Question

On December 23, 2017, ABC, Inc contacted XYZ Bank, in order to discuss ways to renegotiate terms for the long term debt which it owed to the bank. The debt, coming due on January 1, 2018, was a 8% 5-year note issued at par for $2,000,000 plus the annual interest on the note for 2017. The interest was payable annually on January 1. The new terms agreed upon by both parties were as follows:

• the new terms would become effective on January 1, 2018;
• ABC inc. would transfer a land with a book value of $90,000 and a fair market value of $160,000 in full settlement of the the annual interest for 2017 which was due and unpaid as at December 31, 2017;
• the principal payable was reduced to $1,800,000 and would be due January 1, 2023
• the annual interest coupon rate was to be reduced to 6% for the remaining years
• the market rate was determined to be 12% on January 1, 2018.

Answer the following:

1. Show how this debt with the new terms, is to be classified. Be sure to provide clear and sufficient computations to support your answer. (i.e. is it a debt modification or is it a debt settlement as per IFRS?)

2. provide the appropriate journal entries for the transaction on the books of ABC inc for the following:

• for the transfer of the property
• for recording the negotiated debt

3. Under the renegotiated terms, would XYZ bank make a gain or loss? Provide the journal entry which the bank would prepare to record this transaction in its books.

Answer 1

1.

under origina aggrement the closing value of the debt is $2000000 as on 31 December 2017.

Assuming the original effective interest rate is 8%, now the present value of the cash flows under new term using original effective interest rate@8%.

=[ ($1800000 * PVF@8% at 5th year) + ($1800000*6%* PVF @8% for 1-5 year)]

=[$1800000* 0.6806 + $108000* 3.9926 ]

=$1225080 +$431200] = $1656280

Calculation of % change-

=> [($2000000-$1656280) / $2000000] *100 = 17.186%

As per IFRS 9, if the discounted PV under new term using the original effective interest rate is differs form the PV of the original Liability by 10% or more then, it is to be accounted as DEBT SETTLEMENT or DEBT EXTINGUISHMENT.

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2.

Under debt settlement of Extinguishment accounting the new debt is to be recorded at the Fair value

Fair value of new debt-

=[ ($1800000 * PVF@12% at 5th year) + ($1800000*6%* PVF @12% for 1-5 year)]

=[$1800000* 0.5674 + $108000* 3.6048 ]

=$1021320 +$389318] = $1410638

Journal entry in ABC inc Book

	Debit	Credit
1. For Transfer of property
Interest Payable($2000000*8%)	$160000
Land		$90000
Profit or Loss Account		$70000
2.For Recording of negotiated debt
Old Debt	$2000000
New Debt		$1410638
Gain in Debt Dereognition		$589362

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3.

XYZ Bank will make a loss.

Unde IFRS-9

XYZ Bank will have to record the new Financial assets using original Effective rate @8% on the Revised cash flow.

New Financial Asset=

=[ ($1800000 * PVF@8% at 5th year) + ($1800000*6%* PVF @8% for 1-5 year)]

=[$1800000* 0.6806 + $108000* 3.9926 ]

=$1225080 +$431200] = $1656280

1. For recording new debt
New Financial Assets	$1656280
Loss of Financial assets Dereocgnisition	$343720
Old Financial Assets		$2000000
2. For recording interest payment
Land	$160000
Interest Receivables(Financial Assets)		$160000