[Anonymous]

E&S Partnership purchased land for $500,000 on May 1, Year 1, paying $100,000 cash and giving $400,000 note payable to Big State Bank. E&S made three annual payments on the note total $179,000, which included interest of $89,000. E&S then defaulted on the note. Title to the land was transferred by E&S to Big State, which cancelled the note, releasing the partnership from further liability. At the time of default, fair value approximated the note balance. In E&S’ Year 4 income statement, the amount of loss should be:

a) $279,000

b) $221,000

c) $190,000

d) $100,000

Ans: C, 190,000.

The calculation is pretty straightforward, It’s just the original cost of land (400+100) less the FMV of land transferred to bank on default (400-90) This may seem like a silly question, but I can’t figure out why the interest on the note isn’t factored into the balance in this question. If anyone could help, it would be greatly appreciated. Thanks!

[ScruffMcGruff]

It is because the interest is not part of the ‘value' of the asset that was bought (in this case, land). The interest is just the expense for E&S receiving $400,000 in cash upfront to finance the purchase of the land.

To answer the question then (which you basically already did), the loss will equal the FV of the land (500) less any amount not yet paid yet (310 –> 400 N/P – 90 Principle Paid).

AUD - 85
FAR - 78 (lol@ FAR Sims)
REG - 85
BEC - August

[Anonymous]

How does that question differ from this question:

In Year 1, May Corp. acquired land by paying $75,000 down and signing a note with a maturity value of $1,000,000. On the note's due date, December 31, Year 6, May owed $40,000 of accrued interest and $1,000,000 principal on the note. May was in financial difficulty and was unable to make any payments. This situation was unusual and infrequent for May Corp., and is considered material. May and the bank agreed to amend the note as follows:

•The $40,000 of interest due on December 31, Year 6, was forgiven.

•The principal of the note was reduced from $1,000,000 to $950,000 and the maturity date extended 1 year to December 31, Year 7.

•May would be required to make one interest payment totaling $30,000 on December 31, Year 7.

As a result of the troubled debt restructuring, May should report a gain, before taxes, in its Year 6 income statement of:

(a) $90,000

(b) $60,000

(c) $40,000

(d) $50,000

Correct answer is (b) based on the interest being added in

[Author]

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