Oakwood Corporation is delinquent on a $2,400,000, 10% note to Second National Bank that was due January 1, 2019. At that time, Oakwood owed the principal amount plus $34,031.82 of accrued interest. Oakwood enters into a debt restructuring agreement with the bank on January 2, 2019.Required:
Prepare the journal entries for Oakwood to record the debt restructuring agreement and all subsequent interest payments assuming the following independent alternatives:
- The bank extends the repayment date to December 31, 2022, forgives the accrued interest owed, reduces the principal by $200,000, and reduces the interest rate to 8%.
- The bank extends the repayment date to December 31, 2022, forgives the accrued interest owed, reduces the principal by $200,000, and reduces the interest rate to 1%.
- The bank accepts 160,000 shares of Oakwood’s $5 par value common stock, which is currently selling for $14.50 per share, in full settlement of the debt.
- The bank accepts land with a fair value of $2,300,000 in full settlement of the debt. The land is being carried on Oakwood’s books at a cost of $2,200,000.
General JournalShaded cells have feedback.Prepare the journal entries for Oakwood to record the debt restructuring agreement and all subsequent interest payments assuming the following independent alternatives:1. The bank extends the repayment date to December 31, 2022, forgives the accrued interest owed, reduces the principal by $200,000, and reduces the interest rate to 8%.General Journal InstructionsHow does grading work?PAGE 2019PAGE 2020PAGE 2021PAGE 2022GENERAL JOURNALScore: 175/179
DATE ACCOUNT TITLE POST. REF. DEBIT CREDIT
1 ? ?
2 ?
3 ? ?
Points:32.26 / 33FeedbackCheck My WorkWhen a restructuring agreement involves only a modification of terms, you should compare the carrying value of the liability (face value of the debt plus any unpaid accrued interest) to the undiscounted future cash payments (principal plus interest) specified by the new terms. If the undiscounted total future cash payments are equal to or greater than the carrying value of the liability, the debtor does not recognize a gain, the carrying value of the liability is not reduced, and interest expense is recognized in future periods using an imputed interest rate. The imputed or effective interest rate is that rate which discounts the principal and interest payment required under the new agreement to the original carrying value of the note. You can find this rate by trial and error using (in this problem) (n=4 and i=?).Computation of Interest Expense and Principal Reduction
Date Cash credit Interest Expense debit Notes Payable debit Carrying Value of Note
01/02/19 $2,434,031.82
12/31/19
12/31/20
12/31/21
12/31/22 0
Three types of entries are required: - Transfer the Interest Payable balance to Notes Payable.
- Record the end of year interest expense from the table above.
- Record the final payoff of the note. This can be combined with the interest expense entry.
Oakwood Corporation is delinquent on a $2,400,000, 10% note to Second National Bank that was due January 1, 2019. At that time, Oakwood owed the principal amount plus $34,031.82 of accrued interest. Oakwood enters into a debt restructuring agreement with the bank on January 2, 2019. Required: Prepare the journal entries for Oakwood to record the debt restructuring agreement and all subsequent interest payments assuming the following independent alternatives: 1. The bank extends the repayment date to December 31, 2022, forgives the accrued interest owed, reduces the principal by $200,000, and reduces the interest rate to 8%. 2. The bank extends the repayment date to December 31, 2022, forgives the accrued interest owed, reduces the principal by $200,000, and reduces the interest rate to 1%. 3. The bank accepts 160,000 shares of Oakwood’s $5 par value common stock, which is currently selling for $14.50 per share, in full settlement of the debt. 4. The bank accepts land with a fair value of $2,300,000 in full settlement of the debt. The land is being carried on Oakwood’s books at a cost of $2,200,000. Prepare the journal entries for Oakwood to record the debt restructuring agreement and all subsequent interest payments assuming the following independent alternatives: 1. The bank extends the repayment date to December 31, 2022, forgives the accrued interest owed, reduces the principal by $200,000, and reduces the interest rate to 8%. General Journal Instructions How does grading
The Correct Answer and Explanation is:
Here’s a complete answer and explanation for Alternative 1:
The bank extends the repayment date to December 31, 2022, forgives the accrued interest owed, reduces the principal by $200,000, and reduces the interest rate to 8%.
📘 Key Details:
- Original Note: $2,400,000
- Accrued Interest (10% x 1 year): $34,031.82
- Total liability on 1/1/2019: $2,434,031.82
- New principal after $200,000 reduction: $2,200,000
- Interest Rate: 8%
- Term: 4 years (2019 through 2022)
- Future cash flows = 4 payments of $176,000 (8% × $2.2M) + $2.2M principal repayment = $2,904,000
- Total cash payments ($2,904,000) > carrying amount ($2,434,031.82): no gain is recognized
- Use effective interest method to allocate payments to interest and principal (use internal rate of return (IRR) or imputed rate based on present value = $2,434,031.82)
🧾 Journal Entries
📅 January 2, 2019 – Record Restructuring
DATE ACCOUNT DEBIT CREDIT
01/02/2019 Notes Payable 2,400,000
Interest Payable 34,031.82
Notes Payable (New Terms) 2,434,031.82
Explanation: Combine old note and unpaid interest into a new note under restructured terms. No gain recorded.
📅 December 31, 2019 – Record Interest Expense
Assume you calculate imputed interest rate (using Excel IRR or trial and error):
Effective rate = 10.0752% (this is the rate that makes PV of future payments = $2,434,031.82)
12/31/2019 Interest Expense 245,270
Notes Payable 69,270
Cash 176,000
Explanation: Interest expense is imputed using the effective rate; the difference between expense and cash interest is applied to reduce the note balance.
📅 December 31, 2020
12/31/2020 Interest Expense 238,289
Notes Payable 62,289
Cash 176,000
📅 December 31, 2021
12/31/2021 Interest Expense 230,555
Notes Payable 54,555
Cash 176,000
📅 December 31, 2022 – Final Payment
12/31/2022 Interest Expense 222,133
Notes Payable 2,421,865
Cash 2,644,000
🧠 Explanation
This restructuring involves only a modification of terms (no transfer of assets or equity), which is treated as a troubled debt restructuring under U.S. GAAP (ASC 470-60). Since the undiscounted total future payments ($2.2M principal + $704K interest = $2.904M) exceed the carrying amount of the debt ($2.434M), Oakwood does not recognize a gain on the restructuring.
The journal entry on January 2, 2019, consolidates the original note and accrued interest into a new restructured note. The old liabilities are removed, and a new note payable of $2,434,031.82 is recognized.
For interest recording, Oakwood must use the effective interest method based on the original carrying value of the note and the imputed interest rate. That rate is the discount rate that equates the present value of the revised cash flows ($2,904,000) to the carrying amount ($2,434,031.82), calculated to be approximately 10.0752%.
Each year, Oakwood pays $176,000 in cash interest (8% × $2.2M), but the interest expense recognized is higher due to the higher effective rate. The difference between interest expense and cash paid reduces the principal balance of the note payable over time.
At the end of the term (December 31, 2022), Oakwood makes a final cash payment that includes both the last interest installment and the remaining principal. The entire carrying value of the note is derecognized.
This treatment follows GAAP for modifications without substantial change in terms (no gain/loss unless undiscounted cash flows < carrying amount), emphasizing economic substance over form.
