Chapter 5

Accounting for financially

distressed corporations
Discussants:

Arce, Rachelle
Emuslan, Edhel Joie
Ponteros, Marry Joy
Sescon, Blaire
Vidal, Judith
CBET-01-601E

EXERCISE 5-1 QUASI-REORGANIZATION

Lugina Corporation has incurred losses from operations from many years. At the
recommendation of the new president, the board of directors voted to implement a
quasi-reorganization, subject to shareholders approval. Immediately prior to the
quasi-reorganization on September 30, 2014, Luginas statement of financial
position contains the following balances:
Current assets

P 1,100,000

Property, plant and equipment

1,350,000

Total liabilities

1,200,000

Ordinary share capital

3,200,000

Additional paid-in capital

Retained earnings (deficit)

600,000
(

800,000)

The shareholders approve the quasi-reorganization effective October 1, 2014, to

be accomplished by a revaluation of property, plant and equipment to their net
revalued amount of P3,600,000.

Instructions: Prepare the journal entries to

record the quasi-reorganization on October 1,
2014.

Journal entries to record the quasi-reorganization follows:

1. Property, Plant and Equipment 2,250,000
Revaluation Surplus2,250,000
To record revaluation of plant assets
#
2. Revaluation Surplus

800,000

Retained Earnings

800,000

To record elimination of the deficit

Ex. 5-2 Troubled

Debt
Restructuring:
Asset Swap

Contina co. Owed

maunlad bank a
3,000,000 , three year, 10% note payable dated
january 1, 2012. The interest on the note is
payable on december 31 of each year. During
2014, contina experienced unusual financial
difficulties and was unable to pay the principal and
interest due on december 31, 2014.
On january 1, 2015, maunlad bank agreed to
accept settlement for the entire obligation of
3,000,000 plus the unpaid interest in 2014 for
120,000 cash plus land with a recorded value of
1,200,000 and fair value of 1,800,000.

Requirement: Prepare all entries required

to record the restructuring on the books
of Contina Co. and Maunlad Bank.
Books of Contina Co.
Notes Payable
3,000,000
Interest Payable
300,000
Cash
120,000
Land
1,200,000
Gain on Ext. of Liability
1,380,000
Gain on Transfer of Asset
600,000

To calculate gain on extinguishment of debt:

Carrying value of the note

Face value
3,000,000
Accrued interest (3M x 10%)
300,000

3,300,000
Less: Total Restructured Debt
FV of land to be transferred
1,800,000
Cash payment
120,000
1,920,000
Gain of extinguishment of debt
1,380,000

To calculate gain on transfer of asset:

Fair value of the land to be transferred 1,800,000

Less: Carrying value of the land
1,200,000
Gain on transfer of land
600,000

Books of Maunlad Bank

Cash
120,000
Land
1,800,000
Bad Debts Expense
1,380,000
Notes Receivable
3,000,000
Interest Receivable
300,000

Exercise 5-3
(Troubled Debt Restructuring; Equity Swap)

Walana Co. is threatened with

bankruptcy due to its inability to meet
interest payments and fund
requirement to retire 8,000,000 of longterm notes.The notes are all held by
Masagana to exchange equity
securities for the debt.

The terms of the exchange are as follows:

40,000 ordinary shares, par value of P50
and fair value of P80
20,000 preference shares, par value of
P100 and fair value of P120

EQUITY SWAP
TRANSFER OF EQUITY SHARES
FOR THE SETTLEMENT OF
OBLIGATION

Instruction: Prepare journal entries to

record the restructuring on the books
of Walana Co. and Masagana Corp.

Accounting procedures in Equity

Swap
page.271

BOOKS OF WALANA COMPANY

Notes Payable

P 8,000,000

Issuance of Share Capital

Ordinary Share Capital
( 40,000 x P50 ) = P2,000,000

Preference Share Capital

( 20,000 x P100 ) = P2,000,000

BOOKS OF WALANA COMPANY

Notes Payable
P 8,000,000
Ordinary Share Capital
P2,000,000
Preference Share Capital
2,000,000

Gain on Extinguishment of Liability

CV of the Note
FV of the Shares transferred
OSC(40,000XP80)
3,200,000
PSC(20,000XP120) 2,400,000
Gain on Ext.of liability

P8,000,000

(5,600,000)
P2,400,000

BOOKS OF WALANA COMPANY

Notes Payable
Ordinary Share Capital
Preference Share Capital
Gain on extinguishment

P 8,000,000
P2,000,000
2,000,000
2,400,000

Premium on Ordinary and Preference Share

Capital
Difference of Fair Value and Par Value of the
Shares
Ordinary Share Capital
FV
( 40,000X80)
Par Value( 40,000X50)
Premium on OSC

P3,200,000
2,000,000
P 1,200,000

Premium on Preference Share Capital

FV ( 20,000X P120 )
PV ( 20,000X P100)
Premium on Preference SC

P2,400,000
2,000,000
400,000

BOOKS OF WALANA COMPANY

Notes Payable
P 8,000,000
Ordinary Share Capital
P2,000,000
Preference Share Capital
Gain on extinguishment
Premium on OSC
Premium on PSC

2,000,000
2,400,000
1,200,000
400,000

MASAGANA CORPORATION

Inv. in Equity Securities

P5,600,000

Debit Investment in Equity Securities for the

Total Fair Value of Shares received
Ordinary Share Capital
Preference Share Capital

P2,400,000
3,200,000
5,600,000

MASAGANA CORPORATION

Inv. in Equity Securities

P5,600,000
Bad Debts Expense
2,400,000
Notes Receivable
P8,000,000

Bad debts Expense

CV of the Notes Receivable
FV of the Shares Received

P8,000,000
5,600,000
P2,400,000

MASAGANA CORPORATION

Inv. in Equity Securities

P5,600,000
Bad Debts Expense
2,400,000
Notes Receivable
P8,000,000

EXERCISE 5-4 (MODIFICATION OF TERMS)

Peligro Co. is experiencing financial difficulties and its income has
exhibited a downward trend. It has also reported losses for the past years.
The company has been unable to service its obligations and has missed
two semiannual interest payments. In an attempt to improve financial
picture of the company, management has negotiated a modification of its
debt terms with bondholders. These modified terms are effective January
1, 2014.
The data relative to the bonds are as follows:
Face value
Unamortized premium
Term
Stated interest rate

P7,500,000
P 210,000
10 years
10%

Instructions: Prepare the necessary journal entries

on the books of the debtor and the creditor for each of
the independent situations listed below:
1. Bondholders agree to condone past-due interest
and reduce the interest rate on the bonds from 10%
to 5%
2. Bondholders agree to condone past-due interest
and face amount of P3,000,000.
3. Bondholders agree to condone past-due interest,
reduce the interest rate on the bonds from 10% to
6% and condone P2,000,000 of the face amount of
the bonds.

Face Value P 7,500,000

Unamortized Premium
210,000
Interest Payable (P7,500,000 X 10%)
750,000
Carrying value P 8,460,000
a. Maturity Value P 7,500,000
Interest Payment
(P7,500,000 X 5% X 8 yrs)
3,000,000
Total Future Cash Payment P 10,500,000

Face Value P 7,500,000

Unamortized Premium
210,000
Interest Payable (P7,500,000 X 10%)
750,000
Carrying value P 8,460,000
b. Maturity Value
(P7,500,000 P3,000,000)
P 4,500,000
Interest Payment
(P4,500,000 X 10% X 8 yrs)
3,600,000
Total Future Cash Payment P 8,100,000

Bonds Payable7,500,000
Premium on Bonds Payable
210,000
Interest Payable
750,000
Restructured Obligation
8,100,000
Gain on Extinguishment of Liability (SCH 1)
360,000

SCH 1
Carrying Value of the note:
Face Value
P 7,500,000
Unamortized Premium
210,000
Interest Payable
750,000
P 8,460,000
Total Future Cash Payment
8,100,000
Gain on Extinguishment of Payable
P 360,000

Face Value
Unamortized Premium
Interest Payable (P7,500,000 X 10%)
Carrying value
c.

Maturity Value
(P7,500,000 P2,000,000)
Interest Payment
(P5,500,000 X 6% X 8 yrs)
Total Future Cash Payment

P 7,500,000
210,000
750,000
P 8,460,000

P 5,500,000

2,640,000
P 8,140,000

Bonds Payable
7,500,000
Premium on Bonds Payable
210,000
Interest Payable
750,000
Restructured Obligation
8,140,000
Gain on Extinguishment of Liability (SCH 2)
320,000

SCH 2
Carrying Value of the note:
Face Value
P 7,500,000
Unamortized Premium
210,000
Interest Payable
750,000
Total Future Cash Payment
Gain on Extinguishment of Payable

P 8,460,000
8,140,000
P 320,000

a.
PV of P7,500,000 due in 8 yrs at 10% interest
payable semi-annually (P7,500,000 X .4665)

P 3,498,750.00

PV of interest payment of P187,500 payable semiannually due in 8 yrs at 10% (P187,500 X 5.3349)
PV of the restructured receivable
Carrying amount of the receivable
Loss on Restructuring

1,000,293.75
P 4,499,043.75
8,460,000.00
P3,960,956.25

Bad Debts Expense

3,960,956.25
Allow. for Uncollectible Receivable 3,210,956.25
Interest Receivable
750,000.00

b.
PV of P4,500,000 due in 8 yrs at 10% interest
payable semi-annually (P4,500,000 X .4665)

P 2,099,250.00

PV of interest payment of P225,000 payable semiannually due in 8 yrs at 10% (P225,000 X 5.3349)
PV of the restructured receivable

P 3,299,602.50

Carrying amount of the receivable

Loss on Restructuring P5,160,397.50

8,460,000.00

1,200,352.50

Bad Debts Expense

5,160,397.50
Allow. for Uncollectible Receivable
4,410,397.50
Interest Receivable
750,000.00

c.

PV of P5,500,000 due in 8 yrs at 10% interest

payable semi-annually (P5,500,000 X .4665)

P 2,565,750.00

PV of interest payment of P165,000 payable semiannually due in 8 yrs at 10% (P165,000 X 5.3349)
880,258.50
PV of the restructured receivable
P 3,446,008.50
Carrying amount of the receivable
8,460,000.00
Loss on Restructuring
P5,013,991.50

Bad Debts Expense

5,013,991.50
Allow. for Uncollectible Receivable
4,263,991.50
Interest Receivable
750,000.00

PROBLEM 5-1
TROUBLED DEBT
RESTRUCTURING

Mahina Co. owed Malakas Corp. a

P6,000,000, five year, 10% mortgage
mote payable with a remaining term of
three years. Mahina Co. is having
financial difficulties and has asked
Malakas Corp. for restructuring the
obligations.

INSTRUCTIONS: PREPARE THE JOURNAL ENTRIES ON THE BOOKS OF

MAHINA CO. AND MALAKAS CORP. UNDER EACH OF THE FOLLOWING
INDEPENDENT ASSUMPTIONS

1.

2.

3.
4.

Malakas Corp. agreed to accept a piece of land

insettlement of the obligation. The land has a carrying
value of P2,500,00 and a fair market value of P4,750,000.
Malakas Corp. agreed to take an equity interest in Mahina
Co. by accepting ordinary shares with total par value of
P2,000,00 and a fair market value of P4,500,000.
Malakas Corp. agreed to a modification of terms by
waiving the receipt of interest for the next three years.
Malakas Corp. agreed to a modification of terms by
reducing the principal balance to P4,000,000 and
reducing the interest rate from 10% to 6%

1.

Books of Mahina Co.

Mortgage Note Payable
Land
Gain on Transfer of Land
Gain on Extinguishment of Liability

The gain on extinguishment of debt is

calculated as follows:
Carrying value of the note P6,000,000
FV of the land to be
4,750,000
transferred
Gain on extinguishment of P1,250,000
payable

6,000,000
2,500,000
2,250,000
1,250,000

The gain on transfer of asset land is computed as

follows:
FV of the land to be transferred

P4,750,000

Carrying value of land

Gain on transfer of land

2,500,000
P2,250,000

Books of Malakas Corp.

Land
Bad Debts Expense
Mortgage Note Receivable

4,750,000
1,250,000
6,000,000

2.

Books of Mahina Co.

Mortgage Note Payable
Ordinary Share Capital
Ordinary Share Premium
Gain on Extinguishment of Liability

The gain on extinguishment of debt is

calculated as follows:
Carrying value of the note P6,000,000
FV of shares to be
4,500,000
transferred
Gain on extinguishment of P1,500,000
payable

6,000,000
2,000,000
2,500,000
1,500,000

Premium on share caputal is computed as

follows:
FV of shares to be transferred P4,500,000
Par value of the shares
Premium on share capital

Books of Malakas Corp.

Investment
in
Equity 4,500,000
Securities
Bad Debts Expense
1,500,000
Mortgage Note Receivable
6,000,000

2,000,000
P2,500,000

3.
Books of Mahina Co.
No entry

Books of Malakas Corp.

Bad Debts Expense
1,492,200
Allowance for Uncollectible
1,492,200
Accounts
PV of principal payment
(P6,000,000 x .7513)

P4,507,80
0

Carrying Value of receivable

Loss on restructuring

6,000,000
P1,492,20
0

4.
Books of Mahina Co.
Mortgage Note Payable
Restructured Obligation
Gain on Extinguishment of Liability

6,000,000
4,720,000
1,820,000

Total future cash payments:

Face value
Interest (P4,000,000 x 6% x 3
years)
Carrying value of obligation
Gain on extinguishment of liability

P4,000,0
00
720,000

P4,720,0
00
6,000,00
0
P1,280,0

Books of Malakas Corp.

Bad Debts Expense
2,373,075
Allowance for Uncollectible
2,373,075
Accounts
The loss on restructuring is computed as follows:
PV of principal payment at historical

rate of 10%
(P4,000,000 x .7513)
P3,005,200
PV of interest payment at historical

rate of 10%
(P4,000,000 x 6% =
621,725
P240,000 x 2.4869)
PV of restructured receivable
P3,626,925
CV of receivable
6,000,000
Loss on Restructuring
P2,373,075

STATEMENT OF
AFFAIRS

EXERCISE 5-5

STATEMENT OF AFFAIRS

Blazers Inc. has work in process costing P33,000.

Completion of such goods is expected to require
materials costing P10,000 and labor and other costs of
P17,000. When completed, it is estimated that the
goods can be sold for P70,000. Materials on hand cost
P40,000; materials other than those require for the
completion of goods in process are eliminated to bring
P27,000. Finished goods cost P44,000 and are
estimated to have a sales value of P49,000.
Instructions: Determine how would these facts be
reported on the Statement of Affairs

Book
Value

Assets

Est.
Amoun Loss
Appraise
(Gain) on
t
d Value
Realizati
Availa
on
ble

Free assets:
P44,00
Finished
P49,00
P49,000
0
goods
0

(P
5,000)

PAGE 284, NO. 6

Balances for unsecured creditors are
extended to the Amount Unsecured
column. The amounts that are expected
to be realized on all assets that are not
pledged are extended to the Estimated
Amont Available column.

PAGE 285, NO. 9

A column for Loss or Gain on
Realization of Assets is provided for the
difference between the book values and
the amounts estimated to be realized on
the sale of the assets. Estimated gains
are shown in parethesis.

Book
Value

Appraised

Assets

Value

Est.
Amount
Available

Loss (Gain)
on
Realization

Free assets:
33,000

Work in process:
Est. value upon completion

P70,000

Less costs to complete:

Materials

10,000

Labor and other costs

17,000

27,000

43,000 43,000

(10,000)

PAGE 285, NO. 12

Assets may require additional cost
to complete them before they are
offered for sale. The cost to
complete the asset is deducted from
the estimated value after
completion.

Book
Value

Appraised
Value

Assets

Loss
Est.
(Gain) on
Amount
Realizatio
Available
n

Free assets:
40,000 Materials
Required to complete WIP
Balance, est. to realize

P10,000
27,000

37,000

37,000

3,000

Exercise 5-6 Statement of Affairs

The following balances are found on the books of the
Magic Company:
Cash Balances in savings account
with AB Bank P 70,000
Cash overdraft in checking account
with AB Bank (90,000)
Cash balance representing sinking
fund accumulation with CD Bank 330,000
Cash overdraft in checking account
with CD Bank (30,000)
Total cash per books
P 280,000

Instruction:
Determine how can each
balance could appear on a
Statement of Affairs prepared by
Magic Company.

Book Value

Assets

Appraised
Value

Estimated
Amount
Available

Free assets:
P 330,000

Sinking fund in
in CD Bank

P 330,000

Less: Bank
Overdraft in CD

(30,000)

P 300,000

Loss or
(gain) on
realization

Book
Value

Liabilities and Shareholders

Equity

Amount
Unsecured

Unsecured Creditors:
Bank overdraft AB Bank
Less:Cash savings in AB
Bank

90,000
(70,000)

P 20,000

5-7 Statement of Affairs

Mazda, trustee for Chevrolet, Inc. Prepares a
statement of affairs for this company on Jan. 31.
the following data were given:
a. 400 shares of Mercury stock costing P40,000,
par P100, market value per share, P110; 200
shares are pledged to creditors whose claims total
P21,000; remaining shares were unpledged.
b. Work in process costing P40,000, estimated
to realize P36,000 after completion, which requires
materials of P1,000 and additional labor of P4,000.

c. Materials costing P24,000 estimated to

realize P25,000 after withdrawal of materials
required to complete work in process(b).
d. Accounts receivable with a book value of
90,000, estimated to realize P40,000, pledge to
holders of notes of P45,000.
Instruction:
Determine how the above data would be
reported on the statement of affairs on January
31.

Book value

Assets

Appraised
value

Estimated
amount
available

Loss(gain) on
realization

Assets pledged with fully

secured creditors:
P 20,000

Mercury stock(200sh)
Less Claim (seecontra)

P22,000
21,000

( P 2,000)
P 1,000

Assets pledged with

partially secured creditors:
90,000

Accounts Receivable
(deducted contra)

40,000

50,000

Book
value

Assets

Appraised
value

Estimated
amount
available

Loss(gain)
on
realization

P 22,000

P 22,000

(P 2,000)

31,000

31,000

9,000

Free assets:
P20,000
40,000

Mercury stock(200sh)
Work in process:
Estimated value
upon completion P36,000

24,000

Materials

(1,000)

Labor

(4,000)

Materials
req. to complete

A. Page 284 No. 4

Fully secured creditors, the property pledged as
security on such claim is shown on the asset side
of the statement. If the property is expected to
realize more than the claim that will be made
against it, such is extended to the Estimated
amount Available column.
B. Page 285 No. 12
Assets may require additional cost to complete
them before they are offered for sale. The cost to
complete the asset is deducted from the
estimated value after completion.

Book value

Unsecured
amount

Liabilities and Shareholders Equity

Fully Secured creditors:

P 21,000

Claims (deducted contra)

P 21,000

Partly secured creditors:

45,000

Notes Payable

45,000

less: Accounts receivable

40,000

5,000

D. Page 284 No.5

Partially secured creditors, the amount of
the claim in excess of the estimated value of
the plegded property is extended to the
Amount unsecured column. The property
that is pledged on such claim is shown on
the asset side of the statement and none of
the asset value is reported as available to
unsecured creditors.

EX. 5-8
DEFICIENCY
STATEMENT

The ff. are the data for the Cameron Company

Shareholders equity, per books:

Capital Stock
Deficit
Balance

200,000
31,000
169,000

Est. gains on realization of assets:

Land and buildings

45,000

Est. losses in realization of assets

Accounts Receivable
Inventories

13,200
48,000

Prepaid insurance and other

prepaid expenses
1,200
Machinery and equipment
40,000
Goodwill and patents
90,000
192,000
Est. claims requiring settlement, not recorded on
books:
Liquidation costs 10,000
Contingent liabilities
15, 000
25,000

Cameron Company
Deficiency
Requirement:
Prepare aStatement
deficiency statement.
(Date)

Estimated losses on realization of assets:

Accounts receivable
Inventories
Prepaid insurance and other prepaid expenses
Machinery and equipment
Goodwill and patents
Additional liabilities:
Liquidation costs
Contingent liabilities
Estimated gross loss
Deduct:
Est. gain on realization of land and buildings
Estimated net loss
Less to be borne by owners:
Capital stock
Less deficit

13,200
48,000
1,200
40,000
90,000

10,000
15,000

200,000
31,000

192,400

25,000
217,400

45,000
172,400

169,000

Statement of
affairs in
Alternative Form

Exercise 5-9
The Review of the assets and liabilities of the
Clippers Company, in bankruptcy on
November 30, 2014, discloses the following:
a. A mortgage payable of P200,000 is secured by
land and buildings valued at P320,000.
b. Notes payable of P100,000 are secured by
furniture and equipment valued at P80,000.

c. Assets other than those referred to have

an estimated value of P90,000.
d. Liabilities other than those referred to
total P240,000, which included claims with
priority of P30,000.

Clippers Company
Statement of Affairs
November 30,2014

Liabilities

Appraised
value

A. Mortgage
Payable

200,000

B. Notes
Payable

100,000

D. Other
Liabilities

240,000

Deficit

(50,000)

Total
ASSETS

490,000

A. LAND AND
BUILDING

320,000

B.FURNITURE
AND EQUIPMENT

80,000

C.OTHER ASSETS

90,000

With
priority

Fully
secured

Partially
secured

Unsecured

200,000
80,000
30,000

30,000

20,000
210,000

200,000

80,000

200,000

230,000
180,000

80,000
90,000

Liabilities

Appraised
value

A. Mortgage
Payable

200,000

B. Notes
Payable

100,000

D. Other
Liabilities

240,000

Deficit

(50,000)

Total
ASSETS

490,000

A. LAND AND
BUILDING

320,000

B.FURNITURE
AND EQUIPMENT

80,000

C.OTHER ASSETS

90,000

With
priority

Fully
secured

Partially
secured

Unsecured

200,000
80,000
30,000

30,000

20,000
210,000

200,000

80,000

200,000

230,000
180,000

80,000
90,000

Total unsecured creditors

P 230,000
Estimated amount available
to unsecured creditors
180,000
Estimated deficiency
P 50,000

Estimated amount payable per peso of

unsecured liability:
(P180,000 divided by P230,000)= .78