Solution manual advanced accounting 4e jeter ch10

In a voluntary petition, the debtor files a petition with a bankruptcy court for liquidation under Chapter 7 or for reorganization under Chapter 11.. In an involuntary petition, creditor

Voluntary assignment of assets An insolvent debtor elects to voluntarily place his property under the control of a trustee for the benefit of his creditors

2 In a voluntary petition, the debtor files a petition with a bankruptcy court for liquidation under Chapter 7 or for reorganization under Chapter 11 The bankruptcy judge may refuse a voluntary petition if refusal is considered to be in the best interest of the creditors

In an involuntary petition, creditors initiate the action by filing a petition for liquidation or reorganization with the bankruptcy court If there are twelve or more creditors, the petition must be signed by three or more of such creditors whose claims aggregate at least $5,000 more than the value of any liens on the property of the debtor If there are fewer than twelve creditors, the petition may be filed by one or more of such creditors whose claims aggregate at least $5,000 more than the value of any liens on the debtor’s property

3 Fully secured claims Those claims with liens against specific assets whose realizable value is equal to or in excess of the claim

Partially secured claims Those claims with liens against specific assets whose realizable value is less than the amount of the claim

Unsecured claims Those claims that are not secured by liens against specific assets and are, therefore, paid from whatever total money remains after secured creditors are satisfied Some unsecured claims take priority over others under federal bankruptcy law

4 The five categories of unsecured claims with priority are:

a Administrative expenses, fees, and charges incurred in administering the bankrupt’s estate

b Unsecured claims for wages, salaries, or commissions earned by an employee within 90 days before the date of filing a petition in bankruptcy, limited to the extent of $4,650 per employee

c Claims for contributions to employee benefit plans from services rendered within 180 days before the date of filing a petition in bankruptcy, but subject to certain limitations

d Unsecured claims of individuals, to the extent of $2,100 for each such individual, arising from the deposit of money in connection with the purchase, lease, or rental of property or services that were not delivered or performed

e Claims of governmental units for unpaid taxes

5 Dividends represent the final distribution made to general unsecured creditors

6 a Transfer of Assets:

The transfer of assets by a debtor to a creditor generally produces two types of gain or loss A gain on restructuring of debt is recognized for the excess of the carrying value of the payable over the fair value of the assets transferred This gain is reported as a component of operating income In addition, a gain or loss on transfer of assets is recognized for the difference between the fair value and book value of the assets transferred This gain (loss) is reported as a component of operating income also

b Grant of an Equity Interest:

A debtor who grants an equity interest to a creditor will report a gain for the difference between the fair value of the equity interest issued and the carrying amount of the payable settled

c Modification of Terms:

In a modification of terms, the debtor will report a gain on restructuring only if the total future cash payments specified by the new terms are less than the carrying value of the payable The amount of gain is measure as the difference between the total future cash payments specified by the new terms and the carrying value of the payable

7 The statement of affairs is an accounting report that is designed to permit interested parties to determine the total expected amounts that could be realized from the disposition of a company’s assets, the priorities in the use of the realization proceeds in satisfying claims, and the potential net deficiency that would result if the assets were realized and claims liquidated

8 The officer is incorrect Some claims, such as for taxes, fines, and penalties are not discharged

9 The primary duties of a trustee are:

a To be accountable of all property received

b To examine proofs of claims and object to the allowance of any claim that is improper

c To furnish such information concerning the estate and the estate’s administration as is requested

by a party in interest

d If the business of the debtor is authorized to be operated, file with the court and with any governmental unit charged with responsibility for collection of any tax arising out of such operation, periodic reports and summaries of the operation of the business

e If the debtor has not done so, file with the court a list of creditors, a schedule of assets and liabilities, and a statement of the debtor’s financial affairs

f If applicable, file a plan of reorganization, and, if the plan is accepted, file such reports as are required by the court

10 The purpose of a combining workpaper is to serve as a means by which the trustee’s accounts are united with the debtor company’s accounts in order to prepare appropriate financial statements

11 The purpose of a realization and liquidation account is to report summary realization and distribution activities of a trustee or receiver to the court It reports the changes that have occurred during a period in the monetary items because that is what the court officials are primarily interested in

BUSINESS ETHICS SOLUTIONS

1 In chapter 7 bankruptcy liquidation, firms are assumed to be past the stage of reorganization and

must sell off any un-exempt assets to pay creditors In contrast, Chapter 11 bankruptcy allows

the firm the opportunity to reorganize its debt and to try to re-emerge as a healthy organization

In both cases, the creditors and other claim-holders suffer losses as they will be most likely getting less return on investment than expected at the time of the initial decision to invest in the company From an ethical perspective, a chapter 11 bankruptcy provides the creditors and other claim-holders a better chance of recovering higher value for their investments than under

chapter 7 as the firm strives to recover and reorganize under chapter 11 but not under chapter 7

2 The new law makes sweeping changes to American bankruptcy laws and makes it more

difficult for individuals to file bankruptcy under chapter 7 The new law requires a means test to determine whether the borrowers have enough resources to pay for their debts For additional

information, see the following link:

http://en.wikipedia.org/wiki/Bankruptcy_Abuse_Prevention_and_Consumer_Protection_Act ]

In addition the new law laid down the following requirements

Mandatory credit counseling and debtor education

Additional filing requirements and fees

Increased attorney liability and costs

Fewer automatic protections for filers

Increased compliance requirements for small businesses

Increased amount of debt repayment under Chapter 13

Increased length of time between discharges

These changes provide more safety for the creditors, who should consequently be better

protected Individuals who fail the means test may opt instead for Chapter 13, which involves a repayment of their debt over time

3 Applying this test to businesses would benefit the creditors and other claim-holders, as they

would feel a slight buffer to their risk, which might stimulate new business as a result of easier fund raising It may also prevent businesses from venturing into unduly risky areas as they would not be able to bail out as easily by filing under chapter 7 if things went wrong (hence becoming somewhat more risk averse) It would seem to shift the risk balance somewhat to the shoulders of the entrepreneur from those of the investor

4 Filing for bankruptcy is never a desirable or ethical option, but sometimes circumstances may

arise that seem to force a business or an individual into this tough situation Whether the individual finds another way at such a time or not is a personal issue and an ethical dilemma, and there is not necessarily a correct answer to this question The purpose of this discussion is

to get the student to thinking about his or her personal position, and where his ethical stance

would be before the situation arises Ideally, of course, the student will never find himself or

herself in such a position, but, as the old saying goes, until you’ve walked a mile in another’s shoes…

Exercise 10-2

1 False Insolvency is the inability to pay debts as they become due Classification as to current

and long-term is irrelevant

2 True

3 True

4 False Secured creditors are paid first from the proceeds of sale of specific assets If there are

proceeds remaining, unsecured creditors with priority will be paid before other unsecured creditors

5 True

6 False A gain on restructuring is measured by the excess of the carrying value of the payable

settled over the fair value of the assets transferred

7 False Restructuring gains from troubled debt restructurings are reported by the debtor as a

separate component of operating income

8 False The statement of affairs is a report that shows the estimated amount to be paid to each

class of claim in the event of liquidation

Exercise 10-3

To revalue the copyright to its current fair value [$95,000 – ($100,000 - $55,000)]

Part B The gain on transfer of assets ($50,000) should be reported as a separate component (assuming

material in amount) of operating income; the gain on restructuring ($70,000) should also be reported as a separate component of operating income

To revalue the copyright to its current fair value [$30,000 – ($100,000 - $55,000)]

Gain on Debt Restructuring ($165,000 - $30,000) 135,000

Exercise 10-4

Part A No gain should be recognized because the total future cash payments specified by the new

terms of $1,144,250 ($995,000 carrying value plus 3 years’ interest at $49,750 per year)

exceed the current carrying value of the debt, $995,000

Exercise 10-5

Part A A gain on restructuring should be recognized because the carrying value of the debt, $995,000,

exceeds the total future cash payments specified by the new terms, $744,000 ($600,000 face value plus $144,000 interest) The gain of $251,000 should be reported as a separate

component of operating income

Remainder available to general unsecured creditors $171,000 Payment rate to general unsecured creditors

(Including balance due to partially secured creditors)

Realizable Value of Assets:

Amounts to be paid to:

Partially secured creditors [$90,000 + 45($30,000)] 103,500

Exercise 10-7

BALL COMPANY Statement of Affairs June 30, 2009

Book

Realizable Value

Assets Pledged with Fully Secured Creditors:

Assets Pledged with Partially Secured Creditors:

Free Assets

Liabilities having Priority – Wages 120,000

Estimated Deficiency to Unsecured Creditors 124,600

Equities

Unsecured Liabilities Having Priority:

Exercise 10-7 (continued)

BALL COMPANY Deficiency Account June 30, 2009

Property and Equipment 110,000 Estimated Deficiency to Unsecured Creditors 124,600

Exercise 10-8

Allowance for Uncollectibles ($48,700 - $40,000) 8,700

To record the revaluation of assets

Exercise 10-8 (continued)

Balance Sheet December 31, 2009

To record purchases on account

Exercise 10-9 (continued)

To record estimated bad debts and depreciation expense

To write off uncollectible accounts

Exercise 10-10

TRX COMPANY – IN RECEVERSHIP

Combining Workpaper December 31, 2009

Cost of Goods Sold ($191,900 + $127,500 - $149,700) (1) 169,700 169,700

(1) To adjust inventory and set up cost of goods sold

(2) To eliminate reciprocal accounts.

ANSWERS TO PROBLEMS

Problem 10-1

Problem 10-2 (continued)

Total future cash payments:

Total future cash payments:

Gain on Restructuring of Debt ($100,500 – (100,000 $.59) 41,500

Retained Earnings

Gain on restructuring (2) 4,000 Gain on restructuring (3) 7,880 Gain on restructuring (5) 14,300 Gain on restructuring (6) 41,500

Problem 10-2 (continued)

Balance Sheet January 2, 2009

Retained Earnings since Reorganization on 1/2/09 - 0 -

Problem 10-3

Part A

PROST COMPANY Statement of Affairs December 31, 2009 Book

Realizable Value Assets Pledged with Fully Secured Creditors:

400,000 Plant and Equipment 205,000 $405,000

Mortgage Payable 350,000 Accrued Interest 3,000 353,000 $ 52,000 Assets Pledged with Partially Secured Creditors:

60,000 Notes Receivable * 57,500 76,000 Accounts Receivable 55,000 112,500

Free Assets

Liabilities having Priority – Accrued Wages 45,000

Estimated Deficiency to Unsecured Creditors 150,335

* $60,000 - $2,500 = $57,500

Notes Receivable $57,500 Accounts Receivable 55,000 112,500 $112,500 Unsecured Creditors:

Stockholders’ Equity 380,000 Capital Stock

Accounts Receivable 21,000 Investment in Stock 7,000

Property and Equipment 195,000 Retained Earnings (361,500)

Unrecorded Accrued Interest 3,000 to Unsecured Creditors 150,335

* ($47,515 + $84,150 + $18,000) – ($43,000 + $60,000 + $51,000)

Part B Estimated dividend to be paid general unsecured creditors:

Net free assets minus cash payment to complete work in process inventory

Total amount owed unsecured creditors ($182,165 - $11,000)/$332,500 = 51.6%

Problem 10-4

BRAN COMPANY Jim Brown, Trustee Reconciliation and Liquidation Account June 30, 2009 to December 31, 2009

Less: Accumulated Depreciation 70,000 145,000 Assets Not Realized

Less: Allowance for Uncollectibles 2,000 13,000

Less: Accumulated Depreciation 55,000 96,000

Liabilities to be Liquidated

* ($215,000 - $14,000 - $50,000) = $151,000

Problem 10-4 (continued)

Cash Balance June 30 15,000 Accounts Payable (old) 110,000

Accounts Receivable (old) 38,000 Operating Expenses 47,000 Accounts Receivable (new) 85,000 Trustee Expenses 2,000 Sale of Land and Equipment 38,000

Plum Company – in Receivership ($252,750 - $3,750 - $36,825) 212,175

To record the receipt of Plum Company’s assets

To record collection of accounts receivable

To record cash expenses

To record adjustment for bad debts and depreciation

To write off uncollectible accounts

To record payment of old accounts payable

To record the sale of property and equipment

To close income statement accounts

Plum Company Books

To record the transfer of assets to P Smith

Problem 10-5 (continued)

Part B PLUM COMPANY – IN RECEVERSHIP

Combining Workpaper For Five Months Ending October 31, 2009

Trustee Company Dr Cr Statement Sheet

(1) To adjust inventory and set up cost of goods sold

(2) To eliminate reciprocal accounts