Corporate Liquidations and Reorganizations

Corporate Liquidations
and Reorganizations
Chapter 17
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 1

Learning Objective 1
Understand differences among

types of bankruptcy filings.

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The 1898 Act was repealed when Congress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.

Bankruptcy Law
The bankruptcy law facilitates debt relief to

individuals and corporations under various
provisions, called chapters.

Types of Bankruptcies
Type Description
Chapter 7 –  A trustee is appointed to sell off
Liquidation assets of the individual or company
and pay claims to creditors.
Chapter 9 –  Municipalities (not covered here).
Adjustments
of debts of a
municipality

Type Description
Chapter 11 –  A debtor corporation is expected to be
Reorganization 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.

Type Description
Chapter 12 –  Family farmers with regular income
Farmers (not covered here).
Chapter 13 –  Exclusively applies to individuals,
Adjustments including sole proprietorships.
of debts of an  Unsecured debts less than $250,000
individual with and secured debts less than $750,000
regular income (not covered here).

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.).
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.
Comprehend trustee
responsibilities and accounting
during liquidation.

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.

Statement of Affairs
This statement is a legal

document prepared for the
bankruptcy court.
It emphasizes liquidation value.

Trustee Accounting
The Bankruptcy Act

does not cover
procedural accounting
details.

Trustee Accounting
Statement of Cash Receipts and Disbursements

Statement of Changes in Estate Equity
Balance Sheet
Statement of Realization and Liquidation

Understand financial reporting

during reorganization.

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.

Trustee or Debtor in Possession
A private trustee may be appointed.
The debtor corporation may continue in possession.

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
Committee Representation
Creditors’ committees are responsible

for protecting the interests of the
creditors they represent.

Operating Under Chapter 11
Protection of the debtor

Possible Benefits in possession allowing
possible cost reductions
Losing the confidence

Disadvantages of its lenders, suppliers,
customers, and employers

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
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.

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.

Income Statement
Professional fees and similar expenses

related directly to the Chapter 11
proceedings are expensed as incurred.
Reorganization items should be reported.

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.

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.

Understand financial reporting

after emerging from
reorganization including
fresh-start accounting.

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.

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.

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:

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.

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

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.

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.

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.

Building depreciation: $50,000 per year

Old equipment: $60,000 per year
Patent amortization: $50,000 per year

(Tiger Balance Sheet)
Current assets
Cash $ 50,000
Accounts receivable, net 500,000
Inventory 300,000
Other current assets 50,000 $ 900,000
Plant assets
Land $200,000
Building, net 500,000
Equipment, net 300,000
Patent 200,000 1,200,000
$2,100,000
(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 $1,100,000
15% bonds payable
(partially secured) 1,200,000
Stockholders’ deficit
Capital stock 500,000
Deficit –700,000 – 200,000
$2,100,000
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 2,300
To reclassify liabilities subject to compromise

Income and Retained Earnings
Statement for the Year 2003
Sales $ 1,000,000
Cost of sales (430,000)
Wages and salaries (250,000)
Depreciation and amortization (170,000)
Other expenses (50,000)
Earnings before reorganization items 100,000
Professional fees related to bankruptcy (450,000
Net loss (350,000)
Beginning deficit (700,000)
Deficit December 31, 2003 $(1,050,000)

Tiger Balance Sheet
at December 31, 2003
Current assets
Cash $150,000
Accounts receivable, net 350,000
Inventory 370,000
Other current assets 50,000 $ 920,000
Plant assets
Land $200,000
Building, net 450,000
Equipment, net 330,000
Patent 150,000 1,130,000
$2,050,000
Tiger Balance Sheet
at December 31, 2003
Current liabilities
Short-term borrowings $ 150,000
Accounts payable 100,000
Wages and salaries payable 50,000 $ 300,000
Liabilities subject to
compromise 2,300,000
Stockholders’ deficit
Capital stock 500,000
Deficit –1,050,000 – 550,000
$2,050,000

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:

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.
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

Proposed Reorganized
Capital Structure
Postpetition liabilities $ 255,000
Taxes payable 150,000
Current portion of senior debt,
due December 2004 100,000
Senior debt, 12% bonds 500,000
Subordinated debt 395,000
Common stock 800,000
$2,200,000

Comparative Balance Sheets
at June 30, 2004 (000)
Preconfirmation Adjustments Reorganized
Balance Sheet Debits Credits Balance Sheet
Assets
Cash $ 300 $ 300
Accounts receivable 335 335
Inventory 350 a 25 375
Other current assets 30 30
Land 200 b 100 300
Building 425 c 75 350
Equipment 290 d 30 260
Patent 125 c 125 —
Reorganization excess — f 250 250
$2,055 $2,200
at June 30, 2004 (000)
Equities (claims)
Short-term bank loan $ 75 $ 75
Accounts payable 125 125
Wages payable 55 55
Prepetition claims
Accounts payable, old 600 h 600 —
Taxes payable 150 150
Interest 90 i 90 —
Bank note 260 j 260 —
15% bonds payable 1,200 g 1,200 —

at June 30, 2004 (000)
Stockholders’ Equity
Capital stock, old 500 k 500 —
Deficit (1,000) c 75 a 25 —
d 30 b 100
e 125 f 250
g 100
h 185
i 90
j 80
k 400

at June 30, 2004 (000)
New Equities
Current portion, bonds — g 100 100
12% senior debt — g 500 500
Subordinated debt — h 275
j 120 395
Common stock, new — g 500
h 140
j 60
k 100 800
Retained earnings, new —
$2,055 $2,200
End of Chapter 17

Corporate Liquidations and Reorganizations

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Corporate Liquidations

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 1

Understand differences among

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 2

Prior to 1898, state government legislation

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 3

The bankruptcy law facilitates debt relief to

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 4

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 5

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 6

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 7

III. Unsecured Nonpriority Claims

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 10

The filing of a case creates an estate.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 11

This statement is a legal

It emphasizes liquidation value.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 12

The Bankruptcy Act

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 13

Statement of Cash Receipts and Disbursements

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 14

Understand financial reporting

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 15

Less than 30% of business bankruptcy cases

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 16

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

Creditors’ committees are responsible

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 19

Protection of the debtor

Losing the confidence

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 20

– Identify class of claims

The reorganization process

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 22

Unsecured liabilities and undersecured

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 23

Professional fees and similar expenses

Reorganization items should be reported.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 24

Cash flow items relating to reorganization

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 25

SOP 90-7 requires that condensed combined

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 26

Understand financial reporting

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 27

Ordinarily, a corporate reorganization

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 28

Generally, the reorganization value is

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 29

Fresh-start reporting results in

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 30

1. The reorganization value of the emerging

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 31

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 32

Liabilities are reported at present values

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 33

Tiger Corporation files for protection from

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 34

The bankruptcy court allows Tiger to invest

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 17 - 35