Solution manual advanced accounting 9e by hoyle ch13

Find more slides, ebooks, solution manual and testbank on www.downloadslide.com CHAPTER 13 ACCOUNTING FOR LEGAL REORGANIZATIONS AND LIQUIDATIONS Chapter Outline I Because of a myriad of possible financial or business difficulties, a company may become insolvent, unable to pay its debts as they come due A To ensure the equitable treatment of all parties involved with an insolvent company (stockholders as well as creditors), laws have been written to provide structure for the bankruptcy process in the United States B At present, legal guidance is provided primarily by the Bankruptcy Reform Act of 1978 as amended This law attempts to arrive at a fair distribution of a debtor's assets It also seeks to discharge the obligations of an honest debtor II Bankruptcy proceedings can be formally instigated by either the debtor or a group of creditors A A voluntary petition is filed with the court by the insolvent company while an involuntary petition must be filed by a minimum number of creditors with a minimum level of debt B After a bankruptcy petition is received, normally the court will grant an order for relief to halt all actions against the debtor III Within the bankruptcy process, determining the appropriate classification of all creditors is an important step in achieving a fair settlement A Fully secured creditors hold a collateral interest in assets of the insolvent company having a value in excess of the related liability B Partially secured creditors also have a collateral interest but the expected net realizable value will not satisfy the entire obligation C Some unsecured obligations (including administrative expenses, certain debts to employees, and government claims for unpaid taxes) have priority over other unsecured debts D The remaining unsecured creditors receive assets from the debtor only after the above claims have been satisfied IV A Statement of Financial Affairs is frequently produced by an insolvent company to disclose its current financial position A Assets are reported at net realizable value along with the disclosure of any pledged amounts Liabilities are classified according to the security or priority of the creditor B A Statement of Financial Affairs is especially useful if prepared at the beginning of the bankruptcy process to assist all parties in evaluating the outcome of various actions C Most of the asset balances reported in this statement are merely estimations, projections of future events V Bankruptcy proceedings often conclude with the assets of the debtor being liquidated to satisfy creditor claims (a Chapter bankruptcy) McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 13-1 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com A A trustee is appointed to oversee termination of business affairs, liquidation of noncash properties, and distribution of cash resources B The trustee prepares a periodic reporting of activities, frequently in the form of a Statement of Realization and Liquidation This statement indicates the book value and classification of remaining assets and liabilities It also discloses the effects of all transactions that have occurred to date Vl As an alternative to liquidation, a company may seek to stay in business and attempt to return to solvency (a Chapter 11 bankruptcy) A A reorganization plan has to be devised that can win the approval of each class of creditors and each class of stockholders as well as the court B Reorganization plans normally entail a specific course of action designed to save the company and can include proposed changes in operations, methods of generating additional working capital, and a settlement of the debts that were in existence on the day that the order for relief was entered Vll Financial reporting during reorganization A The AICPA Statement of Position 90-7 (SOP 90-7) provides guidance for preparing financial statements while a company goes through reorganization Gains, losses, revenues, and expenses that result from reorganization must be reported separately on the income statement Professional fees incurred in connection with the bankruptcy must be expensed immediately Liabilities subject to compromise are reported based on the expected amount of the allowed claims VIII Fresh start accounting may be required when a company emerges from reorganization A Assets are restated to current value but only if the fair value of assets is less than the allowed claims and the original owners are left holding less than 50 percent of company B The recognition of goodwill may also be required if the reorganization value of the emerging company is greater than the value of the identifiable assets (both tangible and intangible) C Retained earnings is set at zero to indicate that a new entity has been formed Learning Objectives Having completed Chapter 13 of this textbook, "Accounting for Legal Reorganizations and Liquidations," students should be able to fulfill each of the following learning objectives: Understand the necessity of having laws to protect the parties involved with an insolvent company Identify the Bankruptcy Reform Act of 1978 as the primary legal basis for bankruptcy proceedings in this country Explain the difference between a voluntary and an involuntary bankruptcy petition McGraw-Hill/Irwin 13-2 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Describe the purpose of an order for relief List and describe the categories used to classify creditors during bankruptcy proceedings Give examples of the types of unsecured liabilities that have priority in a bankruptcy Produce a Statement of Financial Affairs for an insolvent company Identify the responsibilities of a trustee in a liquidation (a Chapter bankruptcy) Prepare a Statement of Realization and Liquidation for a business going through liquidation 10 Indicate possible proposals that might be included in a reorganization plan and the method by which a plan becomes accepted and confirmed 11 Produce an income statement during reorganization with reorganization items identified and separately reported 12 Produce a balance sheet during reorganization with liabilities classified as "subject to compromise" and "not subject to compromise." 13 Identify companies that are required to apply fresh start accounting when they emerge from reorganization 14 Apply fresh start accounting to a company emerging from bankruptcy according to SOP 907 Answers to Discussion Questions What Do We Do Now? Students are given a chance in this case to look at a non-accounting business decision: the forcing of a valued client into bankruptcy proceedings Thurber has already committed several unfortunate mistakes in this case For example, he has seen a dramatic slowdown in cash payments by Abraham and Sons without seeking any further information about the prospects of the client Furthermore, he has let the treasurer pressure him into providing additional credit without any valid justification He is now being pushed by another company into filing a bankruptcy petition without adequate assurance that Abraham and Sons has a real problem Because Thurber has not acted earlier, he should now request audited financial statements from Abraham and Sons so that he can make a reasonable decision as to the course of action to take Many important figures can be gleaned from these statements including the amount of the company's working capital, the current ratio, the debt to equity ratio, the trend in sales, the trend in long-term debt, operating cash flows, the gross profit percentage, any expenses that have risen at a fast rate, the amount of property that has been mortgaged, and the like He should then ask for a meeting with the treasurer (or another officer) of Abraham and Sons In this meeting, Thurber should discuss the possibility of having the current debt secured in some manner as protection The development of a formal repayment schedule would also be wise If Thurber is not satisfied by the financial statements and the discussion with the client, he should meet with the clothing manufacturer who has called as well as with a lawyer and/or accountant They should discuss possible actions and the outcomes that could result from each Inevitably, if loss of the receivable seems probable, filing an involuntary petition for McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 13-3 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com bankruptcy may be the wisest course of action to take However, that procedure should only be undertaken after adequate study has been made In the long run, companies not prosper by having their clients go into bankruptcy Students often address this type of case as either a black or white issue: give more credit or force them into bankruptcy The case simply does not provide enough data to arrive at either choice Thus, the students should be directed to consider the types of information that could prove to be beneficial in making this decision Often, in decision-making, the gathering of information is the key step in arriving at the proper conclusion How Much Is That Building Really Worth? College textbooks often present fair value as if it were a known number that was dependable Students may view an asset’s fair value as if getting that much money was virtually assured Thus, students often believe that producing a statement of financial affairs requires little more than establishing and reporting what a buyer will pay for an asset This case was written to emphasize that a net realizable value might actually be no more than a wild guess Obviously, the value of most stocks and bonds can be determined with accuracy However, many other assets such as the building in this case might eventually prove to have a liquidation value that can vary from zero (many deserted buildings are simply never sold because no one wants to buy that type of building in that particular location even if it is in great condition) up to a significant amount The accountant faces the problem of preparing a statement of financial affairs that requires that a single number be reported as the value of each asset Users of this statement can then make important financial decisions based on the number that is presented Subsequently, the actual amount received may be significantly higher or lower than the figure shown The users of the information may feel as if they have been mislead when, in fact, the accountant made the best possible estimation Given the problems faced in determining fair value, the accountant will probably seek a very conservative number for reporting purposes In most cases, less potential damage will be created by reporting a relatively low figure However, use of a particularly low value may tempt the creditors to allow the company to reorganize because little would seem to be gained by forcing liquidation For this reason, a conservative approach can favor the company attempting to avoid liquidation Probably the most important lesson from this case is that decision makers should look with skepticism on many of the numbers reported as representing fair value In some cases, fair value is a figure that can only be estimated and may depend on a number of factors that cannot be anticipated in advance by the accountant or by anyone else Is this the Real Purpose of the Bankruptcy Laws? During the 1980s, as described in this case, the country saw a rash of bankruptcies that were filed to resolve major financial problems Previously, the bankruptcy laws had been used almost exclusively to settle insolvency problems However, if a voluntary petition is filed and accepted by the courts, companies such as Manville and A H Robins are provided with a method of settling issues before actual insolvency occurs Sometimes the final results are good for the companies but not always A H Robins, for example, had to agree to be bought as one of the conditions of its reorganization In effect, the company lost its independence in order to satisfy the lawsuits resulting from the Dalkon Shield McGraw-Hill/Irwin 13-4 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com As with many of the discussion questions in this book, this case is simply intended to alert students to a real-life issue and encourage them to consider the ramifications To function in society, accounting students must know more than just the mechanical aspects of a bankruptcy What are the objectives of the bankruptcy laws and these particular cases fall outside of those objectives? Would either Manville or its claimants, for example, have been better served by having the company slowly pulled into insolvency over years or perhaps decades? Should a different set of bankruptcy laws be established for companies having these types of financial crises? Although these questions are not directly related to accounting, they are the types of questions that accountants (both as business people and as citizens) need to address Answers to Questions "Insolvent" refers to a state of financial position whereby a company (or individual) is unable to pay debts as they come due In the United States today, the primary piece of federal legislation that governs most bankruptcy proceedings is the Bankruptcy Reform Act of 1978 and its subsequent amendments Bankruptcy cases have two overriding objectives: — To achieve a fair distribution of assets to the various parties that are involved with an insolvent company (or individual) and — To discharge the obligations of an honest debtor A voluntary bankruptcy petition is one filed by an insolvent company to gain protection from its creditors Creditors may also seek to prevent or limit losses by filing their own (involuntary) petition Where a company has at least 12 unsecured creditors, a minimum of three (having total unsecured debts of over $13,475) must sign an involuntary petition If fewer than 12 unsecured creditors exist, only one is needed to file the petition but the minimum debt level remains at $13,475 The granting of an order for relief halts all actions against an insolvent company The order for relief provides the company as well as the creditors with time to decide on a future course of action It also brings the court into the process and provides a structure for what might otherwise be a chaotic event, the distribution of assets to the parties involved A fully secured creditor has an obligation from an insolvent company but holds a collateral interest in assets that have a value in excess of the debt Thus, these parties can assume that they will suffer no loss regardless of the outcome of the bankruptcy proceedings A partially secured creditor also has a collateral interest but the liability is larger than the anticipated proceeds from the realization of the attached assets A portion of the liability is covered but a risk of loss still exists in connection with the remaining debt Unsecured creditors have no collateral interest and can only hope to collect after the various secured interests have been satisfied Obviously, this last group of creditors has the highest chance of incurring a loss A liability classified "with priority" is still unsecured However, because of provisions of the Bankruptcy Reform Act of 1978, these debts must be paid before any other unsecured obligations Thus, the chance of loss is reduced, sometimes significantly Unsecured liabilities having priority include the following: — Claims for administrative expenses, McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 13-5 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com — Obligations arising between the date that a bankruptcy petition is filed and the appointment of a trustee or the issuance of an order for relief — Employee claims for wages earned during the 180 days preceding the filing of a bankruptcy petition (limited to $10,950 per person), — Employee claims for contributions to a benefit plan earned during the 180 days preceding the filing of a bankruptcy petition (within certain restrictions), — Deposits made with the company to acquire goods or services (up to a $2,425 limit), — Government claims for unpaid taxes Administrative expenses are classified as liabilities with priority to offer some protection to those individuals who serve the company during the period of insolvency Without a legitimate chance for monetary reward, few people would be willing to provide the various administrative services needed during the bankruptcy process Also, these debts were incurred after the order for relief In a Chapter bankruptcy, the assets of the insolvent company are liquidated to satisfy the claims of the creditors Business activities cease and noncash assets are sold Conversely, in a Chapter 11 bankruptcy, the company attempts to survive its financial problems and return to solvency A reorganization plan is developed that will allow the company to continue operations and reach a settlement of its debts This reorganization plan must be accepted by each class of creditors, each class of stockholders, and the court 10 Unsecured creditors often face the possibility of absorbing substantial losses in a Chapter liquidation because their claims rank below fully secured and partially secured liabilities Frequently, little or nothing is expected As a result of this risk, unsecured creditors may feel that they have a better chance of limiting their losses by agreeing to a reorganization plan to keep the company alive as a potential future customer 11 The statement of financial affairs helps the parties involved with a bankruptcy to anticipate their potential losses It reports all assets of the insolvent company at net realizable value whereas liabilities are classified as fully secured, partially secured, with priority, and unsecured Based on the potential cash inflows and outflows, an estimation can be made of the losses that will be incurred by each group of claimants A statement of financial affairs is considered especially useful at the beginning of the bankruptcy process since it can assist the parties in evaluating the outcome of various possible actions 12 In general, a trustee is assigned to prevent loss of the insolvent company's assets and oversee the liquidation and distribution process A number of rather procedural tasks are normally accomplished by the trustee shortly after appointment such as notifying the post office, changing locks, obtaining possession of corporate records, and opening a new bank account Thereafter, the trustee might have to operate the company for a period of time to complete any business still in process The trustee also has the power to void any transfer made by the debtor within 90 days prior to the filing of the bankruptcy petition if the company was insolvent at the time Subsequently, the trustee works to liquidate noncash assets and make appropriate disbursements to the various claimants During this entire process, the trustee needs to make periodic reportings to the court and other interested parties 13 A trustee can demand the return of any payment (or other asset transfer) made within 90 days prior to the filing of a bankruptcy petition if the company was already insolvent This legal procedure is known as the voiding of a preference transfer and is intended to prevent one party from gaining an unfair advantage over the remaining claimants In effect, the payment is viewed as a distribution of the insolvent company's assets, a process that is to be controlled solely by the trustee and the court McGraw-Hill/Irwin 13-6 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 14 A statement of realization and liquidation is designed to report (1) the account balances of the insolvent company at the date the order for relief is entered, (2) the liquidation of noncash assets, (3) the cash distributions made to the various claimants, (4) any other transactions incurred during this period, and (5) any remaining asset and liability balances 15 During the liquidation of an insolvent company, control is turned over to an outside trustee However, in a Chapter 11 bankruptcy (a reorganization), operations will usually be continued so that an attempt can be made to arrive at a plan to save the company While the bankruptcy proceeds, control is normally retained by the ownership, a group legally referred to as the debtor in possession 16 In a Chapter 11 bankruptcy, the debtor in possession (the present ownership of the company) is given the initial opportunity of filing a reorganization plan with the court If a formal proposal is not put forth by the debtor in possession within 120 days of the order for relief or is not accepted within 180 days, any interested party has the right to submit a plan Bankruptcy proceedings often drag on for lengthy periods because the time limitations can be extended by the court However, because of recent changes in the bankruptcy laws, the debtor’s exclusivity to propose a plan cannot be extended beyond 18 months 17 Numerous types of proposals are to be found in reorganization plans For example, many will set forth specific ideas for changes to be made in the company's operations (to increase profitability) such as selling assets or terminating complete lines of business In addition, most reorganization plans identify sources that will be tapped in the future to generate additional funding Proposed changes in management may also be spelled out in an attempt to persuade claimants that the company will have the ability to overcome its past economic problems Last, and probably most important, a reorganization plan must include some anticipated settlement of the claims against the company that were in existence at the time the order for relief was entered Before any reorganization plan is approved, the creditors (as well as the court) must be convinced that the financial rewards will outweigh the amounts that could be received from a liquidation 18 To become effective, a reorganization plan must be accepted by all interested parties For approval, each class of creditors (more than two-thirds in dollar amount and one-half in number) must vote for the proposal Each group of stockholders (two-thirds of the shares being voted) must also accept the plan The court will then confirm the reorganization plan but only if the court feels that all parties are being treated fairly The court also has the authority to confirm a proposal even if not accepted by the creditors or stockholders This procedure (known as a "cram down") is only used if the plan is judged to be fair and equitable 19 A "cram down" is a legal provision whereby the court can confirm a reorganization proposal for an insolvent company even though the plan has not been accepted by a particular class of creditors or stockholders This step is not taken unless the court believes the plan being put forth is fair and equitable 20 During reorganization, some debts are in jeopardy of being settled at a significantly reduced amount whereas others will probably be paid at face value Unsecured and partially secured liabilities are likely to be settled at a lowered figure Conversely, fully secured liabilities and any debts incurred during the reorganization period are normally not at risk of being reduced Thus, if a balance sheet is produced while a company is in reorganization, all liabilities are reported as either being subject to compromise (reduction) or not being subject to compromise The debts subject to compromise are reported at the expected amount of allowed claims rather than at an estimation of the settlement figure Such estimations are often difficult, if not impossible, to make McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 13-7 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 21 A company going through a Chapter 11 bankruptcy will report specified reorganization items on its income statement separately from operating figures However, these reorganization items are reported prior to income tax expense rather than in a manner similar to an extraordinary item These separately disclosed figures include gains and losses on the sale of assets necessitated by the reorganization Professional fees incurred in connection with the reorganization are also reported in a similar manner as well as any interest revenue that would not have been earned except for the bankruptcy proceeding 22 Professional fees incurred during a reorganization must be expensed as incurred Capitalization is not allowed 23 “Fresh start accounting” refers to the adjustment of a company's assets to current value at the time the organization emerges from bankruptcy A company must use fresh start accounting if two criteria are met at the time the reorganization is finalized: (1) the fair value of the assets is less than the total allowed claims as of the date of the order for relief plus the liabilities incurred during reorganization and (2) the original owners are left with less than 50 percent of the voting stock In fresh start accounting, all assets are reported at current value while liabilities are reported based on the present value of the settlement amounts If the reorganization value of the company as a whole is greater than the total fair value of the individual assets, goodwill is reported for the excess Initially, in fresh start accounting, retained earnings must be reported at a zero balance 24 Fresh start accounting is used by companies that are emerging from a bankruptcy reorganization if the value of the assets held at that time are less than the allowed claims associated with company’s liabilities (those present at the date of the order for relief and those incurred since that date) and the original owners are left with less than 50 percent of the voting stock of the reorganized company 25 In fresh start accounting, the tangible and intangible assets of the company are reported at their fair values Liabilities are reported at the present value of the future cash flows 26 When a company emerges from bankruptcy, the reorganization value of its assets as a whole must be determined The figure is normally computed by discounting anticipated future cash flows from the business This figure is then assigned to the various assets of the company based on individual fair values The total reorganization value may well be greater than the current value of the individual assets If so, the residual amount is recorded as the intangible account Goodwill Each year (or more often in some cases) it is reviewed for impairment McGraw-Hill/Irwin 13-8 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Problems B D B C A D C B C 10 B 11 A 12 A 13 A 14 B 15 C 16 A 17 C 18 A 19 D 20 C 21 C McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 13-9 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 22 (10 Minutes) (Distribution of cash in a liquidation) Free Assets: Current Assets Buildings and Equipment Total $ 35,000 110,000 $145,000 Liabilities with Priority: Administrative Expenses Salaries Payable (only $3,000 per employee) Income Taxes Total $ 20,000 6,000 8,000 $ 34,000 Free Assets After Payment of Liabilities with Priority ($145,000 – $34,000) $111,000 Unsecured Liabilities Notes Payable (in excess of value of security) Accounts Payable Bonds Payable Total $ 30,000 85,000 70,000 $185,000 Percentage of Unsecured Liabilities To Be Paid: $111,000/$185,000 = 60 % Payment On Notes Payable: Value of Security (land) 60% of Remaining $30,000 Total Collected by holders McGraw-Hill/Irwin 13-10 $ 90,000 18,000 $108,000 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 45 (40 Minutes) (Prepare a statement of financial affairs) LYNCH, INC Statement of Financial Affairs March 14, 2008 Book Values $40,000 14,000 1,000 25,000 100,000 15,000 Assets Pledged with Fully Secured Creditors: Land and building Less: Notes payable Available for Unsecured Creditors $75,000 (70,000) $5,000 Pledged with Partially Secured Creditors: Equipment $19,000 Less: Notes payable (150,000) -0- Free Assets: Cash Accounts receivable Inventory Investments Total available to pay liabilities with priority and unsecured creditors Less: Liabilities with priority (listed below) Available for unsecured creditors Estimated deficiency 115,000 $195,000 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e 1,000 15,000 33,000 21,000 $75,000 (22,000) $53,000 $168,000 © The McGraw-Hill Companies, Inc., 2009 13-37 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 45 (continued) Book Values Unsecured— Nonpriority Liabilities Liabilities and Stockholders' Equity -0$5,000 1,000 Liabilities with Priority: Administrative expenses (estimated) Salaries payable Payroll taxes payable Total (above) $16,000 5,000 1,000 $22,000 70,000 Fully Secured Creditors: Notes payable Land and building $70,000 (75,000) -0- $150,000 (19,000) $ 131,000 150,000 33,000 4,000 (68,000) $195,000 McGraw-Hill/Irwin 13-38 Partially Secured Creditors: Notes payable Equipment Unsecured Creditors: Accounts payable Advertising payable Stockholders' equity 33,000 4,000 $168,000 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 46 (30 Minutes) (Prepare a statement of realization and liquidation) a LYNCH, INC Statement of Realization and Liquidation March 14, 2008 to July 23, 2008 Book balances, 3/14/08 Answer from Problem 45 Accounts receivable collected —remaining balance assumed to be uncollectible Inventory sold Accounts payable discovered Land and buildings all sold Fully secured note paid Equipment sold Payment made on partially secured debt Investments sold Administrative expenses accrued Remaining partially secured claims reclassified as unsecured liabilities Final balances remaining for unsecured creditors Cash Noncash Assets $ 1,000 $194,000 18,000 40,000 (25,000) (100,000) 71,000 (70,000) 11,000 (40,000) Liabilities with Priority $6,000 Fully Secured Creditors Partially Secured Creditors StockUnsecured holders' Nonpriority Equity Liabilities (Deficits $70,000 $150,000 $ 37,000 $(68,000) 10,000 (11,000) 21,000 (70,000) (14,000) (3,000) (11,000) (15,000) 6,000 (20,000) 20,000 _ $81,000 (7,000) (60,000) (10,000) 31,000 -0- $26,000 (139,000) -0- -0- 139,000 $186,000$(131,000) b The statement of realization and liquidation prepared in (a) indicates that $81,000 in cash remains However, $26,000 of this amount must be distributed to the liabilities with priority leaving only $55,000 for the unsecured nonpriority creditors Since these unsecured liabilities amount to $186,000, only 30% (rounded) ($55,000/$186,000) of each debt will be paid Thus, a creditor holding a $1,000 claim will receive approximately $300 McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 13-39 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com 47 (30 Minutes) (Prepare Journal entries for company emerging from bankruptcy using fresh start accounting) The Holmes Corporation must use fresh start accounting because the reorganization value of $225,000 is less than the company's allowed debts and the original owners hold less than 50 percent of the voting stock after the reorganization BOOK VALUES AFTER EMERGING FROM REORGANIZATION — Total assets = $248,200 ($225,000 reorganization value plus proceeds from sale of stock of $36,000 less $12,800 payment made to settle unsecured liabilities [20 percent of $64,000]) — Total liabilities = $118,000 ($18,000 + $70,000 + $30,000) — Total common stock = $105,000 (11,000 additional shares are issued with a $5 per share par value – total outstanding shares = 21,000) — Deficit = -0- (eliminated by the reorganization) — Additional paid-in capital = $25,200 (figure needed to balance above accounts after reorganization) JOURNAL ENTRIES — Goodwill Additional paid-in capital To adjust to total reorganization value as part of fresh start accounting ($225,000 – $210,000) 15,000 15,000 — Salary payable Note payable—1 year To record note issued for accrued salaries 18,000 — Notes payable Note payable—6 years Common stock ($5 par value) Additional paid-in capital (5/21 of total computed above) Gain on discharge of debt To record settlement of partially secured debt 140,000 — Cash Common stock ($5 par value) Additional paid-in capital To record shares sold to new investor 36,000 McGraw-Hill/Irwin 13-40 18,000 30,000 25,000 6,000 79,000 30,000 6,000 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com — Notes payable Accounts payable Accrued expenses Cash Gain on discharge of debt To record payment of unsecured debts—20% payment made — Gain on debt discharge Additional paid-in capital ($27,000 – $25,200) Retained earnings (deficit) To adjust additional paid-in capital to appropriate balance, close out gain, and eliminate deficit balance as part of fresh start accounting McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e 50,000 10,000 4,000 12,800 51,200 130,200 1,800 132,000 © The McGraw-Hill Companies, Inc., 2009 13-41 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Develop Your Skills Research Case This case allows the student to review the official information provided by the Securities and Exchange Commission in connection with bankrupt organizations Therefore, the student has the opportunity to make use of the SEC website as well as gain information about reporting requirements for organizations in bankruptcies In addition, this assignment allows the student to see how the SEC attempts to educate the public on matters pertaining to financial investing This site includes a significant amount of general information including the following:             The differences between a Chapter and a Chapter 11 bankruptcy The risks incurred by the various parties A description of a prepackaged bankruptcy plan The advantages of filing under Chapter 11 The appointment of creditor committees The development of a reorganization plan Steps in a Chapter 11 reorganization, especially those that involve the SEC Conveyance of information about a bankruptcy Voting on a reorganization plan The effect on stockholders and bondholders The steps of a Chapter liquidation Sources of additional information for a specific bankruptcy case Research Case This assignment provides the student with the chance to work with actual data from a real company Thus, the student can get the feel for the process of retrieving information of interest about a company that has previously gone through bankruptcy In addition, this assignment can help the student appreciate the frustration that sometimes comes about when analyzing financial statements Textbooks often have information laid out for the student so that analysis may resemble a ―connect the dots‖ assignment In reality, pages and pages of data are often available that require slow and meticulous study Here is the actual note supplied by the Hawaiian Airlines which can serve as the basis for considerable class discussion On March 21, 2003 (the Petition Date), Hawaiian filed a voluntary petition for reorganization under Chapter 11 of the U.S Bankruptcy Code (the Bankruptcy Code) in the U.S Bankruptcy Court for the District of Hawaii (the Bankruptcy Court) The Company did not file for relief under Chapter 11 of the Bankruptcy McGraw-Hill/Irwin 13-42 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Code On May 30, 2003, a bankruptcy trustee was selected to serve in connection with the Chapter 11 case and operate Hawaiian, which thereafter operated its business under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court until June 2, 2005, the effective date of Hawaiian’s joint plan of reorganization and its emergence from bankruptcy (the Effective Date) On March 11, 2005, the Company, together with the bankruptcy trustee, the Official Committee of Unsecured Creditors of Hawaiian, a wholly-owned subsidiary of the Company formerly known as HHIC, Inc (HHIC), a Delaware corporation, and RC Aviation, LLC (RC Aviation), which is currently the Company’s largest shareholder, sponsored the Third Amended Joint Plan of Reorganization (the Joint Plan) to provide for Hawaiian to emerge from bankruptcy The Joint Plan provided for payment in full of all allowed claims, including unsecured claims The Joint Plan also provided for the merger of Hawaiian with and into HHIC, with HHIC being the surviving entity and renamed Hawaiian Airlines, Inc., a Delaware corporation As used hereinafter in this report, the term ―Hawaiian‖ refers to the predecessor company for all periods prior to the merger with HHIC, and the successor company for all periods subsequent to the merger with HHIC The Company retained its 100% equity interest in Hawaiian; however, in connection with the Joint Plan, the Company issued shares of its common stock to creditors of Hawaiian to help fund the Joint Plan, resulting in a dilution of the ownership interest of its common shareholders The following table summarizes the classification and treatment of claims under the Joint Plan (in millions): Class Classification Unclassified Unsecured Priority Tax Claims Treatment under the Joint Plan In cash, paid in 24 equal quarterly installments Cash $ 1.2 Long-Term Common Obligations Stock $ 29.5 - Class Secured Priority (Unimpaired) Tax Claims In cash, paid in accordance with the legal, equitable and contractual rights of the holder of the claim 0.9 - - Class Other Secured (Unimpaired) Claims Generally, at the election of Hawaiian, (i) cash, (ii) surrender of the collateral securing the claim, (iii) cure and reinstatement, or (iv) retention by the holder of its legal, equitable and contractual rights 1.3 1.2 - Class Cash 0.1 - - Other Priority McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 13-43 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com (Unimpaired) Claims Class (Impaired) Unsecured Claims Cash equal to 100% of not included in a the allowed claim Category below 31.7 - Class (Impaired) Lease Related Claims A combination of cash, common stock of the company based on a stock value of $6.16 per share and subordinated convertible notes of the Company 27.0 60.0 $87.0 Class (Impaired) Convenience Claims Cash 0.8 - - $ 63.0 $ 90.7 $ 87.0 Class Equity (Impaired/ Interests Unimpaired) - Holders of equity interests in Hawaiian retained their interests in the reorganized Hawaiian, without modification or alteration by the Joint Plan However, the Company was required to issue new common stock to creditors of Hawaiian, which resulted in a dilution of the ownership interest of the Company’s common shareholders Total The Joint Plan was financed through the issuance of approximately 14.1 million shares of the Company’s common stock to the holders of aircraft lease related claims, a $50.0 million senior secured credit facility of Hawaiian, a $25.0 million junior secured term loan of Hawaiian and a private placement by the Company of $60.0 million in subordinated convertible notes (collectively, the Exit Financing Transactions), as discussed further in Note Analysis Case Students may look up any one of a number of companies that have emerged recently from bankruptcy reorganization The type of results that will be found will be based on the specific company One company, for example, that has emerged from reorganization is AMF Bowling Here is a press release obtained at www.amf.com: McGraw-Hill/Irwin 13-44 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Richmond, Virginia, March 8, 2002 - AMF Bowling Worldwide, Inc today announced that it has emerged from Chapter 11 after completing its exit financing arrangements with Deutsche Banc Alex Brown and its affiliate Bankers Trust Company AMF Bowling Worldwide, Inc and its U.S subsidiaries filed voluntary petitions for reorganization under Chapter 11 on July 2, 2001 "We are emerging from this Chapter 11 process as a healthy company, and we are grateful to all parties for helping us to conclude the proceeding," said Roland Smith, the Company's President and Chief Executive Officer "We will now be able to focus our resources on the business of bowling We are determined to build value for the Company's stakeholders, including our employees, whose hard work and dedication were key factors in the Company's successful reorganization." The Company today closed on its $350 million exit financing The agreement consists of a $290 million term loan, as well as a $60 million revolving credit facility In addition, the Company issued $150 million in subordinated notes In accordance with the previously approved plan of reorganization, the Company will provide its pre-petition senior secured lenders with recovery of their approximately $620 million in claims through a combination of equity (equal to 92 percent of the common stock of the reorganized company), $150 million in subordinated notes, and cash In addition, unsecured creditors will share proportionately in percent of the common stock, as well as warrants for the right to purchase additional shares The unsecured creditors' common stock and warrants will be issued later this year The Company's former parent, AMF Bowling, Inc., which conducts no operations, filed a separate Chapter 11 case and will likely have no assets to distribute to its common stockholders, and little, if any, assets to distribute to its creditors AMF Bowling Worldwide, Inc is no longer affiliated with AMF Bowling, Inc The shares of AMF Bowling Worldwide's common stock that were issued under its plan of reorganization are separate and distinct from the shares of its former parent The Company is the largest owner and operator of bowling centers in the world and is a leader in the manufacturing and marketing of bowling products In addition, the company manufactures and sells the PlayMaster, Highland and Renaissance brands of billiards tables Additional information about AMF is available on the Internet at www.amf.com A second source of information is the Securities and Exchange Commission According to the SEC website, using an EDGAR search, AMF filed a Form 8-K on the same date as the above press release that made public the following: McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 13-45 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com On March 8, 2002, AMF Bowling Worldwide, Inc issued a Press Release announcing that it has emerged from Chapter 11 under the United States Bankruptcy Code A copy of the Press Release is filed herewith as Exhibit 99.1 In connection with its emergence and pursuant to the previously approved Second Amended Second Modified Plan of Reorganization, among other things, AMF Bowling Worldwide, Inc filed an Amended and Restated Certificate of Incorporation with the Secretary of State of the State of Delaware; adopted Amended and Restated Bylaws; entered into a new Senior Secured Credit Agreement providing for a term loan of $290,000,000 and a revolving credit facility of $60,000,000 secured by substantially all of its domestic assets and guaranteed by its subsidiaries; issued $150,000,000 of 13.00% Senior Subordinated Notes due 2008 pursuant to an Indenture with Wilmington Trust Company, as Trustee, guaranteed by its domestic subsidiaries; entered into a Registration Rights Agreement with certain holders of common stock; entered into a Series A Warrant Agreement and a Series B Warrant Agreement with Mellon Investor Services LLC, as Warrant Agent, providing for the issuance of warrants to purchase an aggregate of up to 3,488,844 shares of common stock; and adopted a 2002 Stock Option Plan providing for the issuance of options to purchase up to 1,839,388 shares of common stock to certain directors, officers, advisors, employees and independent consultants Copies of these documents are filed herewith as exhibits Following this information in the Form 8-K, over 70 pages of additional documents were presented including the certificate of incorporation Finally, a search of The Wall Street Journal finds a number of articles discussing the bankruptcy reorganization of AMF including: ―AMF Bowling Worldwide Inc.: Chapter 11 Protection Ends Via $350 Million Financing,‖ March 11, 2002, p B-2 ―AMF Bowling Property Said Court Approved Its Reorganization Plan,‖ February 5, 2002, p A-4 ―AMF Bowling Inc.: Unit Changes the Payments In Its Reorganization Plan,‖ January 11, 2002, p B-8 So, there are obviously many ways available to investors who are trying to get information about a bankruptcy reorganization plan Analysis Case McGraw-Hill/Irwin 13-46 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com While a company is going through a bankruptcy reorganization, creditors, investors, employees, and other interested parties all want to know the current status of the process This assignment was designed simply to help students determine what information can be readily gained from a company’s website about a reorganization that is in process Different companies will undoubtedly provide widely differing amounts of information Following is a portion of a December 30, 2004 press release made by Aloha Airlines that was posted on its website: In a continuing effort to restore the company’s long-term financial health, Aloha Airgroup, Inc and its principal operating subsidiary, Aloha Airlines, Inc., announced today they have filed voluntary petitions for reorganization under Chapter 11 of the U.S Bankruptcy Code ―It will be business as usual as we move forward to complete the restructuring of our Company,‖ said David A Banmiller, Aloha’s president and chief executive officer Banmiller went on to say Aloha hopes to emerge from Chapter 11 as expeditiously as possible ―Meanwhile, it is important for the traveling public to know that reservations for future travel will continue to be taken, tickets will be honored, and flights will continue to operate as scheduled.‖ Banmiller said: ―Despite actions already taken to cut unprofitable routes and reduce senior management by 36 percent, Aloha must continue to pursue cost-reduction initiatives necessary to offset higher fuel and operating expenses in what has become a fiercely competitive market environment If Aloha is to effectively compete, we must align our aircraft lease rates to market levels and match our expenses to those of competitors who have already benefited from bankruptcy protection ―The decision to file Chapter 11 was not easy for Aloha - a company with a proud history etched by a conscientious desire to be a good corporate citizen and deeply rooted in the communities we serve.‖ Banmiller emphasized: ―With our valued customers and loyal employees in mind, Aloha is focused on successfully emerging to become a bigger, stronger and more competitive player in the industry, so that we can continue to optimize our route network and provide our high-quality service at affordable fares to travelers in the cities we serve in Hawaii and North America.‖ Chapter 11 of the U.S Bankruptcy Code enables companies to reorganize under court supervision while they continue to operate and meet their customers’ needs Aloha’s restructuring efforts will be led by Banmiller, a veteran airline executive with an accomplished background specializing in airline financings and turnaround ventures for ―financially-challenged‖ companies Banmiller has a McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 13-47 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com proven record of successfully taking other airline companies such as Sun Country Airlines and Pan Am through Chapter 11 reorganization In addition, Banmiller has retained Giuliani Capital Advisors to assist Aloha in exploring all strategic alternatives to maximize value through the Chapter 11 process This is the first time in Aloha’s 58-year history that the privately held Honolulu-based company has sought bankruptcy protection Another Hawaiibased carrier, publicly held Hawaiian Airlines, came under Chapter 11 in 1993 and again in March 2003 Since the attacks of September 11, 2001, the nation’s airlines have faced what has been described as ―the perfect storm‖ of financial hardships A general economic slowdown and a skittish world travel market stiffened competition, which brought air fares down and reduced revenue at a time when the price of fuel, insurance and other fixed costs were skyrocketing In Hawaii, the prolonged slump in visitor arrivals from Asia and the increase in Mainland flights going direct to the Neighbor Islands had a compounding economic impact on Aloha, the state’s largest provider of inter-island air services In 2002, when a merger attempt was called off between Aloha and Hawaiian airlines, and private capital was unavailable, Aloha Airlines sought and received a loan guarantee from the federal Air Transportation Stabilization Board in 2002 The federally backed $45 million loan program enabled Aloha to upgrade systems and pursue expansion plans To date, Aloha has repaid approximately half of the loan Rapidly mounting fuel and other operational costs sapped the company’s financial strength in 2004 In spite of an percent increase in enplanements in the airline’s transpacific service, Aloha was unable to post a profit in the third quarter of 2004 due to higher fuel cost and lower ticket prices Through November 2004, Aloha has paid $24 million more in fuel than over the same period in 2003 representing a 48% increase in fuel expenses year-over-year In announcing the airline’s restructuring, Banmiller emphasized that: • Aloha’s top priority will be to provide travelers with safe and consistently reliable and high-quality service • Aloha’s inter-island and transpacific flights will continue to operate according to schedule • All Aloha tickets and coupons will be honored Reservations, ticketing and refunds will continue as normal • AlohaPass members will still be able to earn and redeem mileage and Aloha will continue to offer frequent flyers the option of earning United Mileage Plus miles on Aloha flights • Transactions made with the Aloha AirAwards Card will continue to earn bonus miles • Vendors will be paid in the ordinary course for goods and services provided after the filing date • Aloha will continue to operate its air-cargo freight service McGraw-Hill/Irwin 13-48 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com • Aloha will continue to provide contracted services to those airlines with signed agreements • Code-sharing agreements with partner airlines will not be affected by the filing Founded in 1946, the privately held, Honolulu-based Aloha is a leading provider of aviation services in the State of Hawaii Aloha offers approximately 620 interisland flights per week between Honolulu, Kahului, Kona, Hilo and Lihue In February 2000, Aloha inaugurated transpacific service from Hawaii to Oakland, California Today the airline operates 140 transpacific flights a week between Hawaii and Oakland, Burbank, Orange County, San Diego and Sacramento, California; 42 weekly flights between California and Nevada; and daily service between Vancouver, Canada, and Hawaii Aloha provides Hawaii with critical airlift for passengers flying between the five major airports throughout the Islands and carries 85 percent of the state’s interisland air freight business Aloha is also the largest provider of contract aviation services for more than 20 domestic and international air carriers serving Hawaii Aloha is among Hawaii’s top employers with a workforce of over 3,600 and an annual payroll of $113 million Aloha’s fleet consists of 13 Next Generation Boeing 737-700s, 10 B737-200s, three dedicated B737-200 freighters and one B737-200 QC Frequently Asked Questions for Vendors and Suppliers What is Chapter 11? Chapter 11 is a part of the U.S Bankruptcy Code that allows companies to restructure under court supervision while they continue normal day-to-day operations Why is Aloha filing for Chapter 11? Like other airlines, Aloha has elected to enter Chapter 11 in order to pursue costreduction initiatives needed to offset higher fuel and operating expenses Through this legal process, our company can restructure its debts and obligations and emerge a stronger competitor United, Hawaiian and ATA airlines are going through this process in their efforts to lower costs Our goal is to emerge with a much lower cost structure that will enable Aloha to be more competitive in an industry dominated by low-cost carriers When will Aloha emerge from Chapter 11 protection? Aloha hopes to emerge as expeditiously as possible What remedies creditors have in a Chapter 11 proceeding? McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 13-49 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Creditors are prohibited by law from taking certain collection actions against Aloha Common examples of prohibited actions including contacting Aloha by telephone, mail or otherwise to demand repayment, taking actions to collect money or obtain property from Aloha, repossessing Aloha’s property, and starting or continuing lawsuits against Aloha What if I believe I have a right to a reclamation claim for goods delivered to Aloha? In the limited circumstances where creditors believe they have a right to reclaim goods that were delivered to Aloha, we expect to ask the Court shortly to establish a procedure for protection of the value of the claims of those creditors How can vendors or suppliers file a claim for any invoices that were generated prior to the Chapter 11 filing? Upon filing for Chapter 11, Aloha, by law, cannot pay for goods and services received before the filing, unless the Bankruptcy Court otherwise orders Payment for these pre-petition invoices will be determined by the Bankruptcy Court at a later time You will have the opportunity to file a claim for any prepetition debt with the Bankruptcy Court, and will receive instructions for filing such claim shortly Will payment for goods and services after the Chapter 11 filing date be honored? Aloha will continue to pay for all goods and services provided after the Chapter 11 filing Please be aware that post-petition suppliers are given ―administrative priority status‖ under the law, providing additional protection to you, so we encourage you to continue providing goods and services to Aloha on normal terms What will unsecured creditors receive as payment for their claims? It is too early in the process to accurately forecast any eventual payment of prepetition claims However, Aloha intends to pay post-petition expenses in the normal course of business How can vendors or suppliers receive updates regarding status of payment of outstanding invoices? Please continue to work with your normal contact at Aloha, who can answer your questions, or visit Aloha’s Web Site at www.AlohaAirlines.com for more information McGraw-Hill/Irwin 13-50 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Communications Case A study of almost any large bankrupt organization can lead to a considerable degree of speculation as to the reasons for the company’s decline For example, the following articles provide a few examples of the discussions surrounding the struggles of Kmart Because the company was so widely known, its bankruptcy was closely followed by the press so that the process is easy to follow ―Kmart Records Wider Net Loss As Chapter 11 Struggles Continue,‖ The Wall Street Journal, December 24, 2002, p C-12 ―Turning Red Ink to Green?—Attention, Kmart Shoppers: Retailer's Turnaround Plan Has New Aprons, Wider Aisles,‖ The Wall Street Journal, October 15, 2002, p B-1 ―A FIX-UP ON FAST FORWARD—Creditors want quicker results from Kmart's CEO,‖ Business Week, October 14, 2002, p 101 ―The SEC's Accounting Reforms Won't Answer Investors' Prayers,‖ Business Week, June 17, 2002, p 28 ―Why Companies Fail; CEOs offer every excuse but the right one: their own errors Here are ten mistakes to avoid,‖ Fortune Magazine, May 27, 2002, p 50 ―Kmart's Review Of Practices Turns To Vendor Credits,‖ The Wall Street Journal, May 10, 2002, p B-8 ―KMART'S LAST CHANCE,‖ Business Week, March 11, 2002, p 68 COMMUNICATIONS CASE This assignment is designed so that the student can work with several practical accounting journals such as the CPA Journal and the Journal of Accountancy These sources provide a considerable amount of information about the nature of the work that can be performed for a company before, during, and after bankruptcy McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The McGraw-Hill Companies, Inc., 2009 13-51 ... Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e © The... Collected by holders McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e $ 50,000 24,000 $ 74,000 © The McGraw-Hill Companies, Inc., 2009 13-11 Find more slides, ebooks, solution manual. .. to be controlled solely by the trustee and the court McGraw-Hill/Irwin 13-6 © The McGraw-Hill Companies, Inc., 2009 Solutions Manual Find more slides, ebooks, solution manual and testbank on www.downloadslide.com