Chapter 17 Test Bank
CORPORATE LIQUIDATIONS, REORGANIZATIONS, AND DEBT RESTRUCTURINGS FOR FINANCIALLY
DISTRESSED CORPORATIONS
Multiple Choice Questions
LO1 1. When the bankruptcy court grants an order for relief
a. creditors may not seek payment for their claims directly from the debtor corporation.
b. the reorganization plan was accepted by creditors having at least one-half of the total number of claims
and the claims represent at least two-thirds of the total amount owed.
c. the bankruptcy court confirms that the reorganization plan is fair and equitable to creditors.
d. the court discharges the debtor except for those claims provided for in the reorganization plan.
LO1 2. Which of the following must approve a Chapter 11 plan?
a. The organization’s management.
b. The assigned trustee.
c. The entity’s stockholders.
d. The court and the creditors.
LO1 3. When the accounting equation of a corporation computes a negative ownership position, because
liabilities are greater than assets, the firm is
a. a distressed corporation.
b. a bankrupt corporation.
c. insolvent in the equity sense.
d. insolvent in the bankruptcy sense.
LO1 4. A bankruptcy petition filed by a firm’s creditors is
a. a Chapter 7 petition.
b. a petition for liquidation.
c. an involuntary petition.
d. a voluntary petition.
LO1 5. The duties of a debtor in possession in a Chapter 11 bankruptcy case do not include
a. filing a list of creditors and schedules of assets and liabilities with the bankruptcy court.
b. operating the business during the reorganization period.
c. filing a reorganization plan.
d. surrendering all property to the trustee.
LO1 6. Liabilities incurred after entering Chapter 11
a. can only occur after secured creditors are paid.
b. must be approved by creditors’ committees in liquidation cases.
c. must be approved by trustees.
d. must be preapproved by the bankruptcy court.
LO1 7. In a troubled debt restructuring involving a modification of terms, the debtor’s gain on
restructuring
a. will equal the creditor’s gain on restructuring.
b. will equal the creditor’s loss on restructuring.
c. may or may not equal the creditor’s gain on restructuring.
d. may or may not equal the creditor’s loss on restructuring.
LO1 8. A single creditor
a. can never file a petition for bankruptcy.
b. with a $10,000 or more secured claim may file a petition for bankruptcy.
c. with a $10,000 or more unsecured claim may file a petition for bankruptcy, if there are fewer than 12
unsecured creditors.
d. with a $10,000 or more unsecured claim may file a petition for bankruptcy if there are more than 12
unsecured creditors.
LO1 9. A case against a corporate debtor
a. can be filed only under Chapter 7.
b. can be filed only under Chapter 11.
c. * can be filed either under Chapter 7 or Chapter 11.
d. will be determined by the trustee whether is shall be Chapter 7 or Chapter 11.
LO1 10. A primary difference between voluntary and involuntary bankruptcy petitions is that
a. creditors file the petition in an involuntary filing.
b. trustees are not used in an voluntary filing.
c. voluntary petitions are not subject to review by the bankruptcy court.
d. the debtor corporation files the petition in an involuntary filing.
LO1 11. Creditor committees are elected
a. in all bankruptcy cases.
b. in Chapter 7 cases.
c. only in bankruptcy cases arising from involuntary petitions.
d. in Chapter 11 cases.
LO2 12. The first-to-last ranking order of priority of the following: I.stockholder claims II.unsecured
priority claims III.secured claims II.unsecured nonpriority claims
in a Chapter 7 bankruptcy case is
a. I,II,IV, and III.
b. III,II,IV and I.
c. III,I,IV, and II.
d. II,IV,III,and I.
LO2 13. In typical trustee accounting
a. gains and losses on the sale of assets are charged to the estate equity account.
b. unrecorded liabilities discovered by the trustee are credited to the estate equity account and credited
to the liability account.
c. liquidation expenses are charged to the estate equity account.
d. all of the above procedures are typical for trustee accounting.
LO2 14. Trustees in a bankruptcy cases have the duty to
a. nullify affiliate transactions.
b. relegate tax payments to an unsecured status.
c. call creditor meetings on liquidation proceedings.
d. provide payments to creditors and customers.
LO3 15. If a debtor has material gains on its debt restructurings, these gains will be reported as
a. operating gains of the debtor.
b. other non-operating gains of the debtor.
c. extraordinary gains of the debtor.
d. discontinued operations.
LO3 16. A creditor will record assets transferred in full settlement of a note receivable at the
a. lower of cost or market value of the note receivable.
b. book value of the transferred assets.
c. fair market value of the note receivable.
d. fair market value of the transferred assets.
LO3 17. A judge would permit a debtor-in-possession in a
a. case with only secured creditors.
b. Chapter 7 case.
c. Chapter 11 case.
d. voluntary case.
LO4 18. Under the AICPA’s SOP 90-7, a reorganized company must meet a “reorganization value test” as
one of the two conditions necessary for fresh start accounting. Reorganization value approximates the
a. fair value of the entity’s total assets.
b. fair value of the entity’s net assets.
c. book value of the entity’s net assets.
d. None of the above choices are correct.
LO4 19. Under the AICPA’s SOP 90-7, “prepetition liabilities subject to compromise” are liabilities incurred
before the Chapter 11 filing and are classified as
a. residual claims.
b. contingent claims.
c. current operating claims.
d. unsecured and undersecured claims.
LO4 20. Which of the following statements is correct concerning companies emerging from reorganization
under Chapter 11 when they do not qualify for fresh start accounting?
a. The forgiveness of debt is reported as an operating gain.
b. Quasi-reorganization accounting is used.
c. The forgiveness of debt is reported as an extraordinary item.
d. The forgiveness of debt is reported as an increase in contributed capital.
LO2 Exercise 1
Archery Corporation is liquidating under Chapter 7 of the Bankruptcy Act. The accounts of Archery at the
time of filing are summarized as follows:
Book Value
Estimated Realizable Value Cash $ 10,000 $ 10,000 Accounts receivable-net 60,000 50,000 Inventory
110,000 70,000 Equipment-net 70,000 70,000 Land 20,000 40,000 Building-net 200,000 150,000
Goodwill 42,000 $ 512,000 Accounts payable $ 120,000 Wages and salaries 30,000 Contributions due
to pension plan 20,000 Taxes payable 80,000 Accrued interest payable (includes $10,000 from the
mortgage payable and $2,000 from the note payable) 12,000 Note payable 100,000 Mortgage payable
100,000 Capital stock 70,000 Deficit ( 20,000 ) $ 512,000 The land and building are pledged as security
for the mortgage payable as well as any accrued interest on the mortgage. The note payable is secured
with the equipment, but the interest on the note is unsecured. Wages and salaries were accrued within
the last 90 days and pension plan contributions were accrued within the last 6 months; neither exceeds
$4,000 per employee. Liquidation expenses are expected to be $50,000.
Required: 1. Prepare a schedule showing the priority rankings of the creditors and the expected payouts.
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2. Banyo Corporation was a supplier to Archery Corporation and at the time of Archery’s bankruptcy filing,
Banyo’s account receivable from Archery was $40,000. On the basis of the estimates, how much can Banyo
expect to receive?
LO2 Exercise 2
Hinsch Company is in bankruptcy and is being liquidated under the provisions of Chapter 7 of the
bankruptcy code. The trustee has converted all assets into $120,000 cash and has prepared the following
list of approved claims:
Customer deposits ($1,000 from each of two customers
that ordered products that were never
delivered) $ 2,000 Property taxes payable 4,000 Accounts payable, unsecured 30,000 Trustee’s fees
and other costs of liquidation 16,000 Mortgage payable, secured by property that was sold for $80,000
60,000 Note payable to bank, secured by all accounts receivable of which $30,000 were collected and
$10,000
were written off as uncollectible 30,000 Required How much will the bank receive on the note
payable?
LO2 Exercise 3
Ingham Corporation is being liquidated under Chapter 7 of the Bankruptcy Act. The trustee has
determined that the unsecured claims will receive $.30 on the dollar. Platinum Corporation holds a
$35,000 mortgage note receivable from Ingham that is secured by equipment with a $17,500 book value
and a $7,000 fair value.
Required:
How much of the mortgage receivable will be recovered by Platinum?
LO2*& Exercise 4
Buckley Corporation incurred major losses in 2005 and entered into voluntary Chapter 7 bankruptcy in
the early part of 2006. By July 1, all assets were converted into cash, the secured creditors were paid, and
$74,000 in cash was left to pay the remaining claims as follows:
Accounts payable $ 22,000 Claims prior to the trustee’s appointment 4,000 Property taxes payable 7,500
Wages payable (all under $4,000 per employee) 21,000 Unsecured note payable 28,000 Accrued interest
on the note payable 3,000 Administrative expenses of the trustee 15,000 Total $ 100,500
Required:
Classify the claims by their Chapter 7 priority ranking, and analyze which amounts will be paid and which
amounts will be written off.
LO2 Exercise 5
Jones Corporation is being liquidated under Chapter 7 of the Bankruptcy Act. The trustee has determined
that the unsecured claims will receive $.50 on the dollar. Kevin Corporation holds a $200,000 mortgage
note receivable from Jones that is secured by marketable securities with a $150,000 book value and a
$164,000 fair value.
Required:
How much of the mortgage receivable will Kevin recover?
LO2 Exercise 6
Kresta Corporation is being liquidated under Chapter 7 of the Bankruptcy Act. The trustee has determined
that the unsecured claims will receive $.25 on the dollar. Loanstar Corporation holds an $80,000 mortgage
note receivable from Kresta that is secured by marketable securities with an $88,000 book value and a
$60,000 fair value.
Required:
How much of the mortgage receivable will Loanstar recover?
LO3 Exercise 7
On December 31, 2005, Goldcoast bank agreed to restructure an $800,000, 10% loan receivable from
Fielding Corporation because of Fielding’s financial problems. The loan was issued at par and at December
31, there was $40,000 of accrued interest for a six-month period. Terms of the restructuring agreement
are as follows:
** Reduce the loan from $800,000 to $600,000; ** Extend the maturity date by 2 years from December
31, 2005
to December 31, 2007; and, ** Reduce the interest rate on the loan from 10% to 6%.
Present value assumptions:
Present value of $1 for 2 years at 6% = 0.8900 Present value of $1 for 2 years at 10% = 0.8264 Present
value of an annuity of $1 for 2 years at 6% = 1.8334 Present value of an annuity of $1 for 2 years at 10%
= 1.7355
Required: 1. What amount of gain or loss from restructuring the loan will Fielding report for 2005? 2.
Compute the gain or loss that will be reported by Goldcoast Bank. Assume that the bank has not
recognized an impairment before the restructuring.
LO3 Exercise 8
Logan Corporation owes Mango Finance Company $825,000 plus $53,750 of accrued interest. Logan has
a cash flow shortage and arranges for an equity settlement of the loan with Mango by issuing 55,000
shares of its $1.00 par value common stock to Mango on April 1, 2006. Logan common stock has a market
value of $13.75 per share on April 1.
Required:
Prepare Logan's journal entry to record the troubled debt restructuring.
LO3 Exercise 9
Matrix Corporation owes Norman Finance Company $750,000 on a note payable plus $37,500 of accrued
interest. Matrix has a cash flow shortage and negotiates a debt restructuring with Norman by issuing
60,000 shares of its $1.00 par value common stock to Norman on January 1, 2006. Matrix's common stock
has a market value of $10.10 per share on January 1st.
Required:
Prepare Matrix's journal entry to record the troubled debt restructuring.
LO3 Exercise 10
On December 31, 2006, Galvin Bank agreed to restructure a $900,000, 10% loan receivable from Hines
Corporation because of Hines’ financial problems. The debt was issued at par and at December 31, there
was accrued interest of $60,000 for six months. Terms of the restructuring agreement are as follows:
** Reduce the loan from $900,000 to $600,000; ** Extend the maturity date of the loan by 2 years
from December
31, 2006 to December 31, 2008; and, ** Reduce the interest rate from 10% to 8%.
Present value assumptions:
Present value of $1 for 2 years at 8%
= 0.8573 Present value of $1 for 2 years at 10%
=
0.8264 Present value of an annuity of $1 for 2 years at 8% = 1.7833 Present value of an annuity of $1 for
2 years at 10% = 1.7355
Required: 1. What amount of gain or loss from restructuring the loan will Hines report for 2006? 2.
Compute the gain or loss that will be reported by Galvin Bank. Assume that the bank has not recognized
an impairment before the restructuring.
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©2009 Pearson Education, Inc. publishing as Prentice Hall 17-11
SOLUTIONS
Multiple Choice Questions
1. a
2. d
3. d
4. c
5. d
6. d
7. d
8. c
9. c
10. a
11. b
12. b
13. d
14. d
15. c
16. d
17. b
18. a
19. d
20. c
Exercise 1
Requirement 1
Amount of Claim
Expected Payment
Estimated Remaining Cash Estimated available cash $ 390,000 Secured claims: Mortgage payable
& interest $ 110,000 $ 110,000 $ 280,000 Partially secured claims: Note payable ($30,000 reclassified
as unsecured) 100,000 70,000 210,000 Unsecured priority claims: Estimated liquidation expenses
50,000 50,000 160,000 Wages and salaries 30,000 30,000 130,000 Pension fund liability 20,000 20,000
110,000 Taxes payable 80,000 80,000 30,000 Unsecured nonpriority claims: Accounts payable $ 120,000
Unsecured portion of note payable 30,000 Accrued interest on note payable 2,000 0 Expected return
on the dollar for unsecured nonpriority claims: $30,000/$150,000 = $.20 on the dollar
Requirement 2
Banyo’s estimated return: $40,000 claim x $.20 = $8,000
Exercise 2
Cash $ 120,000 Mortgage payable, paid in full ( 60,000 ) 60,000 Note payable to bank, secured portion (
30,000 ) 30,000 Priority claims ($16,000 of administrative costs + $2,000 of customer deposits + $4,000
property tax) ( 22,000 ) Available for unsecured nonpriority claims $ 8,000
Unsecured, nonpriority claims: Unsecured portion of note payable to bank $ 10,000 Accounts payable
30,000 Total unsecured, nonpriority claims $ 40,000 $8,000 cash/$40,000 claims = $.20 on the dollar
Amount paid to bank: $30,000 for secured portion + ($10,000 x .20) for unsecured portion =
$
32,000
Exercise 3
Mortgage note receivable $ 35,000 Less: Portion secured by equipment ( 7,000 ) Unsecured portion $
28,000 Estimated recovery on secured portion $ 7,000 Estimated recovery on unsecured portion
($28,000 x $.30) = 8,400 Recovery on mortgage note receivable $ 15,400
Exercise 4
Requirement 1
Unsecured priority claims:
Claim Amount To be Paid Cash Left Administrative expenses $
15,000 $ 15,000 $ 59,000 Claims prior to the trustee’s
appointment 4,000 4,000 55,000 Wages
payable 21,000 21,000 34,000 Property taxes payable 7,500 7,500 26,500
Unsecured
Nonpriority Claims: Claim Amount To be Paid Written Off
Accounts payable $ 22,000 $ 11,660 *$
10,340
Unsecured note 28,000 14,840 ** 13,160
Accrued interest on the note 3,000 0 3,000
$26,500/($22,000 + $28,000) = 53%
* $22,000 x 53% = $11,660 **$28,000 x 53% = $14,840
Exercise 5
Mortgage note receivable $ 200,000 Less: Portion secured by marketable securities ( 164,000 ) Unsecured
portion $ 36,000 Estimated recovery on secured portion $ 164,000 Estimated recovery on unsecured
portion ($36,000 x $.50) = 18,000 Recovery on mortgage note receivable $ 182,000
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©2009 Pearson Education, Inc. publishing as Prentice Hall 17-15
Exercise 6
Mortgage note receivable $ 80,000 Less: Portion secured by marketable securities ( 60,000 ) Unsecured
portion $ 20,000 Estimated recovery on secured portion $ 60,000 Estimated recovery on unsecured
portion (20,000 x $.25) = 5,000 Recovery on mortgage note receivable $ 65,000
Exercise 7
Requirement 1
Fielding’s gain on restructuring: Carrying value of the debt ($800,000 + $40,000
accrued interest) $ 840,000 Total future cash flows ($600,000 + $72,000 interest) ( 672,000 ) Gain on
restructuring $ 168,000 Requirement 2
Goldcoast Bank’s loss on restructuring:
Carrying value of
the loan before restructuring $ 840,000 Present value of $600,000 due in 2 years at 10% historical rate:
$600,000 x .8264 = $495,840 Present value of $36,000 interest for 2 years at 10% historical rate =
$36,000 x 1.7355 = 62,478 Carrying value of the loan $558,318 ( 558,318 ) Loss on restructuring $ 281,682
Exercise 8
Note payable 825,000 Accrued interest payable 53,750 Common stock, $10 par 55,000 Capital paid in
excess of par 756,250 Extraordinary gain on restructuring 67,500
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©2009 Pearson Education, Inc. publishing as Prentice Hall 17-16
Exercise 9
Note payable 750,000 Accrued interest payable 37,500 Common stock, $1 par 40,000 Capital paid in
excess of par 546,000 Extraordinary gain on restructuring 201,500
Exercise 10
Requirement 1 Hines’ gain on restructuring: Carrying value of the debt ($900,000 + $60,000 accrued
interest) $ 960,000 Total future cash flows ($600,000 + $96,000 interest) ( 696,000 ) Gain on restructuring
$ 264,000 Requirement 2
Galvin’s loss on restructuring:
Carrying value of the loan before
restructuring $ 960,000 Present value of $600,000 due in 2 years at 10% historical rate: $600,000 x .8264
= $495,840 Present value of $48,000 interest for 2 years at 10% historical rate = $48,000 x 1.7355 =
83,304 Carrying value of the loan $579,144 ( 579,144 ) Loss on restructuring $ 380,856