Concept explainers
Long-Term Debt and Ethics
You arc the CFO of Diversified Industries. Diversified has suffered through 4 or 5 tough years. This has deteriorated its financial condition to the point that Diversified is in danger of violating two loan covenants related to its largest loan, which is not due for 12 more years. The loan contract states that if Diversified violates any of these covenants, the loan principal becomes immediately due and payable. Diversified would be unable to make this payment, and any additional loans taken to repay this loan would likely be at higher rates, forcing Diversified into bankruptcy. An investment banker suggests forming another entity (called “special purpose entities” or SPE) and transferring some debt to this SPE. Structuring the SPE very carefully will have the effect of moving enough debt off Diversifier's balance sheet to keep the company in compliance with all its loan covenants. The investment banker assures you that accounting rules permit such accounting treatment.
Required:
How do you react to the investment banker?
Want to see the full answer?
Check out a sample textbook solutionChapter 9 Solutions
Cornerstones of Financial Accounting
- 2. On December 31, 2012, Greendale Corporation is experiencing extreme financial pressure and is in default in meeting interest payments on its long-term note of P6,000,000 due on December 31, 2013. The interest rate is 10% payable every December 31. In an agreement with the creditor, Greendale Corporation obtained certain changes in the terms of the note as listed in the image below. What is Greendale Corporation's gain on debt restructuring? (Round off present value factors to four decimal places) * • The accrued interest of P600,000 on December 31, 2012 is forglven. • The principal is reduced by P1,000,000. • The new interest rate is 12%. • The new date of maturity is December 31, 2017. At the time of restructuring, the stated rate of interest of the original obligation prevailed in the market for similar notes. O a. P 1,979,180 O b. P 1,600,000 O c. P1,221,020 O d. POarrow_forwardOn December 31, 2012, Greendale Corporation is experiencing extreme financial pressure and is in default in meeting interest payments on its long-term note of P6,000,000 due on December 31, 2013. The interest rate is 10% payable every December 31. In an agreement with the creditor, Greendale Corporation obtained certain changes in the terms of the note as listed in the image below. What is Greendale Corporation’s gain on debt restructuring? (Round off present value factors to four decimal places) a. P 1,979,180 b. P 1,600,000 c. P 1,221,020 d. P 0arrow_forward19. On December 31, 2012, Guimary Corporation is experiencing extreme financial pressure and is in default in meeting interest payment in its long-term note of P6,000,0O00 due on December 31, 2013. The interest rate is 10% payable every December 31. In an agreement with the creditor, Guimary Corporation obtained the changes in the terms of the note as shown in the image. At the time of restructuring, the stated rate of interest of the original obligation prevailed in the market for similar notes. What is Guimary Corporation's gain on debt restructuring? * The accrued interest of P600,000 on December 31, 2012 is forgiven. The principal is reduced by P1,000,000. The new interest rate is 12%. The new date of maturity is December 31, 2017. a. P1,979,180 b. P1,600,000 c. P1,221,020 d. POarrow_forward
- 21 Details for one of the loan of BB Company that is probably impaired during the period is as follows: The company made a loan of P40,000,000 to a customer with similar credit risk to BB Company on January 1, 2021. Interest is receivable on this loan at the end of each year at 2% per annum for the next five years. The loan was properly recorded and classified as amortized cost. The company made and initial assessment of the loan and the total expected credit losses over the life of the loan was P1,000,000. The discount rate applicable was at 2%. On January 1, 2021, the probability of default over the next 12 months was 5%. At December 31, 2021, there was a significant increase in the credit risk on the loan made by BB Company, the expert assessed that the total expected credit losses over the life of the loan was increase to P2,200,000. The discount rate applicable was at 2%. How much is the balance of the allowance for credit losses as of December 31, 2021?arrow_forwardTroubled Debt Restructuring Wolfconn Company is having financial difficulties. It has a note payable with a principal amount of $5,000,000, due in three years, plus accrued interest of $750,000 that has not been paid. Wolfconn and the holder of the note negotiate a restructuring of the note, with the following terms: • Principal amount is $2,500,000, payable in five years. • Interest on the note is payable at the end of each of the five years, at a rate of 8 percent per annum. Required a. Prepare the entry to record the restructuring of the debt. Description Debit Answer Answer Credit Answer Answer b. Suppose the new note had a principal amount of $4,500,000, payable in five years, with interest at 8 percent payable at the end of each of the five years. How would this restructuring be recorded? Answerarrow_forwardBefore any debt cancellation, the insolvent KuhnCo holds business equipment, its only asset, with a fair market value of $1 million and related liabilities of $1.25 million. The lender agrees to cancel $400,000 of the liabilities. KuhnCo has no other liabilities. a. How much gross income does KuhnCo report as a result of the debt cancellation? b. How would your answer change, if at all, had the lender cancelled $200,000 of the debt?arrow_forward
- The Balance Sheet and income statement shown for TANG Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years and the notes payable will be rolled over. Find: 1) Break-even pointarrow_forwardPeltzer Manufacturing is experiencing financial difficulties. Rather than entering into a lengthy bankruptcy proceeding, the company has reached an agreement with its long-term creditors to restructure various loans. The restructured loans are described below.Loan A—This 12% debt has a principal balance of $4,000,000 and accrued interest of $80,000. Under the restructuring agreement, $500,000 of debt would be forgiven, and the balance of the amounts due would be refinanced at a rate of 10% with monthly installment payments of $50,000 and a term of eight years. Assets with a net realizable value of $2,500,000 would also be pledged as additional security against the restructured loan.Loan B—This debt has a principal balance of $1,000,000 and accrued interest of $25,000. Under the restructuring agreement, the accrued interest would be forgiven, and the principal amount would be exchanged for preferred stock with a par value of $500,000 and a fair value of $900,000.Loan C—This 12% debt has…arrow_forwardShaw Ltd has received a large order from its long-established and valued South African customer Norden Ply, who has always paid on time in the past. Shaw Ltd is concerned however that, as a consequence of political upheaval in the region, there is a small chance that Norden Pty may fail to pay within six months of the goods being shippedWhat is the most appropriate action for Shaw Ltd to take? A. Refuse to accept the orderB. Approach a debt factor C. Take out export credit insuranceD. Demand cash on deliveryarrow_forward
- Wildhorse Aristocrat nc. (WA) borrowed $210,000 from Grow Business Bank to finance the purchase of equipment costing $157,500 and to provide $52,500 in cash. The legal documentation states that the loan matures in 20 years, and the principal is to be paid in annual instalments of $10,500. The terms of the loan also indicate that WA must maintain a current ratio of 1.25 and cannot pay dividends that will reduce retained earnings below $105,000. The 2024 year-end statement of financial position, immediately prior to the bank loan and the purchase of equipment, follows: Current assets $108,675 Current liabilities $78,750 Non-current assets 415,590 Long-term liabilities 210,000 Common shares 105,000 Retained earnings 130,515 Total assets $524,265 Total liabilities and shareholders' equity $524,265 Prepare the following statement of financial position assuming the maximum divided is declared and paid. Current Assets $ Non-current Assets $ Total Assets Current Liabilities Long-term…arrow_forwardDue to extreme financial difficulties, Armada Company has negotiated a restructuring of its 10% P5,000,000 note payable due on December 31, 2021. the unpaid interest on the note on such date is P500,000. the creditor has agreed to reduce the face value to P4,000,000, forgive the unpaid interest, reduce the interest rate to 8% and extend the due date three years from December 31, 2021. Armada Company should report gain on extinguishment of debt in its 2021 income statement at Group of answer choices 1,203,200 1,703,200 540,000 2,000000arrow_forwardHoward Manufacturing has two debts outstanding with a creditor. Howard is experiencing financial difficulties, and the creditor has granted a concession. Therefore, accounting for the debt in question qualifies as a troubled debt restructuring. At the date of the restructuring, July 1 of the current year, the two debts and the proposed restructuring are as follows:Debt A—This debt has a carrying value of $1,200,000 plus accrued interest of $24,000 at the restructuring date. The terms of restructuring call for Howard to transfer to the creditor a vacant parcel of land with a fair market value of $600,000 and a book value of $425,000. In addition, Howard will pay $70,000 to the creditor at the end of each of the next eight calendar quarters. Debt B—This 6% debt has a carrying value of $2,100,000 and accrued interest of $52,500.The terms of the restructuring call for Howard to issue nonvoting common stock with a fair value of $500,000 to the creditor. In addition, $193,553.02 will be paid…arrow_forward
- Cornerstones of Financial AccountingAccountingISBN:9781337690881Author:Jay Rich, Jeff JonesPublisher:Cengage LearningFinancial Reporting, Financial Statement Analysis...FinanceISBN:9781285190907Author:James M. Wahlen, Stephen P. Baginski, Mark BradshawPublisher:Cengage LearningEBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
- Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning