Question

On December 31, 2017, ZZ enters into a debt restructuring agreement with the bank. The bank
agrees to restructure a 6.75% (issued at par) $30,000,000 bond by making the following modifications:
1. reducing the principal obligation from $30,000,000 to $24,000,000.

2.extending the maturity date
from December 31, 2017, to January 1, 2027.

3. reducing the interest rate from 6.75% to 6.00%.

ZZ's market interest rate is currently 15% due to its risk profile, i.e. declining revenue and earnings.

ZZ pays interest at the end of each year. Assume that on January 1, 2027, ZZ repays the loan in full by
paying $24,000,000 to the Bank.

A. Prepare the interest payment entry for ZZ on December 31, 2018.
B. What entry would ZZ make on January 1, 2027?

Answer 1

Pre- restructurisng carrying amount                                                                                              = $ 30,000,000

Less: Present value of restructured cash flows

>Present value of $ 24,000,000

>ie., extending maturity from 2017 to 2027 (10 years)

>due in 10 years at 6.75%, interest payable annually

Present value of ordinary annuity due of $1 for n=10, i =6.75% is 7.105471

>formula to find out the pv will be p/(1+r)^n

present value of nth year ie., n=10,i=6.75% is 0.520381

thus present value of $24,000,000 due in 10 years @ 6.75% interest payable annually

= $24,000,000 * 0.520381 =                                                                         $12,489,136---(1)

present value of reduced interest 24,000,000*.06= $1,440,000 payable

annually for 10 years at 6.75% will be $1,440,000 * 7.105471 =                  $10,231,879----(2)

                                                                                                                 (!)+(2)                    = $ (22,721,015)

bank loss on Restructure                                                                                                       = $ 7,278,985

no gain for Bank

Q.A. Interest payment entry for ZZ on 31st December 2018

Present value of $ 24,000,000 * 0.06 = $ 1,440,000 payable at 2nd year at 6.75%

will be $1,440,000 * 1.81430 = $ 2,612,596

thus interest payment for the 2nd year = $1440000*0.877535 = $1,263,640

Entry would be

Interest on Borrowings A/c Dr. $1,263,640( IN THE BOOKS OF ZZ)

TO Bank A/c                           Cr. $ 1,263,640

Q.B. Entry as on Jan 1, 2017

ZZ books

pre - structured carrying amount                        = $ 30,000,000

Total future cash flow

ie., reduced principal               $ 24,000,000

interest(24000000*0.06*10)    $ 14,400,000       = $ 38,400,000

                                                                             ---------------------

                           loss on retructure                         ($ 8,400,000)

entry would be

loss on restructure A/c Dr 8,400,000

To Note payable A/c                                  8,400,000