Part I: (Term Modification without Gain—Debtor’s Entries)
On December 31, 2010, the American Bank enters into a debt restructuring agreement with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $3,000,000 note receivable by the following modifications:
1. Reducing the principal obligation from $3,000,000 to $2,400,000.
2. Extending the maturity date from December 31, 2010, to January 1, 2014.
3. Reducing the interest rate from 12% to 10%.
Barkley pays interest at the end of each year. On January 1, 2014, Barkley Company pays $2,400,000 in cash to Firstar Bank.
Instructions:
(a) Will the gain recorded by Barkley be equal to the loss recorded by American Bank under the debt restructuring?
(b) Can Barkley Company record a gain under the term modification mentioned above? Explain.
(c) Assuming that the interest rate Barkley should use to compute interest expense in future periods is 1.4276%, prepare the interest payment schedule of the note for Barkley Company after the debt restructuring.
(d) Prepare the interest payment entry for Barkley Company on December 31, 2012.
(e) What entry should Barkley make on January 1, 2014?
Part II: (Lessee-Lessor Entries, Sales-Type Lease)
On January 1, 2011, Palmer Company leased equipment to Woods Corporation. The following information pertains to this lease.
1. The term of the noncancelable lease is 6 years, with no renewal option. The equipment reverts to the lessor at the termination of the lease.
2. Equal rental payments are due on January 1 of each year, beginning in 2011.
3. The fair value of the equipment on January 1, 2011, is $200,000, and its cost is $150,000.
4. The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,000. Woods depreciates all of its equipment on a straight-line basis.
5. Palmer sets the annual rental to ensure an 11% rate of return. Woods’s incremental borrowing rate is 12%, and the implicit rate of the lessor is unknown.
6. Collectability of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by the lessor.
Instructions:
(Both the lessor and the lessee’s accounting period ends on December 31.)
(a) Discuss the nature of this lease to Palmer and Woods.
(b) Calculate the amount of the annual rental payment.
(c) Prepare all the necessary journal entries for Woods for 2011.
(d) Prepare all the necessary journal entries for Palmer for 2011.