Solution manual advanced accounting 10e by beams ch17

4 The debtor corporation in a bankruptcy case has the following duties: 1 to file a list of creditors, a schedule of assets and liabilities, and a statement of the debtor’s financial aff

CORPORATE LIQUIDATIONS and REORGANIZATIONS

Answers to Questions

1 Equity insolvency occurs when a debtor is unable to pay its debts as they come due Bankruptcy

insolvency occurs when a debtor’s liabilities exceed the fair value of all assets.

2 A bankruptcy proceeding is designated voluntary if the debtor corporation files the petition to place

itself under the protection of the bankruptcy court and involuntary if creditors file the petition to bring

the debtor into bankruptcy court An involuntary petition may be filed by a single creditor with an unsecured claim of $12,300 or more if there are fewer than twelve unsecured creditors Otherwise, three

or more entities with unsecured claims totaling at least $12,300 must file in order to commence an involuntary case The requirements are the same for Chapter 7 and Chapter 11 cases

3 The duties of the U.S trustee are to maintain and supervise a panel of private trustees eligible to serve in

Chapter 7 cases, to serve as trustee or interim trustee in some bankruptcy cases, to supervise the administration of bankruptcy cases, and to preside over creditor meetings Bankruptcy judges still supervise cases in districts without U.S trustees

4 The debtor corporation in a bankruptcy case has the following duties: (1) to file a list of creditors, a

schedule of assets and liabilities, and a statement of the debtor’s financial affairs; (2) to cooperate with the trustee so that the trustee may perform his duties; (3) To surrender all property, including books, documents, records, and so on, to the trustee; and (4) to appear at hearings of the bankruptcy court as required

5 A trustee is not appointed in all Title 11 cases In Chapter 7 cases a trustee will be elected by unsecured

creditors if a majority vote in amount of holders with at least 20 percent of the claims is obtained Otherwise, an appointed interim trustee serves as trustee In Chapter 11 cases a trustee is appointed only

if deemed necessary by the court, but otherwise, the debtor remains in possession of the estate and performs the duties of a trustee Within 30 days from the time the court orders the appointment of a trustee in a Chapter 11 case, a party in interest may request the election of a trustee

6 The trustee in a liquidation case takes possession of the debtor’s estate, converts estate assets into cash,

and distributes the proceeds as directed by the court He also performs other duties such as investigating the financial affairs of the debtor, providing information about the estate to parties of interest, examining creditor claims and objecting to those that appear improper, operating the debtor’s business if authorized

to do so by the court, providing financial reports and summaries about the estate to the court, and filing reports on trusteeship as directed by the court

7 The priority rankings in a Chapter 7 liquidation case are summarized in Exhibit 17–2 of the text The

priorities recognized for unsecured claims (Rank II) are: (1) administrative expenses, (2) claims incurred between an involuntary filing and appointment of a trustee, (3) salary claims up to $10,000 per individual earned within 90 days of filing, (4) employee benefit plan contribution claims up to $10,000 per individual earned within 180 days of filing, (5) individual claims up to $1,800 for goods and services purchased from, but not provided by the debtor, and (6) claims of governmental units for taxes owed by the debtor (subject to time restrictions), including taxes collected and withheld for which the debtor is liable

8 Four ranks within the unsecured nonpriority claim category (general unsecured claims) are: (1) claims

allowed that were timely filed, (2) claims allowed where proof was filed late, (3) claims allowed for fines, penalties or forfeitures, or damages, and arising before the court order for relief or appointment of

a trustee, and (4) claims for interest on unsecured claims

9 The accountant’s statement of affairs is a financial statement that is designed to provide information

about liquidation values and priority rankings for use by the trustee, the court, creditors, and other interested parties in the debtor’s estate Assets are measured at expected net realizable values in the statement, but book values are also included for reference purposes (The Bankruptcy Act refers to a statement of affairs, but that statement is a questionnaire that includes various financial and nonfinancial and legal section

10 A debtor corporation’s estate may be liquidated even though the filing is under Chapter 11 This can

occur when the case is transferred to Chapter 7 for liquidation It can also be carried out in accordance with an approved Chapter 11 plan of reorganization that calls for sale and distribution of the proceeds from the debtor corporation’s estate

11 A debtor in possession reorganization case is a Chapter 11 case in which the bankruptcy court does not

appoint a trustee, but instead, allows the debtor corporation to carry out the duties that otherwise would

be performed by a trustee

12 A creditor committee can file a plan of reorganization under a Chapter 11 case after 120 days from the

date the court order for relief is granted The order for relief occurs when the debtor or creditor’s filing petition is approved by the court

13 The approval of a plan of reorganization requires acceptance of the plan by at least two-thirds in amount

and over half in number of claims in each class of claims Further, each class of claims must accept the plan or not be impaired under it A class of claims that would receive nothing if the corporation were liquidated is not impaired if it receives nothing under a plan and, accordingly, acceptance by that class of claims is not required

14 Prepetition liabilities are the liabilities of an enterprise that were incurred prior to a Chapter 11 filing.

They are reported at the amounts allowed by the bankruptcy court Prepetition liabilities subject to compromise are those liabilities that may be impaired by a plan and that are eligible for compromise

because they are either unsecured or undersecured

15 Reorganization value is an estimate of the value of the reconstituted entity that will emerge from

reorganization, plus the expected net realizable value of the assets that will be disposed of before reconstitution occurs It is also described as the fair value of the entity before considering liabilities Reorganization value approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring

16 Fresh start reporting should be used by a company emerging from Chapter 11 if the following two

conditions are met: (1) the reorganization value of the assets of the emerging entity immediately before the date of confirmation is less than the total of all postpetition liabilities and allowed claims and (2) holders of existing voting shares immediately before confirmation receive less than 50 percent of the voting shares of the emerging entity

17 Entities not qualifying for fresh start reporting report liabilities compromised by a confirmed

reorganization plan in a manner similar to that of a note issued in a noncash transaction under APB Opinion No 21 Forgiveness of debt should be reported as an extraordinary item.

SOLUTIONS TO EXERCISES

Solution E17-3

Amount secured by inventory items at expected recoverable value (30,000) Unsecured portion of note receivable from Patriots Supply 70,000

Solution E17-4

1 On the basis of the reorganization value, Baxter Hardware qualifies for

fresh start reporting because the estimated reorganization value of

$2,000,000 is less than the postpetition liabilities and allowed claims

Liabilities:

2 Old stockholders must retain less than a 50% interest in the “new

entity.”

1,850,000 Reorganized capital structure:

New common stock to prepetition claimants 375,000 2,775,000

Solution E17-5

50,000

Unsecured, nonpriority claims:

$40,000 available cash/$80,000 claims = $.50 on the dollar

Schedule of Distribution of Available Cash

SOLUTIONS TO PROBLEMS

Solution P17-1

March 1, 2008

To record custody of Scott Corporation in liquidation

March 2008

To record collection of receivables and recognize loss

To record sale of inventories at a loss

To record sale of land and buildings at a loss

To write off intangible assets at a loss

Administrative expenses

To accrue trustee expenses

Solution P17-1 (continued)

Balance Sheet

at March 31, 2008

Assets

Liabilities And Deficit

Statement of Cash Receipts and Disbursements

from March 1 to March 31, 2008

Add: Cash receipts

120,600

Statement of Changes in Estate Equity from March 1 to March 31, 2008

Less:

Solution P17-1 (continued)

April 2008

To record payment of secured creditors from proceeds from sale of land and buildings

To record payment of priority liabilities

To record payment of $.32 per dollar to unsecured creditors (available cash of $28,400 divided by unsecured claims of

$90,000)

To write off remaining liabilities and close trustee’s records

Solution P17-2

1 Amount expected to be available for unsecured claims:

Total amount expected to be available for all

Less: Payments to secured and priority claims

Expected to be available for unsecured

2 Expected recovery per dollar of unsecured claims:

Expected to be available (from 1) = $70,000

Unsecured claims ($550,000 - $375,000) = $175,000

Expected recovery on the dollar: $70,000/$175,000 = $.40

3 Expected recovery by class of creditors:

Partially secured — note payable $75,000 + ($25,000 ´ $.40) 85,000 Priority unsecured — liabilities to priority creditors 80,000 Unsecured nonpriority creditors — accounts

Solution P17-3

Fully secured:

Holders of first mortgage and related

Unsecured priority:

3 Wages payable up to $4,000 per

employee

47,000

5 Customer claims for merchandise paid

for and not delivered (maximum

$1,800 per individual)

1,500

6 State government for gross

Local government for property

Unsecured nonpriority:

Local bank for principal of loan 30,000 President for salary due over $4,000 1,000 130,000

$431,000 Total all claims

2 Distribution of available cash:

4th Customers for merchandise not delivered

[Remaining cash ($374,500 - $296,500) of $78,000/$130,000 claim of next rank = $.60 return on dollar]

6th Merchandise creditors ($99,000 ´ 60) $59,400

Local bank for loan principal

Solution P17-4

Statement of Affairs

on June 30, 2008

Assets

Realizable Values-Liability Offsets

Realizable Value Available for

Pledged for partially secured creditors

Less: Mortgage note payable

Available for priority and unsecured creditors

Total available for priority and unsecured

Liabilities And Stockholders’ Equity

Priority liabilities

$12,000 Wages payable (assumed under

Partially secured creditors

31,000 Note payable and accrued

Less: Equipment pledged

Unsecured creditors

Solution P17-4 (continued)

2 Estimated payments per dollar for unsecured creditors

Distribution to partially secured and unsecured

priority creditors:

Available to unsecured nonpriority

A/B = $22,200/$37,000 = $.60 per dollar

Expected recovery for each class of claims

Partially secured

Note payable and interest

Unsecured portion ($3,000 ´ $.60) 1,800 $29,800

Unsecured priority

Unsecured nonpriority

Solution P17-5

Statement of Affairs at July 10, 2008

Assets

Realizable Realizable

Fully secured

Partially secured

Less: Mortgage and interest

Unsecured

Available for priority and

Available for nonpriority

Equities

Secured and

Priority liabilities

150,000

Fully secured

Less: Accounts receivable — net 160,000

60,000

Partially secured

Less: Land and buildings — net 140,000

Unsecured

(205,000) Retained earnings deficit

Solution P17-5 (continued)

Priority claims

Fully secured claims

Partially secured claims

39,000

Unsecured

Calculation of recovery for unsecured nonpriority claims

Less: Paid to partially secured creditors – secured portion (140,000)

Unsecured claims:

A ¸ B = $249,000/$415,000 = $.60 recovery on the dollar

Solution P17-6

Statement of Affairs on June 30, 2008

Assets

Realizable

Offsets for Available for

Pledged for fully secured creditors

Less: Mortgage payable

Available for priority and unsecured creditors

Total available for priority and unsecured

Liabilities and Stockholders’ Equity

Secured and Unsecured

Priority liabilities

70,000

Fully secured creditors

165,000

Unsecured creditors

Stockholders’ equity

(100,000) Retained earnings (deficit)

2 Settlement per dollar of rank 1 unsecured creditors is $.6250 ($100,000

available for unsecured/$160,000 accounts and notes payable) No payment

is made for the $5,000 unsecured interest claim

Solution P17-7

1 The reorganization is eligible for fresh start accounting because the

liabilities on June 30, 2008 of $16,500 exceed the reorganization value

of $16,000 by $500 Also, the common stock of the new entity is

allocated $5,000 to prepetition creditors and $2,000 to Lowstep’s old stockholders, so that the old stockholders have less than a 50 percent interest in the new entity

2 Entries to adjust Lowstep’s accounts for the reorganization plan:

To adjust prepetition liabilities to conform with the plan

To adjust assets to their fair values

To record exchange of common stock

Reorganization value in excess of fair value 1,000

Loss on asset adjustments to fair

To eliminate deficit and record adoption of fresh start reporting

Solution P17-7 (continued)

Final Balance Sheet

as of July 8, 2008

Assets

Liabilities and Stockholders’ Equity

Note: The final balance sheet of Lowstep Corporation will be the same as the beginning balance sheet of Highstep Corporation