Blueberry Corp used to be a leading smartphones maker; it is not the leader anymore. In recent years is has seen it competitors Pineapple and Smashsong introducing more advanced models and grabbing significant market share from Blueberry. As a result, sales have been going down, and the past strong profitability is long gone. In the last 2 years the company started to feel the pressure from the competition on its cash flows. The company has a note it issued to Canada Richest Bank (CRB) on January 1, 2011, exactly 3 years ago with the following terms: 5-year, $12M, 6% stated rate, paid semi-annually. Given the level of risk, CRB paid Blueberry $11,501,004 for the note. With the pressure on its cash flows, Blueberry is facing difficulties in meeting its interest payments. It is also very worried about the $12M it will have to pay CRB in 2 years. In recent weeks Blueberry was discussing with CRB the possibility of receiving some concessions on the note. After endless meetings, on December 31.12.2013, CRB agreed to modify the terms of the loan as follows: stated rate will go down from 6% to 5%, the principal will be reduced by $0.7M, and the loan will be extended until 31.12.2017. Any interest incurred on the note, should be paid on that date, before the terms change.
Blueberry has just hired you to advise them on how to account for the modification to the loan (they promised to pay you a nice sum after you submitted the assignment, lol). Below are the questions they want you to answer:
Required: (round the numbers in your answers when appropriate)
A) Explain in general terms the accounting treatment to changes in terms of existing loans.
B) What should be the accounting treatment of the modification to Blueberry’s note?
C) Provide any journal entry if needed.
D) Would your answer to (B) change if CRB agreed to lower the principal by only $0.4M? Explain.
E) For the case principal is reduced by only $0.4M, provide the journal entry Blueberry will record for the interest on June 30, 2014.