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Term Modification without Gain: Debtor's Journal Entries

(Term Modification without Gain-Debtor's Entries) On December 31, 2007, the Firstar Bank enters into a debt restructuring agreement with Nicole Bradtke Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $2,000,000 note receivable by the following modifications:
Reducing the principal obligation from $2,000,000 to $1,600,000.
Extending the maturity date from December 31, 2007, to December 31, 2010.
Reducing the interest rate from 12% to 10%.

Bradtke pays interest at the end of each year. On January 1, 2011, Bradtke Company pays $1,600,000 in cash to Firstar Bank.
Based on FASB Statement No. 114, will the gain recorded by Bradtke be equal to the loss recorded by Firstar Bank under the debt restructuring?
Can Bradtke Company record a gain under the term modification mentioned above? Explain.
Prepare the interest payment entry for Bradtke Company on December 31, 2009.
What entry should Bradtke make on January 1, 2011?

Solution Preview

Based on FASB Statement No. 114, will the gain recorded by Bradtke be equal to the loss recorded by Firstar Bank under the debt restructuring?

No. As we will see in answer below there is no gain to Bradtke whereas there is a loss to Firstar. The loss to Firstar is -
The current amount is $2,000,000
What Firstar gets is the present value of interest and principal repayment from Bradtke. The rate to be used is 12% since that was the existing rate on debt
Firstar gets annual interest of 1,600,000X10%=160,000 which ...

Solution Summary

The solution explains the debtor's entries relating to a term modification without a gain.

$2.19