Advanced Accounting Fischer Taylor Cheng 11th Edition Test Bank

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CHAPTER 21

UNDERSTANDING THE ISSUES

3. If a creditor is fully secured, by definition no
portion of their claim will become unsecured. 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.
The claims of partially secured creditors
exceed the value of the assets securing
their claims. Therefore, the unsecured
amounts are combined with the other existing unsecured claims. Once the total of all
unsecured claims is identified, those unsecured claims will proceed against the
remaining assets of the company in order
of priority.

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 interest, exceeds the total of all restructured
principal and interest payments. If the total
payments exceed the book value, no gain
is recognized. Note that the present value
of the payments received is not considered
in the determination of the gain. For a
restructuring that is under bankruptcy law,
the gain is measured as the amount by
which the book value of the debt, including
accrued interest, exceeds the fair value of
the restructured consideration received.
The value of the consideration received is
the net present value of the restructured
payments.

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 fiduciary responsibility. The statement also
documents that available assets are being
distributed properly among the various
creditors and in the proper order of priority.
A review of the statement may also provide
outstanding creditors with some sense of
how much they may receive in satisfaction
of their claims.

2. A corporate reorganization is a legal remedy designed to restructure the debt and/or

equity of a troubled company so that the
company may continue to operate and
ultimately become financially sound. The
ultimate goal of a reorganization is to
provide a more attractive alternative than
liquidation and allow the company to continue its business purpose. A corporate
liquidation does not hold promise for a recovery but rather is designed to facilitate a
termination of the business. Assets of the
company are converted into a distributable
form and conveyed to creditors and shareholders to whatever extent possible. Upon
completion of the distribution of assets, the
business entity ceases to exist.

817

Ch. 21Exercises

EXERCISES
Note: Some calculations may vary due to rounding or method of calculation. Answers presented
have been determined using Excel.

EXERCISE 21-1
Alternative AIncome Statement Impact
First Month:
Gain on land:
Fair market value .........................................................................
Carrying value..............................................................................
Gain .............................................................................................

$ 380,000.00
(260,000.00)
$ 120,000.00

Gain on restructuring:
Remaining carrying value of debt:
Original carrying value.............................................................
Value of land ...........................................................................
Current carrying value .............................................................

$ 566,975.00
(380,000.00)
$ 186,975.00

Sum of remaining payments:

Number of payments ...............................................................
Amount of payment .................................................................
Sum of payments ....................................................................

40
$ 5,068.00
$ 202,704.00

Because the restructured payments exceed the current carrying

value, there is no gain on restructuring.
Interest expense:
Effective interest rate is 4.8%
where n = 40, present value is $186,974.50,
and payment is $5,067.60.
Interest expense:
Current carrying value .................................................................
Interest rate (4.8%/12) .................................................................
Interest expense ..........................................................................

$ 186,974.50
0.40%
$
747.90

Second Month:
Interest expense:
Current carrying value .................................................................
where n = 39, interest rate = 4.8%/12,
and the payment is $5,067.60.
Interest rate (4.8%/12) .................................................................
Interest expense ..........................................................................

818

$ 182,654.73

0.40%
730.62

Ch. 21Exercises

Exercise 21-1, Concluded

Alternative BIncome Statement Impact
First Month:
Gain on land:
Fair market value .........................................................................
Carrying value..............................................................................
Gain .............................................................................................
Gain on restructuring:
Remaining carrying value of debt:
Original carrying value.............................................................
Value of land ...........................................................................
Current carrying value .............................................................
Sum of remaining payments:
Number of payments ...............................................................
Amount of payment .................................................................
Sum of payments ....................................................................

$ 380,000.00
(260,000.00)
$ 120,000.00

$ 566,974.50
(380,000.00)
$ 186,974.50
60
$ 3,000.00
$ 180,000.00

Because the restructured payments do not exceed the current

carrying value, there is a gain on restructuring. However, in this
case, there will be no interest expense.
Gain on restructuring:
Current carrying value .............................................................
Sum of payments ....................................................................
Gain.........................................................................................

$ 186,974.50
(180,000.00)
$ 6,974.50

Interest expense ...................................................................................

Not applicable

Second Month:
Interest expense ...................................................................................

819

Not applicable

Ch. 21Exercises

EXERCISE 21-2
Effect on Net Income
Increase (Decrease)

Item
Exchange of preferred stock for debt ($5,100,000 of preferred stock,
at market value in exchange for $5,500,000 of debt).............................
Exchange of land for debt ($3,000,000 of land at book value in
exchange for $4,500,000 of debt) ..........................................................
Restructuring of remaining debt of $10,875,000 with semiannual
payments of $818,016. The sum of the payments is $16,360,320
(20 $818,016). Since the sum of the payments exceeds the
unpaid balance, no gain is recognized on the restructuring...................
Total effect on net income............................................................................
Retained earnings before restructuring........................................................
Adjusted retained earnings ..........................................................................

400,000
1,500,000

0
$ 1,900,000
(3,400,000)
$(1,500,000)

In order to eliminate the deficit in retained earnings, the contributed capital in excess of par value would be reduced to zero, and the par value of the common stock would have to be reduced
by $500,000.

EXERCISE 21-3
(1) The impact on the ratios is directly related to how each of the actions taken by management 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 shareholders equity. Given the above, it would appear that the current ratio would be affected by
the current portion of the restructured debt. Given the fact that the payments are less than
the carrying basis of the original debt, the current portion could very easily be less and,
therefore, the current ratio could increase. It is clear that the debt restructuring would leave
the company with less debt, which, absent any other information, would result in a
decrease in the debt-to-equity ratio. However, the net effect on income of the impairment
loss and the gain on restructuring will obviously have an impact on equity. Therefore, the
debt-to-equity ratio must also reflect any changes due to these transactions. The return on
equity would be affected by the net effect on income of the impairment loss and the restructuring gain. This net effect would obviously impact net income and the balance in retained
earnings. The adjustment of par would have no effect on the return on equity because the
total equity is not changed as a result of eliminating the deficit.
(2) Net income in future periods would be affected by lower depreciation/amortization expense
and no interest expense on the new restructured debt.

820

Ch. 21Exercises

EXERCISE 21-4

Total amount due ..............................

Less amounts applied against debt:
Value of assets transferred .........
Value of stock transferred ...........
Remaining debt.................................
Total of periodic payments to be
applied against remaining debt ......

A
$ 84,000
(80,000)
$

4,000

Outstanding Debt
B
C
$ 520,000
$328,000

D
$350,000

(120,000)
(380,000)
$ 20,000

$328,000

$301,661

$300,000

$320,000

(48,339)

Regarding Debt A: A gain on restructuring of $4,000 would be recognized because no other

consideration is being conveyed to satisfy the remaining debt. There would be no interest
expense.
Regarding Debt B: A gain on restructuring of $20,000 would be recognized because no other
consideration is being conveyed to satisfy the remaining debt. There would be no interest
expense.
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 periodic 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.
Regarding Debt D: Because the total of the periodic payments exceeds the remaining debt,
there is no gain on restructuring. The periodic payments totaling $320,000 therefore represent a
payment of the remaining principal amount due of $301,661 and total interest in the amount of
$18,339. The interest rate is that rate which discounts the five semiannual payments so that
their present value is $301,661. This semiannual rate is 2%, and the interest for the first six
months is $6,033 (2% $301,661).

821

Ch. 21Exercises

EXERCISE 21-5
(1)

Debt Restructuring
Nonbankruptcy
Bankruptcy
Approach
Approach
Carrying basis of debt:
Principal .........................................................................
Accrued interest .............................................................

$2,100,000
72,737
$2,172,737

$2,100,000
72,737
$2,172,737

Basis of consideration exchanged for debt (see Note A):

Sum of future payments .................................................
Present value of future payments ..................................
Total ...............................................................................

$2,400,000
N/A
$2,400,000

N/A
$1,758,004
$1,758,004

Gain on forgiveness of debt .................................................

Gain on debt restructuring (see Note B) ..............................
Total ...............................................................................

$ 200,000
0
$ 200,000

$ 200,000
214,733
$ 414,733

Future interest expense (see Note C) ..................................

$ 427,263

$ 641,996

Note A: The carrying value of the debt that is not forgiven is $1,972,737 ($2,100,000
$200,000 + $72,737). If this debt is to be serviced over 60 months at an interest rate of 8%,
the monthly payments are $40,000. The total of these payments is $2,400,000 ($40,000
60 months). The net present value of these payments using a market rate of interest of 13%
is $1,758,004.
Note B: Under the nonbankruptcy approach, a gain on restructuring results only if the sum of
the future payments is less than the carrying basis of the restructured debt. Under the bankruptcy approach, a gain is recognized to the extent that the fair value of the consideration
received ($1,758,004) is less than the carrying basis of the restructured debt ($1,972,737).
Note C: Under the nonbankruptcy approach, the total interest expense is represented by the
difference between the sum of the future payments ($2,400,000) and the carrying basis of
the restructured debt ($1,972,737). In a bankruptcy approach, the total interest expense is
represented by the difference between the sum of the payments ($2,400,000) and the present value of the future payments using a market rate of interest ($1,758,004).
(2)
Retained earnings deficit......................................................
Gain on forgiveness and restructuring of debt .....................
Revised deficit......................................................................
Present paid-in capital in excess of par value......................
Necessary reduction in par value of common stock.............

Nonbankruptcy
Approach
$ 500,000
(200,000)
$ 300,000
(80,000)
$ 220,000

Bankruptcy
Approach
$ 500,000
(414,733)*
$ 85,267
(80,000)
$
5,267

*If the gain had been recorded directly as an increase in paid-in capital rather than as a
component of net income, the answer would remain the same.

822

Ch. 21Exercises

EXERCISE 21-6
(1)
Item
Loan A restructuring:
$3,580,000 restructured at 10%, 8 years, and monthly
installments. The monthly payment is $50,000.....................................
Loan B restructuring:
No effect on cash outflows....................................................................
Loan C restructuring:
Debt to be paid in installments is $1,787,500 ($2,000,000 +
$37,500 $250,000). Given n = 20 and i = 2.25%,
the payment is $111,973 ......................................................................
Total quarterly cash outflows.. .....................................................................

(2)
Item
Loan A restructuring:
Gain on forgiveness of debt................................................ ...
Gain on restructuring of remaining debt:
Total payments = $4,800,000 (96 $50,000). Net present
value of payments is $3,295,074 versus carrying basis of
$3,580,000 ........................................................................
Interest expense:
Based on stated rate of 10% ............................................... ..
Based on imputed rate of 7.6644% (see note) .................... ..

Quarterly
Cash Outflows

$150,000
0

111,973
$261,973

Effect on Net Income If

Part of a
Not Part of a
Formal Filing Formal Filing
$500,000

$500,000

284,926

(81,812)
(68,075)

Loan B restructuring:
Gain on forgiveness of accrued interest. ...............................
Gain on exchange of preferred stock.....................................

25,000
100,000

25,000
100,000

Loan C restructuring:
Gain on transfer of land .........................................................
Interest based on 9%........................................................... ..

50,000
(40,219)

50,000
(40,219)

Total effect on net income for the first quarter ...........................

$837,895

$566,706

Note: This is the interest rate given a periodic payment of $50,000, the 96 monthly periods,
and a present value of $3,580,000.

823

Ch. 21Exercises

EXERCISE 21-7

Accounts payable..........................
Note payableA ...........................
Note payableB ...........................
Mortgage payable .........................
Accrued interest ............................
Other liabilities...............................

Fully
Secured
$130,000

Partially
Secured
$560,000
300,000

Liabilities
Unsecured
With
Without
Priority
Priority
$150,000
40,000
200,000

180,000
12,000
$322,000

$860,000

$10,000
$10,000

14,000
$404,000

Total
$ 280,000
600,000
500,000
180,000
12,000
24,000
$1,596,000

Realizable
Value
Assets to be applied against
the liabilities:
Inventory
Inventory ....................................
Receivables ...............................
Equipment..................................
Equipment..................................
Land ...........................................
Cash...........................................
Other assets...............................
Dividend .....................................

$ 150,000 $130,000
$ 20,000 $ 150,000
200,000
$200,000
200,000
360,000
360,000
360,000
300,000
300,000
300,000
60,000
60,000
60,000
260,000 192,000
68,000
260,000
60,000
$10,000
50,000
60,000
45,000
45,000
45,000
$1,435,000 $322,000 $860,000 $10,000 $243,000 $1,435,000
100.0%

Total consideration to be received by Note B:

Received toward partially secured portion.............................
Received toward unsecured portion:
Unsecured portion ...........................................................
Dividend...........................................................................
Total consideration received..................................................

824

100.0%

100.0%

60.15%

$300,000
$200,000
60.15%

120,300
$420,300

Ch. 21Exercises

EXERCISE 21-8
(1)

Nonbankruptcy Approach
Alternative A
Alternative B
Income Statement
Gain on sale of land:
Market value of land ............
Basis of land ........................
Gain on sale of land.............
Land transaction costs.........
Net gain on sale of land .......
Gain on restructuring
(see Schedule A).............
Income statement effect ............

Bankruptcy Approach
Alternative A Alternative B

$550,000
(400,000)
$150,000
(35,000)
$115,000

$550,000
(400,000)
$150,000
(35,000)
$115,000

$550,000
(400,000)
$150,000
(35,000)
$115,000

$550,000
(400,000)
$150,000
(35,000)
$115,000

85,000
$200,000

0
$115,000

355,393
$470,393

361,027
$476,027

Balance Sheet
Before restructuring:
Land.....................................
Note payable........................
Retained earnings................

$ 400,000
2,000,000
0

$ 400,000
2,000,000
0

$ 400,000
2,000,000
0

$ 400,000
2,000,000
0

After restructuring:
Land.....................................
Note payable........................
Retained earnings................

$
0
1,400,000
200,000

$
0
1,700,000
115,000

$
0
1,129,607
470,393

$
0
1,338,973
476,027

Schedule A

Original basis of debt.................

Less net land proceeds .............
Remaining balance....................
Remaining payments:
Absolute value .....................
Net present value
discounted at 6%.............
Gain on restructuring .................

Nonbankruptcy Approach
Alternative A
Alternative B
$2,000,000
$2,000,000
(300,000)
(515,000)
$1,485,000
$1,700,000
(1,400,000)

(1,700,000)

85,000

Bankruptcy Approach
Alternative A Alternative B
$2,000,000
$2,000,000
(515,000)
(300,000)
$1,485,000
$1,700,000

1,129,607
$ 355,393

1,338,973
$ 361,027

(2) Given a nonbankruptcy approach, Alternative B would be preferable since it involves giving
up the least net present value in satisfaction of the original debt. Furthermore, Alternative B
retains some of the cash that was realized from the sale of the land. It is possible that this
cash can be put to a more productive use rather than being invested in a nonoperating asset such as idle land. If interest rates were to rise over time, it might be advantageous to
lock into an interest rate for a longer period of time. Alternative B has a lower net present
value of consideration given up in satisfaction of the debt than does Alternative A as set
forth below.
Net present values:
Cash from sale of land.........
Remaining payments ...........
Total.....................................

Alternative A

Alternative B

$ 515,000
1,129,607
$1,644,607

$ 300,000
1,338,973
$1,638,973

825

Ch. 21Exercises

EXERCISE 21-9

Claims against the bankrupt estate:

Bank loan balance and accrued interest ........................
Dealer-financed vehicle loan..........................................
Accounts payable due vendors ......................................
Line of credit due............................................................
Payroll and taxes due.....................................................
Expenses to administer the estate .................................
Accrued payroll ..............................................................
Shareholder loans ..........................................................
Other unsecured creditors without priority .....................
Subtotal ..........................................................................
Assets available to satisfy fully and partially secured claims
Net unsatisfied balance........................................................
Reclassify as unsecured without priority..............................
Subtotal................................................................................
Assets available to satisfy unsecured claims.......................
Net unsatisfied balance........................................................
Dividend to unsecured creditors ..........................................

Amounts received by each major class of creditor:

Amounts received:
Secured amount received..........................................
Unsecured amount received:
100% Dividend on $39,200 ...................................
47.77% Dividend on $10,000 ................................
47.77% Dividend on $111,000 ..............................
Total...........................................................................

Fully
Secured
$ 85,000

30,000

$115,000
(115,000)
$

Partially
Secured
$

18,000
21,000

Fully
Secured

Partially
Secured

$115,000

$29,000

Unsecured
With
Without
Priority
Priority
$

23,000
12,000
4,200
$ 39,000
(29,000)
$ 10,000
(10,000)
$

$39,200
$39,200
$39,200
(39,200)
$

100.00%

80,000
31,000
$111,000
$111,000
10,000
$121,000
(57,800)
$ 63,200
47.77%

Unsecured
With
Without
Priority
Priority

$39,200
$33,777

Total
$144,000

4,777
$115,000

Total
$ 85,000
18,000
21,000
30,000
23,000
12,000
4,200
80,000
31,000
$304,200
(144,000)
$160,200

$160,200
(97,000)
$ 63,200

$39,200

$53,023
$53,023

39,200
4,777
53,023
$241,000

Note: Although the solution to this exercise is fairly straightforward, setting up a presentable schedule may be a challenge to students. This is an excellent occasion to discuss with students the importance of documenting ones work in an understandable
and user friendly manner.

826

Ch. 21Exercises

EXERCISE 21-10
(1)

The Rodak Corporation

Statement of Realization and Liquidation
For Period July 1, 2019, to August 12, 2019
Liabilities
Assets
Cash
Noncash

Beginning balances, assigned

July 1, 2019............................. $ 12,000
Cash receipts:
Sale of inventory .....................
Collection on receivables........
Sale of securities.....................
Sale of machinery ...................

30,000
39,000
22,500
36,000

Cash disbursements:
Payment of loan ......................
Payment of accounts payable.
Payment of bank loan .............

(12,000)
(25,000)
(36,000)

Subsequently discovered:
Liabilities .................................
Ending balance .......................... $ 66,500

$590,000

Unsecured
With
Without
Priority
Priority

Fully
Secured

Partially
Secured

$200,000

$175,000 $54,000

$150,000

(25,000)
(54,000)
(18,000)
(45,000)

Owners
Equity
$ 23,000
5,000
(15,000)
4,500
(9,000)

(12,000)
(25,000)
(50,000)

$448,000

$163,000

$125,000 $54,000

(2) Estimated assets available:

Cash .....................................................................................................
Estimated value of noncash assets ......................................................

Value of all liabilities excluding unsecured creditors

without priority.......................................................................................
Assets available for unsecured creditors without priority............................
Estimated dividend to unsecured creditors without priority:
$134,500 $179,000 = 75%

827

14,000
15,000
$179,000

$ 66,500
410,000
$476,500

342,000
$134,500

(15,000)
$ (6,500)

Ch. 21Problems

PROBLEMS
Note: Some calculations may vary due to rounding or method of calculation. Answers presented
have been determined using Excel.

PROBLEM 21-1
Atoyo Fabricating, Inc.
Evaluation of Proposed Plan of Reorganization

Liability
Note
Accounts payable.............
Accounts payable.............
Accounts payable.............
Equipment note ................
Shareholder note..............
Mortgage payable ............
Other creditors .................

Type of Claim

Book Value

Consideration
Suggested
to Be Received if a
Monthly
Liquidation Reorganization
Payment

Fully secured
Partially secured
Unsecured
Partially secured
Partially secured
Fully secured
Unsecured

40,000
74,000
20,000
338,000
20,000
448,000
160,000
$1,100,000

40,000
66,815
14,868
334,664
18,717
448,000
118,944
$1,042,008*

40,000
58,820
14,560
338,000
22,460
448,000
130,838
$1,052,678

$13,601
20,000
3,000
9,732
6,482
4,266
17,099
$74,180

*Difference due to rounding errors.

Note A: The payment is based on a present value of $40,000, a period of three months, and an
interest rate of 1% per month.
Note B: The present value of the three payments of $20,000 at a monthly interest rate of 1% is
$58,820. The amount to be received if a liquidation is the $46,000 plus the remaining unsecured
amount of $28,000 times 74.34%.
Note C: The present value of the five payments of $3,000 at a monthly interest rate of 1% is
$14,560. The amount to be received upon liquidation is $20,000 times 74.34%.
Note D: The payment that would be the lowest is one based on a present value of $338,000, a
term of 42 months, and an interest rate of 11%. The payment would be $9,732. The amount to
be received upon liquidation is $325,000 plus 74.34% of the unsecured portion of $13,000.
Note E: In addition to the $15,000 secured amount, the shareholder would have received
74.34% of the remaining $5,000, or $3,717, for a total of $18,717. The payments to equal 120%
of this amount ($22,460), given a term of four semiannual periods and an interest rate of 12%,
would be $6,482.
Note F: The payment is based on a present value of $448,000, a period of 360 months, and an
interest rate of 11%.
Note G: The unsecured creditors would have received 74.34% as a dividend, or $118,944.
110% of this amount would be equal to $130,838. The payments necessary to equal this present value, given eight monthly periods and an interest rate of 12%, is $17,099.

828

See

A
B
C
D
E
F
G

Ch. 21Problems

Problem 21-1, Concluded

Analysis of Creditor Claims if the Company Had Been Liquidated

Original balance ................................

Distribution of assets:
To fully secured...........................
To partially secured.....................
Reclassify partially secured ..............
Balance .............................................

Assets at Net
Realizable
Value
$1,042,000

Fully
Secured
$ 488,000

(488,000)
(386,000)
$ 168,000

Liabilities
Partially
Secured Unsecured
$432,000
$180,000

(488,000)

(386,000)*
(46,000)
46,000
$
0
$226,000

The dividend to unsecured creditors would be 74.34% ($168,000 $226,000).

*$46,000 + $325,000 + $15,000 from insurance policy.
The goals set by management have been met. The restructuring will result in monthly payments
of $74,180 which is less than the target of $75,000 and the net present value of the restructuring
is greater than the amount that would be received under a liquidation.

PROBLEM 21-2
(a) Cash ...............................................................................................
Accumulated Amortization..............................................................
Loss on Sale of Patents..................................................................
Patents......................................................................................
To record the sale of patents.

20,000
115,000
5,000

(b) Impairment Loss .............................................................................

Goodwill ....................................................................................
To record impairment loss on goodwill.

100,000

(c) Cash ...............................................................................................

Transaction Expense......................................................................
Loss on Disposal of Land ...............................................................
Vacant Land..............................................................................
To record sale of vacant land.

185,000
10,000
15,000

Mortgage Payable ..........................................................................

Accrued Interest Payable ...............................................................
Cash .........................................................................................
Gain on Restructuring...............................................................
To record gain on restructuring of mortgage.

230,000
15,000

829

140,000

100,000

210,000

185,000
60,000

Ch. 21Problems

Problem 21-2, Continued

(d) Loan from Shareholder...................................................................
Accrued Interest Payable ...............................................................
Restructured Shareholder Loan................................................
Cash .........................................................................................
To record restructuring of shareholder loan. The net
present value of the 16 payments given an interest rate
of 6% is $124,500.

150,000
4,500

(e) Vendor Account Payable ................................................................

Cash .........................................................................................
Vendor Note Payable................................................................
Gain on Restructuring...............................................................
To record restructuring of vendor payable.

85,000

(f)

124,500
30,000

15,000
60,000
10,000

Bank Debt.......................................................................................
Accrued Interest Payable ...............................................................
Investment Securities ...............................................................
Treasury Stock..........................................................................
Contributed Capital from Treasury Stock..................................
Restructured Bank Debt ...........................................................
Gain on Restructuring...............................................................
To record restructuring of bank debt.

510,000
22,000

(g) Bank Note.......................................................................................

Restructured Bank Note ...........................................................
Gain on Restructuring...............................................................
To record restructuring of bank note.

60,000

(h) Creditor Debt ..................................................................................

Accumulated Depreciation..............................................................
Equipment.................................................................................
Gain on Disposal of Equipment ................................................
Restructured Creditor Debt.......................................................
To record restructuring of creditor debt.

120,000
150,000

830

62,000
150,000
50,000
252,000
18,000

51,000
9,000

220,000
10,000
40,000

Ch. 21Problems

Problem 21-2, Concluded

Total Interest Expense in Connection with First Quarterly Payment

Mortgage payable ............

Shareholder loan..............
Vendor payable ................
Bank debt .........................
Bank note .........................
Secured creditor...............

Original
Balance
$245,000
154,500
85,000
532,000
60,000
120,000

Mortgage payable ............

Shareholder loan..............
Vendor payable ................
Bank debt .........................
Bank note .........................
Secured creditor...............

Unpaid
Balance
$
0
124,500
60,000
252,000
51,000
40,000

Reduction
in Balance
$245,000
30,000
25,000
280,000
9,000
80,000
Quarterly
Interest
Rate
0.00%
1.50
0.00
1.60
0.00
1.40

831

Unpaid
Balance
$
0
124,500
60,000
252,000
51,000
40,000

Interest
$
0
1,867.50
0
4,032.00
0
560.00

Quarterly
Payment
$
0
8,810.25
10,000.00
27,470.38
17,000.00
6,997.12

Implicit
Number Quarterly
of
Interest
Payments
Rate
0
0.00%
16
1.50
6
0.00
10
1.60
3
0.00
6
1.40

Ch. 21Problems

PROBLEM 21-3
(1)

Original
December 31, 2017
Dr. (Cr.)
Debit
Cash...................................... $ (15,000)
Accounts receivable (net)......
500,000
(a)
Inventory ...............................
150,000
(a)
Plant and equipment (net).....
1,560,000
(b)
Goodwill ................................
150,000
(b)
Other assets:
Current portion ................
6,209 (c) $
1,616
Noncurrent portion ..........
28,791
(c)
Accounts payable..................
(320,000)
7% Note payable:
Current portion ................
0
(d)
Noncurrent portion ..........
(1,500,000) (d)
300,000
Common stock at par ............
(550,000) (e) 1,000,000 (e)
Contributed capital in excess
of par ...............................
(550,000) (e)
550,000 0
Retained earnings .................
300,000
(e)
2017 Net income ...................
240,000
(e)
Impairment loss.....................
(a)
95,000
Impairment loss.....................
(b)
425,000
(d)
(e)
Total ................................ $
0
$2,371,616

Adjusted
December 31, 2017
Credit
Dr. (Cr.)
$ (15,000)
$ 75,000
425,000
20,000
130,000
275,000
1,285,000
150,000
0
7,825
27,175
(320,000)

1,616

240,000
550,000

(240,000)
(1,200,000)
(100,000)

300,000
240,000

60,000
460,000
$2,371,616

0
0

(a) To recognize impairment in the value of receivables and inventory.

(b) To recognize impairment in the value of equipment and goodwill.
(c) To reclassify note between current and noncurrent given the new payment of $10,450
($35,000 is the present value of four payments at 7.5% interest).
(d) To recognize restructuring gain. 12 payments of $120,000 = $1,440,000. Therefore, the
restructuring gain is $60,000, and all payments are considered to be principal only. Because the total of all payments is less than the book value of the note, all payments are
considered to be principal.
(e) To record quasi-reorganization by adjusting par value of common stock and eliminating
contributed capital in excess of par.
(2) Calculation of ratios:

Before Actions

After Actions

2.00
3.25

0.98
NA*

Current ratio ............................................

Debt-to-equity..........................................

*The debt-to-equity ratio is not meaningful in that there is negative equity. The adjusted assets total $1,475,000, and the adjusted debt totals $1,760,000. All assets are being financed by debt capital.

832

Ch. 21Problems

Problem 21-3, Concluded

(3) The above ratios have not improved as a result of managements actions. However, several
benefits may not be apparent from the ratio analysis. First, management has a balance
sheet that more clearly reflects market values. Second, the recognition of impairment losses
on equipment will translate into lower depreciation expense in future years. It is also possible that impairment losses on current assets will result in lower near-term expense levels
associated with bad debt expense and cost of sales. These adjustments to expense levels
will result in an improved measure of income. Third, the restructuring of the 7% note payable
results in the company paying out a lower net present value on the debt than would have
been the case had the debt not been restructured. Finally, the elimination of the deficit will
make it easier for the company to be in a position to return a dividend to its shareholders.

PROBLEM 21-4
Carlton Company
Statement of Affairs
April 30, 2015

Book
Value
$ 82,500
10,000
40,000
25,000
20,000
3,750
11,250
14,000
57,250

Assets
Assets pledged with partially secured creditors:
Land and building (net)..............................
Notes receivable........................................
Equipment (net) .........................................
U.S. Treasury bonds..................................
Free assets:
Subscriptions receivable............................
Groves common stock...............................
Cash ..........................................................
Accounts receivable ..................................
Inventory (see Schedule A) .......................

Estimated
Net
Realizable
Value
$ 75,000
0
12,000
23,200
20,000
3,300
11,250
3,000
52,175

Estimated amount available for unsecured

creditors with and without priority ..............
Less unsecured creditors with priority .............

$263,750*

Estimated amounts for unsecured creditors

without priority:
Net realizable amount available ................
Deficiency (to agree to total unsecured
amount without priority) ..........................
Total ................................................................

Estimated
Amount
Available for
Unsecured
Creditors

Estimated
Gain (or
Loss) on
Liquidation
$ (7,500)
(10,000)
(28,000)
(1,800)

$ 20,000
3,300
11,250
3,000
52,175

(450)
(11,000)
(5,075)

$ 89,725
(7,300)

$ 82,425

$199,925

52,375
$134,800

$(63,825)

*The total represents the original $250,250 plus the notes receivable of $10,000 plus the additional labor costs on work in process of $3,500.

833

Ch. 21Problems

Problem 21-4, Concluded

Book
Value
$ 87,500
10,000
62,500
25,000

Liabilities and Owners Equity

Partially secured creditors:
First and second mortgages payable ........
Notes receivable discounted .....................
Note payableWilliams ............................
Note payableAerotex .............................

6,150
1,150

Unsecured creditors with priority:

Salaries payable** .....................................
Property taxes payable..............................

$ 75,000
0
12,000
23,200

$ 12,500
10,000
50,500
1,800
$6,150
1,150

Unsecured creditors without priority:

60,000
Accounts payable ......................................
$252,300*** Totals...............................................................
11,450
$263,750

Estimated
Unsecured Amount
With
Without
Priority
Priority

Estimated
Secured
Amount

$110,200

$7,300

60,000
$134,800

Owners equity
Total liabilities and owners equity

**$2,650 + $3,500
***The total represents the original $238,800 plus the notes receivable discounted of $10,000
plus the unpaid labor costs on work in process of $3,500.

Schedule A
Realization of Inventory

Raw materials ...................................

Work in process ................................
Finished goods..................................

March 31
Book
Value
$15,000
11,250
27,500
$53,750

Additional
Costs
(Transfers)
$(3,000)
3,000
3,500
$ 3,500

Revised
Book
Value
$12,000

Net
Realizable
Value
$ 2,400

17,750
27,500
$57,250

19,525
30,250
$ 52,175

This amount represents additional labor costs that are unsecured with priority.

834

Ch. 21Problems

PROBLEM 21-5
(a) Note PayableOfficer....................................................................
Patents (net) .............................................................................
Gain on Patents ........................................................................
To record transfer of patents against note.

230,000

(b) Mortgage Payable ..........................................................................

Cash .........................................................................................
To record payment on mortgage payable.

100,000

210,000
20,000

100,000

(c) Bank A Note Payable ($980,000 + $95,000) .................................. 1,075,000

Development Land....................................................................
Marketable Securities (other current assets) ............................
Gain on Land ............................................................................
Gain on Marketable Securities..................................................
To record transfer of land and securities against note.
(d) Bank B Note Payable .....................................................................
Loss on Equipment.........................................................................
Equipment (net) ........................................................................
To record transfer of equipment against note.

220,000
20,000

Bank B Note Payable .....................................................................

Gain on Restructuring...............................................................
To record gain on restructuring. The 10 payments of
$55,000 are less than the remaining balance on the note
of $600,000 ($820,000 $220,000).

50,000

(e) Note PayableOfficer....................................................................

Mortgage Payable ..........................................................................
Bank A Note Payable .....................................................................
Bank B Note Payable .....................................................................
Interest Expense.............................................................................
Cash .........................................................................................
To record June 30, 2016, payments on notes (see Note A).
(f)

240,000

50,000

33,327
23,178
95,770
55,000
45,075
252,350

Common Stock ($10 par value) ......................................................

Common Stock ($5 par value) ..................................................
Paid-In Capital from Reduction in Par Value ............................
To record reduction in par value.

200,000

Paid-In Capital from Reduction in Par Value ..................................

Paid-In Capital in Excess of Par .....................................................
Retained Earnings ....................................................................
To eliminate deficit in retained earnings.

100,000
100,000

835

700,000
80,000
280,000
15,000

100,000
100,000

200,000

Ch. 21Problems

Problem 21-5, Concluded

Note A:

Note payableofficer.......
Mortgage payable ............
Bank A note payable ........
Bank B note payable ........

Original
Balance
$ 400,000
1,500,000
2,100,000
820,000

Reduction
in Balance
$ 230,000
100,000
1,075,000
270,000

Note payableofficer.......
Mortgage payable ............
Bank A note payable ........
Bank B note payable ........

Unpaid
Balance
$ 170,000
1,400,000
1,025,000
550,000

Quarterly
Interest
Rate
1.00%
2.00
1.50
0.00

836

Unpaid
Balance
$ 170,000
1,400,000
1,025,000
550,000

Payment
$ 35,026.77
51,178.05
111,145.03
55,000.00
$252,349.85

Quarterly
Payment
$ 35,026.77
51,178.05
111,145.03
55,000.00

Interest
$ 1,700
28,000
15,375

$45,075

Implicit
Number Quarterly
of
Interest
Payments
Rate
5
1.00%
40
2.00
10
1.50
10
0.00

Principal
$ 33,327
23,178
95,770
55,000
$207,275

Ch. 21Problems

PROBLEM 21-6
St. John Corporation
Statement of Realization and Liquidation
For the Period January 1, 2016, to June 30, 2016
Liabilities
Assets
Cash
Noncash

Fully
Secured

Partially
Secured

Unsecured
With
Without Shareholders
Priority
Priority
Equity

Beginning balances, assigned

January 1, 2016 ...................... $42,000 $5,910,000
Accounts payable....................
$ 400,000 $ 320,000
$ 92,000
Note payableofficer .............
400,000
Bank A note payable...............
2,100,000
Bank B note payable...............
820,000
Mortgage payable ...................
1,500,000
Other liabilities ........................
90,000
$ 35,000
95,000
Beginning balances................. $42,000 $5,910,000 $2,810,000 $2,820,000 $ 35,000 $187,000
Subsequently discovered items:
Additional assets.....................
Administrative expenses .........
Cash receipts:
Sale of inventory .....................
Sale of equipment ...................
Sale of patent..........................
Sale of development land .......
Sale of other assets ................
Collection of receivables .........

15,000
20,000
480,000
700,000
250,000
360,000
100,000
150,000

(430,000)
(800,000)
(210,000)
(300,000)
(130,000)
(150,000)

Cash disbursements:
Inventory completion costs ..... (25,000)
Payment of accounts
payable ................................ (400,000)
(400,000)
Payment of accounts
payable ................................
Payment of brokers fee .......... (10,000)
Payment to Bank A ................. (940,000)
(940,000)
Payment of other liabilities...... (110,000)
(90,000)
(20,000)
Payment of administrative
expenses ............................. (10,000)
(10,000)
Ending balances......................... $ 602,000 $3,890,000 $2,320,000 $1,880,000 $ 25,000 $187,000

837

$100,000

$100,000
15,000
(20,000)
50,000
(100,000)
40,000
60,000
(30,000)

(25,000)

(10,000)

$ 80,000

Ch. 21Problems

PROBLEM 21-7
Trial Balance as of
March 31
Debit
Credit
Cash and cash equivalents .....................

Accounts receivable ................................

Allowance for uncollectible accounts ......

847,000

Inventory..................................................

1,100,000

Equipment (net).......................................
Other assets............................................
Accounts payable....................................

325,000
110,000

Second Quarter
Activities/Adjustments
Debit
Credit

46,000

600,000
550,000
125,000

Restructured note....................................
Shareholders' equity................................
Net sales .................................................
Cost of sales ...........................................
Selling, general, and administrative ........

700,000
385,000

Interest expense......................................

17,250

480,000
762,300

A1

120,000

C1

1,530,000

Note payable A........................................

Note payable Arestructured.................
Note payable B........................................
Note payable Brestructured.................
Other liabilities.........................................

A1 $
B1

230,000

C2
D1
D2
E1
E2
F1

800,000
135,000
360,000
600,000
27,541
550,000

E1
G1
D3

6,000
15,000
46,458

219,750
853,000
A3
A2
B2
D3
E2

C2
D3
E2
B1
A2
B2
A3
D1
E1
C1

60,000
230,000

E1

444,036

F1

465,651

D2
G1
A1

360,000
14,704
600,000

Gain on vacant lot ...................................

838

$4,660,477

$ 314,358

204,700
$

10,235

700,000
325,000
50,000
465,000

416,495

465,651
104,000
313,542
205,046
1,453,000
1,210,000
395,235
25,193

D1
E1
F1
G1
E1
$3,704,000

800,000
49,942
32,000
762,300
6,000
4,235
510,000
120,000

510,000
6,000
4,235
3,484
4,459

Gain on restructuring...............................

$3,704,000

Trial Balance as of
June 30
Debit
Credit

15,000
45,964
84,349
296
56,000
$4,660,477

145,609

56,000
$3,429,532 $3,429,532

Ch. 21Problems

Problem 21-7, Concluded

Notes
D2 The net present value of the 15 payments of $24,971.17 is equal to the accounts payable eliminated in the amount of $360,000. Given this
information, the interest rate on this restructured note is 6%.
D3 Interest on the note in (D2) for May and June is as follows:
Month

Payment

May
June

$24,971.17
24,971.17
$49,942.34

Interest @ 6%
$ 1,800.00
1,684.14
$ 3,484.14

Principal
$23,171.17
23,287.03
$46,458.20

Balance
$360,000.00
336,828.83
313,541.80

E1

The net present value of the 30 payments is $444,036. This present value along with the vacant lot valued at $116,000 consists of $$560,036
of value being paid against a debt of $606,000. This results in a restructuring gain of $45,964.

E2

Interest on the note in (E1) for May and June is as follows:

F1

Month

Payment

May
June

$16,000.00
16,000.00
$32,000.00

Interest @ 6.12% Principal

$ 2,264.58
2,194.53
$ 4,459.12

$13,735.42
13,805.47
$27,540.89

Balance
$444,036.00
430,300.58
416,495.12

The net present value of the 48 payments of $11,000 based on a market interest rate of 6.3% is $465,651. Given the note balance of
$550,000, this results in a restructuring gain of $84,349.

839