Case Synthesis Essay

Case Synthesis 2 : Carter Manufacturing

Case Background
    Due to cash flow problems, Carter has a debt to its bondholders. The market value of bonds dropped to $30 million ($50 million at par). It is agreed that all the bonds are exchanged into preference share with market value of $30 million. The auditor argues that the difference is an extraordinary gain from troubled debt restructuring. However, as Carter is facing bankruptcy, the accountant of Carter cannot accept to report $20 million as a gain. We will now focus on treatment and financial statement implications in reporting gain on troubled debt restructuring and exchange of bonds for preference shares.

Recording a gain on troubled debt restructuring
    To avoid bankruptcy proceedings, there are three ways for the bondholders to grant a concession and settle the Carter’s debt for less than its carrying amount:
    1. Asset Swap (Non-cash asset transfer) or Equity Swap (Equity interest transfer)
        ➢ If the Carrying Value of the debt is greater than the Fair Market Value of the assets transferred or the equity interests provided, a gain is recorded.
    2. Modification of terms (lower interest rate, extend maturity date or lower face amount)
        ➢ If the Carrying Value of the debt is greater than the Future Cash Flow after restructuring, a gain is recorded.

    In the case, Carter has been granted for an Equity Swap by transferring the debt into preference shares. Since the carrying value of debt ($50 million) is greater than the Fair Market Value of the preference shares ($30 million), a restructured gain of $20 million should be recognized.

  Here comes the comparison between the treatment of auditor and Carter’s accountant:
    1. Accountant’s treatment
          Bonds Payable 50,000,000
              Preference Share Capital 50,000,000

    2. Auditor’s treatment
          Bonds Payable 50,000,000
              Preference Share Capital...