Question

7. Cromwell Company has a debt investment in the bonds issued by Hsu Inc. The bonds were purchased at par for $400,000 and, at the end of 2020, have a remaining life of 3 years with annual interest payments at 10%, paid at the end of each year. This debt investment is classified as held-for collection.

Hsu is facing a tough economic environment and informs all of its investors that it will be unable to make all payments according to the contractual terms. The controller of Cromwell has prepared the following revised expected cash flow forecast for this bond investment.

Dec. 31                         Expected Cash Flows

2023                            $ 35,000

2024                                35,000

2025                              385,000

Total cash flows            $455,000

Required:

a. What is the impairment loss for Cromwell on December 31, 2022? (Show your work.)

b. Prepare the entry to record the impairment loss for Cromwell on December 31, 2022.

c. On January 15, 2023, Hsu receives a major capital infusion from a private equity investor. Hsu informs Cromwell that the bonds now will be paid according to the contractual terms. Briefly describe how Cromwell would account for the bond investment in light of this new information.

Answer 1

Answer :

(a)

Contractual cash flow
[($400,000 X .10 X 3) + $400,000]......................... $520,000
Expected cash flow ................................................ (455,000)
Cash flow loss ........................................................ $ 65,000
Recorded investment ............................................. $400,000
Less: Present value of $350,000 due in
3 years at 10% ($350,000 X .75131) .......... $262,959
Present value of $35,000 annual interest
for 3 years at 10% ($35,000 X 2.48685) .... 87,040 349,999
Impairment loss ...................................................... $ 50,001

(b)

Loss on Impairment ................................................ 50,001
Debt Investments ............................................ 50,001

(c)

Since Cromwell will now receive the contractual cash flow ($520,000) there is no cash flow loss. Therefore Cromwell must reverse the impairment loss by debiting Debt Investments and crediting Recovery of Impairment Loss.

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