Question

Lake Company, a major creditor of financially troubled Spain Company, has agreed to modify the terms of a debt owed to Lake Company. The debt consists of a $810,000, 11% note that is due currently along with accrued interest of $110,000. The terms of modification of the debt are

1.		Accrued interest of $110,000 is to be canceled.
2.		The face value of the note is reduced to $660,000, payable at the end of three years. Interest on the new face value at 7% is to be paid annually.

(a)

Should a gain on restructuring be recognized?

YesNo

(If no gain is to be recognized, please enter 0. Do not leave any fields blank.)

Amount of gain to be recognized

$

Answer 1

Yes, the gain should be recognized because of the total future cash payments specified by the new terms of $798,600 ($660,000 carrying value plus 3 years’ interest at $46,200 per year) lower than the current carrying value of the debt, $920,000.

Amount of gain to be recognized $324,509

Present Value of Principal $482,592

($660,000 x PV factor at 11% for 3 years)

($660,000 x 0.7312)

Present Value of Interest $112,899

($46,200 x Annuity PV factor at 11% for 3 years)

($46,200 x 2.4437)

Value of restructured loan = $595,491

Amount of gain = $920,000 - $595,491 = $324,509