BBL Chapter Thirteen

1. Chapter Thirteen
Accounting for
Legal
Reorganizations
and
Liquidations
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2. LO 1
Bankruptcy
A basic assumption of accounting is
that a business is a going concern (will
remain in business).
Occasionally, a business becomes
insolvent (unable to pay debts as they
come due).
An insolvent business can either cease
to exist, or can seek a legal remedy
called bankruptcy.
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3. Accounting for Legal
Reorganizations and Liquidations
What happens to a business when it fails?
Who gets the assets?
If the assets are sold, who gets the money?
Are the creditors protected?
How is the business failure reported?
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4. Size of Recent American
Bankruptcies
Company
Bankruptcy Date
Lehman Brothers
07/15/2008
Washington Mutual 09/26/2008
WorldCom
07/21/2002
General Motors
06/01/2009
Enron
12/02/2001
Conseco
12/17/2002
Chrysler
04/30/2009
Thornburg Mortgage 05/01/2009
Pacific GE
04/06/2001
Texaco
04/12/1987
Total Assets
(in Billions)
$691.1
327.9
103.9
91.1
65.5
61.4
39.3
36.5
36.2
35.0
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5. Bankruptcy Reform Act of 1978
The Act strives to achieve two goals
in connection with insolvency cases:
1) the fair distribution of assets to
creditors, and
2) the discharge of an honest debtor
from debt.
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6. LO 2
Bankruptcy Reform Act of 1978
Involuntary Bankruptcy
Voluntary Bankruptcy
Creditors file
petition with the
court.
Company files a petition
with courts requesting
bankruptcy.
Can force company
into liquidation
under Chapter 7 or
receiving
protection under
Chapter 11.
When facing prospect of
severe losses or a
difficult operating
environment, companies
will seek voluntary
Chapter 11.
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7. Criteria for Forcing
Involuntary Bankruptcy
When there are 12 or more unsecured
creditors:
At least 3 must sign the petition
Those that sign must have total unsecured
debts of at least $14,425
If there are fewer than 12:
Only 1 must sign
The minimum debt limit remains $14,425
(Debt limit balances are adjusted every
three years based on the Consumer Price
Index)
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8. Court Response to the Petition
 Neither a voluntary nor involuntary
petition automatically creates a
bankruptcy.
 Bankruptcy Court may reject voluntary
petitions if the action is considered
detrimental to the creditors.
 Bankruptcy Court may reject involuntary
petitions unless evidence indicates the
debtor’s inability to meet obligations as
they come due (slowness of payment is
NOT sufficient cause!!)
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9. Court Response to the Petition
If the court accepts the petition, it grants
an order for relief.
The order for relief halts all actions
against the debtor.
The automatic stay prohibits creditors
from collecting debts without the court’s
permission
A trustee is appointed to oversee the
bankruptcy process.
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10. LO 3
Classification of Creditors
Each level must be paid in full prior to making
distributions to the next level.
Top
Priority
Fully
Secured
Partially
Secured
Unsecured
With Priority
Unsecured
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11. Unsecured Liabilities
Having Priority
1. Administrative costs related to liquidation
2. Debts arising between the filing date and
the issuance of an order of relief.
3. Employee claims for wages earned and/or
benefit plan contributions earned during
the 180 days prior to filing (limit $11,725
per employee, each claim).
4. Customer deposits. Limited to $2,600 per
customer.
5. Government claims for unpaid taxes.
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12. LO 4
Reorganization or Liquidation?
How will the debtor be discharged
from its obligations?
 Under Chapter 7, the debtor’s assets will be
liquidated and the proceeds distributed to
creditors (based on their priority status) OR
 Under Chapter 11, the debtor will be
permitted to reorganize and continue
operations.
 (These “chapters” refer to the relevant
sections of the Bankruptcy Reform Act)
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13. LO 5
Statement of Financial Affairs
Statement helps creditors decide between
reorganization and liquidation for debtor.
Assets labeled as:
 Pledged with fully
secured creditors.
 Pledged with partially
secured creditors.
 Available for priority
liabilities and
unsecured creditors.
Debts labeled as:
 Liabilities with
priority.
 Fully secured
creditors.
 Partially secured
creditors.
 Unsecured creditors.
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14. Liquidation –
Chapter 7 Bankruptcy
LO 6
1.
Interim Trustee is appointed by court.

Changes locks, and secures assets and
records.
Posts notices that assets are in possession of
US trustee.
Compiles all financial records.
Obtains possession of all corporate records.



2. An advisory committee of 3 - 11 unsecured
creditors is appointed.
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15. Committee of Creditors
 Consults with the trustee concerning
estate administration
 Makes recommendations regarding
the trustee’s performance
 Submits to the court questions
affecting estate administration
 (The selection of this committee is to
help ensure fairness and to protect
the creditor group’s interests.)
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16. Role of the Trustee
Charged with preserving the assets and
preventing loss of the estate
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17. Statement of
Realization and Liquidation
Trustee tracks the liquidation of a company’s
assets (form not specified by GAAP).
Included Information
1. Account balances at the date on which the
Order for Relief was filed.
2. Cash receipts generated by sale of property.
3. Cash disbursements by the trustee.
4. Write-offs and recognition of previously
unrecorded liabilities.
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18. LO 7
Reorganization Chapter 11 Bankruptcy
A legal way to “salvage” a company
rather than liquidate it.
 The company is temporarily
protected from its creditors.
 Creditors are encouraged to
negotiate new terms with the
company.
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19. Reorganization
Chapter 11 Bankruptcy
Control of the company is normally
maintained by the owners (“debtor in
possession”)
 Workers keep their jobs.
 Suppliers keep their customers.
 Customers maintain their source of
supply.
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20. Reorganization
Chapter 11 Bankruptcy
A plan of reorganization must be put forth
within 120 days and approved within 180
days by the debtor in possession.
Examples include Plans:
 Proposing changes in company’s operations.
 For generating additional monetary
resources.
 For changes in management of the company.
 To settle debts that existed when the order
of relief was issued.
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21. Reorganization
Chapter 11 Bankruptcy
Acceptance of a reorganization plan
requires approval of:
2/3 of the $ amount and more than 1/2 of
the creditors who cast votes
2/3 of each class of stockholders who cast
votes
Confirmation by the court
 The court can also force acceptance of a plan
that was voted down (known as a “cram
down”).
 As a final alternative, the court can convert a
Chapter 11 Bankruptcy to a Chapter 7
Liquidation at any time.
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22. LO 8
Financial Reporting
During Reorganization
 FASB’s Accounting Standards
Codification Topic 852, Reorganizations,
requires financial statements be prepared
During the reorganization and
When entity emerges from reorganization.
 Gains, losses, revenues and expenses of the
reorganization are reported separately.
 Liabilities are restated.
 Current versus noncurrent classification
not applicable.
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23. LO 9
Fresh Start Reporting
When a company emerges from
Chapter 11, GAAP permits fresh start
reporting if two conditions are met:
 The reorganization (or market) value of the
assets is less than the total of the allowed
claims as of the date of the order for relief
plus any subsequent liabilities.
 The previous owners are left with less than
50% of the voting stock.
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24. Fresh Start Accounting
Fresh Start Accounting
 Assets are restated to current market
value.
 Liabilities are stated at the discounted
present value of future cash
payments.
 Retained Earnings is set to zero.
 Normally, APIC is adjusted to
balance.
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25. Summary
 Bankruptcy laws are intended to provide an
orderly settlement to cases of insolvency, by
assuring fair distribution of remaining assets
while discharging the obligations of an honest
debtor.
 Bankruptcy may be voluntary or involuntary,
and the result may be either liquidation
(Chapter 7) or reorganization (Chapter 11).
 Many companies emerging from liquidation
are able to apply “fresh start” accounting.
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