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:
📌Scenario Summary (Alternative 1):
- Original Note: $2,400,000 at 10%, due 1/1/2019
- Accrued interest as of 1/1/2019: $34,031.82
- Total liability before restructuring: $2,434,031.82
- Restructuring terms (on 1/2/2019):
- New maturity: 12/31/2022 (4 years)
- Accrued interest forgiven
- Principal reduced by $200,000 (new principal = $2,200,000)
- New interest rate = 8% annually
- Must compute effective interest rate to allocate payments properly
✅ Step 1: Transfer Accrued Interest Payable to Notes Payable
Date: January 2, 2019
| Date | Account Title | Debit | Credit |
|---|---|---|---|
| Jan 2, 2019 | Notes Payable | 34,031.82 | |
| Interest Payable | 34,031.82 |
✅ Step 2: Compute Present Value of New Terms
- New cash flows: 8% annual interest on $2,200,000 = $176,000 per year, plus principal at the end
- Cash flows:
- 12/31/2019: $176,000
- 12/31/2020: $176,000
- 12/31/2021: $176,000
- 12/31/2022: $176,000 + $2,200,000 = $2,376,000
- Use Excel/Trial and Error/Financial Calculator to compute effective interest rate that discounts these to $2,434,031.82:
- Effective Rate ≈ 6.64%
Use this rate to compute interest expense and allocate each payment over 4 years.
✅ Step 3: Record Annual Interest Expense & Cash Payment
We compute using amortization:
| Date | Cash Paid | Interest Exp (6.64%) | Reduction of Principal | CV of Note |
|---|---|---|---|---|
| 1/2/2019 | 2,434,031.82 | |||
| 12/31/2019 | 176,000 | 161,569 | 14,431 | 2,419,600.82 |
| 12/31/2020 | 176,000 | 160,596 | 15,404 | 2,404,196.85 |
| 12/31/2021 | 176,000 | 159,655 | 16,345 | 2,387,851.65 |
| 12/31/2022 | 2,376,000 | 158,659 | 2,217,341 | 0 |
Example Entry – December 31, 2019:
| Date | Account Title | Debit | Credit |
|---|---|---|---|
| Dec 31, 2019 | Interest Expense | 161,569 | |
| Notes Payable | 14,431 | ||
| Cash | 176,000 |
Repeat similarly for years 2020, 2021, and 2022 using calculated values.
✅ Final Entry – December 31, 2022
| Date | Account Title | Debit | Credit |
|---|---|---|---|
| Dec 31, 2022 | Interest Expense | 158,659 | |
| Notes Payable | 2,217,341 | ||
| Cash | 2,376,000 |
📘 Explanation
Instead, Oakwood uses the effective interest method to recognize interest expense, where the original carrying amount of the note is amortized over the new term using an imputed interest rate—in this case, approximately 6.64%. This rate is computed by discounting the new series of cash flows to the note’s carrying amount.
Each annual journal entry splits the $176,000 cash payment into interest expense (based on the imputed rate and the carrying value) and a reduction in principal. These adjustments ensure the note is fully extinguished by the end of 2022.
This restructuring benefits Oakwood by reducing the principal from $2.4M to $2.2M and lowering the interest rate from 10% to 8%. Furthermore, the forgiveness of accrued interest of $34,031.82 does not result in immediate income recognition due to the nature of the restructuring. Properly accounting for this restructuring ensures accurate representation of Oakwood’s financial obligations and expense recognition over time.
