Beams11 ppt18

Chapter 18
Corporate Liquidations
and Reorganizations
to accompany
Advanced Accounting, 11th edition
by Beams, Anthony, Bettinghaus, and Smith
Copyright 2012 Pearson Education,
Inc. Publishing as Prentice Hall
18-1
Corporate Liquidations and

Reorganizations: Objectives
1. Understand differences among types
of bankruptcy filing.
2. Comprehend trustee responsibilities
and accounting during liquidation.
3. Understand financial reporting during
reorganization.
4. Understand financial reporting after
emerging from reorganization,
including fresh-start accounting.
18-2
Corporate Liquidations and Reorganizations
1: TYPES OF BANKRUPTCIES

18-3
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
18-4
Types of Bankruptcies
Chapter 7: Liquidation
Trustee appointed to sell assets of
business
Chapter 9: Adjustment of Debt of a Municipality
Chapter 11: Reorganization

Debtor is expected to be rehabilitated
Chapter 12: Farmers
Chapter 13: Adjustment of Debts of an Individual
18-5
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

18-6
2: TRUSTEE
RESPONSIBILITIES AND
ACCOUNTING

18-7
Duties of Debtor Corporation

In both liquidation and reorganization cases,
the debtor corporation must
File a list of creditors, a schedule of assets
and liabilities, and a statement of financial
affairs
Cooperate with trustee
Surrender property to the trustee, including
records
Appear at court hearings
18-8
Duties of Trustee
Trustee serves 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
18-9
Ranking of Claims: Liquidation

18-10
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
18-11

18-12

18-13
Trustee Accounting
At start of case, trustee creates a new set of
books.
During the 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
18-14
Debtor in Possession
Unless there is a reason to appoint a
trustee, the debtor corporations
management is permitted to continue to
run the company while in bankruptcy.
The Debtor in Possession has the same
responsibilities as a trustee in a
reorganization case.
18-15
Creditors Committee
The Creditors Committee is elected in a
liquidation case, and is appointed in a
reorganization case from the largest
unsecured creditors.
Makes decisions on behalf of all
creditors
Reviews ongoing transactions of the
debtor in possession and can object
Handles negotiations with any creditor
regarding settlement or continued
business.
18-16
Benefits of Chapter 11
Benefits of being the Debtor in Possession
include:
Rejecting executory contracts
Cancelling unexpired leases
Legal protection from creditor action, such
as lawsuits or repossession of property
However, day-to-day operations may become
more difficult as lenders, suppliers, customers,
and employees are aware of the bankruptcy
filing.
18-17
Reorganization Plan
A plan may be filed at the time of the bankruptcy
filing (prepackaged bankruptcy) or by the
debtor corporation within 120 days of filing.
Other interested parties may file proposed plans
after 120 days.
Identify classes of claims
Specify the expected payout of each class
Claims within a given class must be treated
alike
Define the expected requirements for
execution of the plan
Must be fair and equitable
18-18
3: FINANCIAL REPORTING
DURING REORGANIZATION

18-19
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
Likely to be paid at an amount less than face value
Prepetition secured liabilities and post petition
liabilities reported in normal fashion
Prepetition claims discovered after filing
Included at court-allowed amounts
18-20
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
18-21
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

18-22
4: EMERGING FROM
REORGANIZATION

18-23
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
1. Fresh start reporting
2. Report liabilities at present value and
forgiveness of debt as extraordinary item
18-24
Fresh-Start Reporting
Fresh-Start Reporting recognizes that the
emerging company is a new entity.
To qualify,
1. Revaluation value immediately before the
reorganization plan is confirmed must be
less than post-petition liabilities and allowed
claims, and
2. Holders of existing voting shares receive
less than 50% of emerging entity
18-25
Apply Fresh Start Reporting

Allocated reorganization value to identifiable
assets
Unallocated amount is an intangible called
Reorganization value in excess of amounts allocated
to identifiable assets
Liabilities at current value at confirmation date
Deferred tax benefits are first applied to reduce
any intangible asset recorded
Prepare final reports of old entity
The effects of adjustments to asset and liability
accounts are shown, so that ending balance sheet
of old entity = beginning balance sheet of new
entity
18-26
Continued Reporting of Old Company

If a company does not qualify for Fresh-Start
Reporting, then
Report liabilities at the appropriate interest
rate under GAAP
Report debt forgiveness as an extraordinary
item

18-27
Reorganization Example
Tig files for protection under Chapter 11 on
January 5, 2011. Accordingly, it
reclassifies prepetition liabilities
obtains short-term financing
acquires additional equipment
continues operations through June 30, 2012
when the plan is approved, with a
reorganization value of $2,200
First, we'll look at the statements pre and post
reorganization. Then we'll go through the
entries and adjustments that occurred.
18-28
Balance Sheet Assets

Filed
1/5/11
Fair
FYE Before
Revalue
12/31/11 6/30/12 valuation 6/30/12
Cash
50
150
300
0
Accounts receivable
500
350
335
0
Inventory
300
370
350
25
Other current assets
50
50
30
0
Land
200
200
200
100
Building, net
500
450
425
(75)
Equipment, net
300
330
290
(30)
Patent
200
150
125
(125)
Reorganization value in excess of identifiable assets
2,100
2,050 2,055
(105)
300
335
375
30
300
350
260
0
1,950
AFTER
6/30/12
300
335
375
30
300
350
260
0
250
2,200
18-29
Changes to Assets
Fair values and revaluation amounts are shown on 6/30/12
for comparison.
Tig continues operations, records depreciation,

and even acquires equipment from filing on
1/5/11 to reorganization on 6/30/12.
The reorganization revalues the assets to their
fair value on that date. Patents are completely
written off.
Tig records an intangible "Reorganization value

in excess of identifiable assets" of $250. Not all
reorganizations result in this intangible.
18-30
Balance Sheet - Liability & Equity

Filed
1/5/11
Short-term borrowing (post)

Accounts payable (pre/post)
Wages payable (post)
Taxes payable (pre)
Accrued bond interest (pre)
Note payable (pre)
Subordinated debt (post)
12% bonds payable current (post)
12% bonds payable (post)
15% bonds payable (pre)
Liabilities subject to compromise
Capital stock (old)
Capital stock (new)
Deficit
600
FYE
12/31/11
150
100
50
Before
6/30/12
75
125
55
150
90
260
AFTER
6/30/12
75
125
55
150
395
100
500
1,200
2,300
500
500
(700)
2,100
(1,050)
2,050

2,300
500
(1,000)
2,055
800
0
2,200
18-31
Changes to Liabilities
Upon filing on 1/5/11, Tig reclassifies the
unsecured and partially secured liabilities at that
point as Pre-petition Liabilities Subject to
Compromise.
Pre-petition Liabilities Subject to Compromise
are then reclassified or settled according to the
plan.
Accounts payable on 12/31/11 does not include
any of the $600 due prior to filing.
Taxes payable are still to be paid, and eventually
recorded again inCopyright
full.2012 Pearson Education,
18-32
Changes to 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!
18-33
Can Tig Use Fresh Start?

Post-petition liabilities
Allowed claims
Total liabilities
Less reorganization value
Excess liabilities
$255
2,300
$2,555
(2,200)
$355
On 6/30/12 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.
18-34
Reorganization Plan: 6/30/12

Pre-petition
Liabilities and Equity
15% partially secured
bonds, $1200
Priority tax claims $150
New Agreements
$500 new stock, $500
senior 12% bonds, and
another $100 bonds due
12/31/12
To be paid cash once
confirmed
Debt Discharge
$100
$0
Remaining unsecured claims, $950:
$600 accounts payable

$90 accrued interest
$260 note
Old stock
$275 subordinated debt

and $140 new stock
Forgiven
$120 subordinated debt
and $60 new stock
Total debt discharged
$100 new stock

$185
$90
$80
$455
Equity
18-35
Record New Debt Agreements

Liabilities subject to compromise (pre)
Taxes payable
12% senior debt
12% senior debt - current
Subordinated debt
Common stock (new)
Gain on debt discharge
settlement of prepetition claims
2,300
150
500
100
395
700
455
This entry reclassifies the pre-petition debt

according to the reorganization plan.
18-36
Give Shareholders New Shares

Common stock (old)
Common stock (new)
Additional paid in capital
exchange of stock with owners
500
100
400
They will lose control since creditors have

$700 of common stock.

18-37
Revalue Assets
Inventory
25
Land
100
Loss on asset revaluation
105
Buildings, net
Equipment, net
75
30
Patent
revalue assets to fair value
125
A loss is recorded in revaluing the assets. Refer

back to the Asset side of the balance sheet.
18-38
Calculate Balance in Retained

Earnings (Deficit)
Deficit, 6/30/12
(1,000)

Final measure of deficit, 6/30/12
455
(105)
($650)
Write-off Additional paid in capital

Reorganization value in excess of
identifiable assets (intangible asset)
400
($250)
If sufficient APIC had existed, there would be

no intangible asset, and excess APIC would
remain on the balance sheet.
18-39
Eliminate Deficit in Equity

Reorganization value in excess of
identifiable assets
250
455
Additional paid in capital

400
Deficit
105
1,000
The $1,000 deficit on 6/30/12 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.
18-40
Simplifying Assumptions
All transactions are recorded on
6/30/12.
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.
18-41
Disclosures
Adjustments to historical values
Assets
Liabilities
Debt forgiveness
Prior retained earnings or deficit eliminated
Significant factors in determining the
reorganization value
18-42
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18-43

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Chapter 18

Corporate Liquidations and

Corporate Liquidations and Reorganizations

Copyright 2012 Pearson Education,

Chapter 11: Reorganization

Copyright 2012 Pearson Education,

Corporate Liquidations and Reorganizations

Copyright 2012 Pearson Education,

Duties of Debtor Corporation

In reorganization cases, in addition to above

Ranking of Claims: Liquidation

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Corporate Liquidations and Reorganizations

Copyright 2012 Pearson Education,

Chapter 11: Balance Sheet

Chapter 11: Other Statements

Cash flow items related to reorganization

Combined Financial Statements

Copyright 2012 Pearson Education,

Corporate Liquidations and Reorganizations

Copyright 2012 Pearson Education,

Apply Fresh Start Reporting

Continued Reporting of Old Company

Copyright 2012 Pearson Education,

Balance Sheet Assets

Tig continues operations, records depreciation,

Tig records an intangible "Reorganization value

Balance Sheet - Liability & Equity

Short-term borrowing (post)

Copyright 2012 Pearson Education,

Can Tig Use Fresh Start?

On 6/30/12 there were $255 in post-petition

Reorganization Plan: 6/30/12

Remaining unsecured claims, $950:

$600 accounts payable

$275 subordinated debt

Copyright 2012 Pearson Education,

Record New Debt Agreements

This entry reclassifies the pre-petition debt

Give Shareholders New Shares

They will lose control since creditors have

Copyright 2012 Pearson Education,

Loss on asset revaluation

A loss is recorded in revaluing the assets. Refer

Calculate Balance in Retained

Gain on debt discharge

Write-off Additional paid in capital

If sufficient APIC had existed, there would be

Eliminate Deficit in Equity

Gain on debt discharge

Additional paid in capital

The $1,000 deficit on 6/30/12 is adjusted for

This work is protected by United States copyright laws and

All rights reserved. No part of this publication may be

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