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 © Pearson Education, Inc publishing as Prentice 17-1 Corporate Liquidations: Objectives Understand differences among types of bankruptcy filings Comprehend trustee responsibilities and accounting during liquidation Understand financial reporting during reorganization Understand financial reporting after emerging from reorganization, including fresh-start accounting © Pearson Education, Inc publishing as Prentice 17-2 Corporate Liquidations and Reorganizations 1: Types of Bankruptcies © Pearson Education, Inc publishing as Prentice 17-3 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 © Pearson Education, Inc publishing as Prentice 17-4 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 © Pearson Education, Inc publishing as Prentice 17-5 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 liquidation © Pearson Education, Inc publishing as Prentice 17-6 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 © Pearson Education, Inc publishing as Prentice 17-7 Ranking of Claims: Liquidation © Pearson Education, Inc publishing as Prentice 17-8 Corporate Liquidations and Reorganizations 2: Corporate Liquidation © Pearson Education, Inc publishing as Prentice 17-9 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 © Pearson Education, Inc publishing as Prentice 17-10 Balance Sheet Assets Filed FYE Before Fair value Revaluation 6/30/09 1/5/08 12/31/08 6/30/09 Cash 50 150 300 300 Accounts receivable 500 350 335 335 Inventory 300 370 350 375 25 Other current assets 50 50 30 30 Land 200 200 200 300 100 Building, net 500 450 425 350 (75) Equipment, net 300 330 290 260 (30) Patent 200 150 125 (125) Reorganization value in excess of identifiable assets 2,100 2,050 2,055 1,950 (105) © Pearson Education, Inc publishing as Prentice AFTER 6/30/09 300 335 375 30 300 350 260 250 2,200 17-23 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 © Pearson Education, Inc publishing as Prentice 17-24 Balance Sheet – Liability & Equity Short term borrowing (post) Accounts payable (pre/post) Wages payable (post) Taxes payable (pre) Accrued bond interest (pre) Note payable (pre) Subordinated debt (post) 12% bonds payable – current (post) 12% bonds payable (post) 15% bonds payable (pre) Liabilities subject to compromise Capital stock (old) Capital stock (new) Additional paid in capital Deficit Filed 1/5/08 FYE 12/31/08 150 100 50 600 150 90 260 1,200 2,300 500 500 (700) 2,100 Before 6/30/09 75 125 55 395 100 500 2,300 500 (1,050) 2,050 © Pearson Education, Inc publishing as Prentice AFTER 6/30/09 75 125 55 150 (1,000) 2,055 800 0 2,200 17-25 What Happened to Liabilities? • Upon filing on 1/5/08, Tiger reclassifies the unsecured and partially secured liabilities at that point as Prepetition 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 © Pearson Education, Inc publishing as Prentice 17-26 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! © Pearson Education, Inc publishing as Prentice 17-27 Can Tiger Use Fresh Start? Post-petition liabilities Allowed claims Total liabilities Less reorganization value Excess liabilities $255 2,300 $2,555 (2,200) $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 Liabilities exceed reorganization value Old shareholders retain less than 50% Yes, fresh start is appropriate © Pearson Education, Inc publishing as Prentice 17-28 Reorganization Plan: 6/30/09 Pre-petition Liabilities and Equity 15% partially secured bonds, $1200 Priority tax claims $150 New Agreements $500 new stock, $500 senior 12% bonds, and another $100 bonds due 12/31/09 To be paid cash once confirmed Debt Discharge $100 $0 Remaining unsecured claims, $950: $600 accounts payable $90 accrued interest $260 note Old stock $275 subordinated debt and $140 new stock Forgiven $120 subordinated debt and $60 new stock Total debt discharged $100 new stock © Pearson Education, Inc publishing as Prentice $185 $90 $80 $455 Equity 17-29 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 © Pearson Education, Inc publishing as Prentice 17-30 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 © Pearson Education, Inc publishing as Prentice 17-31 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 © Pearson Education, Inc publishing as Prentice 17-32 Calculate Balance in Retained Earnings (Deficit) Deficit, 6/30/09 Gain on debt discharge Loss on asset revaluation Final measure of deficit, 6/30/09 Write-off Additional paid in capital Reorganization value in excess of identifiable assets (intangible asset) (1,000) 455 (105) ($650) 400 ($250) If sufficient APIC had existed, there would be no intangible asset, and excess APIC would remain on the balance sheet © Pearson Education, Inc publishing as Prentice 17-33 Eliminate Deficit in Equity Reorganization value in excess of identifiable assets Gain on debt discharge 250 Additional paid in capital 400 Loss on asset revaluation 455 105 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 © Pearson Education, Inc publishing as Prentice 17-34 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 © Pearson Education, Inc publishing as Prentice 17-35 Disclosures • Adjustments to historical values – Assets – Liabilities • Debt forgiveness • Prior retained earnings or deficit eliminated • Significant factors in determining the reorganization value © Pearson Education, Inc publishing as Prentice 17-36 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher Printed in the United States of America Copyright © 2009 Pearson Education, Inc Publishing as Prentice Hall © Pearson Education, Inc publishing as Prentice 17-37 ... 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... reorganization Understand financial reporting after emerging from reorganization, including fresh-start accounting © Pearson Education, Inc publishing as Prentice 17-2 Corporate Liquidations and... net realizable values – Classified on basis of availability for classes of creditors – Liabilities are classified • Priority, fully secured, partially secured, unsecured – Historical values included