Question

Sassafras Oil Inc. issued a note payable to Western Bank to finance a new project it was developing. The note was for $300,000, issued at face value, with a 5-year term and interest payable at 6%. Sassafras’s project proved to not be technically feasible and caused the company to go into financial distress. The note is due today, October 8th, 2020 and Sassafras does not have the funds to repay the note or the interest. As a result, Western Bank agreed to extend the note due date for two more years interest free and reduce the face value amount to $200,000 in exchange for receiving 10,000 common shares of Sassafras, currently trading at $5 per share. The current market rate of interest is 8% now.

Using a financial calculator or Excel, prepare the necessary journal entries on the books of Sassafras Oil at the time of this refinancing. Please show your calculations/calculator inputs.

Answer 1

Journal Entry

Date	Particulars	Debit ($)	Credit ($)
Oct 8, 2020	Western bank note payable A/c	3,00,000
	To Western bank note payable A/c		2,00,000
	To Common shares A/c		50,000
	To Other Incomes A/c		50,000
	(Being face value of note payable reduced in exchange of common shares of Sassafras oil)
Oct 8, 2022	Western Bank note payable A/c	2,00,000
	Interest Payable A/c	90,000
	To Cash/bank A/c		2,90,000
	(Being amount of note payable paid after 2 years along with its interest @ 6%)

Workings

S.No.	Particulars	Amount
1	Calculation of Common shares to be issued
	No. of common Shares	10,000
	Price per share	$ 5
	Common shares issued (10,000*5)	50,000
2	Calculation of amount of interest Payable
	Outstanding note payable	$3,00,000
	Rate of interest	6%
	Tenure of loan	5 years
	Interest payable (3,00,000*6%*5)	90,000

Notes

1. Extension of loan repayment granted for 2 more years on interest free rate, which makes no effect on the amount of interest payable to western bank.

2. At the time of refinancing, the face value of note payable is reduced from $3,00,000 to $2,00,000 along with common shares of sassafras for $50,000, which results in income of $50,000 to sassafras after refinancing.