Fischer Chap 21

7/28/2019 Fischer Chap 21

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817

CHAPTER 21

UNDERSTANDING THE ISSUES

1. Given a restructuring that is not underbankruptcy law, the gain on restructuring ismeasured as the amount by which the bookvalue of the debt, including accrued inter-est, exceeds the total of all restructuredprincipal and interest payments. If the totalpayments exceed the book value, no gainis recognized. Note that the present valueof the payments received is not consideredin the determination of the gain. For arestructuring that is under bankruptcy law,the gain is measured as the amount by

which the book value of the debt, includingaccrued interest, exceeds the fair value ofthe restructured consideration received.

The value of the consideration received isthe net present value of the restructuredpayments.

2. A corporate reorganization is a legal rem-edy designed to restructure the debt and/orequity of a troubled company so that thecompany may continue to operate andultimately become financially sound. Theultimate goal of a reorganization is toprovide a more attractive alternative thanliquidation and allow the company to con-tinue its business purpose. A corporateliquidation does not hold promise for a re-covery but rather is designed to facilitate atermination of the business. Assets of thecompany are converted into a distributableform and conveyed to creditors and share-holders to whatever extent possible. Uponcompletion of the distribution of assets, thebusiness entity ceases to exist.

3. If a creditor is fully secured, by definition noportion of their claim will become unse-cured. However, if the value of the assetssecuring their claim exceeds the amount ofthe claim, such excess amounts willbecome available to unsecured creditors.

The claims of partially secured creditorsexceed the value of the assets securingtheir claims. Therefore, the unsecuredamounts are combined with the other exist-ing unsecured claims. Once the total of allunsecured claims is identified, those unse-

cured claims will proceed against theremaining assets of the company in orderof priority.

4. The statement of realization and liquidationserves several purposes. First, it provides areporting of the activities of the trustee inliquidation and helps discharge the fiduci-ary responsibility. The statement alsodocuments that available assets are beingdistributed properly among the variouscreditors and in the proper order of priority.A review of the statement may also provideoutstanding creditors with some sense ofhow much they may receive in satisfactionof their claims.


2/24

Ch. 21Exercises

818

EXERCISES

Note: Some calculations may vary due to rounding or method of calculation. Answers presentedhave been determined using Excel.

EXERCISE 21-1

Al ternative AIncome Statement Impact

First Month:

Gain on land:Fair market value......................................................................... $ 380,000.00Carrying value.............................................................................. (260,000.00)Gain ............................................................................................. $ 120,000.00

Gain on restructuring:

Remaining carrying value of debt:Original carrying value............................................................. $ 566,975.00Value of land........................................................................... (380,000.00)Current carrying value............................................................. $ 186,975.00

Sum of remaining payments:Number of payments............................................................... 40Amount of payment................................................................. $ 5,068.00Sum of payments .................................................................... $ 202,704.00

Because the restructured payments exceed the current carryingvalue, there is no gain on restructuring.

Interest expense:Effective interest rate is 4.8%

where n = 40, present value is $186,974.50,and payment is $5,067.60.

Interest expense:Current carrying value ................................................................. $ 186,974.50Interest rate (4.8%/12)................................................................. 0.40%Interest expense.......................................................................... $ 747.90

Second Month:

Interest expense:Current carrying value ................................................................. $ 182,654.73

where n = 39, interest rate = 4.8%/12,and the payment is $5,067.60.

Interest rate (4.8%/12)................................................................. 0.40%Interest expense.......................................................................... $ 730.62


3/24

Ch. 21Exercises

819

Exercise 21-1, Concluded

Alternative BIncome Statement Impact

First Month:

Gain on land:Fair market value......................................................................... $ 380,000.00Carrying value.............................................................................. (260,000.00)Gain ............................................................................................. $ 120,000.00

Gain on restructuring:Remaining carrying value of debt:

Original carrying value............................................................. $ 566,974.50Value of land........................................................................... (380,000.00)Current carrying value............................................................. $ 186,974.50

Sum of remaining payments:Number of payments............................................................... 60

Amount of payment................................................................. $ 3,000.00Sum of payments .................................................................... $ 180,000.00

Because the restructured payments do not exceed the currentcarrying value, there is a gain on restructuring. However, in thiscase, there will be no interest expense.

Gain on restructuring:Current carrying value............................................................. $ 186,974.50Sum of payments .................................................................... (180,000.00)Gain......................................................................................... $ 6,974.50

Interest expense................................................................................... Not applicable

Second Month:

Interest expense................................................................................... Not applicable


4/24

Ch. 21Exercises

820

EXERCISE 21-2

Effect on Net IncomeItem Increase (Decrease)

Exchange of preferred stock for debt ($5,100,000 of preferred stock,

at market value in exchange for $5,500,000 of debt)............................. $ 400,000Exchange of land for debt ($3,000,000 of land at book value inexchange for $4,500,000 of debt).......................................................... 1,500,000

Restructuring of remaining debt of $10,875,000 with semiannualpayments of $818,016. The sum of the payments is $16,360,320(20 $818,016). Since the sum of the payments exceeds theunpaid balance, no gain is recognized on the restructuring................... 0

Total effect on net income............................................................................ $ 1,900,000Retained earnings before restructuring........................................................ (3,400,000)Adjusted retained earnings .......................................................................... $(1,500,000)

In order to eliminate the deficit in retained earnings, the contributed capital in excess of par val-ue would be reduced to zero, and the par value of the common stock would have to be reducedby $500,000.

EXERCISE 21-3

(1) The impact on the ratios is directly related to how each of the actions taken by manage-ment impacts the financial statements. The recognition of impairment losses will decreaselong-lived assets and decrease net income and corresponding shareholders equity. Futureperiods will base depreciation/amortization on the long-lived assets on the lower impairedvalue, which will increase future income. The restructuring of the long-term debt will resultin a restructuring gain. However, since the future cash payments are less than the carryingbasis of the original debt, no interest expense will be recognized in future periods. Theadjustment of the par value of common stock in order to eliminate the deficit in retainedearnings will have no impact on net income nor will it change the total amount of share-holders equity. Given the above, it would appear that the current ratio would be affected bythe current portion of the restructured debt. Given the fact that the payments are less thanthe carrying basis of the original debt, the current portion could very easily be less and,therefore, the current ratio could increase. It is clear that the debt restructuring would leavethe company with less debt, which, absent any other information, would result in adecrease in the debt-to-equity ratio. However, the net effect on income of the impairmentloss and the gain on restructuring will obviously have an impact on equity. Therefore, thedebt-to-equity ratio must also reflect any changes due to these transactions. The return onequity would be affected by the net effect on income of the impairment loss and the restruc-

turing gain. This net effect would obviously impact net income and the balance in retainedearnings. The adjustment of par would have no effect on the return on equity because thetotal equity is not changed as a result of eliminating the deficit.

(2) Net income in future periods would be affected by lower depreciation/amortization expenseand no interest expense on the new restructured debt.


5/24

Ch. 21Exercises

821

EXERCISE 21-4

Outstanding DebtA B C D

Total amount due.............................. $ 84,000 $ 520,000 $328,000 $350,000Less amounts applied against debt:

Value of assets transferred......... (80,000) (120,000) (48,339)Value of stock transferred........... (380,000)

Remaining debt................................. $ 4,000 $ 20,000 $328,000 $301,661Total of periodic payments to be

applied against remaining debt...... $ $ $300,000 $320,000

Regarding Debt A: A gain on restructuring of $4,000 would be recognized because no otherconsideration is being conveyed to satisfy the remaining debt. There would be no interestexpense.

Regarding Debt B: A gain on restructuring of $20,000 would be recognized because no otherconsideration is being conveyed to satisfy the remaining debt. There would be no interestexpense.

Regarding Debt C: Because the total of the periodic payments is less than the remaining debt,there would be a gain of restructuring in the amount of $28,000. Furthermore, because the pe-riodic payments are less than the remaining debt, no interest expense would be recognized. Allperiodic payments are considered to be a reduction of the revised principal amount due of$300,000.

Regarding Debt D: Because the total of the periodic payments exceeds the remaining debt,there is no gain on restructuring. The periodic payments totaling $320,000 therefore represent apayment of the remaining principal amount due of $301,661 and total interest in the amount of$18,339. The interest rate is that rate which discounts the five semiannual payments so thattheir present value is $301,661. This semiannual rate is 2%, and the interest for the first sixmonths is $6,033 (2% $301,661).


6/24

Ch. 21Exercises

822

EXERCISE 21-5

(1) Debt Restructuring

Nonbankruptcy BankruptcyApproach Approach

Carrying basis of debt:

Principal ......................................................................... $2,100,000 $2,100,000Accrued interest............................................................. 72,737 72,737

$2,172,737 $2,172,737

Basis of consideration exchanged for debt (see Note A):Sum of future payments ................................................. $2,400,000 N/APresent value of future payments .................................. N/A $1,758,004

Total............................................................................... $2,400,000 $1,758,004

Gain on forgiveness of debt................................................. $ 200,000 $ 200,000Gain on debt restructuring (see Note B) .............................. 0 214,733

Total............................................................................... $ 200,000 $ 414,733

Future interest expense (see Note C) .................................. $ 427,263 $ 641,996

Note A: The carrying value of the debt that is not forgiven is $1,972,737 ($2,100,000 $200,000 + $72,737). If this debt is to be serviced over 60 months at an interest rate of 8%,the monthly payments are $40,000. The total of these payments is $2,400,000 ($40,000 60 months). The net present value of these payments using a market rate of interest of 13%is $1,758,004.

Note B: Under the nonbankruptcy approach, a gain on restructuring results only if the sum ofthe future payments is less than the carrying basis of the restructured debt. Under the bank-ruptcy approach, a gain is recognized to the extent that the fair value of the considerationreceived ($1,758,004) is less than the carrying basis of the restructured debt ($1,972,737).

Note C: Under the nonbankruptcy approach, the total interest expense is represented by thedifference between the sum of the future payments ($2,400,000) and the carrying basis ofthe restructured debt ($1,972,737). In a bankruptcy approach, the total interest expense isrepresented by the difference between the sum of the payments ($2,400,000) and the pre-sent value of the future payments using a market rate of interest ($1,758,004).

(2) Nonbankruptcy BankruptcyApproach Approach

Retained earnings deficit...................................................... $ 500,000 $ 500,000Gain on forgiveness and restructuring of debt..................... (200,000) (414,733)*Revised deficit...................................................................... $ 300,000 $ 85,267

Present paid-in capital in excess of par value...................... (80,000) (80,000)Necessary reduction in par value of common stock............. $ 220,000 $ 5,267

*If the gain had been recorded directly as an increase in paid-in capital rather than as acomponent of net income, the answer would remain the same.


7/24

Ch. 21Exercises

823

EXERCISE 21-6

(1) QuarterlyItem Cash Outflows

Loan A restructuring:$3,580,000 restructured at 10%, 8 years, and monthly

installments. The monthly payment is $50,000..................................... $150,000

Loan B restructuring:No effect on cash outflows.................................................................... 0

Loan C restructuring:Debt to be paid in installments is $1,787,500 ($2,000,000 +$37,500 $250,000). Given n = 20 and i = 2.25%,the payment is $111,973...................................................................... 111,973

Total quarterly cash outflows.. ..................................................................... $261,973

(2) Effect on Net Income If

Part of a Not Part of aItem Formal Filing Formal Filing

Loan A restructuring:Gain on forgiveness of debt................................................ ... $500,000 $500,000Gain on restructuring of remaining debt:

Total payments = $4,800,000 (96 $50,000). Net presentvalue of payments is $3,295,074 versus carrying basis of$3,580,000........................................................................ 284,926

Interest expense:Based on stated rate of 10%............................................... .. (81,812)Based on imputed rate of 7.6644% (see note).................... .. (68,075)

Loan B restructuring:Gain on forgiveness of accrued interest................................ 25,000 25,000Gain on exchange of preferred stock..................................... 100,000 100,000

Loan C restructuring:Gain on transfer of land......................................................... 50,000 50,000Interest based on 9%........................................................... .. (40,219) (40,219)

Total effect on net income for the first quarter........................... $837,895 $566,706

Note: This is the interest rate given a periodic payment of $50,000, the 96 monthly periods,and a present value of $3,580,000.


8/24

Ch. 21Exercises

824

EXERCISE 21-7

LiabilitiesUnsecured

Fully Partially With WithoutSecured Secured Priority Priority Total

Accounts payable.......................... $130,000 $150,000 $ 280,000Note payableA........................... $560,000 40,000 600,000Note payableB........................... 300,000 200,000 500,000Mortgage payable......................... 180,000 180,000Accrued interest............................ 12,000 12,000Other liabilities............................... $10,000 14,000 24,000

$322,000 $860,000 $10,000 $404,000 $1,596,000

RealizableValue

Assets to be applied againstthe liabilities:Inventory $ 150,000 $130,000 $ 20,000 $ 150,000

Inventory.................................... 200,000 $200,000 200,000Receivables ............................... 360,000 360,000 360,000Equipment.................................. 300,000 300,000 300,000Equipment.................................. 60,000 60,000 60,000Land........................................... 260,000 192,000 68,000 260,000Cash........................................... 60,000 $10,000 50,000 60,000Other assets............................... 45,000 45,000 45,000

$1,435,000 $322,000 $860,000 $10,000 $243,000 $1,435,000

Dividend..................................... 100.0% 100.0% 100.0% 60.15%

Total consideration to be received by Note B:

Received toward partially secured portion............................. $300,000

Received toward unsecured portion:

Unsecured portion........................................................... $200,000

Dividend........................................................................... 60.15% 120,300

Total consideration received.................................................. $420,300


9/24

Ch. 21Exercises

825

EXERCISE 21-8

(1) Nonbankruptcy Approach Bankruptcy ApproachAlternative A Alternative B Alternative A Alternative B

Income StatementGain on sale of land:

Market value of land............ $550,000 $550,000 $550,000 $550,000Basis of land........................ (400,000) (400,000) (400,000) (400,000)Gain on sale of land............. $150,000 $150,000 $150,000 $150,000Land transaction costs......... (35,000) (35,000) (35,000) (35,000)Net gain on sale of land....... $115,000 $115,000 $115,000 $115,000Gain on restructuring

(see Schedule A)............. 85,000 0 355,393 361,027Income statement effect............ $200,000 $115,000 $470,393 $476,027

Balance SheetBefore restructuring:

Land..................................... $ 400,000 $ 400,000 $ 400,000 $ 400,000

Note payable........................ 2,000,000 2,000,000 2,000,000 2,000,000Retained earnings................ 0 0 0 0

After restructuring:Land..................................... $ 0 $ 0 $ 0 $ 0Note payable........................ 1,400,000 1,700,000 1,129,607 1,338,973Retained earnings................ 200,000 115,000 470,393 476,027

Schedule A

Nonbankruptcy Approach Bankruptcy ApproachAlternative A Alternative B Alternative A Alternative B

Original basis of debt................. $2,000,000 $2,000,000 $2,000,000 $2,000,000Less net land proceeds ............. (515,000) (300,000) (515,000) (300,000)Remaining balance.................... $1,485,000 $1,700,000 $1,485,000 $1,700,000Remaining payments:

Absolute value..................... (1,400,000) (1,700,000)Net present value

discounted at 6%............. 1,129,607 1,338,973Gain on restructuring................. $ 85,000 $ 0 $ 355,393 $ 361,027

(2) Given a nonbankruptcy approach, Alternative B would be preferable since it involves givingup the least net present value in satisfaction of the original debt. Furthermore, Alternative Bretains some of the cash that was realized from the sale of the land. It is possible that thiscash can be put to a more productive use rather than being invested in a nonoperating as-set such as idle land. If interest rates were to rise over time, it might be advantageous to

lock into an interest rate for a longer period of time. Alternative B has a lower net presentvalue of consideration given up in satisfaction of the debt than does Alternative A as setforth below.

Alternative A Alternative BNet present values:

Cash from sale of land......... $ 515,000 $ 300,000Remaining payments........... 1,129,607 1,338,973

Total..................................... $1,644,607 $1,638,973


10/24


11/24


12/24

Ch. 21Problems

828

PROBLEMS

Note: Some calculations may vary due to rounding or method of calculation. Answers presentedhave been determined using Excel.

PROBLEM 21-1

Atoyo Fabricating, Inc.Evaluation of Proposed Plan of Reorganization

Consideration Suggestedto Be Received if a Monthly See

Liability Type of Claim Book Value Liquidation Reorganization PaymentNote

Accounts payable............. Fully secured $ 40,000 $ 40,000 $ 40,000 $13,601 AAccounts payable............. Partially secured 74,000 66,815 58,820 20,000 BAccounts payable............. Unsecured 20,000 14,868 14,560 3,000 C

Equipment note................ Partially secured 338,000 334,664 338,000 9,732 DShareholder note.............. Partially secured 20,000 18,717 22,460 6,482 EMortgage payable............ Fully secured 448,000 448,000 448,000 4,266 FOther creditors ................. Unsecured 160,000 118,944 130,838 17,099 G

$1,100,000 $1,042,008* $1,052,678 $74,180

*Difference due to rounding errors.

Note A:The payment is based on a present value of $40,000, a period of three months, and aninterest rate of 1% per month.

Note B: The present value of the three payments of $20,000 at a monthly interest rate of 1% is$58,820. The amount to be received if a liquidation is the $46,000 plus the remaining unsecuredamount of $28,000 times 74.34%.

Note C:The present value of the five payments of $3,000 at a monthly interest rate of 1% is$14,560. The amount to be received upon liquidation is $20,000 times 74.34%.

Note D: The payment that would be the lowest is one based on a present value of $338,000, aterm of 42 months, and an interest rate of 11%. The payment would be $9,732. The amount tobe received upon liquidation is $325,000 plus 74.34% of the unsecured portion of $13,000.

Note E: In addition to the $15,000 secured amount, the shareholder would have received74.34% of the remaining $5,000, or $3,717, for a total of $18,717. The payments to equal 120%of this amount ($22,460), given a term of four semiannual periods and an interest rate of 12%,would be $6,482.

Note F: The payment is based on a present value of $448,000, a period of 360 months, and aninterest rate of 11%.

Note G: The unsecured creditors would have received 74.34% as a dividend, or $118,944.110% of this amount would be equal to $130,838. The payments necessary to equal this pre-sent value, given eight monthly periods and an interest rate of 12%, is $17,099.


13/24

Ch. 21Problems

829

Problem 21-1, Concluded

Analysis of Creditor Claims if the Company Had Been Liquidated

Assets at Net LiabilitiesRealizable Fully Partially

Value Secured Secured UnsecuredOriginal balance................................ $1,042,000 $ 488,000 $432,000 $180,000Distribution of assets:

To fully secured........................... (488,000) (488,000)To partially secured..................... (386,000) (386,000)*

Reclassify partially secured .............. (46,000) 46,000Balance............................................. $ 168,000 $ 0 $ 0 $226,000

The dividend to unsecured creditors would be 74.34% ($168,000 $226,000).

*$46,000 + $325,000 + $15,000 from insurance policy.

The goals set by management have been met. The restructuring will result in monthly payments

of $74,180 which is less than the target of $75,000 and the net present value of the restructuringis greater than the amount that would be received under a liquidation.

PROBLEM 21-2

(a) Cash ............................................................................................... 20,000Accumulated Amortization.............................................................. 115,000Loss on Sale of Patents.................................................................. 5,000

Patents...................................................................................... 140,000To record the sale of patents.

(b) Impairment Loss ............................................................................. 100,000Goodwill.................................................................................... 100,000

To record impairment loss on goodwill.

(c) Cash ............................................................................................... 185,000Transaction Expense...................................................................... 10,000Loss on Disposal of Land............................................................... 15,000

Vacant Land.............................................................................. 210,000To record sale of vacant land.

Mortgage Payable .......................................................................... 230,000Accrued Interest Payable ............................................................... 15,000

Cash ......................................................................................... 185,000Gain on Restructuring............................................................... 60,000

To record gain on restructuring of mortgage.


14/24

Ch. 21Problems

830

Problem 21-2, Continued

(d) Loan from Shareholder................................................................... 150,000Accrued Interest Payable ............................................................... 4,500

Restructured Shareholder Loan................................................ 124,500

Cash ......................................................................................... 30,000To record restructuring of shareholder loan. The netpresent value of the 16 payments given an interest rateof 6% is $124,500.

(e) Vendor Account Payable................................................................ 85,000Cash ......................................................................................... 15,000Vendor Note Payable................................................................ 60,000Gain on Restructuring............................................................... 10,000

To record restructuring of vendor payable.

(f) Bank Debt....................................................................................... 510,000Accrued Interest Payable ............................................................... 22,000

Investment Securities ............................................................... 62,000Treasury Stock.......................................................................... 150,000Contributed Capital from Treasury Stock.................................. 50,000Restructured Bank Debt........................................................... 252,000Gain on Restructuring............................................................... 18,000

To record restructuring of bank debt.

(g) Bank Note....................................................................................... 60,000Restructured Bank Note........................................................... 51,000Gain on Restructuring............................................................... 9,000

To record restructuring of bank note.

(h) Creditor Debt.................................................................................. 120,000Accumulated Depreciation.............................................................. 150,000

Equipment................................................................................. 220,000Gain on Disposal of Equipment................................................ 10,000Restructured Creditor Debt....................................................... 40,000

To record restructuring of creditor debt.


15/24

Ch. 21Problems

831


Total Interest Expense in Connection with First Quarterly PaymentImplicit

Number QuarterlyOriginal Reduction Unpaid Quarterly of Interest

Balance in Balance Balance Payment Payments RateMortgage payable............ $245,000 $245,000 $ 0 $ 0 0 0.00%Shareholder loan.............. 154,500 30,000 124,500 8,810.25 16 1.50Vendor payable................ 85,000 25,000 60,000 10,000.00 6 0.00Bank debt......................... 532,000 280,000 252,000 27,470.38 10 1.60Bank note......................... 60,000 9,000 51,000 17,000.00 3 0.00Secured creditor............... 120,000 80,000 40,000 6,997.12 6 1.40

QuarterlyUnpaid InterestBalance Rate Interest

Mortgage payable............ $ 0 0.00% $ 0Shareholder loan.............. 124,500 1.50 1,867.50Vendor payable................ 60,000 0.00 0Bank debt......................... 252,000 1.60 4,032.00Bank note......................... 51,000 0.00 0Secured creditor............... 40,000 1.40 560.00


16/24

Ch. 21Problems

832

PROBLEM 21-3

(1) Original AdjustedDecember 31, 2017 December 31, 2017

Dr. (Cr.) Debit Credit Dr. (Cr.)Cash...................................... $ (15,000) $ (15,000)

Accounts receivable (net)...... 500,000 (a) $ 75,000 425,000Inventory............................... 150,000 (a) 20,000 130,000Plant and equipment (net)..... 1,560,000 (b) 275,000 1,285,000Goodwill ................................ 150,000 (b) 150,000 0Other assets:

Current portion................ 6,209 (c) $ 1,616 7,825Noncurrent portion .......... 28,791 (c) 1,616 27,175

Accounts payable.................. (320,000) (320,000)7% Note payable:

Current portion................ 0 (d) 240,000 (240,000)Noncurrent portion .......... (1,500,000) (d) 300,000 (1,200,000)

Common stock at par............ (550,000) (e) 1,000,000 (e) 550,000 (100,000)Contributed capital in excess

of par............................... (550,000) (e) 550,000 0Retained earnings................. 300,000 (e) 300,000 02017 Net income................... 240,000 (e) 240,000 0Impairment loss..................... (a) 95,000Impairment loss..................... (b) 425,000

(d) 60,000(e) 460,000

Total................................ $ 0 $2,371,616 $2,371,616 $ 0

(a) To recognize impairment in the value of receivables and inventory.

(b) To recognize impairment in the value of equipment and goodwill.

(c) To reclassify note between current and noncurrent given the new payment of $10,450($35,000 is the present value of four payments at 7.5% interest).

(d) To recognize restructuring gain. 12 payments of $120,000 = $1,440,000. Therefore, therestructuring gain is $60,000, and all payments are considered to be principal only. Be-cause the total of all payments is less than the book value of the note, all payments areconsidered to be principal.

(e) To record quasi-reorganization by adjusting par value of common stock and eliminatingcontributed capital in excess of par.

(2) Calculation of ratios: Before Actions After ActionsCurrent ratio............................................ 2.00 0.98Debt-to-equity.......................................... 3.25 NA*

*The debt-to-equity ratio is not meaningful in that there is negative equity. The adjusted as-sets total $1,475,000, and the adjusted debt totals $1,760,000. All assets are being fi-nanced by debt capital.


17/24

Ch. 21Problems

833


(3) The above ratios have not improved as a result of managements actions. However, severalbenefits may not be apparent from the ratio analysis. First, management has a balancesheet that more clearly reflects market values. Second, the recognition of impairment losses

on equipment will translate into lower depreciation expense in future years. It is also possi-ble that impairment losses on current assets will result in lower near-term expense levelsassociated with bad debt expense and cost of sales. These adjustments to expense levelswill result in an improved measure of income. Third, the restructuring of the 7% note payableresults in the company paying out a lower net present value on the debt than would havebeen the case had the debt not been restructured. Finally, the elimination of the deficit willmake it easier for the company to be in a position to return a dividend to its shareholders.

PROBLEM 21-4

Carlton Company

Statement of AffairsApril 30, 2015

EstimatedEstimated Amount Estimated

Net Available for Gain (orBook Realizable Unsecured Loss) onValue Assets Value Creditors Liquidation

Assets pledged with partially secured creditors:$ 82,500 Land and building (net).............................. $ 75,000 $ (7,500)

10,000 Notes receivable........................................ 0 (10,000)40,000 Equipment (net)......................................... 12,000 (28,000)

25,000 U.S. Treasury bonds.................................. 23,200 (1,800)Free assets:

20,000 Subscriptions receivable............................ 20,000 $ 20,0003,750 Groves common stock............................... 3,300 3,300 (450)

11,250 Cash.......................................................... 11,250 11,25014,000 Accounts receivable .................................. 3,000 3,000 (11,000)57,250 Inventory (see Schedule A) ....................... 52,175 52,175 (5,075)

Estimated amount available for unsecuredcreditors with and without priority.............. $ 89,725

Less unsecured creditors with priority............. (7,300)

Estimated amounts for unsecured creditors

without priority:Net realizable amount available ................ $ 82,425Deficiency (to agree to total unsecured

amount without priority) .......................... 52,375$263,750* Total ................................................................ $199,925 $134,800 $(63,825)

*The total represents the original $250,250 plus the notes receivable of $10,000 plus the addi-tional labor costs on work in process of $3,500.


18/24

Ch. 21Problems

834


EstimatedEstimated Unsecured Amount

Book Secured With Without

Value Liabilities and Owners Equity Amount Priority PriorityPartially secured creditors:$ 87,500 First and second mortgages payable ........ $ 75,000 $ 12,500

10,000 Notes receivable discounted ..................... 0 10,00062,500 Note payableWilliams ............................ 12,000 50,50025,000 Note payableAerotex............................. 23,200 1,800

Unsecured creditors with priority:6,150 Salaries payable**..................................... $6,1501,150 Property taxes payable.............................. 1,150

Unsecured creditors without priority:60,000 Accounts payable...................................... 60,000

$252,300*** Totals............................................................... $110,200 $7,300 $134,80011,450 Owners equity

$263,750 Total liabilities and owners equity

**$2,650 + $3,500***The total represents the original $238,800 plus the notes receivable discounted of $10,000

plus the unpaid labor costs on work in process of $3,500.

Schedule ARealization of Inventory

March 31 Additional Revised NetBook Costs Book RealizableValue (Transfers) Value Value

Raw materials ................................... $15,000 $(3,000) $12,000 $ 2,400Work in process ................................ 11,250 3,000

3,500 17,750 19,525Finished goods.................................. 27,500 27,500 30,250

$53,750 $ 3,500 $57,250 $ 52,175

This amount represents additional labor costs that are unsecured with priority.


19/24

Ch. 21Problems

835

PROBLEM 21-5

(a) Note PayableOfficer.................................................................... 230,000Patents (net) ............................................................................. 210,000Gain on Patents........................................................................ 20,000

To record transfer of patents against note.

(b) Mortgage Payable .......................................................................... 100,000Cash ......................................................................................... 100,000

To record payment on mortgage payable.

(c) Bank A Note Payable ($980,000 + $95,000).................................. 1,075,000Development Land.................................................................... 700,000Marketable Securities (other current assets)............................ 80,000Gain on Land............................................................................ 280,000Gain on Marketable Securities.................................................. 15,000

To record transfer of land and securities against note.

(d) Bank B Note Payable ..................................................................... 220,000Loss on Equipment......................................................................... 20,000

Equipment (net) ........................................................................ 240,000To record transfer of equipment against note.

Bank B Note Payable ..................................................................... 50,000Gain on Restructuring............................................................... 50,000

To record gain on restructuring. The 10 payments of$55,000 are less than the remaining balance on the noteof $600,000 ($820,000 $220,000).

(e) Note PayableOfficer.................................................................... 33,327Mortgage Payable .......................................................................... 23,178Bank A Note Payable ..................................................................... 95,770Bank B Note Payable ..................................................................... 55,000Interest Expense............................................................................. 45,075

Cash ......................................................................................... 252,350To record J une 30, 2016, payments on notes (see Note A).

(f) Common Stock ($10 par value)...................................................... 200,000Common Stock ($5 par value).................................................. 100,000Paid-In Capital from Reduction in Par Value............................ 100,000

To record reduction in par value.

Paid-In Capital from Reduction in Par Value.................................. 100,000

Paid-In Capital in Excess of Par..................................................... 100,000Retained Earnings .................................................................... 200,000To eliminate deficit in retained earnings.


20/24

Ch. 21Problems

836


Note A:

ImplicitNumber Quarterly

Original Reduction Unpaid Quarterly of Interest

Balance in Balance Balance Payment Payments RateNote payableofficer....... $ 400,000 $ 230,000 $ 170,000 $ 35,026.77 5 1.00%Mortgage payable............ 1,500,000 100,000 1,400,000 51,178.05 40 2.00Bank A note payable........ 2,100,000 1,075,000 1,025,000 111,145.03 10 1.50Bank B note payable........ 820,000 270,000 550,000 55,000.00 10 0.00

QuarterlyUnpaid InterestBalance Rate Payment Interest Principal

Note payableofficer....... $ 170,000 1.00% $ 35,026.77 $ 1,700 $ 33,327Mortgage payable............ 1,400,000 2.00 51,178.05 28,000 23,178Bank A note payable........ 1,025,000 1.50 111,145.03 15,375 95,770

Bank B note payable........ 550,000 0.00 55,000.00 55,000$252,349.85 $45,075 $207,275


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Ch. 21Problems

837

PROBLEM 21-6

St. J ohn CorporationStatement of Realization and Liquidation

For the Period J anuary 1, 2016, to J une 30, 2016

LiabilitiesUnsecured

Assets Fully Partially With Without ShareholdCash Noncash Secured Secured Priority Priority Equity

Beginning balances, assignedJ anuary 1, 2016...................... $42,000 $5,910,000 $100,000Accounts payable.................... $ 400,000 $ 320,000 $ 92,000Note payableofficer ............. 400,000Bank A note payable............... 2,100,000Bank B note payable............... 820,000Mortgage payable................... 1,500,000Other liabilities ........................ 90,000 $ 35,000 95,000Beginning balances................. $42,000 $5,910,000 $2,810,000 $2,820,000 $ 35,000 $187,000 $100,000

Subsequently discovered items:Additional assets..................... 15,000 15,000Administrative expenses......... 20,000 (20,000

Cash receipts:Sale of inventory..................... 480,000 (430,000) 50,000Sale of equipment................... 700,000 (800,000) (100,00Sale of patent.......................... 250,000 (210,000) 40,000Sale of development land....... 360,000 (300,000) 60,000Sale of other assets................ 100,000 (130,000) (30,000Collection of receivables......... 150,000 (150,000)

Cash disbursements:Inventory completion costs ..... (25,000) (25,000Payment of accounts

payable................................ (400,000) (400,000)Payment of accounts

payable................................Payment of brokers fee.......... (10,000) (10,000Payment to Bank A ................. (940,000) (940,000)Payment of other liabilities...... (110,000) (90,000) (20,000)Payment of administrative

expenses ............................. (10,000) (10,000)Ending balances......................... $ 602,000 $3,890,000 $2,320,000 $1,880,000 $ 25,000 $187,000 $ 80,000


22/24

Ch. 21Problems

838

PROBLEM 21-7

Trial Balance as of Second QuarterMarch 31 Activities/Adjustments

Debit Credit Debit Cre

Cash and cash equivalents..................... $ $ 46,000 A1 $ 480,000 C2 $ 800B1 762,300 D3 49

E2 32Accounts receivable................................ 847,000 A1 120,000 B1 762Allowance for uncollectible accounts ...... A2 6

B2 4Inventory.................................................. 1,100,000 C1 230,000 A3 510

D1 120Equipment (net)....................................... 325,000 Other assets............................................ 110,000 E1 60Accounts payable.................................... 1,530,000 C2 800,000 C1 230

D1 135,000D2 360,000

Note payable A........................................ 600,000 E1 600,000

Note payable Arestructured................. E2 27,541 E1 444Note payable B........................................ 550,000 F1 550,000 Note payable Brestructured................. F1 465Other liabilities......................................... 125,000 E1 6,000

G1 15,000Restructured note.................................... D3 46,458 D2 360Shareholders' equity................................ 219,750 G1 14Net sales ................................................. 853,000 A1 600Cost of sales ........................................... 700,000 A3 510,000 Selling, general, and administrative........ 385,000 A2 6,000

B2 4,235Interest expense...................................... 17,250 D3 3,484

E2 4,459

Gain on restructuring............................... D1 15E1 45F1 84G1

Gain on vacant lot................................... E1 56$3,704,000 $3,704,000 $4,660,477 $4,660


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839


Notes

D2 The net present value of the 15 payments of $24,971.17 is equal to the accounts payable eliminated in theinformation, the interest rate on this restructured note is 6%.

D3 Interest on the note in (D2) for May and June is as follows:

Month Payment Interest @ 6% Principal Balance$360,000.00

May $24,971.17 $ 1,800.00 $23,171.17 336,828.83J une 24,971.17 1,684.14 23,287.03 313,541.80

$49,942.34 $ 3,484.14 $46,458.20

E1 The net present value of the 30 payments is $444,036. This present value along with the vacant lot valued aof value being paid against a debt of $606,000. This results in a restructuring gain of $45,964.

E2 Interest on the note in (E1) for May and J une is as follows:

Month Payment Interest @ 6.12% Principal Balance$444,036.00

May $16,000.00 $ 2,264.58 $13,735.42 430,300.58J une 16,000.00 2,194.53 13,805.47 416,495.12

$32,000.00 $ 4,459.12 $27,540.89

F1 The net present value of the 48 payments of $11,000 based on a market interest rate of 6.3% is $465$550,000, this results in a restructuring gain of $84,349.


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Documents

Fischer Chap 21