Troubled Debt: Serial Bonds and Lease Payments, Exams of Accounting

Download Troubled Debt: Serial Bonds and Lease Payments and more Exams Accounting in PDF only on Docsity! Name: __________________________________ Exam 1 Acct 414 – Corporate Accounting & Reporting II Spring 2006 Show any necessary computations if you want to be eligible for partial credit. Present your work in a neat, well-organized manner. If you are using a PV calculator, spell out what you put in for n, i, PMT, FV, PV, etc. Draw a time-line if that would explain your thinking to me. Follow the instructions and answer all parts of the question as directed. 1-4. Time Value of Money (15 points each, max = 60) 5-6. Leases. (60 points total) 7-8. Troubled debt (50 points total) 9. Serial Bonds (30 points) Extra credit points (if any) total: __________ Total points earned (max = 200) Exam 1 – Acct 414 – Spring 2006 Page 2 Are assets or an ownership interest transferred from debtor to creditor in settlement of debt? Is the debt settled in full? Is entity the CREDITOR? CREDITOR discounts expected future cash flows to be received under modified terms using original (historical) interest rate No No Yes Record ordinary gain or loss on asset. Difference between fair value of asset or equity interest and amount due on debt is a gain for DBTOR and ordinary loss for CREDITOR Yes Difference between carrying value of receivable and present value of expected future cash flows is ordinary loss for CREDITOR Are the cash flows to be made under the modified terms greater than the carrying value of the debt after transfer of any asset or equity interest? The difference between carrying value of debt and total future cash flows is recorded as a gain from restructuring for DEBTOR. No interest expense will be recorded in future years. No No gain is recorded by DEBTOR. Find interest rate to set cash flow equal to carrying value of debt. Use this interest rate to amortize the restructured debt over its term. Yes TROUBLED DEBT RESTRUCTURING (FASB 15, 114, 118 & 145) Prepared by T. Gordon 2-5-03 Record ordinary gain or loss on asset or equity interest transferred and reduce balance owed. Difference between fair value of asset or equity interest and new carrying value of debt is recognized as a gain from restructuring for DEBTOR and an ordinary credit loss for CREDITOR. No Yes Exam 1 – Acct 414 – Spring 2006 Page 5 5. Continued (facts repeated for your convenience) Tobby Co. manufactures machines to be sold or leased. On January 1, 2006, Tobby leased machinery to Upsilon, Inc. for a 5-year period. At the end of the lease term, the machinery is to be returned to Tobby. The machinery should be worth $10,000 at the end of the lease. Equal $21,168.38 payments are due at the beginning of each of the 5 years. Toby has no material uncertainties, and the likelihood of collecting all lease payments is high. The implicit rate of the lease is 7%. Upsilon (the lessee) does not know the implicit interest rate but could borrow money to buy the machinery at 10% per annum. The normal sales price of the machinery is $100,000, and the cost to Tobby is $90,000. The useful life of the machinery is 10 years. c. Prepare the journal entries on Tobby’s books (lessor) January 1, 2006 December 31, 2006 Exam 1 – Acct 414 – Spring 2006 Page 6 6. Lease Accounting. (20 points) On April 30, 2006, Muffy Vanderbear, Inc. (lessee) and Leases R Us (lessor) sign a noncancelable lease with the following terms: 1. Term: 5 years 2. Annual payment = $9,228 3. Implicit interest rate (known to lessee) 8% 4. Est. fair value of asset at end of lease $15,000 5. Fair value of asset $50,000 6. Cost of asset $50,000 7. Incremental borrowing rate: 9% 8. First payment due immediately 9. Estimated useful life of asset: 7 years 10. Purchase option at end of lease: $15,000 11. If the purchase option is not exercised, the lessee guarantees that the leased asset will be worth at least $10,000 at lease end. 12. The lease payments appear to be collectible and there are no additional costs expected by the lessor. 13. Both lessor and lessee use the straight-line depreciation method (no salvage value) a. What type of lease is this for Muffy Vanderbear, the lessee? Explain briefly. (4 points) b. Regardless of your answer to part (a), assume this is a capital lease for the lessee. Prepare a lease amortization schedule for Muffy Vanderbear Inc. for the first two years. (9 points) Date Lease Payment Interest Expense Amortized Principal Balance c. Regardless of your answer to a, assume the lease is a capital lease for the lessee. Prepare all necessary journal entries for the lessee, Muffy Vanderbear. Inc. at 4/30/06, 12/31/06 and 4/30/07. (12 points) 4/30/06 12/31/06 Exam 1 – Acct 414 – Spring 2006 Page 7 Exam 1 – Acct 414 – Spring 2006 Page 10 7. Troubled Debt (20 points). Brye Co. is indebted to Dole under a $900,000, 12%, three-year note dated December 31, 2004. Because of Brye's financial difficulties developing in 2006, Brye owed accrued interest of $108,000 on the note at December 31, 2005. Under a troubled debt restructuring, on December 31, 2005, Dole agreed to settle the note and accrued interest for a tract of land having a fair value of $600,000. Brye's acquisition cost of the land is $640,000. Prepare the creditor’s journal entries at 12/31/05 to record the troubled debt restructuring. Exam 1 – Acct 414 – Spring 2006 Page 11 8. Troubled Debt. (30 points) On Nov. 1, 2005, a $500,000 note to Montana Bank & Trust came due but Blue Bikes Corporation does not have enough cash to make the payment. Blue Bikes has already recorded as interest expense the $45,000 unpaid accrued interest and the bank has, likewise, booked the interest revenue receivable. The original note specified annual payments of $125,000 per year plus 9% interest on the unpaid balance. Since Blue Bikes is unable to make the payments, the bank has agreed to restructure the terms of the loan as follows:  The interest currently due is forgiven and will not need to be paid.  The term of the loan is extended until November 1, 2009.  The interest rate is reduced from 9% to 6% and will be paid annually on the 1st of November.  The principal amount owed is reduced by $30,000 to $470,000.  At the end of four years, on November 1, 2009, the principal will be due in a balloon payment. Prepare any journal entry (entries) needed on the debtor’s books at Nov. 1, 2005, December 31, 2005, Nov. 1, 2006. Exam 1 – Acct 414 – Spring 2006 Page 12 9. Serial Bonds (30 points). On Nov. 1, 2005, Trains R Us Corporation issued $6,000,000 in serial bonds. The bond principal will be repaid in $2,000,000 increments beginning on Nov. 1, 2006 with the final payment to be made on Nov. 1, 2008. The bonds pay interest semi-annually on Nov. 1 and May 1. The coupon rate is 9% per annum. An investment banker handled the transaction and the company has just received a check for $5,895,189. The fiscal year of Trains R Us ends on December 31. You may choose either the bonds outstanding method or the effective interest method of amortizing bond premiums. Check the appropriate box so I’ll know what you are attempting! Prepare all necessary journal entries on the dates listed.  I’m using the bonds outstanding method for a maximum of 30 points  I’m using the effective interest method for a maximum of 28 points. If you choose this option, you may assume that the interest rate per year is 10% per annum compounded semi-annually. December 31, 2005 (NOT the date of issue) May 1, 2006 November 1, 2006 Acct 414 Exam 1 – Spring 2006 SOLUTION Page 3 Journal entries on Debtor’s books (not required) Recognize increase in value of land on debtor’s books: Loss on disposition of land 40,000 Land 40,000 Remove debt and land from books, recognize gain: Notes payable 900,000 Accrued interest payable 108,000 Land 600,000 Gain on troubled debt restructuring 408,000 Problem 8 – Debtor accounting for troubled debt Carrying value = $545,000, Future cash flows are $582,800. Therefore, no gain is recognized and the excess over carrying value is treated as interest expense over the new term of the note payable. To determine the new interest rate: PV= -545,000, PMT= 28,200, FV= 470,000, n=4, SOLVE FOR i=1.83% Cash Int Exp Diff Balance 11/1/2005 - 1.83% - 545,000.00$ 11/1/2006 28,200 $9,956 (18,244) 526,756 11/1/2007 28,200 $9,623 (18,577) 508,179 10/31/2008 28,200 $9,283 (18,917) 489,262 11/1/2009 498,200 $8,938 (489,262) 0 582,800 = total cash flows Debtor journal entries Debit Credit 11/1/2005 Accrued interest payable 45,000 Note payable (old) 500,000 Note payable (new) 545,00 0 12/31/2005 Interest expense 1,659 Note payable (or interest payable) 1,659 2 Months to accrue at year end 0.166666667 = 2/12 11/1/2006 Interest expense 8,297 Notes payable* 19,903 Cash 28,200 If interest payable account was used at 12/31/05, you would also need a debit here in the same amount. This would change the debit to Notes Payable from $19,903 as shown above to $18,244 Acct 414 Exam 1 – Spring 2006 SOLUTION Page 4 Problem 9 – TABLES WERE NOT REQUIRED Bonds Outstanding Method 4.50% Face Value: 6,000,000 Period Date Interest Principal Interest Amorti- Carrying BALANCE FACE Amortization Paid Payment Expense zation Value DISCOUNT VALUE Fraction 0 11/01/05 - - - 5,895,189 (104,811) 6,000,000 1 05/01/06 270,000 - 296,203 (26,203) 5,921,392 (78,608) 6,000,000 0.25000 2 11/01/06 270,000 2,000,000 296,203 (26,203) 3,947,595 (52,405) 4,000,000 0.25000 3 05/01/07 180,000 - 197,468 (17,468) 3,965,063 (34,937) 4,000,000 0.16667 4 11/01/07 180,000 2,000,000 197,468 (17,468) 1,982,532 (17,468) 2,000,000 0.16667 5 05/01/08 90,000 - 98,734 (8,734) 1,991,266 (8,734) 2,000,000 0.08333 6 11/01/08 90,000 2,000,000 98,734 (8,734) 0 - 0 0.08333 7 05/01/09 - - - - 0 - 0 0.00000 24,000,000 1.00000 Journal entries: Exam 1 - Spring 2006 Bonds Outstanding Method Debit Credit 11/01/05 Cash 5,895,189 NOT REQUESTED Discount on Bonds Payable 104,811 Bonds Payable 6,000,000 12/31/05 Interest Expense 98,734 Interest Payable 90,000 Discount on Bonds Payable 8,734 FRACTION OF ROW FOR YEAR END ACCRUAL 33.3% (Using yearfrac function) 2/6 33.3% 05/01/06 Interest Expense 197,468 Interest Payable 90,000 Discount on Bonds Payable 17,468 Cash 270,000 11/01/06 Interest expense 296,203 Bonds Payable 2,000,000 Discount on Bonds Payable 26,203 Cash 2,270,000 EFFECTIVE INTEREST AMORTIZATION SCHEDULE 4.50% 5.000% Face Value: 6,000,000 Period Date Interest Principal Interest Amorti- Carrying BALANCE FACE Paid Payment Expense zation Value DISCOUNT VALUE 0 11/01/05 0 0 0 5,895,189 (104,811) 6,000,000 1 05/01/06 270,000 294,759 (24,759) 5,919,949 (80,051) 6,000,000 2 11/01/06 270,000 2,000,000 295,997 (25,997) 3,945,946 (54,054) 4,000,000 3 05/01/07 180,000 197,297 (17,297) 3,963,244 (36,756) 4,000,000 4 11/01/07 180,000 2,000,000 198,162 (18,162) 1,981,406 (18,594) 2,000,000 5 05/01/08 90,000 99,070 (9,070) 1,990,476 (9,524) 2,000,000 6 11/01/08 90,000 2,000,000 99,524 (9,524) (0) (0) 0 7 05/01/09 0 (0) 0 (0) (0) 0 Journal entries: Exam 1 - Spring 2006 Effective Interest Method Debit Credit 11/01/05 Cash 5,895,189 Discount on Bonds Payable 104,811 Bonds Payable 6,000,000 12/31/05 Interest Expense 98,253 Interest Payable 90,000 Discount on Bonds Payable 8,253 05/01/06 Interest Expense 196,506 Interest Payable 90,000 Discount on Bonds Payable 16,506 Cash 270,000 11/01/06 Interest expense 295,997 Bonds Payable 2,000,000 Discount on Bonds Payable 25,997 Cash 2,270,000 8,680,757 8,680,757 0 Acct 414 Exam 1 – Spring 2006 SOLUTION Page 5