Prepared by: Gabriela H. Schneider, CMA Northern Alberta Institute of Technology INTERMEDIATE ACCOUNTING Seventh Canadian Edition KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK

Appendix 16B Accounting for Financial Reorganization Appendix 16B Accounting for Financial Reorganization

15.Describe the accounting for a financial reorganization. Learning Objectives

Financial Reorganization Process where a company that has undergone financial difficulties can reorganize its finances without having to recover a deficitProcess where a company that has undergone financial difficulties can reorganize its finances without having to recover a deficit Agreement is reached between debt and equity holders on process detailsAgreement is reached between debt and equity holders on process details Referred to as fresh start accountingReferred to as fresh start accounting

Financial Reorganization Some debt holders, and all equity holders, give up their right to receive certain future fundsSome debt holders, and all equity holders, give up their right to receive certain future funds Change in control of the company usually resultsChange in control of the company usually results Comprehensive revaluation of all assets and liabilitiesComprehensive revaluation of all assets and liabilities

Comprehensive Revaluation 1.Retained earnings brought to zero balance –Deficit balance removed –Pre-existing write-downs and impairments recorded before retained earnings write-off 2.Negotiated debt and equity changes recorded –Debt may be exchanged for equity (change in control) 3.Remaining assets and liabilities revalued –Revaluation adjustments and related costs are equity transactions –Closed to Share Capital, Contributed Surplus, or other equity account

Reorganization Example New Horizons applies for financial reorganization as at June 30, 2005 Retained Earnings$1,000,000 deficit Negotiated Terms $150,000 in existing debt exchanged for 100% of the common shares Original shareholders give up all shares

Reorganization Example Pre-reorganization Assets $1,000,000 Liabilities $ 150,000 Common Shares 750,000 Shares 750,000 $1,000,000 $1,000,000 Post reorganization Assets $ 650,000 Liabilities $ -0- Equity:Common Shares 450,000 Shares 450,000 Deficit (R/E) 250,000 $ 650,000 $ 650,000 How did we arrive at these numbers?

Reorganization Example 1.Record asset impairments pre-reorganization Deficit(R/E) 750,000 Inventories 225,000 Intangible Assets 525,000 2.Eliminate Retained Earnings Contributed Surplus 1,750,000 Deficit (R/E) 1,750,000 3.Restate asset and liability values, record change in control Assets400,000 Liabilities150,000 Common Shares550,000

Reorganization Exercise BE16-12Truck Corporation Prepare the entries to record the financial reorganization Facts: Plant Assets$105,000write-down Deficit$144,000 Debt$2,300,000 Exchanged for 55% of common shares

Reorganization Exercise – Journal Entries 1.Deficit (Retained Earnings)105,000 Plant Assets105,000 Record write-down of plant assets Record write-down of plant assets 2. Contributed Surplus249,000 Deficit (R/E)249,000 Eliminate deficit balance through Contributed Surplus (144, ,000 = 249,000) 3.Liabilities2,300,000 Common Shares2,300,000 Record retirement of debt, and change in control All three steps have been completed in recording this reorganization

Reorganization Requirements 1.Shareholders approve the reorganization before it is effected 2.Asset and liability valuation are at fair market value 3.Retained earnings has zero balance immediately following reorganization

Reorganization Disclosure 1.In the period of reorganization a.Date of reorganization b.Description of reorganization c.Change amount for each major asset, liability and equity account 2.Each of the three years following reorganization a.Date of reorganization b.Revaluation adjustment amount, and which account recorded to c.Amount of deficit adjusted, and to which account d.Measurement basis for the revaluation of assets and liabilities

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