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To accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 18 Corporate Liquidations and Reorganizations Copyright.

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Presentation on theme: "To accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 18 Corporate Liquidations and Reorganizations Copyright."— Presentation transcript:

1 to accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 18 Corporate Liquidations and Reorganizations Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-1

2 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-2 Corporate Liquidations and Reorganizations: Objectives 1.Understand differences among types of bankruptcy filing. 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.

3 1: TYPES OF BANKRUPTCIES Corporate Liquidations and Reorganizations Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-3

4 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-4 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

5 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-5 Types of Bankruptcies Chapter 7: Liquidation  Trustee appointed to sell assets of business Chapter 9: Adjustment of Debt of a Municipality Chapter 11: Reorganization  Debtor is expected to be rehabilitated Chapter 12: Farmers Chapter 13: Adjustment of Debts of an Individual

6 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-6 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

7 2: TRUSTEE RESPONSIBILITIES AND ACCOUNTING Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-7 Corporate Liquidations and Reorganizations

8 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-8 Duties of Debtor Corporation In both liquidation and reorganization cases, the debtor corporation must  File a list of creditors, a schedule of assets and liabilities, and a statement of financial affairs  Cooperate with trustee  Surrender property to the trustee, including records  Appear at court hearings

9 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-9 Duties of Trustee Trustee serves 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 required In reorganization cases, in addition to above  Filing reorganization plan or statement why one cannot be filed

10 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Ranking of Claims: Liquidation

11 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 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

12 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-12

13 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-13

14 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Trustee Accounting At start of case, trustee creates a new set of books. During the 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

15 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Debtor in Possession Unless there is a reason to appoint a trustee, the debtor corporation’s management is permitted to continue to run the company while in bankruptcy. The Debtor in Possession has the same responsibilities as a trustee in a reorganization case.

16 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Creditors’ Committee The Creditors’ Committee is elected in a liquidation case, and is appointed in a reorganization case from the largest unsecured creditors.  Makes decisions on behalf of all creditors  Reviews ongoing transactions of the debtor in possession and can object  Handles negotiations with any creditor regarding settlement or continued business.

17 Benefits of Chapter 11 Benefits of being the Debtor in Possession include:  Rejecting executory contracts  Cancelling unexpired leases  Legal protection from creditor action, such as lawsuits or repossession of property However, day-to-day operations may become more difficult as lenders, suppliers, customers, and employees are aware of the bankruptcy filing. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-17

18 Reorganization Plan A plan may be filed at the time of the bankruptcy filing (“prepackaged bankruptcy”) or by the debtor corporation within 120 days of filing. Other interested parties may file proposed plans after 120 days.  Identify classes of claims  Specify the expected payout of each class  Claims within a given class must be treated alike  Define the expected requirements for execution of the plan  Must be fair and equitable Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-18

19 3: FINANCIAL REPORTING DURING REORGANIZATION Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Corporate Liquidations and Reorganizations

20 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 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  Likely to be paid at an amount less than face value Prepetition secured liabilities and post petition liabilities reported in normal fashion Prepetition claims discovered after filing  Included at court-allowed amounts

21 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 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

22 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 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

23 4: EMERGING FROM REORGANIZATION Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Corporate Liquidations and Reorganizations

24 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Reorganization Value Approximates 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 use 1.Fresh start reporting 2.Report liabilities at present value and forgiveness of debt as extraordinary item

25 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Fresh-Start Reporting Fresh-Start Reporting recognizes that the emerging company is a new entity. To qualify, 1.Revaluation value immediately before the reorganization plan is confirmed must be less than post-petition liabilities and allowed claims, and 2.Holders of existing voting shares receive less than 50% of emerging entity

26 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Apply Fresh Start Reporting Allocated reorganization value to identifiable assets  Unallocated amount is an intangible called “Reorganization value in excess of amounts allocated to identifiable assets” Liabilities at current value at confirmation date  Deferred tax benefits are first applied to reduce any intangible asset recorded Prepare final reports of old entity  The effects of adjustments to asset and liability accounts are shown, so that ending balance sheet of old entity = beginning balance sheet of new entity

27 Continued Reporting of Old Company If a company does not qualify for Fresh-Start Reporting, then  Report liabilities at the appropriate interest rate under GAAP  Report debt forgiveness as an extraordinary item Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-27

28 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Reorganization Example Tig files for protection under Chapter 11 on January 5, Accordingly, it  reclassifies prepetition liabilities  obtains short-term financing  acquires additional equipment  continues operations through June 30, 2012 when the plan is approved, with a reorganization value of $2,200 First, we'll look at the statements pre and post reorganization. Then we'll go through the entries and adjustments that occurred.

29 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Balance Sheet Assets Filed 1/5/11 FYE 12/31/11 Before 6/30/12 Re- valuation Fair value 6/30/12 AFTER 6/30/12 Cash Accounts receivable Inventory Other current assets Land Building, net (75)350 Equipment, net (30)260 Patent (125)00 Reorganization value in excess of identifiable assets 250 2,1002,0502,055(105)1,9502,200

30 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Changes to Assets Fair values and revaluation amounts are shown on 6/30/12 for comparison. Tig continues operations, records depreciation, and even acquires equipment from filing on 1/5/11 to reorganization on 6/30/12. The reorganization revalues the assets to their fair value on that date. Patents are completely written off. Tig records an intangible "Reorganization value in excess of identifiable assets" of $250. Not all reorganizations result in this intangible.

31 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Filed 1/5/11 FYE 12/31/11 Before 6/30/12 AFTER 6/30/12 Short-term borrowing (post)15075 Accounts payable (pre/post) Wages payable (post)5055 Taxes payable (pre)150 Accrued bond interest (pre)90 Note payable (pre)260 Subordinated debt (post) % bonds payable – current (post) % bonds payable (post) % bonds payable (pre)1,200 Liabilities subject to compromise 2,300 Capital stock (old)500 Capital stock (new) 800 Deficit(700)(1,050)(1,000)0 2,1002,0502,0552,200 Balance Sheet - Liability & Equity

32 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Changes to Liabilities Upon filing on 1/5/11, Tig reclassifies the unsecured and partially secured liabilities at that point as Pre-petition Liabilities Subject to Compromise. Pre-petition Liabilities Subject to Compromise are then reclassified or settled according to the plan. Accounts payable on 12/31/11 does not include any of the $600 due prior to filing. Taxes payable are still to be paid, and eventually recorded again in full.

33 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Changes to 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!

34 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Can Tig Use Fresh Start? On 6/30/12 there were $255 in post-petition liabilities. All $2,300 pre-petition liabilities were allowed by the courts. Firm value is $2, Liabilities exceed reorganization value 2. Old shareholders retain less than 50% Yes, fresh start is appropriate. Post-petition liabilities$255 Allowed claims2,300 Total liabilities$2,555 Less reorganization value(2,200) Excess liabilities$355

35 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Reorganization Plan: 6/30/12 Pre-petition Liabilities and EquityNew Agreements Debt Dis- charge 15% partially secured bonds, $1200 $500 new stock, $500 senior 12% bonds, and another $100 bonds due 12/31/12$100 Priority tax claims $150To be paid cash once confirmed$0 Remaining unsecured claims, $950: $600 accounts payable$275 subordinated debt and $140 new stock$185 $90 accrued interestForgiven$90 $260 note$120 subordinated debt and $60 new stock$80 Total debt discharged$455 Old stock$100 new stockEquity

36 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 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 % senior debt % senior debt - current 100 Subordinated debt 395 Common stock (new) 700 Gain on debt discharge 455 settlement of prepetition claims

37 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 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

38 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Revalue Assets A loss is recorded in revaluing the assets. Refer back to the Asset side of the balance sheet. Inventory25 Land100 Loss on asset revaluation105 Buildings, net 75 Equipment, net 30 Patent 125 revalue assets to fair value

39 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 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, 6/30/12(1,000) Gain on debt discharge455 Loss on asset revaluation(105) Final measure of deficit, 6/30/12($650) Write-off Additional paid in capital400 Reorganization value in excess of identifiable assets (intangible asset) ($250)

40 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Eliminate Deficit in Equity The $1,000 deficit on 6/30/12 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 discharge455 Additional paid in capital400 Loss on asset revaluation 105 Deficit 1,000

41 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Simplifying Assumptions  All transactions are recorded on 6/30/12.  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.

42 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Disclosures Adjustments to historical values  Assets  Liabilities Debt forgiveness Prior retained earnings or deficit eliminated Significant factors in determining the reorganization value

43 This work is protected by United States copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it is should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials. ! All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 18-43


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