Chapter 21
Debt
Restructuring,
Corporate
Reorganizations,
and Liquidations
Relief procedures not requiring
court action
 Troubled
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debt restructuring
transfer of assets in full settlement
granting an equity interest
modification of terms
combination restructuring
 Quasi-reorganizations
 Corporate
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liquidations
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Troubled debt restructuring:
Transfer of assets in full settlement
 Debtor
transfers assets to creditors in order to
settle debt
 Debtor records gain, as an extraordinary item
if material, as measured by the difference
between the carrying basis of the debt and the
fair market value (FMV) of the assets
transferred
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Troubled debt restructuring: Transfer
of assets in full settlement, continued
 The
difference between the FMV of the assets
transferred and their book value is recorded by
the debtor as a gain or loss separate from the
restructuring gain
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Troubled debt restructuring: Transfer
of assets in full settlement, continued
Example:
Loan Payable
Accrued Interest
Assets
Gain on Assets
Restructuring Gain
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100,000
8,000
70,000
10,000
28,000
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Troubled debt restructuring:
Granting an equity interest
 Debtor
transfers an equity interest (stock) in
order to settle debt
 Debtor records gain, as an extraordinary item
if material, as measured by the difference
between the carrying basis of the debt and the
FMV of the equity interest
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Troubled debt restructuring:
Granting an equity interest, continued
Example:
Loan Payable
100,000
Accrued Interest
8,000
Common Stock at par
50,000
Paid-in-Capital in Excess of par 30,000
Restructuring Gain
28,000
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Troubled debt restructuring:
Modification of terms
 Principal
and/or interest on debt may be
modified
 If total future cash payments called for by
restructuring are less than carrying basis of
debt, a restructuring gain is recognized and no
subsequent interest expense is recognized
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Troubled debt restructuring:
Modification of terms, continued
 If
total future cash payments called for by
restructuring are greater than carrying basis of
debt, no restructuring gain is recognized and
subsequent interest expense (at an effective
rate) is recognized
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Troubled debt restructuring:
Modification of terms, continued
Example: Year-end payments of $25,639 are
made for the next five years.
Loan Payable
Accrued Interest
Restructuring Loan Payable
Restructuring Loan Payable
Interest Expense (6%)
Cash
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100,000
8,000
108,000
19,159
6,480
25,639
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Quasi-Reorganization
 Goal
is to eliminate a large deficit in retained
earnings in order to possibly permit future
dividend distributions
 Assets should be written down as necessary
 Par value of common stock is reduced to
additional paid-in-capital
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Quasi-Reorganization, continued
Example: Beginning deficit in retained earnings
is $60,000.
Retained Earnings
Net Assets
50,000
Common Stock
Common Stock
Paid-in-Capital
120,000
Paid-in-Capital
Retained Earnings
110,000
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50,000
10,000
110,000
110,000
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Corporate relief procedures under the
Bankruptcy Act
 Chapter
7: liquidation - the troubled
corporation is liquidated
 Chapter 11: reorganization - the corporation
remains in business through a restructuring of
its debt and/or equity
 Filings under either act may be voluntary or
involuntary
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Restructuring debt under a
Chapter 11 reorganization
 The
accounting for the restructuring differs
from a restructuring which is not covered by
the Bankruptcy Act
 The gain on restructuring is measured as the
difference between the FMV of the
restructured consideration (the net present
value of future payments discounted at
imputed market rates) and the carrying basis
of the debt being restructured
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Chapter 11 reorganization, continued
 The
gain on restructuring is recognized as
either an extraordinary item or additional
paid-in-capital
 Subsequent to the restructuring, interest is
recognized on the restructured debt at the
imputed market rate
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Chapter 7: corporate liquidations
 A trustee
in liquidation is appointed
 The liquidating entity files an inventory of
property and debts/claims
 Assets are liquidated and the debts/claims of
the entity are settled
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Chapter 7: corporate liquidations,
continued
 Claims
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against the entity may be
fully secured
partially secured
unsecured with priority
unsecured without priority
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Corporate Liquidations, continued
 A reorganization
plan will not be confirmed
unless creditors will receive as much as they
would under a Chapter 7 - Liquidation
 Certain debts/claims are not dischargeable
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Statement of Affairs
 Used
in a liquidation to approximate the
estimated amounts available to each class of
claims
 The estimated realizable value of assets are
categorized as: assets pledged with fully
secured creditors, assets pledged with partially
secured creditors, and free assets (estimated
amounts available for unsecured creditors)
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Statement of Affairs, continued
 Liabilities
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are classified
fully secured creditors
partially secured creditors
unsecured creditors with priority
unsecured creditors without priority
 The
statement provides an estimate of to what
extent claims will be satisfied
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Statement of Realization and
Liquidation
 The
bankruptcy court will generally require
the trustee to report
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unrealized assets assigned to the trustee
including those subsequently discovered
assets that have been realized or liquidated
liabilities to be liquidated that have been
assigned to the trustee
liabilities that have been liquidated
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Statement of Realization and
Liquidation, continued
 The
Statement of Realization and Liquidation
provides much of the above information in
that it reports the actual (versus estimated)
results of the liquidation process
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