22-03-2012, 04:04 PM
Troubled Debt Restructuring
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When the borrower is in severe financial difficulty, the creditor(s) may change the terms of debt agreement (i.e.,reduce the amount of principal or reduce the amount of interest payments or both.) rather than force the borrower to liquidate.
Troubled Debt Restructuring (Contd.)
This new agreement is referred to as a trouble debt restructuring.
A trouble debt restructuring can be one of the following:
1.The debt is settled at the time of restructuring ; or
2.The debt is continued but with modified terms.
Debt is Settled
Assumed that the carrying amount of the land is $32 million. The following journal entries are recorded for this troubled debt restructuring:
($ in million)
1)Land (40million-32million) 8
Gain on disposition of assets 8
(ordinary gain)
2)Note Payable 50
Land(at fair value) 40
Gain on troubled debt restructuring 10
(extraordinary gain)
Debt is Continued but with Modified Terms:
In this case of troubled debt restructuring, the bank allows the debt to continue but modifies the terms of debt agreement (i.e., reduce or delay the interest payments; reduce or delay the maturing amount or a combination of these concessions.)
Accounting Treatment:
a)Recognize a gain (extraordinary) equals the difference between the carrying amount of the debt and the total future cash payments and reduce the carrying amount of the debt to the total future cash payments.
b)Assume that all interests have been eliminated; and
c)All subsequent cash payments are payments for the debt itself.