Chapter 15 Appendix 15B Chapter 15 Appendix 15B Financial Reorganization Prepared by: Dragan Stojanovic, CA Rotman School of Management, University of Toronto

2 Financial Reorganization Process where a company that has undergone financial difficulties can reorganize its finances without having to recover a deficit Agreement is reached between debt and equity holders on process details Referred to as fresh start accounting

3 Financial Reorganization Some debt holders, and all equity holders, give up their right to receive certain future funds Change in control of the company usually results Comprehensive revaluation of all assets and liabilities

4 Comprehensive Revaluation Under PE GAAP, requires three steps: 1.Retained earnings brought to zero balance – Deficit balance removed – Pre-existing write-downs and impairments recorded before retained earnings write-off 2.Negotiated debt and equity changes recorded – Debt may be exchanged for equity (change in control) 3.Remaining assets and liabilities revalued – Revaluation adjustments and related costs are equity transactions – Closed to Share Capital, Contributed Surplus, or other equity account

5 Reorganization Example New Horizons applies for financial reorganization as at June 30, 2011 Retained Earnings$1 million deficit Negotiated Terms $150,000 in existing debt exchanged for 100% of the common shares Original shareholders give up all shares

6 Reorganization Example 1.Record asset impairments pre-reorganization Deficit(R/E) 750,000 Inventories 225,000 Intangible Assets 525,000 2.Eliminate Deficit Common Shares 1,750,000 Deficit (R/E) 1,750,000 3.Restate asset and liability values, record change in control Assets400,000 Liabilities150,000 Common Shares550,000

7 Reorganization Requirements Under PE GAAP, there must be change in control to apply comprehensive revaluation. In addition, following requirements must be met: 1.Shareholders approve the reorganization before it is effected 2.Asset and liability valuation are at fair value 3.Retained earnings has zero balance immediately following reorganization

8 Reorganization Disclosure 1.In the period of reorganization a.Date of reorganization b.Description of reorganization c.Change amount for each major asset, liability and equity account 2.In following period and subsequent reports a.Date of reorganization b.Revaluation adjustment amount, and which account recorded to c.Amount of deficit adjusted, and to which account

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