17 - 1 ©2003 prentice hall business publishing, advanced accounting 8/e,...

17 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Corporate Liquidationsand Reorganizations

Chapter 17


Learning Objective 1

Understand differences among

types of bankruptcy filings.


Bankruptcy Reform Act of 1978

Prior to 1898, state government legislationgoverned bankruptcy procedures.

The 1898 Bankruptcy Act, a federal law,preempted the state legislation.

The 1898 Act was repealed when Congressenacted the Bankruptcy Reform Act of 1978.


Bankruptcy Law

The bankruptcy law facilitates debt relief toindividuals and corporations under various

provisions, called chapters.


Types of Bankruptcies

Chapter 7 –Liquidation

A trustee is appointed to sell offassets of the individual or companyand pay claims to creditors.

DescriptionType

Chapter 9 –Adjustmentsof debts of amunicipality

Municipalities (not covered here).



Chapter 11 –Reorganization

A debtor corporation is expected to berehabilitated and the reorganization ofthe corporation is anticipated.

Either a trustee is appointed or thecompany performs the duties of atrustee (debtor in possession).

A plan of reorganization is negotiated.

DescriptionType



Description

Chapter 12 –Farmers

Family farmers with regular income(not covered here).

Type

Chapter 13 –Adjustmentsof debts of anindividual withregular income

Exclusively applies to individuals,including sole proprietorships.

Unsecured debts less than $250,000and secured debts less than $750,000(not covered here).


Payment of Claims

I. Secured ClaimsClaims secured by valid liens.

II. Unsecured Priority Claims1. Administrative expenses incurred in preserving and

liquidating the estate.2. Claims incurred between the date of filing and the

date an interim trustee is appointed.3. Claims for wages, salaries, and commissions.4. Claims for contributions to employee benefit plans.5. Claims of individuals regarding property or services.6. Claims of governmental units (taxes, duties, etc.).


Payment of Claims

III. Unsecured Nonpriority Claims1. Allowed claims that were timely filed.2. Allowed claims where proof of claims was filed late.3. Allowed claims for any fine, penalty, or forfeiture, or

for charges arising prior to the order for relief.4. Claims for interest on the unsecured priority claims

or the unsecured nonpriority claims.IV. Stockholders’ Claims

Remaining assets are returned to the debtor corporationor its stockholders.



Comprehend trustee

responsibilities and accounting

during liquidation.


Duties of the Trusteein Liquidation Cases

The filing of a case creates an estate.

The trustee takes possession of the estate,converts the assets into cash, and distributes

the proceeds according to the priority ofclaims, as directed by the bankruptcy court.


Statement of Affairs

This statement is a legaldocument prepared for the

bankruptcy court.

It emphasizes liquidation value.


Trustee Accounting

The Bankruptcy Actdoes not cover

procedural accountingdetails.


Trustee Accounting

Statement of Cash Receipts and Disbursements

Statement of Changes in Estate Equity

Balance Sheet

Statement of Realization and Liquidation



Understand financial reporting

during reorganization.


Reorganization

Less than 30% of business bankruptcy casesare filed under Chapter 11 each year.

A Chapter 11 reorganization case isinitiated voluntarily or involuntarily.


Trustee or Debtor in Possession

A private trustee may be appointed.

The debtor corporation may continue in possession.


The Duties of a TrusteeIncluding the Following:

– Being accountable for the debtor’s property

– Filing a list of creditors, schedules of assets and liabilities, and a financial statement

– Furnishing information to the court

– Examining creditor claims for authenticity

– Filing a reorganization plan

– Filing final papers on the trusteeship


Committee Representation

Creditors’ committees are responsiblefor protecting the interests of the

creditors they represent.


Operating Under Chapter 11

Protection of the debtorin possession allowing

possible cost reductions

Losing the confidenceof its lenders, suppliers,

customers, and employers

Possible Benefits

Disadvantages


The Plan of Reorganization Must:

– Identify class of claims

– Specify any class of claims that is not impaired

– Specify any class of claims that is impaired

– Treat all claims within a particular class alike

– Provide adequate means for the plan’s execution

– Prohibit the issuance of nonvoting securities

– Prohibit the issuance of nonvoting securities


Financial Reporting DuringReorganization

The reorganization processcan take several years.

The corporation must still preparefinancial statements and filings

for the SEC during this timeperiod and after it emerges

from reorganization.


Effects of Chapter 11 on theBalance Sheet

Unsecured liabilities and undersecuredliabilities incurred before the company

entered Chapter 11 are prepetitionliabilities subject to compromise.


Effects of Chapter 11 on theIncome Statement

Professional fees and similar expensesrelated directly to the Chapter 11

proceedings are expensed as incurred.

Reorganization items should be reported.


Effects of Chapter 11 on theStatement of Cash Flows

Cash flow items relating to reorganizationare disclosed separately from cash flow

items relating to the ongoingoperations of the business.


Supplementary CombinedFinancial Statements

SOP 90-7 requires that condensed combinedfinancial statements for all entities in

reorganization proceedings be presentedas supplementary financial information.



Understand financial reporting

after emerging from

reorganization including

fresh-start accounting.


Financial Reporting forthe Emerging Company

Ordinarily, a corporate reorganizationinvolves a restructuring of liabilities and

capital accounts and a revaluation of assets.

For many companies, their reorganizationplan includes the sale of the company.


Reorganization Value

Generally, the reorganization value isdetermined by discounting future cashflows for the reconstituted business…

plus the expected proceeds from sale ofassets not required in the new business.


Fresh-Start Reporting

Fresh-start reporting results ina new reporting entity with no

retained earnings or deficit balance.

The SOP provides two conditions thatmust be met for fresh-start reporting:



1. The reorganization value of the emergingentity’s assets immediately before the date ofconfirmation of the reorganization plan is less than the total of all postpetition liabilitiesand allowed claims.

2. Holders of existing voting shares immediatelybefore confirmation of the reorganization planreceive less than 50% of the emerging entity.


Fresh-Start Reporting Resultsin a New Reporting Entity

– Allocating the reorganization valueto identifiable assets

– Reporting liabilities

– Final statement of old entity

– Disclosures in initial financialstatements of new entity

– Comparative financial statements


Reporting by Entities That Do NotQualify for Fresh-Start Reporting

Liabilities are reported at present valuesusing appropriate interest rates.

Forgiveness of debt should be reportedas an extraordinary item.

Quasi-reorganization accounting is not used.


Illustration of a Reorganization Case

Tiger Corporation files for protection fromcreditors under Chapter 11 on January 5, 2003.

During 2003, no prepetition liabilities arepaid and no interest is accrued on the

bank note or the bonds payable.



The bankruptcy court allows Tiger to invest$100,000 in new equipment in August 2003.

The new equipment has a useful life offive years, and is depreciated over a five

year period to the nearest half-year.



Building depreciation: $50,000 per yearOld equipment: $60,000 per yearPatent amortization: $50,000 per year



(Tiger Balance Sheet)Current assets

Cash $ 50,000Accounts receivable, net 500,000Inventory 300,000Other current assets 50,000 $ 900,000

Plant assetsLand $200,000Building, net 500,000Equipment, net 300,000Patent 200,000 1,200,000

$2,100,000



(Tiger Balance Sheet)Current liabilities

Accounts payable $600,000Taxes payable 150,000Accrued interest on bonds 90,000Note payable to bank 260,000 $1,100,000

15% bonds payable(partially secured) 1,200,000

Stockholders’ deficitCapital stock 500,000Deficit –700,000 – 200,000

$2,100,000


Reclassification of LiabilitiesSubject to Compromise

(000)Accounts Payable 600Taxes Payable 150Accrued Interest on 15% Bonds 90Note Payable to Bank 26015% Bonds Payable (partially secured) 1,200

Liabilities Subject to Compromise 2,300To reclassify liabilities subject to compromise


Income and Retained EarningsStatement for the Year 2003

Sales $ 1,000,000Cost of sales (430,000)Wages and salaries (250,000)Depreciation and amortization (170,000)Other expenses (50,000)

Earnings before reorganization items 100,000Professional fees related to bankruptcy (450,000

Net loss (350,000) Beginning deficit (700,000)

Deficit December 31, 2003 $(1,050,000)


Tiger Balance Sheetat December 31, 2003

Current assetsCash $150,000Accounts receivable, net 350,000Inventory 370,000Other current assets 50,000 $ 920,000

Plant assetsLand $200,000Building, net 450,000Equipment, net 330,000Patent 150,000 1,130,000

$2,050,000


Tiger Balance Sheetat December 31, 2003

Current liabilitiesShort-term borrowings $ 150,000Accounts payable 100,000Wages and salaries payable 50,000 $ 300,000

Liabilities subject tocompromise 2,300,000

Stockholders’ deficitCapital stock 500,000Deficit –1,050,000 – 550,000

$2,050,000


The Reorganization Plan

1. Tiger’s 15% bonds payable were secured with the land and building. The bondholders agree to accept

$500,000 new common stock, $500,000 senior debtof 12% bonds and $100,000 cash payable 12/31/03.

2. The priority tax claims of $150,000 will be paid incash as soon as the reorganization plan is confirmed.

3. The remaining unsecured, nonpriority, prepetitionclaims of $950,000 will be settled as follows:


The Reorganization Plan

a. Creditors represented by the accounts payablewill receive $275,000 subordinated debt and$140,000 common stock.

b. The $90,000 accrued interest on the 15% bondswill be forgiven.

c. The $260,000 note payable to the bank will beexchanged for $120,000 subordinated debtand $60,000 common stock.

4. Equity holders will exchange their stock for $100,000common stock of the emerging company.



The reorganization value is compared with the totalpostpetition liabilities and court-allowed claims at June 30

to determine if fresh-start reporting is appropriate.

Postpetition liabilities $ 255,000Allowed claims subject to compromise 2,300,000

Total liabilities on June 30, 2004 2,555,000Less: Reorganization value –2,200,000

Excess liabilities over reorganization value $ 355,000


Proposed ReorganizedCapital Structure

Postpetition liabilities $ 255,000Taxes payable 150,000Current portion of senior debt,

due December 2004 100,000Senior debt, 12% bonds 500,000Subordinated debt 395,000Common stock 800,000

$2,200,000


Comparative Balance Sheetsat June 30, 2004 (000)

AssetsCashAccounts receivableInventoryOther current assetsLandBuildingEquipmentPatentReorganization excess

$ 300 335 350 30 200 425 290 125 —$2,055

a 25

b 100

f 250

c 75d 30c 125

$ 300 335 375 30 300 350 260 — 250$2,200

PreconfirmationBalance Sheet

AdjustmentsDebits Credits

ReorganizedBalance Sheet



Equities (claims)Short-term bank loanAccounts payableWages payablePrepetition claimsAccounts payable, oldTaxes payableInterestBank note15% bonds payable

$ 75 125 55

600 150 90 260 1,200

h 600

i 90j 260g 1,200

$ 75 125 55

— 150 — — —






Stockholders’ EquityCapital stock, oldDeficit

500(1,000)

k 500c 75d 30e 125

a 25b 100f 250g 100h 185i 90j 80k 400

——






New EquitiesCurrent portion, bonds12% senior debtSubordinated debt

Common stock, new

Retained earnings, new

———

—

—$2,055

g 100g 500h 275j 120g 500h 140j 60k 100

100 500

395

800

$2,200





End of Chapter 17

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