1. Prepared by Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK

2. C H A P T E R 15 Long-Term Financial Liabilities

3. Appendix 15A Accounting for Troubled Debt

4. Study Objectives 1.Distinguish between and account for: 1)A loss on loan impairment 2)A troubled debt restructuring that results in the settlement of a debt, and 3)A troubled debt restructuring that results in a continuation of debt with modification of terms

5. Accounting Issues In troubled debt cases, two important issues emerge: When should a loss be recognized? When it is likely a loss will occur, and When the loss can be measured What is the amount of loss to be recognized?

6. Troubled Debt: Key Terms Troubled debt Impairment Restructuring Probable loss: Creditor unable to collect principal and interest. Creditor grants a concession to debtor due to debtor’s financial difficulties.

7. Troubled Debt: Key Terms Restructuring Creditor grants a concession to debtor due to debtor’s financial difficulties. Settlement Modification of Terms Debtor transfers equity interest or non-cash assets to creditor 1. Reduction of principal 2. Reduction of interest rate 3. Extension of maturity date 4. Reduction of accrued interest

8. Progression of Troubled Debt Loan Origination Loan Impairment Modification of Terms Bankruptcy Loss recognized Next usual stage If all else fails – to ensure some level of collection

9. Impairments Loss measured at estimated realizable value Expected future cash flows discounted at the historical interest rate When future cash flows not determinable loss measured at: FV of any security attached to loan, or Market price of loan (if any)

10. Impairments - Example Given: December 31, 2001: $500,000 5-year note issued to Community Bank Effective interest rate:10% Entries to record the issuance of the note

11. Impairments - Example Cash310,460 Discount on Notes Payable189,540 Notes Payable500,000 Debtor Creditor Notes Receivable500,000 Discount on Notes Receivable189,540 Cash310,460

12. Impairments - Example Loan becomes impaired during 1993 Future cash flows expected: $300,000 Amount of loss to be recorded based on expected future cash flows Loss equal to: Carrying value of loan less less PV of expected future cash flows

13. Impairments - Example PV of expected future cash flows: Expected future cash flow: $300,000 Discounted at: 10% Number of discount periods: 3 Present value = $225,396 Loss on Impairment: Carrying value of loan less $375,657 PV of expected future cash flows = 225,396 $150,261 $150,261 Carrying value of loan At December 31, 2001 $310,460 Dec. 31/02 Accrued Interest (310,460 * 10%) 31,046 341,506 Dec. 31/03 Accrued Interest (341,506 * 10%) 34,150 Carrying Value $375,657 Entry to record the loss: Bad Debt Expense150,261 Allowance for Doubtful Accounts150,261 Allowance for Doubtful Accounts150,261

14. Gain or Loss: Debtor and Creditor Settlement DebtorCreditor Gain = excess of carrying amount of payable over fair value of assets transferred to creditor The gain is extraordinary Recognize loss or gain on disposition of non-cash assets transferred to creditor Loss = excess of loan receivable over fair value of assets received from debtor The loss is ordinary and is charged to Allowance for Doubtful Accounts

15. Modification of Terms No gain or loss recognized New effective interest rate must be found Carrying value of old debt equates to cash flows of newly arranged debt First step required Determine if a settlement has occurred or a modification of terms

16. Modification of Terms - Example Given: Debt terms are modified Carrying value of debt:$10,500,000 Total future cash flows:$11,880,000 Annual payments:$ 720,000 The effective interest rate must be such that the PV of $11,880,000 is $10,500,000 In this case (using a financial calculator and n = 4, interest rate = 3.466%)

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