Chapter 17: Corporate Liquidations and Reorganizations

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Chapter 17: Corporate Liquidations and Reorganizationsby Jeanne M. David, Ph.D., Univ. of Detroit Mercy

to accompanyAdvanced Accounting, 10th editionby Floyd A. Beams, Robin P. Clement,

Joseph H. Anthony, and Suzanne Lowensohn


Corporate Liquidations: Objectives1. Understand differences among types of

bankruptcy filings.2. Comprehend trustee responsibilities and

accounting during liquidation.3. Understand financial reporting during

reorganization.4. Understand financial reporting after emerging

from reorganization, including fresh-start accounting.


1: Types of Bankruptcies1: Types of BankruptciesCorporate Liquidations and Reorganizations


Insolvency• Equity insolvency

– Inability to pay debts on time• May avoid bankruptcy proceedings• Negotiate directly with creditors

• Bankruptcy insolvency– Having total debts in excess of the fair value of

assets• May be liquidated, or• Reorganized


Types of Bankruptcies

Chapter 7: Liquidation• Trustee appoint to sell assets of business Chapter 9: Adjustments of Debts of a MunicipalityChapter 11: Reorganization• Debtor is expected to be rehabilitatedChapter 12: FarmersChapter 13: Adjustment of Debts of an Individual

with Regular Income


Characteristics• Voluntary bankruptcy proceedings

– Filed by debtor• Involuntary bankruptcy proceedings

– Filed by creditor or group of creditors• Court action

– Dismiss a case– Accept the petition– Change form

Chapter 11 reorganization Chapter 7 liquidation


Duties of TrusteeTrustee in liquidation cases• Investigate debtor's financial affairs• Provide information • Examine, perhaps object to, creditor claims• File report on trusteeship• If authorized to operate debtor's business, other

period reports are requiredIn reorganization cases, in addition to above• Filing reorganization plan or statement why one

cannot be filed


Ranking of Claims: Liquidation


2: Corporate Liquidation2: Corporate LiquidationCorporate Liquidations and Reorganizations


Statement of Affairs• Legal document prepared for bankruptcy court

– Assets at expected net realizable values– Classified on basis of availability for classes

of creditors– Liabilities are classified

• Priority, fully secured, partially secured, unsecured

– Historical values included for reference




Trustee Accounting• At start of case

– New set of books• Through case

– Records transactions– Statement of cash receipts and disbursements– Statement of changes in estate equity– Balance sheet– Statement of realization and liquidation

• At close of case– Final settlement of claims– Trustee is dismissed


3: Corporate Reorganization3: Corporate ReorganizationCorporate Liquidations and Reorganizations


Chapter 11: Balance Sheet• Prepetition liabilities subject to compromise are

reported as a separate line item in liabilities– Arose before filing– Include

• Unsecured and under-secured liabilities• Prepetition secured liabilities and post petition

liabilities reported in normal fashion• Prepetition claims discovered after filing

– Included at court allowed amounts


Chapter 11: Other Statements• Reorganization costs shown separately• Interest to be paid or probable amount

– Differences from contractual amounts should be noted

• Expected stock or stock equivalent issuances should be disclosed

• Cash flow items related to reorganization shown separately


Combined Financial Statements• Condensed combined financial statements are

prepared for all entities in reorganization proceedings as supplementary information– Intercompany receivables and payables– Write-down if necessary


4: Emerging from Reorganization4: Emerging from ReorganizationCorporate Liquidations and Reorganizations


Reorganization ValueApproximates fair value of entity without

considering liabilities– Discounted future cash flows of

reorganized business– Consider business and financial risk

Reorganization value determines how much creditors recover

Emerging business will either use1. Fresh start reporting2. Report liabilities at present value and

forgiveness of debt as extraordinary item


Qualify for Fresh Start Reporting• Just before confirmation of the plan,

– Revaluation value must be less than post petition liabilities and allowed claims, and

– Holders of existing voting shares receive less than 50% of emerging entity


Apply Fresh Start Reporting• Allocated reorganization value to identifiable

assets– Unallocated amount is an intangible

• Reorganization value in excess of amounts allocated to identifiable assets

• Liabilities at current value at confirmation date• Deferred taxes follow FASB No. 109

• Prepare final reports of old entity


Reorganization Example• Tiger files for protection under Chapter 11 on

1/5/08. Accordingly, it reclassifies prepetition liabilities.

• It obtains short term financing, acquires additional equipment and continues operations through 6/31/09 when the plan is approved.

First, we'll look at the statements pre and post reorganization. Then we'll go through the entries and adjustments that occurred.


Balance Sheet Assets

Filed

1/5/08FYE

12/31/08Before

6/30/09

Fair value

6/30/09Revalu-

ationAFTER 6/30/09

Cash 50 150 300 300 300 Accounts receivable 500 350 335 335 335 Inventory 300 370 350 375 25 375 Other current assets 50 50 30 30 30 Land 200 200 200 300 100 300 Building, net 500 450 425 350 (75) 350 Equipment, net 300 330 290 260 (30) 260 Patent 200 150 125 0 (125) 0 Reorganization value in excess of identifiable assets 250 2,100 2,050 2,055 1,950 (105) 2,200


Changes to AssetsFair values and revaluation amounts are shown on 6/30/09 for

comparison.• Tiger continues operations, records depreciation and

even acquires equipment from filing on 1/5/08 to reorganization on 6/30/09.

• The reorganization revalues the assets to their fair value on that date. Patents are completely written off.

• Tiger records an intangible "Reorganization value in excess of identifiable assets" of $250. Not all reorganizations result in this intangible.


Filed

1/5/08FYE

12/31/08Before

6/30/09AFTER 6/30/09

Short term borrowing (post) 150 75 75 Accounts payable (pre/post) 600 100 125 125 Wages payable (post) 50 55 55 Taxes payable (pre) 150 150 Accrued bond interest (pre) 90 Note payable (pre) 260 Subordinated debt (post) 395 12% bonds payable – current (post) 100 12% bonds payable (post) 500 15% bonds payable (pre) 1,200 Liabilities subject to compromise 2,300 2,300 Capital stock (old) 500 500 500 Capital stock (new) 800 Additional paid in capital 0 Deficit (700) (1,050) (1,000) 0 2,100 2,050 2,055 2,200

Balance Sheet – Liability & Equity


What Happened to Liabilities?• Upon filing on 1/5/08, Tiger reclassifies the unsecured

and partially secured liabilities at that point as Pre-petition Liabilities subject to compromise.

• Pre-petition Liabilities subject to compromise are reclassified or settled according to the plan.

• Accounts payable on 12/31/08 does not include any of the $600 due prior to filing.

• Taxes payable are still to be paid, and eventually recorded again in full.


Changes in Equity• Some of the creditors receive stock in the

reorganized firm. The old shareholders also receive stock, but now own only $100 of $800 of the stock at book value.

• Although some APIC was recorded in reorganizing, it was subsequently eliminated. If it had been sufficient to wipe out the deficit, no intangible "reorganization value in excess of identifiable assets" would be recorded.

• The Deficit is removed: Fresh Start!


Can Tiger Use Fresh Start?

On 6/30/09 there were $255 in post-petition liabilities. All $2,300 pre-petition liabilities were allowed by the courts. Firm value is $2,200.1. Liabilities exceed reorganization value2. Old shareholders retain less than 50%

Yes, fresh start is appropriate.

Post-petition liabilities $255 Allowed claims 2,300 Total liabilities $2,555 Less reorganization value (2,200)Excess liabilities $355


Reorganization Plan: 6/30/09Pre-petition Liabilities and Equity

New Agreements Debt Dis-charge

15% partially secured bonds, $1200

$500 new stock, $500 senior 12% bonds, and another $100 bonds due 12/31/09 $100

Priority tax claims $150 To be paid cash once confirmed $0

Remaining unsecured claims, $950:$600 accounts payable $275 subordinated debt

and $140 new stock $185$90 accrued interest Forgiven $90$260 note $120 subordinated debt

and $60 new stock $80Total debt discharged $455

Old stock $100 new stock Equity


Record New Debt Agreements

This entry reclassifies the pre-petition debt according to the reorganization plan.

Liabilities subject to compromise (pre) 2,300 Taxes payable 150 12% senior debt 500 12% senior debt - current 100 Subordinated debt 395 Common stock (new) 700 Gain on debt discharge 455

settlement of prepetition claims


Give Shareholders New Shares

They will lose control since creditors have $700 of common stock.

Common stock (old) 500 Common stock (new) 100 Additional paid in capital 400

exchange of stock with owners


Revalue Assets

A loss is recorded in revaluing the assets. Refer back to the Asset side of the balance sheet.

Inventory 25 Land 100

Loss on asset revaluation 105 Buildings, net 75 Equipment, net 30 Patent 125

revalue assets to fair value


Calculate Balance in Retained Earnings (Deficit)

If sufficient APIC had existed, there would be no intangible asset, and excess APIC would remain on the balance sheet.

Deficit, 6/30/09 (1,000)Gain on debt discharge 455 Loss on asset revaluation (105)

Final measure of deficit, 6/30/09 ($650)Write-off Additional paid in capital 400

Reorganization value in excess of identifiable assets (intangible asset) ($250)


Eliminate Deficit in Equity

The $1,000 deficit on 6/30/09 is adjusted for the gain on debt discharge and loss on asset revaluation. The net $650 deficit eliminates all of the APIC and creates a $250 intangible.

Reorganization value in excess of identifiable assets 250 Gain on debt discharge 455 Additional paid in capital 400

Loss on asset revaluation 105

Deficit 1,000


Simplifying Assumptions• All transactions are recorded on 6/30/09.

Generally this takes some time.• Creditors may have interest between

submission and approval of plan. • All pre-petition debt is approved.• The $2,200 reorganization value of the firm

probably used a discounted cash flow firm valuation model.


Disclosures• Adjustments to historical values

– Assets– Liabilities

• Debt forgiveness• Prior retained earnings or deficit eliminated• Significant factors in determining the

reorganization value


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Chapter 17: Corporate Liquidations and Reorganizations