MGMT 351 1st Edition Lecture 5 Last Lecture OutlineI. Long-Term Bonds Payable a. Example 12-2 Current Lecture Outline I. Asset Swap II. Equity Swap III. Modification of debt financing IV. Conversion of Debt Current Lecture I. Asset Swap a. Debtori. Recognize (1) a gain or loss on the non=cash asset given: - realized because this is a negotiated in a bind contract 1. Gain= FMV-BV of the asset ii. (2) a gain or loss on restructuring of the debt: 1. Gain= Value of the debt – FMV of the asset given b. What the debtor gains is essentially what the creditor loses c. Creditor i. Recognize loss on restructuring: Loss= value of the Bond investment (or N/Rec) 1. FMV of the non-cash asset received d. The debt is settled by giving the creditor a noncash concessionSS (’14): E12-41 Asset SwapMcKeon (Debtor)Value of the debt = $210k = BV of debt + Accrued (unpaid) interest; BV = Face Value because there is not discount or premiumFMV of the Inv. Parts asset = $195k – given Gain on parts asset = $35kGain on debt restruc. = $15k = BV – Value of InvAsset givenN/Pay (BV) 210,000I/Pay (or I/Exp) -0-These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.Parts Inventory 160,000  BVGain on Inv. asset 35000Gain on restruc. 15000Tejon (Creditor) – symmetric situationValue of total claim = $210k = BV N/Rec + Accrued Int. RecLoss on restruc. = $15kParts asset 195,000  cost to the creditors Loss on restruc 15,000N/Rec (BV) 210,000I/Rec (or I/Rev) 0Q: Where on the I/S should the “gain/loss on restructuring” be reported?II. Equity Swap a. Creditors become shareholders of the debtor’s company, the debtor issues stock as a concession for their debt b. Stock received by the creditor is an investment and therefore an asset, so journal entry includes the FMV of that stock SS (’14): E12-42 Equity SwapMedQuest (Debtor)Value of Debt = $5,000kMV of the Stocks given = $4,560 = (300k)(10) + (24k)(65)Gain on restruc. = $440k= (5,000,000)- (4560000)N/Pay (BV) 5,000,000, - no premium or discount so BV= Face Amount I/Pay (or I/Exp) -0-P.S. at par 240,000PIC in excess – P.S. 1320,000 MV – total parCom. Stock at par 300,000PIC in excess – C.S. 2,700,000Gain on restruc. 440kDynasty (Creditor)Invest. in C.S & P.S. 4,560k Loss on restruc. 440kN/R (BV) 5,000kIII. Modification of Terms a. New debt is larger than all debt (not typical)b. New debt is smaller than all debt – less future value of debtSS (’14): E12-43 Modification of TermsMoriarity (Debtor)a. Value of old Debt = $11,210k = BV + Accrued Interest (10,000,000+210,000)+1,000,000Amount of new Debt = $12,500k= (Face; 10,000,000) + Total Interest; (10,000,000)(.05)(5) New debt > old debt -- uncommon in the real world (situation 1)b. Value of old Debt = same as (a)Amount of new Debt = $10,500k= new face value (7,000,000) + Total Int. (7,000,000)(.10)(5) – more realistic situationGain on restruc. = $710k = BV on B/Pay 11,210,000- 10,500,000Int. Pay. 1,000k – interest forgiven Bonds Pay (old) 10,000kBond Prem 210,000Bonds Pay. (new) 10,500,000Gain on debt restruc. 710k c. Value of old Debt = same Amount of new Debt = $10,400k Gain on restruc. = $810kInt. Pay. 1,000kBonds Pay (old) 10,000kBond Prem 210kBonds Pay (new) 10,400kGain on debt restruc. 810kIV. Convertible Debt - You should know whether or not the debt is convertible into stocks or shares – become a shareholder of that company - Sell at a higher price because the option to become a shareholder is more valuable then the creditor - Two Methods 1. BV Method – no gain/loss: if “reasonably possible” or probable conversion2. MV Method – gain/loss- Consider the likelihood that the bonds will be converted into common stock atthe time of issuance P12-59 Conv. Bonds8/1/15 Cum. disct. amort. Thru 7/31/15 = $1,950 = Straight-line method: (150/month)(13 months) BV of Bonds converted = $197,325 = Face – discount balance BV Method (reasonably possible at issuance date)8/1/15 I/Exp 1,358  Straight Line AmortizationCash 1,333  (200k)(.04)(1/6)Bond Disct. Amort. 25 B/Pay 200kCom Stock at par 1800k  (200)(9)(1)PIC in excess of par 195,525 Bond Disct. 2,675BV= 200,000 – 2,6758/31/15 Remaining Bonds I/Exp 13,583I/Pay 13,333 Bond Disct. 250 12/31(FYE): I/Exp 27,167I/Pay 26,667 Bond Disct. 500 Q: What if NOT reasonably possible at issuance date? Use the MV method. Assume: MV per share = @$120 total MV of shrs. = (200 bonds)(9 shrs)(@$120) = $216k Loss on conversion = MV 216k – BV 197,325 = $18,676 B/Pay 200kLoss on conv. 18,676Com Stock at par 1,800 PIC in excess of par 214,200Bond Disct.