On December 30, 1992, Hale Corp. paid $400,000 cash and issued 80,000 shares of its $1 par value common stock to its unsecured creditors on a pro rata basis pursuant to a reorganization plan under Chapter 11 of the bankruptcy statutes.  Hale owed these unsecured creditors a total of $1,200,000.  This transaction is considered an extraordinary event for Hale.  Hale's common stock was trading at $1.25 per share on December 30, 1992.  Ignoring income taxes, as a result of this transaction, Hale's total stockholder's equity had a net increase of:

Answer

Rule: A troubled debt restructuring exists when a creditor grants a concession to a debtor that it would not otherwise consider for economic or legal reasons (bankruptcy chapter 11 reorganization).

Gain is recognized by debtor if the face amount of the payable exceeds the FMV of assets and/or equity transferred.  In this case, the gain would be classified as extraordinary.

Face amount of payables                                                                                        $1,200,000

Less: Assets/equity transferred:

             Cash paid                                                                        $400,000

             Stock issued: 80,000 shares @ $1.25 FMV                  100,000

                                                                                                                                     (500,000)

             Gain on troubled debt restructuring                                                                     700,000

             Add: 80,000 shares of stock issued @ $1.25 PV                                             100,000

             Increase in stockholders' equity                                                                    $   800,000

Note that both the "gain" (assuming no income tax effects) and the issuance of new stock increase stockholders' equity

Choice "b" is correct.  $800,000 net increase in total stockholders' equity.

An alternative way to think is that debt is decreased by $1,200,000 and assets are increased by $400,000 and therefore the total equity is increased by $800,000. --> I think it is not right.

I guess it should be Asset decreased by $400,000 not increased.(cash paid not rec'd) ..

A (decreased 400,000)= L (decreased 1,200,000)+ SHE ( increased 800,000)