Question

Ferguson Company issues a one-year interest-bearing note in return for inventory purchased from Allegri Company. The note has stated rate of 5% and face value of $3,300,000. Interest is paid in every 3 months. After the second interest payment is made, Ferguson and Allegri agree to settle the note. Ferguson gives Allegri securities with a fair value of $3,000,000 for the settlement. The carrying value of the securities is equal to their fair value. Remaining total interest expense until maturity was $190,000 on the day of settlement. Ignoring income taxes, what is the effect of this settlement on Ferguson’s stockholders’ equity?

Answer 1

Solution:

Outstanding Notes of $3,300,000 was settled by fair value of securities amounted to $3,000,000.

Settlement is in additional proceeds of $300,000 as fair value of securities is less than the Outstanding Notes.

This additional proceeds will be taken taken in Profit and loss account.

$190,000 is not due so there is no adjustment for this, but profit for equity is incresed as it will be not paid in future.

So net profit increase = $300,000 + $190,000 = $490,000