1. Chapter 17: Corporate Liquidations and Reorganizations
Beams, Advanced Accounting 10e, Ch. 17
4/12/2017
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
© Pearson Education, Inc. publishing as Prentice Hall
17-1
© Pearson Education, Inc. publishing as Prentice Hall 1

2. Corporate Liquidations: Objectives
Understand differences among types of bankruptcy filings.
Comprehend trustee responsibilities and accounting during liquidation.
Understand financial reporting during reorganization.
Understand financial reporting after emerging from reorganization, including fresh-start accounting.
© Pearson Education, Inc. publishing as Prentice Hall
17-2

3. 1: Types of Bankruptcies
Corporate Liquidations and Reorganizations
1: Types of Bankruptcies
© Pearson Education, Inc. publishing as Prentice Hall
17-3

4. Insolvency 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
Reorganized
© Pearson Education, Inc. publishing as Prentice Hall
17-4

5. Types of Bankruptcies Chapter 7: Liquidation
Trustee appoint to sell assets of business
Chapter 9: Adjustments of Debts of a Municipality
Chapter 11: Reorganization
Debtor is expected to be rehabilitated
Chapter 12: Farmers
Chapter 13: Adjustment of Debts of an Individual with Regular Income
© Pearson Education, Inc. publishing as Prentice Hall
17-5

6. Characteristics 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
Chapter 11 reorganization Chapter 7 liquidation
© Pearson Education, Inc. publishing as Prentice Hall
17-6

7. 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
© Pearson Education, Inc. publishing as Prentice Hall
17-7

8. Ranking of Claims: Liquidation
© Pearson Education, Inc. publishing as Prentice Hall
17-8

9. 2: Corporate Liquidation
Corporate Liquidations and Reorganizations
2: Corporate Liquidation
© Pearson Education, Inc. publishing as Prentice Hall
17-9

10. 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
© Pearson Education, Inc. publishing as Prentice Hall
17-10

11. © Pearson Education, Inc. publishing as Prentice Hall
17-11

12. © Pearson Education, Inc. publishing as Prentice Hall
17-12

13. Trustee Accounting At start of case New set of books Through case
Records transactions
Statement of cash receipts and disbursements
Statement of changes in estate equity
Balance sheet
Statement of realization and liquidation
At close of case
Final settlement of claims
Trustee is dismissed
© Pearson Education, Inc. publishing as Prentice Hall
17-13

14. 3: Corporate Reorganization
Corporate Liquidations and Reorganizations
3: Corporate Reorganization
© Pearson Education, Inc. publishing as Prentice Hall
17-14

15. 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
© Pearson Education, Inc. publishing as Prentice Hall
17-15

16. Chapter 11: Other Statements
Reorganization costs shown separately
Interest to be paid or probable amount
Differences from contractual amounts should be noted
Expected stock or stock equivalent issuances should be disclosed
Cash flow items related to reorganization shown separately
© Pearson Education, Inc. publishing as Prentice Hall
17-16

17. 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
© Pearson Education, Inc. publishing as Prentice Hall
17-17

18. 4: Emerging from Reorganization
Corporate Liquidations and Reorganizations
4: Emerging from Reorganization
© Pearson Education, Inc. publishing as Prentice Hall
17-18

19. Reorganization Value
Approximates fair value of entity without considering liabilities
Discounted future cash flows of reorganized business
Consider business and financial risk
Reorganization value determines how much creditors recover
Emerging business will either use
Fresh start reporting
Report liabilities at present value and forgiveness of debt as extraordinary item
© Pearson Education, Inc. publishing as Prentice Hall
17-19

20. 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
© Pearson Education, Inc. publishing as Prentice Hall
17-20

21. 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
© Pearson Education, Inc. publishing as Prentice Hall
17-21

22. 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 reorganization. Then we'll go through the entries and adjustments that occurred.
© Pearson Education, Inc. publishing as Prentice Hall
17-22

23. Balance Sheet Assets Cash 50 150 300 Accounts receivable 500 350 335
Filed 1/5/08
FYE 12/31/08
Before
6/30/09
Fair value 6/30/09
Revalu-
ation
AFTER 6/30/09
Cash 50
150
300
Accounts receivable
500
350
335
Inventory
370
375 25
Other current assets 30
Land
200
100
Building, net
450
425
(75)
Equipment, net
330
290
260
(30)
Patent
125
(125)
Reorganization value in excess of identifiable assets
250
2,100
2,050
2,055
1,950
(105)
2,200
© Pearson Education, Inc. publishing as Prentice Hall
17-23

24. 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.
© Pearson Education, Inc. publishing as Prentice Hall
17-24

25. Balance Sheet – Liability & Equity
Filed 1/5/08
FYE 12/31/08
Before 6/30/09
AFTER 6/30/09
Short term borrowing (post)
150 75
Accounts payable (pre/post)
600
100
125
Wages payable (post) 50 55
Taxes payable (pre)
Accrued bond interest (pre) 90
Note payable (pre)
260
Subordinated debt (post)
395
12% bonds payable – current (post)
12% bonds payable (post)
500
15% bonds payable (pre)
1,200
Liabilities subject to compromise
2,300
Capital stock (old)
Capital stock (new)
800
Additional paid in capital
Deficit
(700)
(1,050)
(1,000)
2,100
2,050
2,055
2,200
© Pearson Education, Inc. publishing as Prentice Hall
17-25

26. What Happened to Liabilities?
Upon filing on 1/5/08, Tiger reclassifies the unsecured and partially secured liabilities at that point as Pre-petition Liabilities subject to compromise.
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.
© Pearson Education, Inc. publishing as Prentice Hall
17-26

27. 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!
© Pearson Education, Inc. publishing as Prentice Hall
17-27

28. Can Tiger Use Fresh Start?
Post-petition liabilities
$255
Allowed claims
2,300
Total liabilities
$2,555
Less reorganization value
(2,200)
Excess liabilities
$355
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
2. Old shareholders retain less than 50%
Yes, fresh start is appropriate.
© Pearson Education, Inc. publishing as Prentice Hall
17-28

29. Reorganization Plan: 6/30/09
Pre-petition Liabilities and Equity
New Agreements
Debt Dis-charge
15% partially secured bonds, $1200
$500 new stock, $500 senior 12% bonds, and another $100 bonds due 12/31/09
$100
Priority tax claims $150
To be paid cash once confirmed $0
Remaining unsecured claims, $950:
$600 accounts payable
$275 subordinated debt and $140 new stock
$185
$90 accrued interest
Forgiven
$90
$260 note
$120 subordinated debt and $60 new stock
$80
Total debt discharged
$455
Old stock
$100 new stock
Equity
© Pearson Education, Inc. publishing as Prentice Hall
17-29

30. Record New Debt Agreements
Liabilities subject to compromise (pre)
2,300
Taxes payable
150
12% senior debt
500
12% senior debt - current
100
Subordinated debt
395
Common stock (new)
700
Gain on debt discharge
455
settlement of prepetition claims
This entry reclassifies the pre-petition debt according to the reorganization plan.
© Pearson Education, Inc. publishing as Prentice Hall
17-30

31. Give Shareholders New Shares
Common stock (old)
500
Common stock (new)
100
Additional paid in capital
400
exchange of stock with owners
They will lose control since creditors have $700 of common stock.
© Pearson Education, Inc. publishing as Prentice Hall
17-31

32. Revalue Assets Loss on asset revaluation 105
Inventory 25
Land
100
Loss on asset revaluation
105
Buildings, net 75
Equipment, net 30
Patent
125
revalue assets to fair value
A loss is recorded in revaluing the assets. Refer back to the Asset side of the balance sheet.
© Pearson Education, Inc. publishing as Prentice Hall
17-32

33. Calculate Balance in Retained Earnings (Deficit)
(1,000)
Gain on debt discharge
455
Loss on asset revaluation
(105)
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)
If sufficient APIC had existed, there would be no intangible asset, and excess APIC would remain on the balance sheet.
© Pearson Education, Inc. publishing as Prentice Hall
17-33

34. Eliminate Deficit in Equity
Reorganization value in excess of identifiable assets
250
Gain on debt discharge
455
Additional paid in capital
400
Loss on asset revaluation
105
Deficit
1,000
The $1,000 deficit on 6/30/09 is adjusted for the gain on debt discharge and loss on asset revaluation. The net $650 deficit eliminates all of the APIC and creates a $250 intangible.
© Pearson Education, Inc. publishing as Prentice Hall
17-34

35. 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.
© Pearson Education, Inc. publishing as Prentice Hall
17-35

36. Disclosures Adjustments to historical values Assets Liabilities
Debt forgiveness
Prior retained earnings or deficit eliminated
Significant factors in determining the reorganization value
© Pearson Education, Inc. publishing as Prentice Hall
17-36

37. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.
Copyright © 2009 Pearson Education, Inc.   Publishing as Prentice Hall
© Pearson Education, Inc. publishing as Prentice Hall
17-37