Question

On December 31, 2025, American Bank enters into a debt restructuring agreement with Grouper Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $4,200,000 note receivable by the following modifications:

1. Reducing the principal obligation from $4,200,000 to $3,360,000.
2. Extending the maturity date from December 31,2025 , to January 1,2029,
3. Reducing the interest rate from 12% to 10%.
Grouper pays interest at the end of each year. On January 1,2029, Grouper Company pays $3,360,000 in cash to American Bank Answer the following questions related to American Bank (creditor).
What interest rate should American Bank use to calculate the loss on the debt restructuring?
Interest rate ______%

Answer 1

American Bank should generally use the original effective interest rate of 12% to calculate the loss on the restructured debt owed by Grouper Company, but may also consider the current market rate.

Step-by-step explanation:

When a bank such as American Bank enters into a debt restructuring agreement with a company like Grouper Company, it needs to calculate the loss on the restructured debt. To calculate that loss, American Bank should use the effective interest rate that was originally used for the note receivable.

In the scenario provided, this was a 12% interest rate. However, this may vary in actual accounting practice, and American Bank may also consider using the market rate of interest at the date of restructuring if it’s significantly different from the original rate.

The loss is determined by comparing the restructured cash flows discounted at the effective interest rate with the carrying amount of the original debt.