was zero-interest-bearing, Field Furniture agreed to sell furniture to this customer at lower than market price. A 10% rate of interest is normally charged on this type of loan. Prepare the journal entry to record this transaction and determine the amount of interest expense to report for 2017.
E14-18 (L03) (Imputation of Interest with Right) On January 1, 2017, Margaret Avery Co. borrowed and received $400,000 from a major customer evidenced by a zero-interest-bearing note due in 3 years. As consideration for the zero-interest-bearing feature, Avery agrees to supply the customer’s inventory needs for the loan period at lower than the market price. The appropriate rate at which to impute interest is 8%.
Instructions
(a) Prepare the journal entry to record the initial transaction on January 1, 2017. (Round all computations to the nearest dollar.)
(b) Prepare the journal entry to record any adjusting entries needed at December 31, 2017. Assume that the sales of Avery’s product to this customer occur evenly over the 3-year period.
E14-19 (L04) (Fair Value Option) Fallen Company commonly issues long-term notes payable to its various lenders. Fallen has had a pretty good credit rating such that its effective borrowing rate is quite low (less than 8% on an annual basis). Fallen has elected to use the fair value option for the long-term notes issued to Barclay’s Bank and has the following data related to the carrying and fair value for these notes. Any changes in fair value are due to changes in market rates, not credit risk.
Carrying Value Fair Value
December 31, 2017 $54,000 $54,000
December 31, 2018 44,000 42,500
December 31, 2019 36,000 38,000
Instructions
(a) Prepare the journal entry at December 31 (Fallen’s year-end) for 2017, 2018, and 2019, to record the fair value option for these notes.
(b) At what amount will the note be reported on Fallen’s 2018 balance sheet?
(c) What is the effect of recording the fair value option on these notes on Fallen’s 2019 income?
(d) Assuming that general market interest rates have been stable over the period, does the fair value data for the notes indicate that Fallen’s creditworthiness has improved or declined in 2019? Explain.
E14-20 (L05) (Long-Term Debt Disclosure) At December 31, 2017, Redmond Company has outstanding three long-term debt issues. The first is a $2,000,000 note payable which matures June 30, 2020. The second is a $6,000,000 bond issue which matures September 30, 2021. The third is a $12,500,000 sinking fund debenture with annual sinking fund payments of $2,500,000 in each of the years 2019 through 2023.
Instructions
Prepare the required note disclosure for the long-term debt at December 31, 2017.
*E14-21 (L06) (Settlement of Debt) Strickland Company owes $200,000 plus $18,000 of accrued interest to Moran State Bank.
The debt is a 10-year, 10% note. During 2017, Strickland’s business deteriorated due to a faltering regional economy. On December 31, 2017, Moran 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 value of $180,000.
Instructions
(a) Prepare journal entries for Strickland Company and Moran State Bank to record this debt settlement.
(b) How should Strickland report the gain or loss on the disposition of machine and on restructuring of debt in its 2017 income statement?
(c) Assume that, instead of transferring the machine, Strickland decides to grant 15,000 shares of its common stock ($10 par) which has a fair value of $180,000 in full settlement of the loan obligation. If Moran State Bank treats Strickland’s stock as a trading investment, prepare the entries to record the transaction for both parties.
*E14-22 (L06) (Term Modification without Gain—Debtor’s Entries) On December 31, 2017, American Bank enters into a debt restructuring agreement with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $3,000,000 note receivable by the following modifications:
1. Reducing the principal obligation from $3,000,000 to $2,400,000.
2. Extending the maturity date from December 31, 2017, to January 1, 2021.
3. Reducing the interest rate from 12% to 10%.
Barkley pays interest at the end of each year. On January 1, 2021, Barkley Company pays $2,400,000 in cash to American Bank.
Instructions
(a) Will the gain recorded by Barkley be equal to the loss recorded by American Bank under the debt restructuring?
(b) Can Barkley Company record a gain under the term modification mentioned above? Explain.
(c) Assuming that the interest rate Barkley should use to compute interest expense in future periods is 1.4276%, prepare the interest payment schedule of the note for Barkley Company after the debt restructuring.
(d) Prepare the interest payment entry for Barkley Company on December 31, 2019.
(e) What entry should Barkley make on January 1, 2021?
*E14-23 (L06) (Term Modification without Gain—Creditor’s Entries) Using the same information as in E14-22, answer the following questions related to American Bank (creditor).
Instructions
(a) What interest rate should American Bank use to calculate the loss on the debt restructuring?
(b) Compute the loss that American Bank will suffer from the debt restructuring. Prepare the journal entry to record the loss.
(c) Prepare the interest receipt schedule for American Bank after the debt restructuring.
(d) Prepare the interest receipt entry for American Bank on December 31, 2019.
(e) What entry should American Bank make on January 1, 2021?
*E14-24 (L06) (Term Modification with Gain—Debtor’s Entries) Use the same information as in E14-22 above except that American Bank reduced the principal to $1,900,000 rather than $2,400,000. On January 1, 2021, Barkley pays $1,900,000 in cash to American Bank for the principal.
Instructions
(a) Can Barkley Company record a gain under this term modification? If yes, compute the gain for Barkley Company.
(b) Prepare the journal entries to record the gain on Barkley’s books.
(c) What interest rate should Barkley use to compute its interest expense in future periods? Will your answer be the same as in E14-22 above? Why or why not?
(d) Prepare the interest payment schedule of the note for Barkley Company after the debt restructuring.
(e) Prepare the interest payment entries for Barkley Company on December 31, of 2018, 2019, and 2020.
(f) What entry should Barkley make on January 1, 2021?
* E14-25 (L06) (Term Modification with Gain—Creditor’s Entries) Using the same information as in E14-22 and E14-24, answer the following questions related to American Bank (creditor).
Instructions
(a) Compute the loss American Bank will suffer under this new term modification. Prepare the journal entry to record the loss on American’s books.
(b) Prepare the interest receipt schedule for American Bank after the debt restructuring.
(c) Prepare the interest receipt entry for American Bank on December 31, 2018, 2019, and 2020.
(d) What entry should American Bank make on January 1, 2021?
* E14-26 (L06) (Debtor/Creditor Entries for Settlement of Troubled Debt) Gottlieb Co. owes $199,800 to Ceballos Inc. The debt is a 10-year, 11% note. Because Gottlieb Co. is in financial trouble, Ceballos Inc. agrees to accept some land and cancel the entire debt. The property has a book value of $90,000 and a fair value of $140,000.
Instructions
(a) Prepare the journal entry on Gottlieb’s books for debt restructure.
(b) Prepare the journal entry on Ceballos’s books for debt restructure.
*E14-27 (L06) (Debtor/Creditor Entries for Modification of Troubled Debt) Vargo Corp. owes $270,000 to First Trust. The debt is a 10-year, 12% note due December 31, 2017. Because Vargo Corp. is in financial trouble, First Trust agrees to extend the maturity date to December 31, 2019, reduce the principal to $220,000, and reduce the interest rate to 5%, payable annually on December 31.
Instructions
(a) Prepare the journal entries on Vargo’s books on December 31, 2017, 2018, 2019.
(b) Prepare the journal entries on First Trust’s books on December 31, 2017, 2018, 2019.
