Pert 8-financial Difficulty

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Baker / Lembke / King

Corporations in Financial IFRS Adapted Difficulty Irwin/McGraw-Hill

Edited by Taufik Hidayat

© The McGraw-Hill Companies, Inc., 1999

Outline

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Corporation in Financial Difficulty

Courses of Action

Impairment of Loan

Nonjudicial Action

Judicial Action

Nonjudicial Action

Debt Restructuring

Reorganization

Judicial Action

Transfer of Assets

Liquidation

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Nonjudicial Actions Formal arrangement between the company and its creditors are legally binding but are not administered by a court.

 Debt restructuring arrangements  Creditors’ committee management  Transfer of assets Irwin/McGraw-Hill

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Debt Restructuring Arrangements  Arrangement between a debtor and one or

more its creditors in temporary financial difficulty.  Debtor: may solicit an extension of due date of its debt, ask to decrease of the interest rate on debt, or ask for a modification of other terms of debt contract.

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Debt Restructuring Arrangements  Creditors:  willing to extent concessions to a debtor

rather than risk the legal expense and ill will from legal action.  agree to accept less than the face amount of their claim (composition agreement). Creditors receive an immediate cash payment and ussually negotiate the timing of the remaining cash payment.

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Judicial Actions  In the case of bankrupcy  A

judicial action is administered by

bankrupcy court and bankrupcy judge.  Indonesia Bankrupcy Law No 37/2004

is the guidance for bankrupcy case.

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Judicial Actions  Bankrupcy Law provide two major alternatives

under the protection of the bankcrupcy:  Suspension of payment: the debtor is provided

judicial protection for a rehabilitation period during which it can eliminate unprofitable operation, obtain new credit, develop a new company structure with sustainable operation, and work out arrangement with creditors. Irwin/McGraw-Hill

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Judicial Actions

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 Bankrupcy Law provide two major alternatives

under the protection of the bankcrupcy:  State

of

bankrupcy

and

liquidation:

is

administered by a trustee appointed by the court. The debtor’s asset are sold and its liabilities extinguished as the business is liquidated.

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ACCOUNTING FOR CREDITOR

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Impairment of Loans • Requirements for impairment testing under IAS 39 – Required for all financial instruments except those measured at fair value through profit and Loss (FVTPL). – Only when there is objective evidence as a result of “loss event(s)”

• Example of “loss event(s)” include: – – – – – –

Issuer encounters significant financial difficulties; Default of payments Lender has to grant special concession to the borrower Borrower faces probable bankruptcy Disappearance of an active market Objective evidence on a decrease of estimated cash flows of the issuer

• Accounting treatment depends on how financial asset is measured Irwin/McGraw-Hill

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Impairment of Loans • Accounting treatment depends on how financial asset is measured:  Amortized Cost : Difference between carrying amount and the present value of expected future cash flow, discounted using original discount rate. Reversal of impairment is allowed.  Fair Value (AFS) : Different between acquisition cost (net of amortization) and current fair value, less any impairment loss previously recognized in P/L. Reversal of impairment is not allowed for equity instrument.  Cost : Difference between carrying amount and the present value of expected future cash flow, discounted using current market rate of similar instrument. Reversal of impairment is not allowed. Irwin/McGraw-Hill

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Impairment of Loans Procedures for assessing impairment (IAS 39: 63-65) Test for impairment for Financial Assets Individually Significant

Not Individually Significant Individually

Individually Fail

Pass

Fail

Collectively

Pass

Collectively tested with similar credit risk

Impairment loss Irwin/McGraw-Hill

=

Carrying amount

-

Edited by Taufik Hidayat

PV of estimated future cash flows

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Impairment of Loans Procedures for assessing impairment (IAS 39: 63-65) Test for impairment for Financial Assets $100 Not Individually Significant $70

Individually Significant $30

Individually $15

Individually Fail $10

Pass $20

Fail $0

Collectively tested with similar credit risk $10 Irwin/McGraw-Hill

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Collectively $55

Pass $15

Total Collectively $65

Creditor Accounting for Impaired Loans On December 31, 20X5, Creditor Company holds an unsecured 10 percent note receivable for $30,000 from Peerless Products Corporation due on December 31, 20X6. The interest of $3,000 is currently in default. Creditor Company determines as of December 31, 20X5, that is it probable that the loan from Peerless Products will not be collected in full. The best estimate of the amount that will collected on December 31, 20X6, is $23,000. Irwin/McGraw-Hill

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Creditor Accounting for Impaired Loans Step 1: Determine if the loan is impaired by comparing its carrying value with the present value of the estimated future cash flows (effective interest rate, 10 percent). Carrying value of the loan: Principal Accrued interest Carrying amount Present value of total future cash flows: Estimated total future cash flows Present value factor for 10%, 1 year Creditor loss on impaired loan

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$ 30,000 3,000 $ 23,000 x .90909

$33,000 20,909 $12,091

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Creditor Accounting for Impaired Loans Step 2: On December 31, 20X5, make entries to recognize the impaired loan receivable. Bad Debt Expense Allowance for Impaired Loans

12,091

Impaired Notes Receivable Notes Receivable

30,000

12,091 30,000

The December 31, 20X5 balance sheet Impaired Note Receivable, including interest of $3,000 Less: Allowance for Impaired Loan Present Value of Impaired Loan Irwin/McGraw-Hill

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$33,000 -12,091

$20,909

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Creditor Accounting for Impaired Loans It is important to note that Debtor will not make any entries for the impaired loan. If secured by collateral, consedered in PV EFCF amout to estimated proceed less cost to sell. Interest income is thereafter recognized using the same rate for PV EFCF. Irwin/McGraw-Hill

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Creditor Accounting for Impaired Loans On December 31, 20X6, Creditor Company will recognize interest revenue using the effective interest method. Accrued Interest Receivable ($30,000 x .10) Allowance for Impaired Loans Interest Revenue ($20,909 PV x .10)

3,000

909 2,091

The balance in the valuation account is now $13,000 ($12,091 plus $909). Creditor Company receives only the $23,000 it had estimated. Cash Allowance for Impaired Loans Impaired Notes Receivable Accrued Interest Receivable Irwin/McGraw-Hill

Edited by Taufik Hidayat

23,000 13,000

30,000 6,000

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TROUBLED DEBT RESTRUCTURING

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Troubled Debt Restructuring On December 31, 20X6, the company has an unsecured current liability of $30,000 to Creditor Company, on which $3,000 interest has been accrued and is unpaid. Peerless Products Corporation has been negotiating with Creditor Company to restructure the current debt of $33,000 ($30,000 + $3,000).

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Troubled Debt Restructuring Alternative 1: Transfer of cash in full settlement Carrying value of the debt: Principal Accrued interest (10% for 1 year) Cash flows Restructuring difference (debtor = creditor)

$30,000 3,000

$33,000 (27,000) $ 6,000

The entry on Peerless Products books-Notes Payable Accrued Interest Payable Cash Gain on Restructure of Debt Irwin/McGraw-Hill

30,000 3,000 IAS 39 par 58

Edited by Taufik Hidayat

27,000 6,000

Troubled Debt Restructuring

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The entry required for Creditor Company-Cash Allowance for Doubtful Accounts Notes Receivable Accrued Interest Receivable

27,000 6,000

30,000 3,000

If creditor company had not provided adequately for uncollectible receivables, the bad debts expense account is debited instead of allowance for doubtful accounts.

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Troubled Debt Restructuring Alternative 2: Transfer of noncash assets in settlement of debt Peerless Products agrees to transfer inventory with a book value of $45,000 and a fair value of 26,000 to Creditor Company in full settlement of the $33,000 debt. Carrying value of the debt: Principal Accrued interest (10% for 1 year) Fair value of assets transferred Restructuring difference (debtor = creditor) Irwin/McGraw-Hill

Edited by Taufik Hidayat

$30,000 3,000

$33,000 (26,000) $ 7,000

Troubled Debt Restructuring

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The entry on Peerless Products’ books-Notes Payable Accrued Interest Payable Loss on Disposal of Inventory Inventory Gain on Restructuring of Debt

30,000 3,000 19,000

45,000 7,000

IAS 39 par 41

The entry on the creditor’s books-Inventory Allowance for Uncollectibles Notes Receivable Accrued Interest Receivable Irwin/McGraw-Hill

Edited by Taufik Hidayat

26,000 7,000

30,000 3,000

Troubled Debt Restructuring Alternative 3: Modification of terms  Reduction of the stated interest rate for the

remainder of the original debt.  Extension of the maturity date of the original debt at the lower rate of interest.  Reduction of part of the face amount of the original debt.  Reduction in the accrued interest.

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Troubled Debt Restructuring Alternative 3: Modification of terms  A substantial modification of terms of existing

financial liability or part of it should be accounted for an extinguishment of the original financial liability and recognized a new financial liability.  If the different between PV EFCF under new term (including any fees paid & received) and PV of remaining cash flow of the original financial liability (current carrying amount) is <10%, the modification is not accounted for as extinguishment. (IAS 39 par AG 62) Irwin/McGraw-Hill

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Troubled Debt Restructuring Alternative 3: Modification of terms  If exchange of debt or modification of terms is

accounted for as extinguishment, the difference between carrying amount and PV EFCF is recognized immediately in P/L. Any cost or fees incurred are recognized as part of gain or loss.  If exchange of debt or modification of terms is not accounted for as extinguishment, the difference is recognized as adjustment of effective interest rate. Any cost or fees incurred are recognized as adjustment of liability’s carrying amount. (IAS 39 par AG 62) Irwin/McGraw-Hill

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Troubled Debt Restructuring Peerless Products Corporation, the debtor, owes $30,000 principal plus $3,000 accrued interest to Creditor. On December 31, 20X6, the two entities agree to the following modification of terms: 1. Forgive accrued interest of $3,000. 2. Reduce the interest rate from 10 percent to 5 percent. 3. Extend the maturity date for one additional year to December 31, 20X7.

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Troubled Debt Restructuring

Debtor & Creditor

Carrying value of the debt: Principal Interest Carrying value of the debt Total future estimated cash flows: Total future principal Total future contractual interest Total future estimated cash flows Present value factor, 10%, 1 year Present value of future cash flows Restructuring difference

Original effective rate Irwin/McGraw-Hill

$ 30,000 3,000 $ 33,000 $ 30,000 1,500 $ 31,500 x .90909 $ 28,636

$33,000

(28,636) $ 4,364

>10% of $33,000 Edited by Taufik Hidayat

Troubled Debt Restructuring The modification of terms is accounted for as extinguishment:

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Troubled Debt Restructuring

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The entry on debtor’ books-Accrued Interest Payable Notes Payable (10%) Notes Payable - new (5%) Gain on Extinguishment of Debt

3,000 30,000

28,636 4,364

The entries on the creditor’s books-Allowance for Uncollectibles Accrued Interest Receivable Allowance for Impaired Loans

4,364

Impaired Notes Receivable (5%) Notes Receivable (10%)

30,000

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3,000 1,364 30,000

Troubled Debt Restructuring

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Assume that the modification of terms is not accounted for as extinguishment:

Notes Payable (10%) Gain on Restructuring of Debt

Irwin/McGraw-Hill

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4,364

4,364

Troubled Debt Restructuring Assume that the modification of terms is not accounted for as extinguishment and accrued interest of $3,000 is still payable at maturity, the alternative accounting treatment:

New effective interest rate of 4,54%. Irwin/McGraw-Hill

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Repayment of 30.000 + 3.000.

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Reorganization & Liquidation

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 Reorganization: the debtor continues a

business after reorganization. – Fresh start accounting – Creditors become stockholders

– Previous stockholders become minority (NCI)

 Liquidation:

the business survive in a liquidation.

does

– Sale the assets at liquidation value. – Pay the liabilities in certain order. Irwin/McGraw-Hill

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not

Latihan Pada tanggal 31 Desember 2009, PT Kreditur memiliki piutang dengan nominal Rp 800.000.000 kepada PT Debitur. Atas piutang tersebut dikenakan bunga 12%per tahun yang diterima tiap akhir tahun. PT Debitur menyatakan tidak mampu melunasi bunga yang jatuh tempo akhir tahun 2009. Piutang akan jatuh tempo pada akhir tahun 2011. Oleh karena itu PT Kreditur mempertimbangkan untuk melakukan penurunan nilai atas piutangnya. PT kreditur memperkirakan bahwa: • Bunga terpiutang tahun 2009 tidak akan tertagih dan dihapus akhir tahun 2010. • Bunga akhir tahun 2010 yang dapat ditagih hanya sebesar Rp.60.000.000 • Bunga akhir tahun 2011 yang dapat ditagih hanya sebesar Rp.50.000.000 • Pelunasan pokok akhir tahun 2011 yang dapat ditagih hanya sebesar Rp.600.000.000

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Soal PV single sum n=1 i=12  0.89286, 0.79719

PV single sum n=2 i=12 

Diminta : 1.Hitunglah rugi penurunan nilai yang diakui PT Kreditur tahun 2009. Sertakan perhitungannya. (10%) 2.Buatlah jurnal yang dicatat PT Kreditur tahun 2010 dan 2011 serta penyajian piutang di neraca 31 Desember 2010 dan 2011. (10%)

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Principle Interest Years to maturity Interest default Total receivable

800,000,000 12% 2 96,000,000 896,000,000

Estimated Future Cash Flow Default interest 2010 interest 60,000,000 2011 interest 50,000,000 Principal 600,000,000 710,000,000

Carrying Amount: Principle 800,000,000 Interest default 96,000,000 Estimated Future CF: 710,000,000 PV Est Future CF Loss on Impairment Value of loan in B/S 31/12/09

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PV 53,571,429 39,859,694 478,316,327 571,747,449

896,000,000 571,747,449 324,252,551 571,747,449

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31/12/09 Loss on impairment Allowance Impaired N/R N/R Presentation: N/R + Interest - Allowance

31/12/10 Interest receivable Allowance Interest revenue Cash Allowance Interest Receivable Presentation: N/R - Allowance

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324,252,551 324,252,551 800,000,000 800,000,000

896,000,000 (324,252,551) 571,747,449

31/12/11 Interest receivable Allowance Interest revenue Cash Allowance Impaired N/R Interest Receivable

96,000,000 27,390,306 68,609,694 60,000,000 132,000,000 192,000,000

800,000,000 (219,642,857) 580,357,143

Edited by Taufik Hidayat

96,000,000 26,357,143 69,642,857 650,000,000 246,000,000 800,000,000 96,000,000

Chapter Twenty-Two

The End

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