Question

Strickland Company owes $202,900 plus $18,600 of accrued interest to Moran State Bank. The debt is a 10-year, 10% note. During 2014, Strickland’s business deteriorated due to a faltering regional economy. On December 31, 2014, Moran State Bank agrees to accept an old machine and cancel the entire debt. The machine has a cost of $397,600, accumulated depreciation of $218,680, and a fair value of $186,000.

(a) Prepare journal entries for Strickland Company and Moran State Bank to record this debt settlement

(b) How should Strickland report the following in its 2014 income statement?

(c) Assume that, instead of transferring the machine, Strickland decides to grant 11,200 shares of its common stock ($10 par) which has a fair value of $186,000 in full settlement of the loan obligation. If Moran State Bank treats Strickland’s stock as a trading investment, prepare the entries to record the transaction for both parties.

Answer 1

a. Strickland Company (Debtor)

Date Account Title and Calculation Debit Credit

Notes payable $202,900

Interest payable $18,600

Accumulated depreciation (Machine) $218,689

Machine $397,600

Gain on disposition of machine $7,080

(186,000 + 397,000 - 218,680)

Gain on debt restructuring $35,500

[(202,900 + 18,600) - 186,000]

Moran State Bank (Creditor)

Date Account Title and Calculation Debit Credit

Machine $186,000

Allowance for Doubtful accounts $35,000

Notes receivable $202,900

Interest receivable $18,600

b. Gain on machine disposition and the gain on debt restructuring should be reported as an ordinary gain in the income statement.

c. Strickland Company (Debtor)

Date Account Title and explanation Debit Credit

Notes payable $202,900

Interest payable $18,600

Common stock $112,000

Additional paid-in-capital $74,000

Gain on debt restructuring $35,500

Moran State Bank (Creditor)

Date Account Title and explanation Debit Credit

Investment Trading $186,000

Allowance for Doubtful accounts $35,500

Notes receivable $202,900

Interest receivable $18,600