Presentation on theme: "Prepared by: Gabriela H. Schneider, CMA Northern Alberta Institute of Technology INTERMEDIATE ACCOUNTING Seventh Canadian Edition KIESO, WEYGANDT, WARFIELD,"— Presentation transcript:
Prepared by: Gabriela H. Schneider, CMA Northern Alberta Institute of Technology INTERMEDIATE ACCOUNTING Seventh Canadian Edition KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK
9.Account for impairments on notes and loans receivable 10.Distinguish between and account for debt restructurings resulting in extinguishment versus debt continuation Learning Objectives
Accounting Issues In troubled debt cases, two important issues emerge:In troubled debt cases, two important issues emerge: When should a loss be recognized?When should a loss be recognized? When it is likely a loss will occur, andWhen it is likely a loss will occur, and When the loss can be measuredWhen the loss can be measured What is the amount of loss to be recognized?What is the amount of loss to be recognized?
Troubled Debt: Key Terms Troubled debt Impairment Restructuring Probable loss: Creditor unable to collect principal and interest. Creditor grants a concession to debtor due to debtor’s financial difficulties.
Troubled Debt: Key Terms Restructuring Creditor grants a concession to debtor due to debtor’s financial difficulties. Settlement Modification of Terms Debtor transfers equity interest or assets to creditor 1. Reduction of principal 2. Reduction of interest rate 3. Extension of maturity date 4. Reduction of accrued interest
Progression of Troubled Debt Loan Origination Loan Impairment Restructuring Foreclosure /Bankruptcy Creditor recognizes loss Debtor may recognize gain/Creditor refines estimate of loss If all else fails – to ensure some level of collection
Impairment of Loans/Notes Receivable Loss measured at estimated realizable valueLoss measured at estimated realizable value –Expected future cash flows discounted at the historical interest rate When future cash flows not determinable loss measured at:When future cash flows not determinable loss measured at: –FV of any security attached to loan, or –Market price of loan (if any)
Impairments—Example Given: December 31, 2004: $500,000 5-year note issued to Community Bank Effective interest rate: 10% Entries to record the issuance of the note
Impairments—Example Cash310,460 Discount on Notes Payable189,540 Notes Payable500,000 Debtor Creditor Notes Receivable500,000 Discount on Notes Receivable189,540 Cash310,460
Impairments—Example Loan becomes impaired December 2006Loan becomes impaired December 2006 Future cash flows expected: $300,000Future cash flows expected: $300,000 Amount of loss to be recorded based on expected future cash flowsAmount of loss to be recorded based on expected future cash flows Loss equal to:Loss equal to: Carrying value of loan less less PV of expected future cash flows
Impairments—Example PV of expected future cash flows: Expected future cash flow: $300,000 Discounted at: 10% Number of discount periods: 3 Present value = $225,396 Carrying value of loan At December 31, 2004 $310,460 Dec. 31/05 Accrued Interest (310,460 x 10%) 31,046 341,506 341,506 Dec. 31/06 Accrued Interest (341,506 x 10%) 34,151 Carrying Value $375,657
Impairments—Example Entry to record the loss: Bad Debt Expense150,261 Allowance for Doubtful Accounts150,261 Allowance for Doubtful Accounts150,261 Loss on Impairment: Carrying value of loan less $375,657 PV of expected future cash flows = 225,396 $150,261 $150,261
Interest and Amortization After Impairment Date Cash Received 0% Interest Revenue (10%) Discount Amortized Carrying Amount of Note 12/31/06$225,396 12/31/07$0$22,540$22,540247,936 12/31/08024,79424,794272,730 12/31/09027,27327,273300,000 Total$0$74,607$74,607
Interest and Amortization After Impairment December 31, 2007 entry: Discount on Note22,540 Interest Income 22,540 December 31, 2009 entry: Allowance for Doubtful150,261 Cash300,000 Cash300,000 Discount on Note 49,739 Discount on Note 49,739 Note Receivable500,000
Troubled Debt Restructurings When a creditor grants a favorable concession to a debtorWhen a creditor grants a favorable concession to a debtor Two basic types of transactionsTwo basic types of transactions 1.Settlement of debt at less than carrying value 2.Continuation of debt with modification of terms
Gain or Loss: Debtor and Creditor Settlement DebtorCreditor Gain = excess of carrying amount of payable over fair value of assets transferred to creditorGain = excess of carrying amount of payable over fair value of assets transferred to creditor The gain is not extraordinaryThe gain is not extraordinary Recognize loss or gain on disposition of non-cash assets transferred to creditorRecognize loss or gain on disposition of non-cash assets transferred to creditor Loss = excess of loan receivable over fair value of assets received from debtorLoss = excess of loan receivable over fair value of assets received from debtor The loss is ordinary and is charged to Allowance for Doubtful AccountsThe loss is ordinary and is charged to Allowance for Doubtful Accounts
Modification of Terms No gain or loss recognizedNo gain or loss recognized New effective interest rate must be foundNew effective interest rate must be found –Carrying value of old debt equates to cash flows of newly arranged debt First step requiredFirst step required –Determine if a settlement has occurred or a modification of terms
Modification of Terms—Example Given: Debt terms are modified Carrying value of debt:$10,500,000 Total future cash flows:$11,880,000 Annual payments:$ 720,000 The effective interest rate must be such that the PV of $11,880,000 is $10,500,000 In this case (using a financial calculator and n = 4, interest rate = 3.466%)
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