On December 23, 2017, ABC, Inc
On December 23, 2017, ABC, Inc contacted XYZ Bank, in order todiscuss ways to renegotiate terms for the long term debt which itowed to the bank. The debt, coming due on January 1, 2018, was a8% 5-year note issued at par for $2,000,000 plus the annualinterest on the note for 2017. The interest was payableannually on January 1. The new terms agreed uponby 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 anda fair market value of $160,000 in full settlement of the theannual interest for 2017 which was due and unpaid as at December31, 2017;
- the principal payable was reduced to $1,800,000 and would bedue January 1, 2023
- the annual interest coupon rate was to be reduced to 6% for theremaining 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 supportyour answer. (i.e. is it a debt modification or is it a debtsettlement as per IFRS?)
2. provide the appropriate journal entries for the transactionon 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 bankmake a gain or loss? Provide the journal entry which the bank wouldprepare to record this transaction in its books.
Answer:
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 thepresent value of the cash flows under new term using originaleffective interest [email protected]%.
=[ ($1800000 * [email protected]% at 5th year) + ($1800000*6%* PVF @8% for1-5 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 theoriginal effective interest rate is differs form the PV of theoriginal Liability by 10% or more then, it is to be accounted asDEBT SETTLEMENT or DEBT EXTINGUISHMENT.
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2.
Under debt settlement of Extinguishment accounting the new debtis to be recorded at the Fair value
Fair value of new debt-
=[ ($1800000 * [email protected]% at 5th year) + ($1800000*6%* PVF @12% for1-5 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 usingoriginal Effective rate @8% on the Revised cash flow.
New Financial Asset=
=[ ($1800000 * [email protected]% at 5th year) + ($1800000*6%* PVF @8% for1-5 year)]
=[$1800000* 0.6806 + $108000* 3.9926 ]
=$1225080 +$431200] = $1656280
| 1. For recording new debt | ||
| New Financial Assets | $1656280 | |
| Loss of Financial assetsDereocgnisition | $343720 | |
| Old Financial Assets | $2000000 | |
| 2. For recording interest payment | ||
| Land | $160000 | |
| Interest Receivables(FinancialAssets) | $160000 |
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