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
Fair
Filed FYE Before value Revalu- AFTER
  1/5/08 12/31/08 6/30/09 6/30/09 ation 6/30/09
Cash 50 150 300 300   300
Accounts receivable 500 350 335 335   335
Inventory 300 370 350 375 25 375
Other current assets 50 50 30 30   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 0 (125) 0
Reorganization value in excess of identifiable assets   250
  2,100 2,050 2,055 1,950 (105) 2,200

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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 –
Filed FYE Before AFTER
  Liability & Equity 1/5/08 12/31/08 6/30/09 6/30/09
Short term borrowing (post) 150 75 75
Accounts payable (pre/post) 600 100 125 125
Wages payable (post) 50 55 55
Taxes payable (pre) 150   150
Accrued bond interest (pre) 90  
Note payable (pre) 260  
Subordinated debt (post)       395
12% bonds payable – current (post)       100
12% bonds payable (post)       500
15% bonds payable (pre) 1,200  
Liabilities subject to compromise   2,300 2,300
Capital stock (old) 500 500 500
Capital stock (new)       800
Additional paid in capital       0
Deficit (700) (1,050) (1,000) 0
  2,100 2,050 2,055 2,200
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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 Pre-
petition 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-petition liabilities $255
Allowed claims 2,300
Total liabilities $2,555
Less reorganization value (2,200)
Excess liabilities $355
On 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 New Agreements Debt Dis-
and Equity charge
15% partially secured $500 new stock, $500
bonds, $1200 senior 12% bonds, and
another $100 bonds due
12/31/09 $100
Priority tax claims $150 To be paid cash once
confirmed $0
Remaining unsecured claims, $950:
$600 accounts payable $275 subordinated debt
and $140 new stock $185
$90 accrued interest Forgiven $90
$260 note $120 subordinated debt
and $60 new stock $80
Total debt discharged $455
Old stock $100 new stock Equity
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 Record New Debt Agreements
Liabilities subject to compromise (pre) 2,300  
Taxes payable   150
12% senior debt   500
12% senior debt - current   100
Subordinated debt   395
Common stock (new)   700
Gain on debt discharge   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
Common stock (old) 500  
Common stock (new)   100
Additional paid in capital   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 (1,000)
Gain on debt discharge 455
Loss on asset revaluation (105)
Final measure of deficit, 6/30/09 ($650)
Write-off Additional paid in capital 400
Reorganization value in excess of
identifiable assets (intangible asset) ($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  
Gain on debt discharge 455  
Additional paid in capital 400  
Loss on asset revaluation   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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