Assume that ART Co has recently fallen into financial difficulties. By reviewing all available evidence on December 31, 2020, on e creditor of ART, the MAX bank determined that ART would pay back only 60% of the principal at maturity. As a result, the bank decided that loan was impaired. If the loss is estimated to be $220,000, what entries should both companies make to record this loss?

1.

ART: No entry, still legally owes the whole amount.

MAX: Bad Debt Expenses at $220,000 and Allowance for Doubtful Accounts at $220,000.

2.

ART: Decrease liabilities for $220,000 and record gains for $220,000.

MAX: No entry since the debt is not restructured yet.

3.

ART: Decrease liabilities for $220,000 and record gains for $220,000.

MAX: Bad Debt Expenses at $220,000 and Allowance for Doubtful Accounts at $220,000.

4.

ART: No entry, still legally owes the whole amount.

MAX: No entry since the debt is not restructured yet, but disclose it.