Advanced financial accounting 8e by baker chap020

Chapter 11 Reorganizations– Allows for legal protection from creditors’ actions during a time needed to reorganize the debtor company and return its operations to a profitable level– The

Corporations in

Financial Difficulty

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number of alternatives, of which bankruptcy

is only a final course

bankruptcy for other reasons, such as to

protect itself from an onslaught of legal suits

void union contracts by petitioning for

bankruptcy

Courses of Action

distressed business

– Formal agreements between the company

and its creditors are legally binding but are not administered by a court

Nonjudicial Actions

– The debtor may solicit an extension of due

dates of its debt, ask for a decrease of the interest rate on the debt, or ask for a

modification of other terms of the debt contract

– Composition agreement: Creditors agree to

accept less than the face amount of their claims

Nonjudicial Actions

– The creditors may agree to assist the debtor

in managing the most efficient payment of creditors’ claims

– Most creditors’ committees are advisory and

counsel closely with the debtor because the creditors do not want to assume additional liabilities and problems of actual operation of the debtor

– Usually initiated with a plan of settlement

proposed by the debtor

Nonjudicial Actions

– Debtors may transfer assets, such as

receivables or other financial instruments, in

an effort to obtain quick cash– Assets may be sold “with recourse” or “without

recourse”

– A transfer of financial assets is considered a

sale only if the transferor has surrendered control over the transferred assets

Judicial Actions

by bankruptcy courts and bankruptcy judges using the guidance provided in Title 11 of

the United States Bankruptcy Code

Judicial Actions

that a judicial action is best

– The debtor may file a voluntary petition

seeking judicial protection in the form of an order of relief against the initiation or

continuation of legal claims by the creditors– Creditors may file an involuntary petition

against the debtor

• Certain conditions must exist before creditors

may file a petition

Chapter 11 Reorganizations

– Allows for legal protection from creditors’

actions during a time needed to reorganize the debtor company and return its operations

to a profitable level– The bankruptcy court administers

reorganizations and often appoints trustees to direct the reorganization

– The company petitions the bankruptcy court

– If granted protection, the company receives

an order of relief to suspend making any payments on its prepetition debt

Chapter 11 Reorganizations

– The company continues to operate while it

prepares a plan of reorganization

– A disclosure statement is transmitted to all

creditors and other parties eligible to vote on

the plan of reorganization

– The bankruptcy court then evaluates the

responses to the plan from creditors and other parties and either confirms the plan of

reorganization or rejects it

Chapter 11 Reorganizations

guidance for financial reporting for

companies in reorganization

– The financial statements should distinguish

transactions and events directly associated with the reorganization from those associated with ongoing operations

Chapter 11 Reorganizations

– SOP 90-7 states that fresh start reporting

should be used as of the confirmation date of the plan of reorganization if both the following conditions occur:

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

2 Holders of existing voting shares immediately

before confirmation receive less than 50 percent

Chapter 11 Reorganizations

– First, the company is required to compute the

reorganization value of the emerging entity’s assets

• Reorganization value represents the fair value of

the entity before considering liabilities and approximates the amount a willing buyer would pay for the entity’s assets

– The reorganization value is then allocated to

the assets using the allocation of value method

Chapter 11 Reorganizations

– A reorganization value in excess of amounts

assignable to identifiable assets is reported as

an intangible asset – The emerging company’s liabilities are

recorded at the present values of the amounts

to be paid– Any retained earnings or deficits are

eliminated– A set of final operating statements is prepared

just prior to emerging from reorganization– In essence, the company is a new reporting

Chapter 11 Reorganizations

accounting

– Companies should determine whether their

assets are impaired in value– They should report liabilities at the present

values of the amounts to be paid, with any gain or loss on the revaluation of the liabilities recorded in accordance with APB 30 as to

extraordinary or ordinary events

Chapter 11 Reorganizations

accounting

– They should recognize a liability for a cost

associated with an exit or disposal activity when the liability is incurred, not at the earlier time the company makes a commitment to an exit plan

– Long-lived assets are divided between (1)

those to be held and used and (2) those to be disposed of by sale

Chapter 11 Reorganizations

1 Disposing of unprofitable operations

2 Restructuring of debt with specific creditors

3 Revaluation of assets and liabilities

4 Reductions or eliminations of claims of original

stockholders and issuances of new shares to creditors or others

Chapter 7 Liquidations

bankruptcy courts in the interests of the

corporation’s creditors and shareholders

net dollar amount recovered from disposal

of the debtor’s assets

Chapter 7 Liquidations

– Secured creditors

• Have liens, or security interests, on specific

assets, often called “collateral”

• A creditor with such a legal interest in a specific

asset has the highest priority claim on that asset

– Creditors with priority

• Unsecured creditors having no collateral claim

against specific assets, who have priority over other unsecured creditors

Chapter 7 Liquidations

– Unsecured creditors

• The lowest priority is given to these claims

• They are paid only after secured creditors and

unsecured creditors with priority are satisfied to the extent of any legal limits

• Often they receive less than the full amount of

their claim

Chapter 7 Liquidations

– The basic accounting report made at the

beginning of the process to present the expected realizable amounts from disposal of the assets, the order of creditors’ claims, and the expected amount that unsecured creditors will receive as a result of the liquidation

– A different report, also entitled the “statement

of affairs,” is a list of questions the debtor must answer as part of the bankruptcy petition

Chapter 7 Liquidations

– It is an important planning report for the

anticipated liquidation of a company– It presents the book values of the debtor

company’s balance sheet accounts, the estimated fair market values of the assets, the order of the claims, and the estimated

deficiency to the general unsecured creditors

Additional Considerations

– Bankruptcy courts appoint trustees to manage

a company under Chapter 11 reorganization in cases of management fraud, dishonesty,

incompetence, or gross mismanagement– The trustee then attempts to rehabilitate the

business

Additional Considerations

– In Chapter 7 liquidations, the trustee normally

has the responsibility to expeditiously liquidate the bankrupt company and pay creditors in conformity with the legal status of their secured or unsecured interests

– In some cases under Chapter 7, the court

appoints a trustee to operate the company for

a short time in an effort to obtain a better price for the company in entirety rather than selling

Additional Considerations

– Trustees examine the proofs of all creditors’

claims against the debtor’s bankruptcy estate, that is, the debtor’s net assets

– Sometimes the trustee receives title to all

assets as a receivership, becomes responsible for the actual management of the debtor, and must direct a plan of

reorganization or liquidation

Additional Considerations

– The general form of the trustee’s opening

entry, accepting the assets of the debtor company, is as follows:

Additional Considerations

– Statement of realization and liquidation is a

monthly report prepared for the bankruptcy court

• It shows the results of the trustee’s fiduciary

actions beginning at the point the trustee accepts the debtor’s assets

• The statement has three major sections: assets,

supplementary items, and liabilities

Additional Considerations

liquidation