Chapter Thirteen - PowerPoint Presentation

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Chapter Thirteen

Accounting forLegal Reorganizations and Liquidations

Copyright © 2015

McGraw-Hill

Education.

All

rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Slide2

Learning Objective 13-1

Describe the history andcurrent status of bankruptcyand bankruptcy laws.13-2Slide3

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. 13-3Slide4

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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Size of Recent American Bankruptcies

Total Assets Company Bankruptcy Date (in Billions)Lehman Brothers 07/15/2008 $691Washington Mutual 09/26/2008 328WorldCom 07/21/2002 104General Motors 06/01/2009 91CIT Group 11/01/2009 81

Enron 12/02/2001 66Conseco 12/17/2002 61MF Global Holdings, LTD 10/31/2011 41Chrysler 04/30/2009 39

Thornburg Mortgage 05/01/2009 37

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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, and2) the discharge of an honest debtor from debt.13-6Slide7

Learning Objective 13-2

Explain the difference betweena voluntary and involuntarybankruptcy.13-7Slide8

Company files a

petition with courts requesting bankruptcy.When facing prospect of severe losses or a difficult operating environment, companies will seek voluntary Chapter 11.Bankruptcy Reform Act of 1978

Creditors file petition with the court

.

Can force company

into liquidation under Chapter 7 or receiving protection under Chapter 11.

Involuntary Bankruptcy

Voluntary Bankruptcy

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Criteria for Forcing Involuntary Bankruptcy

When there are 12 or more unsecured creditors:At least 3 must sign the petitionThose that sign must have total unsecured debts of at least $15,325If there are fewer than 12:Only 1 must signThe minimum debt limit remains $15,325(Debt limit balances are adjusted every three years based on the Consumer Price Index)

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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!!)13-10Slide11

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.13-

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Learning Objective 13-3

Identify the various types ofcreditors as they are labeledduring a bankruptcy.13-12Slide13

Fully Secured

Partially SecuredUnsecuredClassification of Creditors

Net

realizable value of

the collateral

exceeds the amount of the obligation.

These

creditors

are

completely protected by the pledged property.

T

he

value of the collateral covers only a

portion of

the obligation. The remainder is considered

unsecured.

All other liabilities are unsecured;

creditors

have no legal right to any of

the debtor’s

specific assets. They are entitled to share only in any funds that remain after

all secured

claims have been settled.

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Administrative costs related to liquidation

Debts arising between the filing date and the issuance of an order of relief.Employee claims for wages earned and/or benefit plan contributions earned during the 180 days prior to filing (limit $

12,475 per employee, each claim).

Customer deposits. Limited to $

2,775 per

customer.

Government claims for unpaid taxes.

Unsecured Liabilities

Having Priority

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Learning Objective 13-4

Describe the difference betweena Chapter 7 bankruptcy and aChapter 11 bankruptcy.13-15Slide16

Liquidation or Reorganization

?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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Learning Objective 13-5

Account for a company as it enters bankruptcy.13-17Slide18

Statement of Financial Affairs

To begin bankruptcy proceedings, the debtor normally prepares a statement of financial affairs. This schedule provides information on the company’s current financial position to help all parties determine the actions to take.It is especially important to unsecured creditors to decide whether to push for reorganization or liquidation.

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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.

Statement of Financial Affairs

Debtor’s

assets and liabilities are reported according

to

the classifications relevant to a liquidation.

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Learning Objective 13-6

Account for the liquidation of a company in bankruptcy especially when using the liquidation basis of accounting.13-20Slide21

Liquidation

- Chapter 7 BankruptcyInterim 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

.

A

committee of 3 - 11 unsecured creditors is

appointed to help protect the group’s interest.

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Committee of Creditors

Consults with the trustee concerning estate administrationMakes recommendations regarding the trustee’s performanceSubmits 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.)13-22Slide23

Appointed by the court; approved by the creditors.

Has possession and control of the debtor’s assets.Can void property transfers made 90 days prior to the petition filing.

Prepares the statement of realization and liquidation.

Role of the Trustee

Charged with preserving

the

assets and

preventing loss

of the estate

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Trustee

tracks the liquidation of a company’s assets.Statement of Realization and LiquidationIncluded Information

Account balances at the date on which the Order for Relief was filed.Cash receipts generated by sale of property.

Cash disbursements by the trustee.

Write-offs and recognition of previously unrecorded liabilities.

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April 2013 -

FASB issued Accounting Standards Update No. 2013‐07: “Liquidation Basis of Accounting,” which is to take affect for annual reporting periods beginning after December 15, 2013.FASB addresses four essential questions about a company being liquidated.

Liquidation Basis of Accounting

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1 When

is a company viewed as actually being in liquidation so that the liquidation basis of accounting is applied?2 At a minimum, what statements should be reported during liquidation to be in conformity with U.S. GAAP?3 How should the liquidating company’s assets be reported during this period?4 How

should the liquidating company’s liabilities be reported during this period?Liquidation Basis of Accounting

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Liquidation

basis is first applied when liquidation becomes imminent, that is:1. when a plan has been approved by the court or by people who have such authority andthe chance that the plan will be blocked or that the entity will return from liquidation is remote.Proper approval of the plan is usually the point at which the liquidation basis becomes required by U.S. GAAP.

Liquidation Basis of Accounting

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Financial

reporting for the liquidating entity:must include a statement of changes in net assets in liquidation to investors and other claimants.

An income statement or a statement of comprehensive income serves

little purpose.

Company

must

issue

a statement of net assets in liquidation to allow all

interested parties to gain

information about the net assets

available

for distribution.

Liquidation Basis of Accounting

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Liquidation Basis of Accounting

On the Statement of Net Assets:assets are reported at the estimated amount of cash (or other consideration

) expected as a result of the liquidation process (a figure not necessarily the same as fair

value).

all

of the assets

of the

company that can be used to generate cash during the liquidation

process are reported.

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Liquidation Basis of Accounting

Liabilities:No attempt is made to anticipate the legal release that might come from the bankruptcy

process. liabilities

continue to be reported

as normal unless actual changes take

place.

the

company should accrue the estimated costs to dispose of its assets as well

as other

costs that are expected.

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Learning Objective 13-7

List the provisions that areoften found in a bankruptcyreorganization plan.13-31Slide32

A legal way to “salvage” a company rather than liquidate it.

Reorganization -Chapter 11 BankruptcyThe company is temporarily protected from its creditors.Creditors are encouraged to negotiate new terms with the company.13-

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Reorganization -

Chapter 11 BankruptcyControl of the company is normally maintained by the owners (“debtor in possession”)Creditors may take over as new owners.Workers keep their jobs.Suppliers keep their customers.Customers maintain their source of supply.

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Reorganization -

Chapter 11 BankruptcyA 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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Reorganization -

Chapter 11 BankruptcyAcceptance of reorganization plan requires approval by:Two-thirds of the dollar amount and more than one-half of the creditors who voteTwo-thirds of each class of stockholders who vote Confirmation by the courtThe 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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Learning Objective 13-8

Account for a company as itmoves through reorganization.13-36Slide37

Financial Reporting

During ReorganizationReorganization raises specific accounting questions :Differentiating income from operations and transactions connected to the reorganizationReporting debtReporting basis of assets due to reorganization FASB’s Accounting Standards Codification Topic 852, Reorganizations, requires financial statements be prepared

During the reorganization andWhen entity emerges from reorganization.

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The Income Statement

During ReorganizationGains, losses, revenues and expenses of the reorganization are reported separately from normal operations on the income statement.Interest does not usually accrue on the debt owed as of the date of reorganization. Interest revenue that would not have been earned except for bankruptcy is reported separately as a reorganization item.

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Balance Sheet

During ReorganizationAssets are still reported at book value.Current versus noncurrent classification not applicable for liabilities subject to reduction by the court’s acceptance of the plan.These liabilities should be reported separately at the amount of the claims.Liabilities not subject to reduction are all shown as current versus non-current.

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Learning Objective 13-9

Describe the financial reporting for a company that successfully exits bankruptcy as a reorganized entity.13-

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Fresh Start Reporting

When a company emerges from Chapter 11, GAAP permits fresh start reporting if two conditions are met:1. The reorganization (or market) value of the assets are less than the total of the allowed claims as of the date of the order for relief plus any subsequent liabilities

.2. The original owners are left with less than

50% of the voting stock.

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Fresh Start Accounting

Fresh Start AccountingAssets are restated to individual current value.Liabilities (except deferred income taxes) are stated at the present value of future cash payments.Normally, APIC is adjusted to balance.Retained Earnings is set to zero.13-

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