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Troubled Debt Restructuring
When the borrower is in severe financialdifficulty, the creditor(s) may change the
terms of debt agreement (i.e.,reduce theamount of principal or reduce the amount ofinterest payments or both.) rather than force
the borrower to liquidate.
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Troubled Debt Restructuring (Contd.)
This new agreement is referred to as atrouble debt restructuring.
A trouble debt restructuring can be one ofthe following:
1.The debt is settled at the time of
restructuring ; or
2.The debt is continued but with modifiedterms.
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Troubled Debt Restructuring (Contd.)
A. Debt is Settled:
The debtors gain = the carry amount of thedebt - the value of the asset(s) transferred to
settle the debt. This gain is reported as an extraordinary
itemas in the case of early extinguishment
of debt.
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Example 1:
A bank holding a $50 million note agrees to
accept a land valued at $40 million from R.J.company, which is in severe financialdifficulty, as a settlement of the $50 million
debt.
Troubled Debt Restructuring (Contd.)
A. Debt is Settled:
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Assumed that the carrying amount of theland is $32 million. The following journalentries are recorded for this troubled debt
restructuring:($ in million)
1)Land (40million-32million) 8Gain on disposition of assets 8
(ordinary gain)2)Note Payable 50
Land(at fair value) 40Gain on troubled debt restructuring 10
(extraordinary gain)
Troubled Debt Restructuring (Contd.)
A. Debt is Settled:
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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 acombination of these concessions.)
Troubled Debt Restructuring (Contd.)
B. Debt is Continued but with Modified Terms:
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Example 2:
Assuming a 10% stated interest on the $50
million note in question and interests($50million x 10% = 5 million) are payable inDecember of the two remaining years. In
addition, R.J. failed to pay $5 million ofinterest for the year just ended. Therefore,the carrying amount of the debt is $55million.
Troubled Debt Restructuring (Contd.)
B. Debt is Continued but with Modified Terms:
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The accounting treatment for this type oftrouble debt restructuring depends on the
total amount of future cash payments. Case I : Total future cash payments