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Chapter 20 - Corporations in Financial Difficulty

Chapter 20
Corporations in Financial Difficulty

Multiple Choice Questions

1. What is defined as a condition in which a company is unable to meet debts as the debts
mature?
A. Deficit
B. Liability
C. Insolvency
D. Credit squeeze

2. Under a composition agreement,


A. creditors agree to accept less than the face amount of their claims.
B. debtors in financial difficulty transfer assets "without recourse."
C. a creditors' committee is initiated with a plan of settlement proposed by the debtor.
D. the debtor petitions for relief in a bankruptcy court.

3. In which of the following ways can debt be restructured?


I. Assets can be transferred to the creditor.
II. An equity interest can be granted to the creditor.
III. The terms of the debt can be modified.
A. I and II only
B. I and III only
C. II and III only
D. I, II, and III

4. Under which nonjudicial action do creditors agree to assist the debtor in managing the most
efficient payment of creditors' claims?
A. Debt restructuring arrangement
B. Creditors' committee management
C. Transfer of assets
D. Composition agreement

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Chapter 20 - Corporations in Financial Difficulty

5. A transfer of assets by a company in financial difficulty is considered a sale if:


I. the transfer includes a recourse provision allowing the buyer to return the asset.
II. the transferee obtains the right to pledge or exchange the transferred assets.
III. the transferred assets have been isolated from the transferor.
IV. the transferor does not maintain effective control over the transferred assets.
A. I, II, and IV
B. Both I and III
C. Both I and II
D. II, III, and IV

6. Chapter 11 of the Bankruptcy Code provides for:


I. Reorganization.
II. Liquidation.
A. I only
B. II only
C. Both I and II
D. Neither I nor II

7. Chapter 7 of the Bankruptcy Code provides for:


I. Reorganization.
II. Liquidation.
A. I only
B. II only
C. Both I and II
D. Neither I nor II

8. The Bankruptcy Reform Act contains chapters which deal with:


I. Individuals.
II. Corporations.
III. Municipal governments.
A. Only I and II
B. Only II and III
C. Only I and III
D. I, II, and III

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Chapter 20 - Corporations in Financial Difficulty

9. A debtor may file which type of petition when seeking judicial protection under the
Bankruptcy Reform Act?
I. Voluntary
II. Involuntary
A. I only
B. II only
C. Either I or II.
D. Neither I nor II

10. Creditors may file which type of petition when seeking remedy under the Bankruptcy
Code?
I. Voluntary
II. Involuntary
A. I only
B. II only
C. Either I or II
D. Neither I nor II

11. Under the Bankruptcy Code, an insolvent corporation may be:


I. Reorganized.
II. Liquidated.
A. I
B. II
C. Either I or II
D. Neither I nor II

12. Which chapters of the Bankruptcy Code deal with corporations?


A. Chapters 1, 3, and 5
B. Chapter 9
C. Chapters 7 and 11
D. Chapters 12 and 13

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Chapter 20 - Corporations in Financial Difficulty

13. Which of the following could be true of the proceedings under Chapter 11 of the
Bankruptcy Code?
A. Always administered by the bankruptcy courts.
B. The debtor's assets are sold and its liabilities extinguished.
C. The company does not operate during this period.
D. The debtor continues as a business after the reorganization.

14. Under Chapter 11 proceedings, what represents the fair value of the entity before
considering liabilities and approximates the amount a willing buyer would pay for the entity's
assets?
A. Reorganization value
B. Fire sale value
C. Fresh start value
D. Excess value

15. A reorganization value in excess of amounts assignable to identifiable assets is:


A. not reported.
B. reported as an intangible asset called Reorganization Value in Excess of Amounts
Allocable to Identifiable Assets.
C. reported as Goodwill Associated with Exit or Disposal Activities.
D. passed on to prior shareholders of the company.

16. Which of the following observations regarding the use of fresh start accounting is true?
A. It is always required under Chapter 11 bankruptcy proceedings.
B. Prior shareholders will have control of the emerging company.
C. It results in a new reporting entity.
D. It is used under Chapter 7 bankruptcy proceedings.

17. _____ have liens, or security interests, on specific assets.


A. Secured creditors
B. Creditors with priority
C. Unsecured creditors
D. Assured creditors

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Chapter 20 - Corporations in Financial Difficulty

18. As defined by the Bankruptcy Code, creditors with priority:


I. have collateral claim against specific assets.
II. are unsecured creditors who have priority over other unsecured creditors.
III. are the first to be paid from any proceeds available to unsecured creditors.
A. I only
B. II only
C. I, II and II
D. Both II and III

19. Which of the following observations concerning claims by general unsecured creditors is
NOT true?
A. They are paid only after secured creditors and unsecured creditors with priority are
satisfied to the extent of any legal limits.
B. They often receive less than the full amount of their claim.
C. They are entitled to "preference payments" at the discretion of the debtor's management.
D. The amounts to be paid to them are usually stated as a percentage of the total claim.

20. The payment to general unsecured creditors is often termed:


A. a "preference payment."
B. a "dividend."
C. a "write-off."
D. a "bonus."

21. "Preference payments" made by the debtor to one creditor to the detriment of all other
creditors within 90 days before the bankruptcy petition was filed:
A. is reduced from the monies available to the general unsecured creditors.
B. is usually written off.
C. may be recovered and returned to the cash available for all creditors.
D. are not recovered, as management assurances are binding.

22. The accounting statement of affairs is prepared:


A. at the end of the reorganization process.
B. at the end of the liquidation process.
C. at the beginning of the reorganization process.
D. at the beginning of the liquidation process.

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Chapter 20 - Corporations in Financial Difficulty

23. What is the general form of the trustee's opening entry, accepting the assets of the debtor
company?

A. Option A
B. Option B
C. Option C
D. Option D

24. Which monthly report shows the results of the trustee's fiduciary actions beginning at the
point the trustee accepts the debtor's assets?
A. Statement of affairs
B. Statement of realization and liquidation
C. Statement of financial position
D. Statement of activities

25. The Statement of Realization and Liquidation contains sections for all the following items
except:
A. assets.
B. supplementary items.
C. liabilities.
D. stockholders equity.

26. In a statement of realization and liquidation, unusual revenue items are reported under:
A. assets.
B. extraordinary items.
C. supplementary items.
D. These are never reported.

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Chapter 20 - Corporations in Financial Difficulty

27. All of the following items are reported in a statement of realization and liquidation
except:
A. Cash
B. Prepaid assets
C. Depreciable assets (net)
D. Receiver's expenses

28. Which of the following items are likely to be reported in the supplementary items section
of a statement of realization and liquidation?
A. Creditors' claims settled during the period.
B. Trustee's administration fees.
C. New obligations incurred by the trustee.
D. Assets subsequently acquired by the trustee.

Orville Company recently petitioned for bankruptcy and is now in the process of preparing a
statement of affairs. The carrying values and estimated fair values of the assets of Orville
Company are as follows:

Debts of Orville are as follows:

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Chapter 20 - Corporations in Financial Difficulty

29. Based on the preceding information, what is the total amount of unsecured claims?
A. $113,000
B. $126,000
C. $93,000
D. $121,000

30. Based on the preceding information, what estimated amount will be available for general
unsecured creditors upon liquidation?
A. $28,000
B. $93,000
C. $113,000
D. $121,000

31. Based on the preceding information, what is the estimated dividend percentage?
A. 23 percent
B. 93 percent
C. 77 percent
D. 68 percent

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Chapter 20 - Corporations in Financial Difficulty

32. Eagle Company recently petitioned for bankruptcy and is now in the process of preparing
a statement of affairs. The following information has been assembled for this statement:

What amount will be paid to the fully secured creditors and the creditors with priority?

A. Option A
B. Option B
C. Option C
D. Option D

33. A "debtor-in-possession" balance sheet is prepared for a company which:


A. is having its debts restructured.
B. is undergoing a liquidation under Chapter 7.
C. is undergoing a reorganization under Chapter 11.
D. is in bankruptcy reorganization but management still controls the company.

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Chapter 20 - Corporations in Financial Difficulty

34. A debtor-in-possession balance sheet should report:


I. Liabilities not subject to compromise.
II. Liabilities subject to compromise.
A. I only
B. II only
C. Both I and II
D. Neither I nor II

35. On a debtor-in-possession income statement, which of the following items should be


reported under the heading "Reorganization Items"?
A. Sales
B. Selling expenses
C. Income tax benefit
D. Loss on disposal of assets

Essay Questions

36. What are the conditions necessary for using fresh start reporting in reorganization?

20-10
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Chapter 20 - Corporations in Financial Difficulty

37. Wilbur Corporation is to be liquidated under Chapter 7 of the Bankruptcy Code. The
balance sheet on December 31, 2008, is as follows:

The following additional information is available:

1. Marketable securities consist of 2,000 shares of Bristol Inc. common stock. The market
value per share of the stock is $8. The stock was pledged against a $20,000, 8 percent note
payable that has accrued interest of $800.
2. Accounts receivable of $40,000 are collateral for a $35,000, 10 percent note payable that
has accrued interest of $3,500.
3. Inventory with a book value of $35,000 and a current value of $32,000 is pledged against
accounts payable of $60,000. The appraised value of the remainder of the inventory is
$50,000.
4. Only $1,000 will be recovered from prepaid insurance.
5. Land is appraised at $65,000 and plant and equipment at $160,000.
6. It is estimated that the franchises can be sold for $15,000.
7. All the wages payable qualify for priority.
8. The mortgages are on the land and on a building with a book value of $110,000 and an
appraised value of $100,000. The accrued interest on the mortgages is $7,500.
9. Estimated legal and accounting fees for the liquidation are $10,000.

Required
a. Prepare a statement of affairs as of December 31, 2008.
b. Compute the estimated percentage settlement to unsecured creditors.

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Chapter 20 - Corporations in Financial Difficulty

38. A trustee has been appointed for Smith Company, which is being liquidated under Chapter
7 of the Bankruptcy Code. The following transactions occurred after the assets were
transferred to the trustee:

1. Credit sales by the trustee were $100,000. Cost of goods sold were $72,000, consisting of
all the inventory transferred from Smith.
2. The trustee sold all $20,000 worth of marketable securities for $15,000.
3. Receivables collected by the trustee:
Old: $28,000 of the $50,000 transferred
New: $65,000
4. Disbursements by the trustee:
Old current payables: $31,000 of the $65,000 transferred
Trustee's expenses: $6,000
5. Recorded $24,000 depreciation on the plant assets of $120,000 transferred from Smith.

Required:
Prepare a statement of realization and liquidation according to the traditional approach
illustrated in the chapter.

39. Briefly explain the three classes of creditors specified in the Bankruptcy Code.

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Chapter 20 - Corporations in Financial Difficulty

40. To obtain cash quickly, DebCo. sold $750,000 of its receivables to Finco., with recourse.
As the accountant for DebCo., what issues do you need to resolve in order to determine the
appropriate accounting treatment?

Chapter 20 Corporations in Financial Difficulty Answer Key

Multiple Choice Questions

1. What is defined as a condition in which a company is unable to meet debts as the debts
mature?
A. Deficit
B. Liability
C. Insolvency
D. Credit squeeze

AACSB: Reflective Thinking


AICPA: Decision Making

2. Under a composition agreement,


A. creditors agree to accept less than the face amount of their claims.
B. debtors in financial difficulty transfer assets "without recourse."
C. a creditors' committee is initiated with a plan of settlement proposed by the debtor.
D. the debtor petitions for relief in a bankruptcy court.

AACSB: Reflective Thinking


AICPA: Decision Making

20-13
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Chapter 20 - Corporations in Financial Difficulty

3. In which of the following ways can debt be restructured?


I. Assets can be transferred to the creditor.
II. An equity interest can be granted to the creditor.
III. The terms of the debt can be modified.
A. I and II only
B. I and III only
C. II and III only
D. I, II, and III

AACSB: Reflective Thinking


AICPA: Decision Making

4. Under which nonjudicial action do creditors agree to assist the debtor in managing the most
efficient payment of creditors' claims?
A. Debt restructuring arrangement
B. Creditors' committee management
C. Transfer of assets
D. Composition agreement

AACSB: Reflective Thinking


AICPA: Decision Making

5. A transfer of assets by a company in financial difficulty is considered a sale if:


I. the transfer includes a recourse provision allowing the buyer to return the asset.
II. the transferee obtains the right to pledge or exchange the transferred assets.
III. the transferred assets have been isolated from the transferor.
IV. the transferor does not maintain effective control over the transferred assets.
A. I, II, and IV
B. Both I and III
C. Both I and II
D. II, III, and IV

AACSB: Reflective Thinking


AICPA: Decision Making

20-14
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Chapter 20 - Corporations in Financial Difficulty

6. Chapter 11 of the Bankruptcy Code provides for:


I. Reorganization.
II. Liquidation.
A. I only
B. II only
C. Both I and II
D. Neither I nor II

AACSB: Reflective Thinking


AICPA: Decision Making

7. Chapter 7 of the Bankruptcy Code provides for:


I. Reorganization.
II. Liquidation.
A. I only
B. II only
C. Both I and II
D. Neither I nor II

AACSB: Reflective Thinking


AICPA: Decision Making

8. The Bankruptcy Reform Act contains chapters which deal with:


I. Individuals.
II. Corporations.
III. Municipal governments.
A. Only I and II
B. Only II and III
C. Only I and III
D. I, II, and III

AACSB: Reflective Thinking


AICPA: Decision Making

20-15
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Chapter 20 - Corporations in Financial Difficulty

9. A debtor may file which type of petition when seeking judicial protection under the
Bankruptcy Reform Act?
I. Voluntary
II. Involuntary
A. I only
B. II only
C. Either I or II.
D. Neither I nor II

AACSB: Reflective Thinking


AICPA: Decision Making

10. Creditors may file which type of petition when seeking remedy under the Bankruptcy
Code?
I. Voluntary
II. Involuntary
A. I only
B. II only
C. Either I or II
D. Neither I nor II

AACSB: Reflective Thinking


AICPA: Decision Making

11. Under the Bankruptcy Code, an insolvent corporation may be:


I. Reorganized.
II. Liquidated.
A. I
B. II
C. Either I or II
D. Neither I nor II

AACSB: Reflective Thinking


AICPA: Decision Making

20-16
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Chapter 20 - Corporations in Financial Difficulty

12. Which chapters of the Bankruptcy Code deal with corporations?


A. Chapters 1, 3, and 5
B. Chapter 9
C. Chapters 7 and 11
D. Chapters 12 and 13

AACSB: Reflective Thinking


AICPA: Decision Making

13. Which of the following could be true of the proceedings under Chapter 11 of the
Bankruptcy Code?
A. Always administered by the bankruptcy courts.
B. The debtor's assets are sold and its liabilities extinguished.
C. The company does not operate during this period.
D. The debtor continues as a business after the reorganization.

AACSB: Reflective Thinking


AICPA: Decision Making

14. Under Chapter 11 proceedings, what represents the fair value of the entity before
considering liabilities and approximates the amount a willing buyer would pay for the entity's
assets?
A. Reorganization value
B. Fire sale value
C. Fresh start value
D. Excess value

AACSB: Reflective Thinking


AICPA: Decision Making

20-17
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Chapter 20 - Corporations in Financial Difficulty

15. A reorganization value in excess of amounts assignable to identifiable assets is:


A. not reported.
B. reported as an intangible asset called Reorganization Value in Excess of Amounts
Allocable to Identifiable Assets.
C. reported as Goodwill Associated with Exit or Disposal Activities.
D. passed on to prior shareholders of the company.

AACSB: Reflective Thinking


AICPA: Reporting

16. Which of the following observations regarding the use of fresh start accounting is true?
A. It is always required under Chapter 11 bankruptcy proceedings.
B. Prior shareholders will have control of the emerging company.
C. It results in a new reporting entity.
D. It is used under Chapter 7 bankruptcy proceedings.

AACSB: Reflective Thinking


AICPA: Decision Making

17. _____ have liens, or security interests, on specific assets.


A. Secured creditors
B. Creditors with priority
C. Unsecured creditors
D. Assured creditors

AACSB: Reflective Thinking


AICPA: Decision Making

20-18
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Chapter 20 - Corporations in Financial Difficulty

18. As defined by the Bankruptcy Code, creditors with priority:


I. have collateral claim against specific assets.
II. are unsecured creditors who have priority over other unsecured creditors.
III. are the first to be paid from any proceeds available to unsecured creditors.
A. I only
B. II only
C. I, II and II
D. Both II and III

AACSB: Reflective Thinking


AICPA: Decision Making

19. Which of the following observations concerning claims by general unsecured creditors is
NOT true?
A. They are paid only after secured creditors and unsecured creditors with priority are
satisfied to the extent of any legal limits.
B. They often receive less than the full amount of their claim.
C. They are entitled to "preference payments" at the discretion of the debtor's management.
D. The amounts to be paid to them are usually stated as a percentage of the total claim.

AACSB: Reflective Thinking


AICPA: Decision Making

20. The payment to general unsecured creditors is often termed:


A. a "preference payment."
B. a "dividend."
C. a "write-off."
D. a "bonus."

AACSB: Reflective Thinking


AICPA: Decision Making

20-19
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Chapter 20 - Corporations in Financial Difficulty

21. "Preference payments" made by the debtor to one creditor to the detriment of all other
creditors within 90 days before the bankruptcy petition was filed:
A. is reduced from the monies available to the general unsecured creditors.
B. is usually written off.
C. may be recovered and returned to the cash available for all creditors.
D. are not recovered, as management assurances are binding.

AACSB: Reflective Thinking


AICPA: Decision Making

22. The accounting statement of affairs is prepared:


A. at the end of the reorganization process.
B. at the end of the liquidation process.
C. at the beginning of the reorganization process.
D. at the beginning of the liquidation process.

AACSB: Reflective Thinking


AICPA: Decision Making

23. What is the general form of the trustee's opening entry, accepting the assets of the debtor
company?

A. Option A
B. Option B
C. Option C
D. Option D

AACSB: Reflective Thinking


AICPA: Decision Making

20-20
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Chapter 20 - Corporations in Financial Difficulty

24. Which monthly report shows the results of the trustee's fiduciary actions beginning at the
point the trustee accepts the debtor's assets?
A. Statement of affairs
B. Statement of realization and liquidation
C. Statement of financial position
D. Statement of activities

AACSB: Reflective Thinking


AICPA: Decision Making

25. The Statement of Realization and Liquidation contains sections for all the following items
except:
A. assets.
B. supplementary items.
C. liabilities.
D. stockholders equity.

AACSB: Reflective Thinking


AICPA: Decision Making

26. In a statement of realization and liquidation, unusual revenue items are reported under:
A. assets.
B. extraordinary items.
C. supplementary items.
D. These are never reported.

AACSB: Reflective Thinking


AICPA: Decision Making

27. All of the following items are reported in a statement of realization and liquidation
except:
A. Cash
B. Prepaid assets
C. Depreciable assets (net)
D. Receiver's expenses

AACSB: Reflective Thinking


AICPA: Decision Making

20-21
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Chapter 20 - Corporations in Financial Difficulty

28. Which of the following items are likely to be reported in the supplementary items section
of a statement of realization and liquidation?
A. Creditors' claims settled during the period.
B. Trustee's administration fees.
C. New obligations incurred by the trustee.
D. Assets subsequently acquired by the trustee.

AACSB: Reflective Thinking


AICPA: Decision Making

Orville Company recently petitioned for bankruptcy and is now in the process of preparing a
statement of affairs. The carrying values and estimated fair values of the assets of Orville
Company are as follows:

Debts of Orville are as follows:

20-22
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Chapter 20 - Corporations in Financial Difficulty

29. Based on the preceding information, what is the total amount of unsecured claims?
A. $113,000
B. $126,000
C. $93,000
D. $121,000

AACSB: Analytic
AICPA: Measurement

30. Based on the preceding information, what estimated amount will be available for general
unsecured creditors upon liquidation?
A. $28,000
B. $93,000
C. $113,000
D. $121,000

AACSB: Analytic
AICPA: Measurement

31. Based on the preceding information, what is the estimated dividend percentage?
A. 23 percent
B. 93 percent
C. 77 percent
D. 68 percent

AACSB: Analytic
AICPA: Measurement

20-23
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Chapter 20 - Corporations in Financial Difficulty

32. Eagle Company recently petitioned for bankruptcy and is now in the process of preparing
a statement of affairs. The following information has been assembled for this statement:

What amount will be paid to the fully secured creditors and the creditors with priority?

A. Option A
B. Option B
C. Option C
D. Option D

AACSB: Analytic
AICPA: Measurement

33. A "debtor-in-possession" balance sheet is prepared for a company which:


A. is having its debts restructured.
B. is undergoing a liquidation under Chapter 7.
C. is undergoing a reorganization under Chapter 11.
D. is in bankruptcy reorganization but management still controls the company.

AACSB: Reflective Thinking


AICPA: Decision Making

20-24
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Chapter 20 - Corporations in Financial Difficulty

34. A debtor-in-possession balance sheet should report:


I. Liabilities not subject to compromise.
II. Liabilities subject to compromise.
A. I only
B. II only
C. Both I and II
D. Neither I nor II

AACSB: Reflective Thinking


AICPA: Decision Making

35. On a debtor-in-possession income statement, which of the following items should be


reported under the heading "Reorganization Items"?
A. Sales
B. Selling expenses
C. Income tax benefit
D. Loss on disposal of assets

AACSB: Reflective Thinking


AICPA: Decision Making

Essay Questions

36. What are the conditions necessary for using fresh start reporting in reorganization?

The conditions are:


1. The reorganization value of the assets of the emerging entity immediately before the date of
confirmation is less than the total of all postpetition liabilities and allowed claims.
2. Holders of existing voting shares immediately before confirmation receive less than 50
percent of the voting shares of the emerging entity. This implies that the prior shareholders
have lost control of the emerging company.

AACSB: Communication
AICPA: Critical Thinking

20-25
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Chapter 20 - Corporations in Financial Difficulty

37. Wilbur Corporation is to be liquidated under Chapter 7 of the Bankruptcy Code. The
balance sheet on December 31, 2008, is as follows:

The following additional information is available:

1. Marketable securities consist of 2,000 shares of Bristol Inc. common stock. The market
value per share of the stock is $8. The stock was pledged against a $20,000, 8 percent note
payable that has accrued interest of $800.
2. Accounts receivable of $40,000 are collateral for a $35,000, 10 percent note payable that
has accrued interest of $3,500.
3. Inventory with a book value of $35,000 and a current value of $32,000 is pledged against
accounts payable of $60,000. The appraised value of the remainder of the inventory is
$50,000.
4. Only $1,000 will be recovered from prepaid insurance.
5. Land is appraised at $65,000 and plant and equipment at $160,000.
6. It is estimated that the franchises can be sold for $15,000.
7. All the wages payable qualify for priority.
8. The mortgages are on the land and on a building with a book value of $110,000 and an
appraised value of $100,000. The accrued interest on the mortgages is $7,500.
9. Estimated legal and accounting fees for the liquidation are $10,000.

Required
a. Prepare a statement of affairs as of December 31, 2008.
b. Compute the estimated percentage settlement to unsecured creditors.

20-26
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Chapter 20 - Corporations in Financial Difficulty

20-27
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Chapter 20 - Corporations in Financial Difficulty

b)

AACSB: Analytic
AICPA: Measurement

20-28
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Chapter 20 - Corporations in Financial Difficulty

38. A trustee has been appointed for Smith Company, which is being liquidated under Chapter
7 of the Bankruptcy Code. The following transactions occurred after the assets were
transferred to the trustee:

1. Credit sales by the trustee were $100,000. Cost of goods sold were $72,000, consisting of
all the inventory transferred from Smith.
2. The trustee sold all $20,000 worth of marketable securities for $15,000.
3. Receivables collected by the trustee:
Old: $28,000 of the $50,000 transferred
New: $65,000
4. Disbursements by the trustee:
Old current payables: $31,000 of the $65,000 transferred
Trustee's expenses: $6,000
5. Recorded $24,000 depreciation on the plant assets of $120,000 transferred from Smith.

Required:
Prepare a statement of realization and liquidation according to the traditional approach
illustrated in the chapter.

20-29
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Chapter 20 - Corporations in Financial Difficulty

AACSB: Analytic
AICPA: Measurement

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Chapter 20 - Corporations in Financial Difficulty

39. Briefly explain the three classes of creditors specified in the Bankruptcy Code.

The Bankruptcy Code specifies three classes of creditors whose claims have the following
priorities: (1) secured creditors, (2) creditors with priority, and (3) unsecured creditors.

Secured creditors have liens, or security interests, on specific assets, often called "collateral."
A creditor with such a legal interest in a specific asset has the highest priority claim on that
asset. Creditors with priority are unsecured creditors having no collateral claim against
specific assets, who have priority over other unsecured creditors. Creditors with priority are
the first to be paid from any proceeds available to unsecured creditors. General unsecured
creditors are paid only after secured creditors and unsecured creditors with priority are
satisfied to the extent of any legal limits. Often the general unsecured creditors receive less
than the full amount of their claim.

AACSB: Communication
AICPA: Critical Thinking

40. To obtain cash quickly, DebCo. sold $750,000 of its receivables to Finco., with recourse.
As the accountant for DebCo., what issues do you need to resolve in order to determine the
appropriate accounting treatment?

Selling receivables "with recourse" means that the debtor must accept the return of any
uncollectible receivables that were transferred. FASB 140, "Accounting for Transfers and
Servicing of Financial Assets and extinguishment of Liabilities" specifies that a transfer of
financial assets is considered a sale only if the transferor has surrendered control over the
transferred assets. Selling the receivables with recourse does not remove ultimate control from
the debtor.

AACSB: Communication
AICPA: Critical Thinking

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