Advanced accounting 10th by a beams athony ch17

• Equity insolvency – Inability to pay debts on time • May avoid bankruptcy proceedings • Negotiate directly with creditors • Bankruptcy insolvency – Having total debts in excess of the

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Chapter 17: Corporate Liquidations and Reorganizations

by Jeanne M David, Ph.D., Univ of Detroit Mercy

to accompany Advanced Accounting , 10th edition

by Floyd A Beams, Robin P Clement, Joseph H Anthony, and Suzanne Lowensohn

Corporate Liquidations: Objectives

1 Understand differences among types of

bankruptcy filings.

2 Comprehend trustee responsibilities and

accounting during liquidation.

3 Understand financial reporting during

reorganization.

4 Understand financial reporting after emerging

from reorganization, including fresh-start

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• Equity insolvency

– Inability to pay debts on time

• May avoid bankruptcy proceedings

• Negotiate directly with creditors

• Bankruptcy insolvency

– Having total debts in excess of the fair value of

assets

• May be liquidated, or

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• Voluntary bankruptcy proceedings

– Filed by debtor

• Involuntary bankruptcy proceedings

– Filed by creditor or group of creditors

• Court action

– Dismiss a case

– Accept the petition

– Change form

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Duties of Trustee

Trustee in liquidation cases

• Investigate debtor's financial affairs

• Provide information

• Examine, perhaps object to, creditor claims

• File report on trusteeship

• If authorized to operate debtor's business, other

period reports are required

In reorganization cases, in addition to above

• Filing reorganization plan or statement why one

cannot be filed

Ranking of Claims: Liquidation

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Statement of Affairs

• Legal document prepared for bankruptcy court

– Assets at expected net realizable values

– Classified on basis of availability for classes

of creditors

– Liabilities are classified

• Priority, fully secured, partially secured,

unsecured

– Historical values included for reference

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– Statement of cash receipts and disbursements

– Statement of changes in estate equity

3: Corporate Reorganization

Corporate Liquidations and Reorganizations

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Chapter 11: Balance Sheet

• Prepetition liabilities subject to compromise are

reported as a separate line item in liabilities

– Arose before filing

– Include

• Unsecured and under-secured liabilities

• Prepetition secured liabilities and post petition

liabilities reported in normal fashion

• Prepetition claims discovered after filing

– Included at court allowed amounts

Chapter 11: Other Statements

• Reorganization costs shown separately

• Interest to be paid or probable amount

– Differences from contractual amounts should

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Combined Financial Statements

• Condensed combined financial statements are

prepared for all entities in reorganization

proceedings as supplementary information

– Intercompany receivables and payables

– Write-down if necessary

4: Emerging from Reorganization

Corporate Liquidations and Reorganizations

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– Consider business and financial risk

Reorganization value determines how much

creditors recover

Emerging business will either use

1 Fresh start reporting

2 Report liabilities at present value and

forgiveness of debt as extraordinary item

Qualify for Fresh Start Reporting

• Just before confirmation of the plan,

– Revaluation value must be less than post

petition liabilities and allowed claims, and

– Holders of existing voting shares receive less

than 50% of emerging entity

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Apply Fresh Start Reporting

• Allocated reorganization value to identifiable

assets

– Unallocated amount is an intangible

• Reorganization value in excess of amounts

allocated to identifiable assets

• Liabilities at current value at confirmation date

• Deferred taxes follow FASB No 109

• Prepare final reports of old entity

Reorganization Example

• Tiger files for protection under Chapter 11 on

1/5/08 Accordingly, it reclassifies prepetition

liabilities.

• It obtains short term financing, acquires additional

equipment and continues operations through

6/31/09 when the plan is approved.

First, we'll look at the statements pre and post

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Balance Sheet Assets

  1/5/08 Filed 12/31/08 FYE 6/30/09 Before

Fair value 6/30/09 Revalu- ation AFTER 6/30/09

Reorganization value in excess of identifiable assets   250

Changes to Assets

Fair values and revaluation amounts are shown on 6/30/09 for

comparison.

• Tiger continues operations, records depreciation and

even acquires equipment from filing on 1/5/08 to

reorganization on 6/30/09.

• The reorganization revalues the assets to their fair

value on that date Patents are completely written off.

• Tiger records an intangible "Reorganization value in

excess of identifiable assets" of $250 Not all

reorganizations result in this intangible.

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  1/5/08 Filed 12/31/08 FYE 6/30/09 Before AFTER 6/30/09 Short term borrowing (post) 150 75 75 Accounts payable (pre/post) 600 100 125 125 Wages payable (post) 50 55 55 Taxes payable (pre) 150   150 Accrued bond interest (pre) 90  

Note payable (pre) 260  

Subordinated debt (post)       395 12% bonds payable – current (post)       100 12% bonds payable (post)       500 15% bonds payable (pre) 1,200  

Liabilities subject to compromise   2,300 2,300

Capital stock (old) 500 500 500

Capital stock (new)       800

What Happened to Liabilities?

• Upon filing on 1/5/08, Tiger reclassifies the unsecured

and partially secured liabilities at that point as petition Liabilities subject to compromise

Pre-• Pre-petition Liabilities subject to compromise are

reclassified or settled according to the plan.

• Accounts payable on 12/31/08 does not include any of

the $600 due prior to filing.

• Taxes payable are still to be paid, and eventually

recorded again in full.

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Changes in Equity

• Some of the creditors receive stock in the

reorganized firm The old shareholders also

receive stock, but now own only $100 of $800 of the stock at book value.

• Although some APIC was recorded in

reorganizing, it was subsequently eliminated If

it had been sufficient to wipe out the deficit, no

intangible "reorganization value in excess of

identifiable assets" would be recorded.

• The Deficit is removed: Fresh Start!

Can Tiger Use Fresh Start?

On 6/30/09 there were $255 in post-petition

liabilities All $2,300 pre-petition liabilities were allowed by the courts Firm value is $2,200.

1 Liabilities exceed reorganization value

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bonds, $1200 $500 new stock, $500 senior 12% bonds, and

another $100 bonds due

Priority tax claims $150 To be paid cash once

Remaining unsecured claims, $950:

$600 accounts payable $275 subordinated debt

and $140 new stock $185

$260 note $120 subordinated debt

and $60 new stock $80

Total debt discharged $455

Record New Debt Agreements

Liabilities subject to compromise (pre) 2,300  

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Give Shareholders New Shares

They will lose control since creditors have $700 of common stock

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Final measure of deficit, 6/30/09 ($650) Write-off Additional paid in capital 400

Reorganization value in excess of identifiable assets (intangible asset) ($250)

Eliminate Deficit in Equity

The $1,000 deficit on 6/30/09 is adjusted for the

gain on debt discharge and loss on asset

Reorganization value in excess of

Additional paid in capital 400  

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Simplifying Assumptions

• All transactions are recorded on 6/30/09

Generally this takes some time.

• Creditors may have interest between submission

and approval of plan

• All pre-petition debt is approved.

• The $2,200 reorganization value of the firm

probably used a discounted cash flow firm

valuation model

• Prior retained earnings or deficit eliminated

• Significant factors in determining the

reorganization value

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