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Chapter Thirteen Accounting for Legal Reorganizations and Liquidations Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or.

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Presentation on theme: "Chapter Thirteen Accounting for Legal Reorganizations and Liquidations Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or."— Presentation transcript:

1 Chapter Thirteen Accounting for Legal Reorganizations and Liquidations Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2 Learning Objective 13-1 Describe the history and current status of bankruptcy and bankruptcy laws. 13-2

3 Bankruptcy A basic assumption of accounting is that a business is a going concern (will remain in business). Occasionally, a business becomes insolvent (unable to pay debts as they come due). An insolvent business can either cease to exist, or can seek a legal remedy called bankruptcy. The Bankruptcy Reform Act of 1978 strives to achieve two goals in connection with insolvency cases: 1) the fair distribution of assets to creditors, and 2) the discharge of an honest debtor from debt. 13-3

4 Learning Objective 13-2 Explain the difference between a voluntary and involuntary bankruptcy. 13-4

5 Company files a petition with courts requesting bankruptcy. When facing prospect of severe losses or a difficult operating environment, companies will seek voluntary Chapter 11. Bankruptcy Creditors file petition with the court. Can force company into liquidation under Chapter 7 or receiving protection under Chapter 11. Involuntary BankruptcyVoluntary Bankruptcy 13-5

6 Court Response to the Petition Neither a voluntary nor involuntary petition automatically creates a bankruptcy. Bankruptcy Court may reject voluntary petitions if the action is considered detrimental to the creditors. Court may reject involuntary petitions unless evidence indicates the debtor’s inability to meet obligations as they come due (slowness of payment is NOT sufficient cause!) order for relief that If the court accepts the petition, it grants an order for relief that halts all actions against the debtor. A trustee is appointed to oversee the bankruptcy process. 13-6

7 Learning Objective 13-3 Identify the various types of creditors as they are labeled during a bankruptcy. 13-7

8 Fully Secured Partially Secured Unsecured Classification of Creditors 13-8 Net realizable value of the collateral exceeds the amount of the obligation. These creditors are completely protected by the pledged property. The value of the collateral covers only a portion of the obligation. The remainder is considered unsecured. All other liabilities are unsecured; creditors have no legal right to any of the debtor’s specific assets. They are entitled to share only in any funds that remain after all secured claims have been settled.

9 Learning Objective 13-4 Describe the difference between a Chapter 7 bankruptcy and a Chapter 11 bankruptcy. 13-9

10 Liquidation or Reorganization? How will the debtor be discharged from its obligations?   Under Chapter 7, the debtor’s assets will be liquidated and the proceeds distributed to creditors (based on their priority status) OR   Under Chapter 11, the debtor will be permitted to reorganize and continue operations.   (These “chapters” refer to the relevant sections of the Bankruptcy Reform Act) 13-10

11 Learning Objective 13-5 Account for a company as it enters bankruptcy 13-11

12 Statement of Financial Affairs  To begin bankruptcy proceedings, the debtor normally prepares a statement of financial affairs.  This schedule provides information on the company’s current financial position to help all parties determine the actions to take.  It is especially important to unsecured creditors to decide whether to push for reorganization or liquidation.

13 Assets labeled as:   Pledged with fully secured creditors.   Pledged with partially secured creditors.   Available for priority liabilities and unsecured creditors. Debts labeled as:   Liabilities with priority.   Fully secured creditors.   Partially secured creditors.   Unsecured creditors. Statement of Financial Affairs Debtor’s assets and liabilities are reported according to the classifications relevant to a liquidation

14 Learning Objective 13-6 Account for the liquidation of a company in bankruptcy especially when using the liquidation basis of accounting

15 Liquidation - Chapter 7 Bankruptcy Interim Trustee is appointed by court.   Changes locks, and secures assets and records.   Compiles all financial records.   Obtains possession of all corporate records A committee of unsecured creditors is appointed to help protect the group’s interest.   Selection of committee helps ensure fairness and protect the creditor group’s interests.   Consults with trustee concerning estate administration   Makes recommendations regarding trustee’s performance   Submits questions affecting estate administration to court

16 April FASB issued Accounting Standards Update No ‐ 07: “Liquidation Basis of Accounting,” which is to take affect for annual reporting periods beginning after December 15, Liquidation basis is first applied when liquidation becomes imminent, that is: 1. when a plan has been approved by the court or by people who have such authority and 2. 2.the chance that the plan will be blocked or that the entity will return from liquidation is remote. Proper approval of the plan is usually the point at which the liquidation basis becomes required by U.S. GAAP Liquidation Basis of Accounting

17 Financial reporting for the liquidating entity:   must include a statement of changes in net assets in liquidation to investors and other claimants.   An income statement or a statement of comprehensive income serves little purpose.   Company must issue a statement of net assets in liquidation to allow all interested parties to gain information about the net assets available for distribution. Liquidation Basis of Accounting 13-17

18 Learning Objective 13-7 List the provisions that are often found in a bankruptcy reorganization plan

19 Reorganization - Chapter 11 Bankruptcy  The company is temporarily protected from its creditors.  Creditors are encouraged to negotiate new terms with the company.  Control of the company is normally maintained by the owners (“debtor in possession”)  Workers keep their jobs.  Suppliers keep their customers.  Customers maintain their source of supply.  A plan of reorganization must be put forth within 120 days and approved within 180 days by the debtor in possession

20 Reorganization - Chapter 11 Bankruptcy Acceptance of reorganization plan requires approval by:  Two-thirds of the dollar amount and more than one-half of the creditors who vote  Two-thirds of each class of stockholders who vote  Confirmation by the court  The court can also force acceptance of a plan that was voted down (known as a “cram down”).  As a final alternative, the court can convert a Chapter 11 Bankruptcy to a Chapter 7 Liquidation at any time

21 Learning Objective 13-8 Account for a company as it moves through reorganization

22 Financial Reporting During Reorganization FASB’s Accounting Standards Codification Topic 852, Reorganizations, requires financial statements be prepared:  During the reorganization and  When entity emerges from reorganization.  Gains, losses, revenues and expenses of reorganization are reported separately from normal operations on the income statement.  Assets are still reported at book value.  Liabilities are shown as current versus non-current  Except for liabilities subject to reduction - reported separately at the amount of the claims

23 Learning Objective 13-9 Describe the financial reporting for a company that successfully exits bankruptcy as a reorganized entity

24 Fresh Start Reporting When a company emerges from Chapter 11, GAAP permits fresh start reporting if two conditions are met: 1. The reorganization (or market) value of the assets are less than the total of the allowed claims as of the date of the order for relief plus any subsequent liabilities. 2. Original owners are left with less than 50% of voting stock.  Assets are restated to individual current value.  Liabilities (except deferred income taxes) are stated at present value of future cash payments.  Normally, APIC is adjusted to balance.  Retained Earnings is set to zero

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