Corporate Liquidations
and Reorganizations
Chapter 17
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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Learning Objective 1
Understand differences among
types of bankruptcy filings.
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Bankruptcy Reform Act of 1978
Prior to 1898, state government legislation
governed bankruptcy procedures.
The 1898 Bankruptcy Act, a federal law,
preempted the state legislation.
The 1898 Act was repealed when Congress
enacted the Bankruptcy Reform Act of 1978.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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Bankruptcy Law
The bankruptcy law facilitates debt relief to
individuals and corporations under various
provisions, called chapters.
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Types of Bankruptcies
Description
Type
Chapter 7 –
Liquidation
Chapter 9 –
Adjustments
of debts of a
municipality
 A trustee
is appointed to sell off
assets of the individual or company
and pay claims to creditors.
 Municipalities (not covered here).
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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Types of Bankruptcies
Description
Type
Chapter 11 –
Reorganization
 A debtor
corporation is expected to be
rehabilitated and the reorganization of
the corporation is anticipated.
 Either a trustee is appointed or the
company performs the duties of a
trustee (debtor in possession).
 A plan of reorganization is negotiated.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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Types of Bankruptcies
Description
Type
Chapter 12 –
Farmers
Chapter 13 –
Adjustments
of debts of an
individual with
regular income
 Family
farmers with regular income
(not covered here).
 Exclusively applies to individuals,
including sole proprietorships.
 Unsecured debts less than $250,000
and secured debts less than $750,000
(not covered here).
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Payment of Claims
I. Secured Claims
Claims secured by valid liens.
II. Unsecured Priority Claims
1. Administrative expenses incurred in preserving and
liquidating the estate.
2. Claims incurred between the date of filing and the
date an interim trustee is appointed.
3. Claims for wages, salaries, and commissions.
4. Claims for contributions to employee benefit plans.
5. Claims of individuals regarding property or services.
6. Claims of governmental units (taxes, duties, etc.).
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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Payment of Claims
III. Unsecured Nonpriority Claims
1. Allowed claims that were timely filed.
2. Allowed claims where proof of claims was filed late.
3. Allowed claims for any fine, penalty, or forfeiture, or
for charges arising prior to the order for relief.
4. Claims for interest on the unsecured priority claims
or the unsecured nonpriority claims.
IV. Stockholders’ Claims
Remaining assets are returned to the debtor corporation
or its stockholders.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
17 - 9
Learning Objective 2
Comprehend trustee
responsibilities and accounting
during liquidation.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 10
Duties of the Trustee
in Liquidation Cases
The filing of a case creates an estate.
The trustee takes possession of the estate,
converts the assets into cash, and distributes
the proceeds according to the priority of
claims, as directed by the bankruptcy court.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 11
Statement of Affairs
This statement is a legal
document prepared for the
bankruptcy court.
It emphasizes liquidation value.
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Trustee Accounting
The Bankruptcy Act
does not cover
procedural accounting
details.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 13
Trustee Accounting
Statement of Cash Receipts and Disbursements
Statement of Changes in Estate Equity
Balance Sheet
Statement of Realization and Liquidation
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 14
Learning Objective 3
Understand financial reporting
during reorganization.
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Reorganization
Less than 30% of business bankruptcy cases
are filed under Chapter 11 each year.
A Chapter 11 reorganization case is
initiated voluntarily or involuntarily.
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Trustee or Debtor in Possession
A private trustee may be appointed.
The debtor corporation may continue in possession.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 17
The Duties of a Trustee
Including the Following:
– Being accountable for the debtor’s property
– Filing a list of creditors, schedules of assets
and liabilities, and a financial statement
– Furnishing information to the court
– Examining creditor claims for authenticity
– Filing a reorganization plan
– Filing final papers on the trusteeship
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Committee Representation
Creditors’ committees are responsible
for protecting the interests of the
creditors they represent.
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Operating Under Chapter 11
Possible Benefits
Protection of the debtor
in possession allowing
possible cost reductions
Disadvantages
Losing the confidence
of its lenders, suppliers,
customers, and employers
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The Plan of Reorganization Must:
– Identify class of claims
– Specify any class of claims that is not impaired
– Specify any class of claims that is impaired
– Treat all claims within a particular class alike
– Provide adequate means for the plan’s execution
– Prohibit the issuance of nonvoting securities
– Prohibit the issuance of nonvoting securities
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 21
Financial Reporting During
Reorganization
The reorganization process
can take several years.
The corporation must still prepare
financial statements and filings
for the SEC during this time
period and after it emerges
from reorganization.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 22
Effects of Chapter 11 on the
Balance Sheet
Unsecured liabilities and undersecured
liabilities incurred before the company
entered Chapter 11 are prepetition
liabilities subject to compromise.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 23
Effects of Chapter 11 on the
Income Statement
Professional fees and similar expenses
related directly to the Chapter 11
proceedings are expensed as incurred.
Reorganization items should be reported.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 24
Effects of Chapter 11 on the
Statement of Cash Flows
Cash flow items relating to reorganization
are disclosed separately from cash flow
items relating to the ongoing
operations of the business.
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Supplementary Combined
Financial Statements
SOP 90-7 requires that condensed combined
financial statements for all entities in
reorganization proceedings be presented
as supplementary financial information.
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Learning Objective 4
Understand financial reporting
after emerging from
reorganization including
fresh-start accounting.
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Financial Reporting for
the Emerging Company
Ordinarily, a corporate reorganization
involves a restructuring of liabilities and
capital accounts and a revaluation of assets.
For many companies, their reorganization
plan includes the sale of the company.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 28
Reorganization Value
Generally, the reorganization value is
determined by discounting future cash
flows for the reconstituted business…
plus the expected proceeds from sale of
assets not required in the new business.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 29
Fresh-Start Reporting
Fresh-start reporting results in
a new reporting entity with no
retained earnings or deficit balance.
The SOP provides two conditions that
must be met for fresh-start reporting:
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 30
Fresh-Start Reporting
1. The reorganization value of the emerging
entity’s assets immediately before the date of
confirmation of the reorganization plan is less
than the total of all postpetition liabilities
and allowed claims.
2. Holders of existing voting shares immediately
before confirmation of the reorganization plan
receive less than 50% of the emerging entity.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 31
Fresh-Start Reporting Results
in a New Reporting Entity
– Allocating the reorganization value
to identifiable assets
– Reporting liabilities
– Final statement of old entity
– Disclosures in initial financial
statements of new entity
– Comparative financial statements
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 32
Reporting by Entities That Do Not
Qualify for Fresh-Start Reporting
Liabilities are reported at present values
using appropriate interest rates.
Forgiveness of debt should be reported
as an extraordinary item.
Quasi-reorganization accounting is not used.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 33
Illustration of a Reorganization Case
Tiger Corporation files for protection from
creditors under Chapter 11 on January 5, 2003.
During 2003, no prepetition liabilities are
paid and no interest is accrued on the
bank note or the bonds payable.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 34
Illustration of a Reorganization Case
The bankruptcy court allows Tiger to invest
$100,000 in new equipment in August 2003.
The new equipment has a useful life of
five years, and is depreciated over a five
year period to the nearest half-year.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 35
Illustration of a Reorganization Case
Building depreciation: $50,000 per year
Old equipment:
$60,000 per year
Patent amortization: $50,000 per year
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 36
Illustration of a Reorganization Case
(Tiger Balance Sheet)
Current assets
Cash
Accounts receivable, net
Inventory
Other current assets
Plant assets
Land
Building, net
Equipment, net
Patent
$ 50,000
500,000
300,000
50,000
$200,000
500,000
300,000
200,000
$ 900,000
1,200,000
$2,100,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 37
Illustration of a Reorganization Case
(Tiger Balance Sheet)
Current liabilities
Accounts payable
$600,000
Taxes payable
150,000
Accrued interest on bonds
90,000
Note payable to bank
260,000
15% bonds payable
(partially secured)
Stockholders’ deficit
Capital stock
500,000
Deficit
–700,000
$1,100,000
1,200,000
– 200,000
$2,100,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 38
Reclassification of Liabilities
Subject to Compromise
(000)
Accounts Payable
600
Taxes Payable
150
Accrued Interest on 15% Bonds
90
Note Payable to Bank
260
15% Bonds Payable (partially secured) 1,200
Liabilities Subject to Compromise
To reclassify liabilities subject to compromise
2,300
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 39
Income and Retained Earnings
Statement for the Year 2003
Sales
Cost of sales
Wages and salaries
Depreciation and amortization
Other expenses
Earnings before reorganization items
Professional fees related to bankruptcy
Net loss
Beginning deficit
Deficit December 31, 2003
$ 1,000,000
(430,000)
(250,000)
(170,000)
(50,000)
100,000
(450,000
(350,000)
(700,000)
$(1,050,000)
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 40
Tiger Balance Sheet
at December 31, 2003
Current assets
Cash
Accounts receivable, net
Inventory
Other current assets
Plant assets
Land
Building, net
Equipment, net
Patent
$150,000
350,000
370,000
50,000
$200,000
450,000
330,000
150,000
$ 920,000
1,130,000
$2,050,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 41
Tiger Balance Sheet
at December 31, 2003
Current liabilities
Short-term borrowings
Accounts payable
Wages and salaries payable
Liabilities subject to
compromise
Stockholders’ deficit
Capital stock
Deficit
$ 150,000
100,000
50,000
$ 300,000
2,300,000
500,000
–1,050,000
– 550,000
$2,050,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 42
The Reorganization Plan
1. Tiger’s 15% bonds payable were secured with the
land and building. The bondholders agree to accept
$500,000 new common stock, $500,000 senior debt
of 12% bonds and $100,000 cash payable 12/31/03.
2. The priority tax claims of $150,000 will be paid in
cash as soon as the reorganization plan is confirmed.
3. The remaining unsecured, nonpriority, prepetition
claims of $950,000 will be settled as follows:
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 43
The Reorganization Plan
a. Creditors represented by the accounts payable
will receive $275,000 subordinated debt and
$140,000 common stock.
b. The $90,000 accrued interest on the 15% bonds
will be forgiven.
c. The $260,000 note payable to the bank will be
exchanged for $120,000 subordinated debt
and $60,000 common stock.
4. Equity holders will exchange their stock for $100,000
common stock of the emerging company.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 44
Fresh-Start Reporting
The reorganization value is compared with the total
postpetition liabilities and court-allowed claims at June 30
to determine if fresh-start reporting is appropriate.
Postpetition liabilities
$ 255,000
Allowed claims subject to compromise
2,300,000
Total liabilities on June 30, 2004
2,555,000
Less: Reorganization value
–2,200,000
Excess liabilities over reorganization value
$ 355,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 45
Proposed Reorganized
Capital Structure
Postpetition liabilities
Taxes payable
Current portion of senior debt,
due December 2004
Senior debt, 12% bonds
Subordinated debt
Common stock
$ 255,000
150,000
100,000
500,000
395,000
800,000
$2,200,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 46
Comparative Balance Sheets
at June 30, 2004 (000)
Preconfirmation
Balance Sheet
Assets
Cash
Accounts receivable
Inventory
Other current assets
Land
Building
Equipment
Patent
Reorganization excess
$ 300
335
350
30
200
425
290
125
—
$2,055
Adjustments
Debits
Credits
a 25
b 100
c 75
d 30
c 125
f 250
Reorganized
Balance Sheet
$ 300
335
375
30
300
350
260
—
250
$2,200
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 47
Comparative Balance Sheets
at June 30, 2004 (000)
Adjustments
Debits
Credits
Preconfirmation
Balance Sheet
Equities (claims)
Short-term bank loan
Accounts payable
Wages payable
Prepetition claims
Accounts payable, old
Taxes payable
Interest
Bank note
15% bonds payable
$
75
125
55
600
150
90
260
1,200
Reorganized
Balance Sheet
$ 75
125
55
h
600
i
90
j
260
g 1,200
—
150
—
—
—
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 48
Comparative Balance Sheets
at June 30, 2004 (000)
Preconfirmation
Balance Sheet
Stockholders’ Equity
Capital stock, old
Deficit
500
(1,000)
Adjustments
Debits
Credits
k 500
c 75
d 30
e 125
a 25
b 100
f 250
g 100
h 185
i 90
j 80
k 400
Reorganized
Balance Sheet
—
—
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 49
Comparative Balance Sheets
at June 30, 2004 (000)
Preconfirmation
Balance Sheet
New Equities
Current portion, bonds
12% senior debt
Subordinated debt
Common stock, new
Retained earnings, new
—
—
—
—
—
$2,055
Adjustments
Debits
Credits
g 100
g 500
h 275
j 120
g 500
h 140
j 60
k 100
Reorganized
Balance Sheet
100
500
395
800
$2,200
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 50
End of Chapter 17
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