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What is the journal entry to record a settlement related to troubled debt restructuring (TDR)?

There is not straightforward answer here as it depends on the type of asset that is transferred in a settlement. In addition, the journal entry would be different for the creditor and debtor.

In the example below, Silicon Bank is the creditor and Slappy Ventures is the debtor. The debtor is transferring a building to settle the loan. We’ll break down the journal entry for each party.

Silicon Bank – Silicon Bank is receiving the building, so they would record the receipt of the building at fair market value which is $80,000. They would credit the note receivable for the initial loan amount, which was $100,000. The remaining debit would be to record the loss or remove the allowance for doubtful accounts if the creditor had previously reserved for the potential loan default.

Slappy Ventures – Slappy Ventures needs to calculate the gain/loss on debt and gain/loss on the asset(s) transferred. For the debt, you would compare the FMV of the asset transferred to the loan, so $80,000 vs $100,000. Remember that the debtor will always record a gain on a settlement of debt, which would be $20,000 here. However, on the building, it had a carrying value of $110,000 and the fair market value was $80,000, so that is a loss on the transfer of the building. The other entries are to remove the note payable at face value and the carrying value of the building.

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  • In a TDR settlement, what types of gains are recorded?

    When the debtor and creditor agree to a “settlement”, then the debtor needs to record a gain on the debt and potentially a gain on the asset exchanged. The visual below outline the two types of gain that may need to be recorded by the debtor. For example, Fluffy Bunny Ventures entered into a troubled debt restructuring agreement with National Bank. National agreed to accept land with a carrying amount of $75,000 and a fair value of $100,000 in exchange for a note with a carrying amount of $150,000. As you can see below, Fluffy Bunny Ventures would record a total gain of $75,000.

  • For a troubled debt restructuring involving only a modification of terms, what would be compared to the carrying amount of the debt to determine if the debtor should report a gain on restructuring?

    When the debtor and creditor cannot agree on a settlement, then the next step would be to modify the terms. From an accounting perspective, you would compare the sum of future cash flows to the carrying value of the debt. Total future cash cash flows represents the amounts of both principal and accrued interest owed on a debt at the time of its restructuring. This amount will be the continuation of the payable in accordance with the new terms of the deal. The visual below illustrates how there are two types of modifications:

  • In a settlement, does the extinguishment result in a gain or loss for the debtor?

    Generally, a settlement on extinguishment of debt will result in a gain for the debtor and a loss for the creditor. A gain occurs for the debtor because the fair value of the asset exchanged will be less than the outstanding balance on the loan (i.e. carrying value of the loan). From the creditors perspective, they would accept an asset with a fair market value that is lower than the outstanding portion of the debt, which results in a loss.