[javajunkie]

Here is the problem I need help with.

Multiple Choice

PVC-0004

On December 31, 2008, Marsh Company entered into a debt restructuring agreement with Saxe Company, which was experiencing financial difficulties. Marsh restructured a $100,000 note receivable as follows:

• Reduced the principal obligation to $70,000.

• Forgave $12,000 of accrued interest.

• Extended the maturity date from December 31, 2008 to December 31, 2010.

• Reduced the interest rate from 12% to 8%. Interest was payable annually on December 31, 2009 and 2010.

Present value factors

Single sum, 2 years @ 8% .85734

Single sum, 2 years @ 12% .79719

Ordinary annuity 2 years @ 8% 1.78326

Ordinary annuity 2 years @ 12% 1.69005

Marsh does not elect the fair value option for recording this note receivable. In accordance with the agreement, Saxe made payments to Marsh on December 31, 2009 and 2010. How much interest income should Marsh report for the year ended December 31, 2010?

A $ 8,100

B $0

C $11,200

D $ 5,600

Here is the answer explanation:

A $ 8,100 This answer is correct. The requirement is to determine the amount of interest revenue to be recorded by Marsh, after a modification of terms type of troubled debt restructure on December 31, 2010. Under ASC Subtopic 310-40, when a modification of terms results in the present value of future cash flows being less than the carrying amount, then the interest revenue is calculated by using the effective interest method. In this problem the expected future cash flows is determined by discounting the principal and interest at the original effective rate of 12%.

70,000 x .79719 = 55,803

5,600 x 1.69005 = 9,464

Present value of future cash flows 65,267

The interest revenue to be recognized can then be determined using the effective interest method.

PV at 12/31/08 65,267

Interest income at 12/31/09 ($65,267 x 12%) 7,832

Interest receivable at 12/31/09 (70,000 x 8%) 5,600

Increase in carrying value of loan 2,232

PV at 12/31/09 67,499

Interest revenue at 12/31/10 (67,499 x 12%) $8,100

I think I get everything up to the point where the difference of interest increases the loan value… to the 67,499. I have been stuck on this topic for two days and I need to keep moving however, I want to make sure i get this.

any explanation and help/guidance through the answer would be most appreciated thank you guys so much!

Tiffany

FAR - 01/07/2013 - 66 - Rescheduling for April =)
AUD - TBD
BEC - TBD
REG - TBD

[Topsya]

i anyone could answer this one I would also really REALLY appreciate it

Thanks guys!

AUD - 90
FAR - 83
BEC - 81
REG - 80
ETHICS - 100

[Spur]

I think you'll just need to know how to go through the motions on this one. I'm betting that this will appear on my exam on Tuesday so I memorized how to do this. Not necessarily understand it, so if someone has the ability to do so, awesome…

FAR - Bad Fail '11, Fail '12, Fail '13, PASS It's a miracle!
AUD - Fail, PASS!!!!!!!!!!!!!!!!!!!!!!!
BEC - PASS!!!!!!!!
REG - PASS!!!!!!!! And I'm done!

[idavarcpa]

The effective rate is 12%. The new loan amount is 70K. Using PV of 70K in 2 years: 70k*0.79719=55803. In addition interst for 2 years 2009 & 2010=annuity 70K*8%(new rate)=5600 when effective rate is 12% will give you 5600*1.69005

=9464 for a total PV of 65,267. At the end of 2009 interest income should be 65,267*12%=7832 but only 5600 will be paid. The difference between 7832 and 5600 which is 2232 will increase the balanve of loan due to 65267+2232=67499. Next year the income revenue will be 67499*12%=8100 only 5600 will be paid for a difference of 8100-5600=2500 to be added to principal to be 67499+2500=70000(rounding) as agreed originally after restructuring.

[Tina82]

Think of this in terms of bonds.

When you restructure the note you PV at the original rate of 12% (this is your effective rate)

Interest payments are calculated at the reduced rate of 8% (this is your stated rate)

When you PV the new note and interest payments at the effective rate (same as you would do for bonds), the 65,267 is your carrying value of the debt. Since that amount is less that the $70,000 of the new note, there is a “discount” on the notes. You have to amortize that discount the same way you would do it for the bonds (using the effective interest method). So:

Year 3:

CV = 65,267

Interest receivable = 5,600 (the 70,000 FACE x stated rate which is equal to the reduced 8% rate)

Interest income = CV x effective rate of 12%

Difference between the receivable and income is amortization of the note discount, when you amortize a discount you have to add it to the CV of the note to come up with the CV at the end of year 3

So now in Year 4:

CV = 65,267 + 2,232 (the “discount”) = 67,499 this is the CV of note at the beginning of the year

Then you do the same as in year 3 to calculate the interest income and receivable

For bonds you have payable and interest expense, for a creditor these same amounts become interest receivable and income.

Hope this helps.

R - 74;88
A - 84
B - 74;89
F - no study = 67; May 15 = 87 & done

[MrsBing]

A good way to think of it is you always want to go to the face of the note. So if the carrying amount is less than the face, you'll add to the note until you reach $70k (the face). If the carrying amount was more than the face, you'd want to subtract.

Becker, Wiley Test Bank, and Ninja 10 Point Combo!

FAR: 89
REG: 87
AUD: 92
BEC: 75
Ethics: 90

Licensed Arizona CPA

[Author]

Replies