Chapter 5

Corporate Liquidation and Reorganization

PROBLEM 5-1: THEORY

1. D 6. D
2. D 7. E
3. A 8. B
4. D 9. A
5. D 10. C

PROBLEM 5-2: THEORY & COMPUTATIONAL

1. Solutions:

Requirement (a):

Assets pledged to fully secured creditors:

Land 1,300,000
Loan payable (750,000)
Available for unsecured creditors 550,000

Assets pledged to partially secured creditors:

Equipment - net 150,000
Notes payable (500,000)
Available for unsecured creditors -

Free assets:
Excess of land over loan payable 550,000
Cash 200,000
Accounts receivable 450,000
Total free assets 1,200,000
Unsecured liabilities with priority:
Administrative expenses (180,000)
Salaries payable (800,000)
Net free assets 220,000

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Requirement (b):

Unsecured liabilities with priority:

Administrative expenses 180,000
Salaries payable 800,000
980,000

Fully secured creditors:

Loan payable 750,000

Partially secured creditors:

Notes payable 500,000

Unsecured liabilities without priority:

Notes payable - excess 350,000
Accounts payable 700,000
1,050,000

Requirement (c):

Total realizable value of assets 2,100,000

Less: Unsecured liabilities with priority

Salaries (800,000)
Administrative expenses (180,000) (980,000)

Less: Fully secured liabilities

Loan payable (750,000)

Less: Secured portion of partially secured

Liabilities
Notes payable (fair value of equipment) (150,000)

Excess available to unsecured liabilities without

220,000
priority (Net free assets)

Less: Unsecured liabilities without priority

Notes payable - excess over fair value of
equipment (500K - 150K) (350,000)
Accounts payable (700,000)

Estimated deficiency to unsecured non-

priority creditors (830,000)

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Requirement (d):

Estimated recovery percentage Net free assets

of unsecured creditors without = Total unsecured liabilities
priority without priority

= 220,000 ÷ 1,050,000 (see requirement ‘b’) = 20.95%

Requirement (e):
500,000 x 20.95% = 104,761.90

Requirement (f):

BYE-BYE CORPORATION
STATEMENT OF AFFAIRS
AS OF JANUARY 1, 20X1
Available for
Book Realizable unsecured
values ASSETS values creditors
Assets pledged to fully
secured creditors:
1,000,000 Land 1,300,000
Loan payable (750,000) 550,000

Assets pledged to partially

secured creditors:
600,000 Equipment - net 150,000
Notes payable (500,000) -

Free assets:
200,000 Cash 200,000
500,000 Accounts receivable 450,000 650,000
Total free assets 1,200,000
Less: Unsecured liabilities
with priority (see below) (980,000)
Net free assets 220,000
Estimated deficiency
(squeeze) 830,000
2,300,000 Totals 1,050,000

Unsecured
Book Realizable non-priority
values LIABILITIES values liabilities
Unsecured liabilities with
priority:

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 - Administrative expenses 180,000
800,000 Salaries payable 800,000 -

Fully secured creditors:

750,000 Loan payable 750,000 -

Partially secured
creditors:
500,000 Notes payable 500,000
Equipment - net (150,000) 350,000

Unsecured creditors:
700,000 Accounts payable 700,000 700,000

(450,000) Shareholders' equity - -

2,300,000 Totals 1,050,000

2. A

3. A

4. D

5. C - Classes 1 through 6 have higher priority than Class 7.

PROBLEM 5-3: EXERCISES

EXERCISE 1:

Solutions:

Requirement (a):

Assets pledged to fully secured creditors:

Building - net 1,000,000
Mortgage payable (700,000)
Available for unsecured creditors 300,000

Assets pledged to partially secured creditors:

Machinery - net 300,000
Short-term bank loan (500,000)
Available for unsecured creditors -

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Free assets:

Excess of building over mortgage payable 300,000

Cash 100,000
Accounts receivable 500,000
Inventories 500,000
Total free assets 1,400,000
Unsecured liabilities with priority:
Legal and other fees (60,000)
Income tax payable (1,000,000)
Net free assets 340,000

Requirement (b):

Unsecured liabilities with priority:

Legal and other fees 60,000
Income tax payable 1,000,000
1,060,000

Fully secured creditors:

Mortgage payable 700,000

Partially secured creditors:

Short-term bank loan 500,000

Unsecured creditors without priority

Short-term bank loan - excess 200,000
Accrued payables 300,000
Accounts payable 700,000
1,200,000

Requirement (c):

Total realizable value of assets 2,400,000

Less: Unsecured liabilities with priority

Income tax payable (1,000,000)
Legal and other fees (60,000) (1,060,000)

Less: Fully secured liabilities

Mortgage payable (700,000)

Less: Secured portion of partially secured

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liabilities
Short-term bank loan (fair value of
(300,000)
machinery)

Excess available to unsecured liabilities

340,000
without priority (Net free assets)

Less: Unsecured liabilities without priority

Accrued payables (300,000)
Accounts payable (700,000)
Short-term bank loan - excess (500K - 300K) (200,000) (1,200,000)
Estimated deficiency to unsecured non-
priority creditors (860,000)

Requirement (d):

Estimated recovery percentage Net free assets

of unsecured creditors without = Total unsecured liabilities
priority without priority

= 340,000 ÷ 1,200,000 (see requirement ‘b’) = 28.33%

Requirement (e):
100,000 x 28.33% = 28,330

Requirement (f):
None.

Requirement (g):
GONE CORPORATION
STATEMENT OF AFFAIRS
AS OF JANUARY 1, 20X1
Available for
Realizable unsecured
Book values ASSETS values creditors
Assets pledged to fully secured
creditors:
800,000 Building - net 1,000,000
Mortgage payable (700,000) 300,000

Assets pledged to partially secured

creditors:
600,000 Machinery - net 300,000

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 Short-term bank loan (500,000) -

Free assets:
100,000 Cash 100,000
600,000 Accounts receivable 500,000
900,000 Inventories 500,000 1,100,000
Total free assets 1,400,000
Less: Unsecured liabilities with priority
(see below) (1,060,000)
Net free assets 340,000
Estimated deficiency (squeeze) 860,000
3,000,000 Totals 1,200,000

Unsecured
Realizable non-priority
Book values LIABILITIES values liabilities
Unsecured liabilities with priority:

- Legal and other fees 60,000

1,000,000 Income tax payable 1,000,000 -

Fully secured creditors:

700,000 Mortgage payable 700,000 -

Partially secured creditors:

500,000 Short-term bank loan 500,000
Machinery - net (300,000) 200,000

Unsecured creditors:
300,000 Accrued payables 300,000
700,000 Accounts payable 700,000 1,000,000

(200,000) Shareholders' equity - -

3,000,000 Totals 1,200,000

EXERCISE 2:
1. Solution:
Realizable Available for unsecured
value creditors
Assets pledged to fully
secured creditors 370,000
Fully secured creditors (260,000) 110,000

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Free assets 320,000
Total free assets 430,000
Liabilities with priority (70,000)
Net free assets 360,000

2. Solution:
Secured and Unsecured liabilities
Priority claims without priority
Partially secured creditors 200,000
Assets pledged with partially
(120,000)
secured creditors 80,000

Unsecured creditors 540,000

Total unsecured liabilities
without priority 620,000

Net free assets 360,000

Divide by: Total unsecured liabilities without priority 620,000
Recovery percentage 58.06%

3. Solution:
Assets pledged with partially secured creditors 120,000
Partially secured creditors 200,000
Assets pledged with partially secured creditors (120,000)
Excess to be paid from net free assets 80,000
Multiply by: Recovery percentage 58.06% 46,448
Total amount paid to partially secured creditors 166,448

4. Solution:
Unsecured creditors 540,000
Multiply by: Recovery percentage 58.06%
Amount paid to unsecured creditors 313,524

PROBLEM 5-4: CLASSROOM ACTIVITY

Solutions:

Requirement (a):

Assets pledged to fully secured creditors:

Building - net 1,300,000
Notes payable (700,000)

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Available for unsecured creditors 600,000

Assets pledged to partially secured creditors:

Inventories 300,000
Short-term bank loan (500,000)

Available for unsecured creditors -

Free assets:
Excess of building over loan payable 600,000
Cash 200,000
Total free assets 800,000
Unsecured liabilities with priority:
Net defined benefit liability (600,000)
Legal and other fees (100,000)
Net free assets 100,000

Requirement (b):

Unsecured liabilities with priority:

Net defined benefit liability 600,000
Legal and other fees 100,000
700,000

Fully secured creditors:

Notes payable 700,000

Partially secured creditors:

Short-term bank loan 500,000

Unsecured creditors without priority:

Short-term bank loan - excess (500K - 300K) 200,000
Accounts payable 300,000
500,000

Requirement (c):

Total realizable value of assets 1,800,000

Less: Unsecured liabilities with priority

Net defined benefit liability (600,000)

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Legal and other fees (100,000) (700,000)

Less: Fully secured liabilities

Notes payable (700,000)

Less: Secured portion of partially secured liabilities

Short-term bank loan (fair value of inventories) (300,000)

Excess available to unsecured liabilities without

priority (Net free assets) 100,000

Less: Unsecured liabilities without priority

Short-term bank loan - excess over fair value of
inventories (500K - 300K) (200,000)

Accounts payable (300,000)

Estimated deficiency to unsecured non-priority

creditors (400,000)

Requirement (d):

Estimated recovery percentage Net free assets

of unsecured creditors without = Total unsecured liabilities
priority without priority

= 100,000 ÷ 500,000 (see requirement ‘b’) = 20%

Requirement (e):
Amount Estimated Estimated
of claim recovery % recovery
Unsecured liabilities with
priority:
Net defined benefit liability 600,000 100% 600,000
Legal and other fees 100,000 100% 100,000

Fully secured creditors:

Notes payable 700,000 100% 700,000

Partially secured
creditors:
Short-term bank loan (fair 300,000 100% 300,000

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value of inventories)
Excess - unsecured portion 200,000 20% 40,000
Total 500,000 340,000

Unsecured creditors
without priority:
Accounts payable 300,000 20% 60,000

Shareholders' equity
Share capital 1,000,000 0% -

Total realizable value of

assets 1,800,000

Requirement (f):

FIREWOOD CORPORATION
STATEMENT OF AFFAIRS
AS OF JANUARY 1, 20X1
Available
for
Book Realizable unsecured
values ASSETS values creditors
Assets pledged to fully
secured creditors:
800,000 Building - net 1,300,000
Notes payable (700,000) 600,000

Assets pledged to partially

secured creditors:
450,000 Inventories 300,000
Short-term bank loan (500,000) -

Free assets:
200,000 Cash 200,000
100,000 Prepaid assets -
Total free assets 800,000
Less: Unsecured liabilities
with priority (see below) (700,000)
Net free assets 100,000
Estimated deficiency
(squeeze) 400,000
1,550,000 Totals 500,000

Book values LIABILITIES Realizable Unsecured

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 values non-priority
liabilities
Unsecured liabilities with
priority:
- Net defined benefit liability 600,000
600,000 Legal and other fees 100,000 -

Fully secured creditors:

700,000 Notes payable 700,000 -

Partially secured creditors:

500,000 Short-term bank loan 500,000
Inventories (300,000) 200,000

Unsecured creditors:
300,000 Accounts payable 300,000 300,000

(550,000) Shareholders' equity - -

1,550,000 Totals 500,000

PROBLEM 5-5: THEORY

1. B 6. D
2. C 7. B
3. A 8. D
4. D 9. A
5. C 10. D

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