Chapter 17: Corporate

Liquidations and Reorganizations

by Jeanne M. David, Ph.D., Univ. of Detroit Mercy
to accompany
Advanced Accounting, 10th edition
by Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn

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Corporate Liquidations: Objectives

1. 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.
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Corporate Liquidations and Reorganizations

1: Types of Bankruptcies

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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

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Types of Bankruptcies
Chapter 7: Liquidation
Trustee appoint to sell assets of business
Chapter 9: Adjustments of Debts of a Municipality

Chapter 11: Reorganization

Debtor is expected to be rehabilitated
Chapter 12: Farmers
Chapter 13: Adjustment of Debts of an Individual
with Regular Income

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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

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Duties of Trustee
Trustee 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

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Ranking of Claims: Liquidation

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Corporate Liquidations and Reorganizations

2: Corporate Liquidation

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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

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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

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Corporate Liquidations and Reorganizations

3: Corporate Reorganization

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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
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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

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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

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Corporate Liquidations and Reorganizations

4: Emerging from Reorganization

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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
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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

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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

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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.
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Balance Sheet Assets

Cash

Filed
FYE Before
1/5/08 12/31/08 6/30/09

Fair
value Revalu6/30/09
ation

50

150

300

300

Accountsreceivable

500

350

335

335

Inventory

300

370

350

375

50

50

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

(125)

Othercurrentassets

AFTER
6/30/09

335
25

30

Reorganization
value
in excess
identifiable
assets
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Education,
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300
375
30

250
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Changes to Assets
Fair 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.

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Balance Sheet
Liability & Equity

Filed
1/5/08

FYE
12/31/08

Shorttermborrowing(post)
Accountspayable(pre/post)

600

Wagespayable(post)
Taxespayable(pre)
Accruedbondinterest(pre)
Notepayable(pre)
Subordinateddebt(post)

Before AFTER
6/30/09 6/30/09

150

75

75

100

125

125

50

55

55

150

90

260

150

395

12%bondspayablecurrent(post)

100

12%bondspayable(post)

500

15%bondspayable(pre)

1,200

Liabilities subject to compromise

Capitalstock(old)

500

2,300

2,300

500

500

Capitalstock(new)

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800

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What Happened to Liabilities?

Upon filing on 1/5/08, Tiger reclassifies the unsecured
and partially secured liabilities at that point as Prepetition 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.

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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!
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Can Tiger Use Fresh Start?

Post-petitionliabilities

$255

Allowedclaims

2,300

Totalliabilities

$2,555

Lessreorganizationvalue

(2,200)

$355
OnExcessliabilities
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 value
2. Old shareholders retain less than 50%
Yes, fresh start is appropriate.
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Reorganization Plan: 6/30/09

Pre-petition Liabilities
and Equity

New Agreements

15%partiallysecured
bonds,$1200

$500newstock,$500
senior12%bonds,and
another$100bondsdue
12/31/09

Prioritytaxclaims$150

Tobepaidcashonce
confirmed

Debt Discharge

$100
$0

Remaining unsecured claims, $950:

$600accountspayable

$275subordinateddebt
and$140newstock

$185

$90accruedinterest

Forgiven

$90

$260note

$120subordinateddebt
and$60newstock

$80

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Total debt discharged

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$455

Record New Debt Agreements

Liabilitiessubjecttocompromise(pre)

2,300

Taxespayable

150

12%seniordebt

500

12%seniordebt-current

100

Subordinateddebt

395

Commonstock(new)

700

Gainondebtdischarge

455

settlement of prepetition claims

This entry reclassifies the pre-petition debt

according to the reorganization plan.
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Give Shareholders New Shares

Commonstock(old)

500

Commonstock(new)

100

Additionalpaidincapital

400

exchange of stock with owners

They will lose control since creditors have $700 of

common stock.

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Revalue Assets
Inventory

25

Land

100

Loss on asset revaluation

105

Buildings,net

75

Equipment,net

30

Patent

125

revalue assets to fair value

A loss is recorded in revaluing the assets. Refer

back to the Asset side of the balance sheet.
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Calculate Balance in Retained

Earnings (Deficit)
Deficit,6/30/09
Gainondebtdischarge
Lossonassetrevaluation
Finalmeasureofdeficit,6/30/09
Write-offAdditionalpaidincapital
Reorganization value in excess of
identifiable assets (intangible asset)

(1,000)
455
(105)
($650)
400
($250)

If sufficient APIC had existed, there would be no

intangible asset, and excess APIC would remain
on the balance sheet.
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Eliminate Deficit in Equity

Reorganization value in excess of
identifiable assets

250

Gainondebtdischarge

455

Additionalpaidincapital

400

Lossonassetrevaluation

105

Deficit
1,000

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.
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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.

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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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