MCQ 6-30 (2)

Capital stock P300,000

Retained earnings 120,000
Liabilities not liquidated 450,000
Total assets P870,000
Less assets not realized 150,000
Cash balance P720,000

Answer: A
Chapter 8:

CORPORATIONS IN FINANCIAL
DIFFICULTY: reorganization and
troubled debt restructuring
 REORGANIZATION
- Control over the company is normally retained by
the ownership.
- However, the SEC may appoint a trustee because
of fraud, gross mismanagement by current owners
or managers, or to protect the interests of creditors
or stockholders of the company.
 Accounting for Reorganization
- The procedures result in a fresh start accounting
for a reorganized corporation.
 Illustration of a Reorganization
- Assume that Ray corporation filed a petition for
reorganization, rather than for liquidation, on June
30, 2013. (The Statement of Financial Position of
the company before reorganization is presented in
your book).
 Additional Information
- The plan of reorganization which was approved by
stockholders and creditors and confirmed by SEC,
included the following:
 Additional Information
1. Assets. The company’s land has a market value
of P120,000; the building is worth P500,000.
Other assets are worth their book values. The
reorganization value of the company’s assets is
assumed to be P1,000,000.

Land (120K – 100K) 20,000

Building (500K - 400K) 100,000
Reorganization value in excess of
identifiable assets (1M – 920K) 80,000
Additional paid in capital 200,000
 Additional Information
2. Liabilities. Out of the total accounts payable, P100,000 must
be paid in full. The balance of the accounts payable and
accrued expenses will be converted into one-year notes
payable of P70,000, paying interest of 10%. The P300,000
note payable on the balance sheet will be converted into a
10-year, 8% note of P100,000. These creditors will get
20,000 shares of stock that is to be turned in to the
company by the common stockholders. Finally, the
P600,000 bonds payable will be converted into 8-year, 9%
notes totaling P430,000. The bondholders will also get
15,000 shares of common stock turned in by the current
owners.
 Additional Information
2. Liabilities. Out of the total accounts payable, P100,000 must
be paid in full. The balance of the accounts payable and
accrued expenses will be converted into one-year notes
payable of P70,000, paying interest of 10%.

Accounts payable 60,000

Accrued expenses 50,000
Notes payable (1 year) 70,000
Gain on debt discharge 40,000
 Additional Information
2. Liabilities. The P300,000 note payable on the balance sheet
will be converted into a 10-year, 8% note of P100,000.
These creditors will get 20,000 shares of stock that is to be
turned in to the company by the common stockholders.

Note payable (3 years) 300,000

Note payable (10 years) 100,000
Common stock (20,000 shares) 20,000
Additional Paid in Capital (40% of 250,000) 100,000
Gain on debt discharge 80,000
 Additional Information
2. Liabilities. Finally, the P600,000 bonds payable will be
converted into 8-year, 9% notes totaling P430,000. The
bondholders will also get 15,000 shares of common stock
turned in by the current owners.

Bonds payable 600,000

Note payable (8 years) 430,000
Common stock (15,000 shares) 15,000
Additional paid in capital (30% of P250,000) 75,000
Gain on debt discharge 80,000
 Additional Information
3. Stockholders’ Equity. The owners of the common stock will
return 70 percent of their stock (35,000 shares) to the
company to be issued as specified above. The
reorganization value of the assets is P1,000,000 and the
debts of the company after the proceeding total P700,000
(P100,000+P70,000+P100,000+P430,000). Thus,
stockholders’ equity must be the P300,000 difference. Since
shares with a P50,000 par value still be outstanding,
additional paid in capital is adjusted to P250,000.

Common stock 35,000

Additional paid in capital 35,000

Additional paid in capital 200,000

Gain on debt discharge 200,000
Retained earnings (deficit) 400,000
TROUBLED DEBT RESTRUCTURING
- Occurs when a debtor having debt-related financial
distress is granted a concession pertaining to debt
by the related creditor.
ILLUSTRATION OF TROUBLED DEBT
RESTRUCTURING
The following illustration demonstrates the accounting for
various forms of a troubled debt restructuring. Cookie
Corporation is financially distressed and is evaluating a variety
of restructuring alternatives. Following are observation about
Cookie Corporation:
1. On December 31, 2013, the company has an unsecured
current liability of P30,000 to the Creditor Company, on
which P3,000 interest has been accrued and is unpaid.
2. Cookie Corporation has been negotiating with Creditor
Company to restructure the current debt of P33,000
including accrued interest. The three alternatives are
presented below:
Alternative 1: Payment of Cash in Full
Settlement of Debt
The first alterative is the immediate transfer of
P27,000 in full settlement of the book value of the
debt.

Notes payable 30,000

Accrued interest payable 3,000
Cash 27,000
Gain on restructuring of debt 6,000
Alternative 2: Payment of Noncash Assets
in Settlement of Debt
In this alternative, Cookie Corporation agrees to
transfer inventory with a book value of P45,000 and a
fair value of P26,000 to Creditor Company in full
settlement of the P33,000 debt.

Notes payable 30,000

Accrued interest payable 3,000
Loss on disposal of inventory 19,000
Inventory 45,000
Gain on restructuring of debt 7,000
Alternative 3: Modification of terms
In this alternative, Cookie Corporation agrees to
transfer inventory with a book value of P45,000 and a
fair value of P26,000 to Creditor Company in full
settlement of the P33,000 debt.

Notes payable 30,000

Accrued interest payable 3,000
Loss on disposal of inventory 19,000
Inventory 45,000
Gain on restructuring of debt 7,000
Alternative 3: Modification of terms
A common technique of debt restructuring is to
modify some of the terms of the original debt
contract. Modification of terms may include:
1. Reduction of the stated interest rate for the
remainder of the original debt.
2. Extension of the maturity date of the original debt
at a lower rate of interest.
3. Reduction of part of the face amount of the
original debt.
4. Reduction in the accrued interest.
Case A: Carrying Value of Debt Greater than Modified
Total Future Cash Flows-Debtor Gain Recognized.
Using the same data for Cookie Corporation. Assume
that on December 31, 2013, the entities agree to the
following modification of terms on the debt contract:
a. Forgive accrued interest of P3,000
b. Reduce the interest rate from 10% to 5%
c. Extend the maturity for 1 additional year to
December 31, 2014.
Case A: Carrying Value of Debt Greater than Modified
Total Future Cash Flows-Debtor Gain Recognized.
The restructuring difference as of the date of the modification is
computed by the debtor corporation as follows:
Carrying amount of the debt:
Principal P30,000
Interest 3,000 P33,000
Total future estimated cash flows:
Future principal P30,000
Future contractual interest
(P30,000 x .05 x 1 year) 1,500 (31,500)
Restructuring difference P 1,500

Accrued interest payable 3,000

Notes payable (10%) 30,000
Restructured debt payable (5%) 31,500
Gain on restructuring of debt 1,500
Case B: Carrying Value of Debt Less than Modified Total
Future Cash Flows: No Gain Recognized By the Debtor.
Cookie Corporation and Creditor Company agree to
the following modification of terms for the debt of
P30,000 and P3,000 of accrued interest.
a. Forgive P500 of accrued interest
b. Reduce contracted interest rate from 10% to 5%
c. Extend maturity for 1 additional year to December
31, 2014.
Case B: Carrying Value of Debt Less than Modified Total
Future Cash Flows: No Gain Recognized By the Debtor.
Carrying amount of the debt:
Principal P30,000
Interest 3,000 P33,000
Total future estimated cash flows:
Future principal P30,000
Remaining accrued interest not forgiven 2,500
Future contractual interest
(P30,000 x .05 x 1 year) 1,500 (34,000)
Restructuring difference P(1,000)

Accrued interest payable 3,000

Notes payable (10%) 30,000
Restructured debt payable (5%) 33,000

Interest expense 1,000

Restructured debt payable (5%) 33,000
Cash 34,000