in full settlement of Nen’s liability to Baker: Carrying amount of liability settled $450,000 Carrying amount of real estate transferred $300,000 Fair value of real estate transferred $3
Trang 1Chapter 10 Insolvency – Liquidation and Reorganization
Multiple Choice
1 A corporation that is unable to pay its debts as they become due is:
a bankrupt
b overdrawn
c insolvent
d liquidating
2 When a business becomes insolvent, it generally has three possible courses of action Which of the
following is not one of the three possible courses of action?
a The debtor and its creditors may enter into a contractual agreement, outside of formal
bankruptcy proceedings
b The debtor continues operating the business in the normal course of the day-to-day operations
c The debtor or its creditors may file a bankruptcy petition, after which the debtor is liquidated under Chapter 7
d The debtor or its creditors may file a petition for reorganization under Chapter 11
3 Assets transferred by the debtor to a creditor to settle a debt are transferred at:
a book value of the debt
b book value of the transferred assets
c fair market value of the debt
d fair market value of the transferred assets
4 A composition agreement is an agreement between the debtor and its creditors whereby the creditors
agree to:
a accept less than the full amount of their claims
b delay settlement of the claim until a latter date
c force the debtor into a liquidation
d accrue interest at a higher rate
5 In a troubled debt restructuring involving a modification of terms, the debtor’s gain on restructuring:
a will equal the creditor’s gain on restructuring
b will equal the creditor’s loss on restructuring
c may not equal the creditor’s gain on restructuring
d may not equal the creditor’s loss on restructuring
6 A bankruptcy petition filed by a firm is a:
a chapter petition
b involuntary petition
c voluntary petition
d chapter 11 petition
Trang 28 An involuntary petition filed by a firm’s creditors whereby there are twelve or more creditors must
be signed by at least:
a two creditors
b three creditors
c five creditors
d six creditors
9 The duties of the trustee include:
a appointing creditors’ committees in liquidation cases
b approving all payments for debts incurred before the bankruptcy filing
c examining claims and disallowing any that are improper
d calling a meeting of the debtor’s creditors
10 Which of the following items is not a specified priority for unsecured creditors in a bankruptcy
petition?
a Administration fees incurred in administering the bankrupt’s estate
b Unsecured claims for wages earned within 90 days and are less than $4,650 per employee
c Unsecured claims of governmental units for unpaid taxes
d Unsecured claims on credit card charges that do not exceed $3,000
11 Which statement with respect to gains and losses on troubled debt restructuring is correct?
a Creditors losses on restructuring are extraordinary
b Debtor’s gains and losses on asset transfers and debtor’s gains on restructuring are combined and treated as extraordinary
c Debtor gains and creditor losses on restructuring are extraordinary, if material in amount
d Debtor losses on asset transfers and debtor gains on restructuring are reported as a component of net income
12 When fresh-start reporting is used according to Statement of Position (SOP) 90-7, the implication is
that a new firm exists Which of the following statements is not correct about fresh-start
accounting?
a Assets are reported at fair values
b Beginning retained earnings is reported at zero
c The fair value of the assets must be less than the post liabilities and allowed claims
d The original owners must own less than 50% of the voting stock after reorganization
13 A Statement of Affairs is a report designed to show:
a an estimated amount that would be received by each class of creditor’s claims in the event of liquidation
b a balance sheet prepared on the going-concern assumption
c assets and liabilities classified as current and noncurrent
d assets and liabilities reported at their current book values
14 When a secured claim is not fully settled by the selling of the underlying collateral, the remaining
portion:
a of the claim cannot be collected by the creditor
b remains as a secured claim
c is classified as an unsecured priority claim
d is classified as an unsecured nonpriority claim
Trang 315 Layne Corporation entered into a troubled debt restructuring agreement with their local bank The
bank agreed to accept land with a carrying amount of $360,000 and a fair value of $540,000 in exchange for a note with a carrying amount of $765,000 Ignoring income taxes, what amount should Layne report as a gain on its income statement?
a $0
b $180,000
c $225,000
d $405,000
16 The following information pertains to the transfer of real estate in regards to a troubled debt
restructuring by Nen Co to Baker Co in full settlement of Nen’s liability to Baker:
Carrying amount of liability settled $450,000 Carrying amount of real estate transferred $300,000 Fair value of real estate transferred $330,000 What amount should Nen report as ordinary gain (loss) on transfer of real estate?
a $(30,000)
b $30,000
c $120,000
d $150,000
17 The following information pertains to the transfer of real estate in regards to a troubled debt
restructuring by Nen Co to Baker Co in full settlement of Nen’s liability to Baker:
Carrying amount of liability settled $450,000 Carrying amount of real estate transferred $300,000 Fair value of real estate transferred $330,000 What amount should Baker report as a gain or (loss) on restructuring?
a $120,000 ordinary loss
b $120,000 extraordinary loss
c $150,000 ordinary loss
d $150,000 extraordinary loss
18 Dobler Corporation was forced into bankruptcy and is in the process of liquidating assets and paying
claims Unsecured claims will be paid at the rate of thirty cents on the dollar Carson holds a note receivable from Dobler for $75,000 collateralized by an asset with a book value of $50,000 and a liquidation value of $25,000 The amount to be realized by Carson on this note is:
a $25,000
b $40,000
c $50,000
d $75,000
Trang 419 Bad Company filed a voluntary bankruptcy petition, and the statement of affairs reflected the
following amounts:
Estimated
Assets pledged with fully secured creditors $ 900,000 $ 1,110,000 Assets pledged partially secured creditors 540,000 360,000
Liabilities
$3,210,000 Assume the assets are converted to cash at their estimated current values What amount of cash will
be available to pay unsecured nonpriority claims?
a $720,000
b $840,000
c $960,000
d $1,080,000
20 The final settlement with unsecured creditors is computed by dividing:
a total net realizable value by total unsecured creditor claims
b net free assets by total secured creditor claims
c total net realizable value by total secured creditor claims
d net free assets by total unsecured creditor claims
21 Dodge Corporation entered into a troubled debt restructuring agreement with their local bank The
bank agreed to accept land with a carrying value of $200,000 and a fair value of $300,000 in exchange for a note with a carrying amount of $425,000 Ignoring income taxes, what amount should Dodge report as a gain on its income statement?
a $0
b $100,000
c $125,000
d $225,000
22 The following information pertains to the transfer of real estate in regards to a troubled debt
restructuring by Drier Co to Cole Co in full settlement of Drier’s liability to Cole:
Carrying amount of liability settled $375,000
Carrying amount of real estate transferred $250,000
Fair value of real estate transferred $275,000
What amount should Drier report as ordinary gain (loss) on transfer of real estate?
a $(25,000)
b $25,000
c $100,000
d $125,000
Trang 523 The following information pertains to the transfer of real estate in regards to a troubled debt
restructuring by Drier Co to Cole Co in full settlement of Drier’s liability to Cole:
Carrying amount of liability settled $375,000
Carrying amount of real estate transferred $250,000
Fair value of real estate transferred $275,000
What amount should Cole report as a gain or (loss) on restructuring?
a $100,000 ordinary loss
b $100,000 extraordinary loss
c $125,000 ordinary loss
d $125,000 extraordinary loss
24 Poor Company filed a voluntary bankruptcy petition, and the settlement of affairs reflected the
following amounts:
Estimated
Assets pledged with fully secured creditors $ 450,000 $ 555,000
Assets pledged partially secured creditors 270,000 180,000
Liabilities
$1,605,000 Assume the assets are converted to cash to their estimated current values What amount of cash will
be available to pay unsecured nonpriority claims?
a $360,000
b $420,000
c $480,000
d $540,000
25 Dooley Corporation was forced into bankruptcy and is in the process of liquidating assets and
paying claims Unsecured claims will be paid at the rate of thirty cents on the dollar Cerner holds a note receivable from Dooley for $90,000 collateralized by an asset with a book value of $60,000 and a liquidation value of $30,000 The amount to be realized by Cerner on this note is:
a $30,000
b $48,000
c $60,000
d $90,000
Trang 6Problems
10-1 On January 1, 2011, Bargain Mart owed City Bank $1,600,000, under an 8% note with three years
remaining to maturity Due to financial difficulties, Bargain Mart was unable to pay the previous year’s interest City Bank agreed to settle Bargain Mart’s debt in exchange for land having a fair market value of $1,310,000 Bargain Mart purchased the land in 2003 for $1,000,000
Required:
Prepare the journal entries to record the restructuring of the debt by Bargain Mart
10-2 On January 1, 2010, Gannon, Inc owed BancCorp $12 million on a 10% note due December 31,
2011 Interest was last paid on December 31, 2008 Gannon was experiencing severe financial difficulties and asked BancCorp to modify the terms of the debt agreement After negotiation BancCorp agreed to:
- Forgive the interest accrued for the year just ended,
- Reduce the remaining two years interest payments to $900,000 each and delay the first
payment until December 31, 2011, and
- Reduce the unpaid principal amount to $9,600,000
Required:
Prepare the journal entries for Gannon, Inc necessitated by the restructuring of the debt at (1) January 1,
2010, (2) December 31, 2011, and (3) December 31, 2012
10-3 On January 2, 2011 Stevens, Inc was indebted to First Bank under a $12 million, 10% unsecured
note The note was signed January 2, 2005, and was due December 31, 2014 Annual interest was last paid on December 31, 2009 Stevens negotiated a restructuring of the terms of the debt
agreement due to financial difficulties
Required:
Prepare all journal entries for Stevens, Inc to record the restructuring and any remaining transactions relating to the debt under each independent assumption
A First Bank agreed to settle the debt in exchange for land which cost Stevens $8,500,000 and has a
fair market value of $10,000,000
B First Bank agreed to (1) forgive the accrued interest from last year (2) reduce the remaining four
interest payments to $600,000 each, and (3) reduce the principal to $9,000,000
10-4 On December 31, 2011, Community Bank agreed to restructure a $900,000, 8% loan receivable
from Neer Corporation because of Neer’s financial problems At December 31 there was $36,000 of accrued interest for a six-month period Terms of the restructuring agreement are as follows:
- Reduce the loan from $900,000 to $600,000;
- Extend the maturity date by 2 years from December 31, 2011 to December 31, 2013;
- Reduce the interest rate on the loan from 8% to 6%
Present value assumptions:
Present value of $1 for 2 years at 6% = 0.8900
Present value of $1 for 2 years at 8% = 0.8573
Present value of an ordinary annuity of $1 for 2 years at 6% = 1.8334
Present value of an ordinary annuity of $1 for 2 years at 8% = 1.7833
Required:
Compute the gain or loss that will be reported by Community Bank
Trang 710-5 Donnelly Corporation incurred major losses in 2010 and entered into voluntary Chapter 7
bankruptcy in the early part of 2011 By June 1, all assets were converted into cash, the secured creditors were paid, and $150,000 in cash was left to pay the remaining claims as follows
Claims prior to the trustee’s appointment 21,000
Wages payable (all under $4,650 per employee) 54,000
Administrative expenses of the trustee 30,000
Required:
Classify the claims by their Chapter 7 priority ranking, and analyze which amounts will be paid and which amounts will be written off
10-6 Davis Corporation filed a petition under Chapter 7 of the U.S Bankruptcy Act on June 30, 2011
Data relevant to its financial position as of this date are:
Estimated Net Book Value Realizable Values
Note payable plus accrued interest 96,000
Total liabilities and equity $300,000
Required:
A Prepare a statement of affairs assuming that the note payable and interest are secured by
a mortgage on the equipment and that wages are less than $4,650 per employee
B Estimate the amount that will be paid to each class of claims if priority liquidation expenses
including trustee fees are $24,000 and estimated net realizable values are actually realized
Trang 810-7 The following data are taken from the statement of affairs of Mitchell Company
Assets pledged with fully secured creditors (Realizable value, $635,000) $800,000 Assets pledged with partially secured creditors
Free assets (Realizable value, $340,000) 535,000
Partially secured creditor claims 400,000 Unsecured creditor claims with priority 100,000 General unsecured creditor claims 1,165,000
Required:
Compute the amount that will be paid to each class of creditor
10-8 On February 1, 2011, Hilton Company filed a petition for reorganization under the bankruptcy
statutes The court approved the plan on September 1, 2011, including the following provisions:
1 Accrued expenses of $21,930, representing priority items, are to be paid in full
2 Hilton Company is to exchange accounts receivable in the face amount of $138,000 and an
allowance for uncollectible accounts of $29,200 for the full settlement of $198,600 owed on open account to one of its major unsecured creditors The estimated fair value of the
receivables is $104,000
3 Unsecured creditors of open accounts amounting to $91,600 and paid 40 cents on the dollar
in full settlement
4 Hilton Company’s only other major unsecured creditor agreed to a five-year extension of
the $500,000 principal owed him on a 10% note payable Accrued interest on the note on September 1, 2011, amounts to $45,000, one-third of which is to be paid in cash and the remainder canceled In addition, no interest is to be charged during the remaining five years
to maturity of the note
Required:
Prepare journal entries on the books of Hilton Company to give effect to the preceding provisions
Short Answer
1 The Bankruptcy Reform Act assigns priorities to certain unsecured claims, and each rank must be
satisfied in full before the next–lower rank is paid Identify the five categories of unsecured creditor claims
2 Creditors are classified by law as either secured or unsecured Distinguish among fully secured,
partially secured, and unsecured creditors
Trang 9Short Answer Questions from the Textbook
1 List the primary types of contractual agreements between a debtor company and its creditors and
briefly explain what is involved in each of them
2 Distinguish between a voluntary and involuntary bankruptcy petition
3 Distinguish among fully secured, partially se-cured, and unsecured claims of creditors
4 Five priority categories of unsecured claims must be paid before general unsecured creditors are
paid Briefly describe what makes up each category
5 What are “dividends” in a bankruptcy proceeding?
6 For each of the following debt restructurings, indicate whether a gain is recognized and, if so, how
the gain is measured and reported (a)Transfer of assets by the debtor to the creditor.(b)Grant of an equity interest by the debtor to the creditor.(c)Modification of the terms of the payable
7 What is the purpose of a Statement of Affairs?
8 One of the officers of a corporation that had just received a discharge in bankruptcy said, “Good,
now we don’t owe anyone.” Is he correct?
9 What are the duties of a trustee in a liquidation proceeding?
10 What is the purpose of a combining work paper prepared by a trustee?
11 What is the purpose of a realization and liquidation account?
Business Ethics Question from Textbook
From an ethical perspective, some believe that it is never justifiable for an individual or business to declare bankruptcy Others believe that some actions are appropriate only in extreme circumstances Without
question, as stated in the Journal of Accountancy, November 2005,page 51, “the ease with which debtors have been able to walk away from debt has frustrated creditors for years.”
1 Describe the differences between Chapter 7 (liquidations) and Chapter 11 (reorganizations)from an
ethical standpoint Who is most likely to be hurt by a Chapter 7 bankruptcy?
2 Discuss the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Do you believe
the changes wrought by this act will serve to protect creditors?
3 The Protection Act of 2005 requires individuals, but not businesses, to undergo a “means” test
before they can seek Chapter 7 relief Do you believe this change should be applied to businesses as well? Why or why not?
4 Do you think that you would ever resort to filing for bankruptcy relief yourself? Why or why not?
Trang 10ANSWER KEY
Problems
10-2 Carrying amount: $12,000,000 + $1,2000,000 = $13,200,000
Future payments: ($900,000 × 2) + 9,600,000 = 11,400,000
Gain to debtor/Loss to creditor $ 1,800,000 January 1, 2010
December 31, 2011
December 31, 2012