A debtor modifies the terms of its debt. The carrying amount of the debt is $100,000. The total future cash flows (undiscounted) under the new terms are $90,000. How should the debtor account for this modification?

Q: What mistakes do candidates make on this CPA question?

Calculating a new interest rate when a gain exists.

Answer options:

No entry; calculate new effective interest rate.

Recognize a gain of $10,000 in OCI.

Recognize a gain of $10,000 in Net Income and reduce debt carrying amount.

Recognize a loss of $10,000.

How to approach this question

Compare Carrying Amount vs. Total Undiscounted Future Cash Flows. If Future CF < Carrying Amount, it is a Troubled Debt Restructuring with a Gain. Write down debt to the sum of future cash flows. Interest expense going forward is 0.

Full Answer

C.Recognize a gain of $10,000 in Net Income and reduce debt carrying amount.✓ Correct

Since the total future cash flows ($90,000) are less than the carrying amount ($100,000), the debt is written down to $90,000, and a gain of $10,000 is recognized in Net Income.

Common mistakes

Calculating a new interest rate when a gain exists.

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