INTERMEDIATE ACCOUNTING Seventh Canadian Edition KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK Prepared by: Gabriela H. Schneider, CMA Northern Alberta Institute of Technology Appendix 16B Accounting for Financial Reorganization Learning Objectives 15. Describe the accounting for a financial reorganization. Financial Reorganization • Process 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 details • Referred to as fresh start accounting Financial Reorganization • • • Some debt holders, and all equity holders, give up their right to receive certain future funds Change in control of the company usually results Comprehensive 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 $1,000,000 How did we arrive at these numbers? Post reorganization Assets $ 650,000 Liabilities $ -0Equity: Common Shares 450,000 Deficit (R/E) 250,000 $ 650,000 Reorganization Example 1. 2. 3. Record asset impairments pre-reorganization Deficit (R/E) 750,000 Inventories 225,000 Intangible Assets 525,000 Eliminate Retained Earnings Contributed Surplus 1,750,000 Deficit (R/E) 1,750,000 Restate asset and liability values, record change in control Assets 400,000 Liabilities 150,000 Common Shares 550,000 Reorganization Exercise BE16-12 Truck Corporation Prepare the entries to record the financial reorganization Facts: Plant Assets $105,000 write-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 Assets 105,000 Record write-down of plant assets 2. Contributed Surplus 249,000 Deficit (R/E) 249,000 Eliminate deficit balance through Contributed Surplus (144,000 + 105,000 = 249,000) 3. Liabilities 2,300,000 Common Shares 2,300,000 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 COPYRIGHT Copyright © 2005 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.