 Hello and welcome to this session in which we would look at a CPA exam question that deals with debt restructuring. Debt restructuring is covered on the CPA exam as well as your intermediate accounting. So it's a topic that you need to be familiar with. It's not an easy topic but also it's not that difficult and debt restructuring became an issue during 2007-2008 when the financial crisis hits and everybody wanted to teach this topic again debt restructuring. So I'm going to go ahead and work the CPA question that's going to illustrate the concept of this debt restructuring. It's part of lending. It's part of lending money. Basically lending money is making an investment and sometimes you make an investment and as a result the person that you gave the money to cannot pay you back for economic reasons or for whatever reason it is then you have to maybe work a deal with them and that's what debt restructuring is all about. As I said this topic is covered on the CPA exam and if you are a CPA candidate please take a look at my website forhatlectures.com. I don't replace your CPA review course. I can do that but I can be a useful addition to your CPA review course. I can explain the topics differently as you will see in this video. I'll go over the questions a little bit more in details and I do have this debt restructuring covered on my website in much in detailed plus example. So I don't spend five to ten minutes on this topic. Maybe I spent 45 an hour an hour and 15 minutes on the topic when your CPA review course spent 10 minutes. So the difference is I go a little bit more in depth and the reason is is because I teach you the material as if you never looked at it before. On the contrary the CPA review course they assume you already know it and they're just reviewing it with you. There's a good chance your professor did not even cover debt restructuring in college. So when your CPA review course start to give you those mnemonics you'll be like I have no clue what they're talking about and that's understandably so. They're assuming one thing and it may not apply to you. So I can add 10 to 15 points to your CPA exam. Take a look at my website. Your risk is one month of subscription. Your return is passing the exam and if not for anything take a look at my website to find out how well or not well your university doing on the CPA exam. As I said this topic is also covered in intermediate accounting. I do have an intermediate accounting course along other courses as well. Check out my website. Please connect with me with me on LinkedIn and take a look at my LinkedIn recommendation students that use my system to pass the exam. Like this recording share it connect with me on Instagram and Facebook. Okay let's take a look at this exercise to illustrate the concept. On January 1st year one Aram Corp lent Farhat $200,000 with 10% simple interest note payable in 10 years. Well since there's a lot of figures let's see what the question is first. As a result of this debt restructuring Adam should record what? So I know it's a debt restructuring and because it's debt restructuring when you do a debt restructuring what's going to happen is you're going to have it because you have a receivable you're going to have a bad debt expense and evaluation account. So when you do a debt restructuring you're going to lose although it's a loss but since it's a receivable we're going to call it bad debt expense and valuation allowance therefore immediately what I can do before I can even read anything else I'm down to 50-50 my answer is either C or D and if you're on the exam guess what take your take your chance if you don't understand what's going on but don't choose the loss as an answer. Okay so simply put so for in this example I'm going to be assuming I am Adam so I'm Adam so always I say I'm Adam this is what I'm going to be doing although the other party is Farhat Inc. So Adam lent Farhat 200,000 with a 10% simple interest rate notes payable in 10 years pretty straightforward interest on the note is payable annually a typical loan and the principle is due at the end of the term very very straightforward deal as of January first year three due to economic difficulties Farhat has yet to pay any interest so Farhat is not paying his interest Farhat approached Adam for possible renegotiating the terms so Farhat says look I cannot pay the 10% let's work some some deal so we can we can we can save this we can at least pay you rather than just take you you're taking the fold right off okay Adam agrees I agree Adam forgave the interest on the note accrued to date and reduce the interest payment to 8% so I said okay I will agree to to do some to do some renegotiation I'm going to forgive all the interest that was accrued up to this point and the future interest payment rather than 10% it's going to be 8% so let's try to translate this into numbers first the original deal is 200,000 times 10% Farhat is supposed to pay me 20,000 for year one and another 20,000 for year two so what happened is Farhat owes me 40,000 and what I'm going to do I'm going to forgive this I'm going to tell I told I told Farhat don't worry about the 40,000 we're going to start fresh okay so what happened is this simply put I have an old note an old note in a sense that I lent Farhat 200,000 I have a notes receivable and I have 40,000 of interest pay interest receivable as well so as of today before any renegotiation happening I have 240,000 on my books in terms of asset when it comes to this loan now what's going to happen is I'm going to have to renegotiate everything and as a result I'm going to lose of course I'm going to lose because I'm for for one thing I'm losing this 40,000 okay and I'm going to have to reduce my interest so I'm going to be losing but what's the loss well the loss is how much is my new note okay what's my new notes receivable versus this 240,000 what does that mean well here's what does that mean I agree for eight year term so not agreed what what's left is eight years so we kept the same one two three four five six seven and eight so here's the new deal the loan now is eight years so I have a new note eight years and eight years you have to pay me 200,000 okay and also over the eight years you're going to have to pay me 200,000 times eight percent which is 16,000 okay so the payment are so you have to pay me every year now rather than 20 you're going to pay me 16,000 so this is what the problem is now this is the new note so what's the present value of this note receivable I find the present value then I compare the present value to what I have on my books now I have on my books 240,000 that once I renegotiate this deal I have to take it out and replace it with the new note the difference between the present value of the new note and what I had on the books 240,000 it's either it's going to be 64,000 for 80 or 61,000 240 how do I do this well I have to find the present value so I'm going to start with 200,000 it's eight years so you can take out this 10 year you don't have to worry about this 10 year here the 200,000 I'm going to be receiving it only once so I'm going to be using the present value of a dollar and by the way here here why also that restructuring is challenging or difficult for some students it's because they may not be familiar with the time value of money now I'll tell you something when I if you subscribe to my resources for example if you have Becker remember Becker have like f1 module one f1 module two if you if you are subscriber to Roger Roger has far one if you subscribe to Glyme Glyme has you know they start with unit one guess what I have f0 I have far zero and I have unit zero and when students first subscribe to my subscribe to my service they would say we don't have those f0s far zeros and unit zeros well before I start even teaching you f1 far one or unit one you have to understand the time value of money and you have to understand your basic accounting so I have two two units that are considered zero f0 and far zero and unit zero so before you start f1 before you start far one before you start unit one I want to make sure you have a strong understanding of the time value of money and strong understanding of your basic accounting journal entries adjustments financial statements so on and so forth basic financial statements so that's why you know this is why you have to understand time value of money now here's the other trick here do I use 8% or do I use 10% well you as an investor you means me Adam as an investor what I did is I lent my money I want to earn 10% I still want to earn 10% I'm losing now but when I discount my payment when I discount my principle I still have to use 10% therefore I'm going to be multiplying this by 0.467 and that's going to give me 93,400 so this is the present value of the 200,000 now I have to find the present value of the 16,000 it's an annuity so I'm dealing with this table here it's an annuity and again what do I use do I use the 8 or do I use the 10 no to discount I use the 10 why because because I want to earn 10% although I am not earning 10% I lost but I have to discount using 10% although my payment the cash I'll be receiving is 8% I cannot you know I'm receiving 8% cash I use the 8% but I will discount the payment under the assumption as if I'm receiving I'm discounted at 10% I'm at a loss I know I'm at a loss because that's the whole deal is I went into this renegotiating known I'm going to take I'm going to have to write down my loan therefore if I take 16,000 times 0.5335 it's going to give me 85,360 let me just do the calculation real quick we need a calculator here so so I'm going to take 16,000 my payment and I'm going to multiply it by 5.335 which is the present value which is 85,360 85,360 now all I have to do is take 85,360 plus 93,400 and this is my new note my new note is worth 178,760 so those two together will give me the present value of my note which is this is my new asset that's fine now what I'm going to do I'm going to take my new asset and compare my new asset to my old asset what I what I have to kind of remove from the books minus 240,000 and voila I have evaluation allowance of 61,240 therefore the answer is the notice what I told you at the beginning if you want to guess choose between C and D because C and D are part of the entry will be bad that expense but it will be for 61,240 okay if if we do the entry we're not going to do the entry but if we do the entry that's what would happen and this is what would happen that's why I told you you can basically immediately take this question down to 50,50 which is good 50,50 is better than 20 if you're going to take your chances I'm sure you'll prefer to take your chance as 50,50 you know what let's do the journal entry so what would the journal entry looks like let me just I'm gonna erase this erase this hopefully although I'm gonna erase in it you guys get the concept let's look at the journal entry maybe it will it will it will make sense it will hopefully it will create you know some it will clarify some confusion so the first thing I have to do in the journal entry is to remove my old note therefore I have a note receivable of 200,000 I am removing I have to remove remember in addition to the note remember I told you I have to get rid of the note I also have to get rid of my accrued interest so also I have another asset called accrued interest receivable that's 40,000 so this is the credit column and this is the debit column okay so I have to remove the note I have to remove I have to remove the notes receivable this is the original one and I have to I have to remove the I have to remove the accrued interest this is of the old note now I have to book a bet that expense and an allowance account therefore I'm gonna debit bad that expense 61,000 240 60 1,000 240 which is this account here but it's 61,000 240 and I'm gonna credit evaluation allowance 61,000 240 okay now obviously this those entries don't don't balance what I'm missing is the new note the new note again I'm gonna call this new just I'm gonna put it in a different color to call you call it new my new note my new note receivable is 240,000 it has the balance and I'm gonna explain to you you might be saying it's not really 100 it's it's only it should be only 178 whatever it was yes that's gonna be 178 so here's what's gonna happen on the balance sheet you are going to show a note receivable of 240,000 then minus the allowance of 61,000 240 so you have to show the allowance and as a result let's do it again here 240 not 2.4 million 240 minus 61,000 240 and that's gonna give us the note will be for 178,760 so the note will be that much you would still you would still show the new note at the gross amount that minus the allowance and your loss will be booked at 61,000 240 so we already know you have a loss of 61,000 240 so you took the loss you took you you record the loss and this is what they want you to do so this is the debt restructuring problem once again part of it is understanding there's a lot to understand here you have to understand how notes work you have to understand how time value of money work you have to understand the new restructuring deal so here you have I would say three layers and I would say if you get something like this on the exam this is a challenging question it's a challenging question hopefully you'd get it right okay again at the end of this recording I'm gonna invite you again and again to visit my website farhatlectures.com once again I don't replace your CPA review course look if I can tell you don't worry about your CPA review course I can replace it I would love to say this I simply can't do so but what I can do is I can be a useful addition I can explain the material differently helping you at points to pass the exam good luck study hard 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