Solution manual advanced accounting 11th by beams chapter18

trustee are to maintain and supervise a panel of private trustees eligible to serve in Chapter 7 cases, to serve as trustee or interim trustee in some bankruptcy cases, to supervise the

Chapter 18

CORPORATE LIQUIDATIONS and REORGANIZATIONS

Answers to Questions

1 Equity insolvency occurs when a debtor is unable to pay its debts as they come due Bankruptcy insolvency

occurs when a debtor’s liabilities exceed the fair value of all assets

2 A bankruptcy proceeding is designated voluntary if the debtor corporation files the petition to place itself

under the protection of the bankruptcy court and involuntary if creditors file the petition to bring the debtor

into bankruptcy court An involuntary petition may be filed by a single creditor with an unsecured claim of

$12,300 or more if there are fewer than twelve unsecured creditors Otherwise, three or more entities with unsecured claims totaling at least $12,300 must file in order to commence an involuntary case The requirements are the same for Chapter 7 and Chapter 11 cases

3 The duties of the U.S trustee are to maintain and supervise a panel of private trustees eligible to serve in

Chapter 7 cases, to serve as trustee or interim trustee in some bankruptcy cases, to supervise the administration of bankruptcy cases, and to preside over creditor meetings Bankruptcy judges still supervise cases in districts without U.S trustees

4 The debtor corporation in a bankruptcy case has the following duties: (1) to file a list of creditors, a

schedule of assets and liabilities, and a statement of the debtor’s financial affairs; (2) to cooperate with the trustee so that the trustee may perform his duties; (3) To surrender all property, including books, documents, records, and so on, to the trustee; and (4) to appear at hearings of the bankruptcy court as required

5 A trustee is not appointed in all Title 11 cases In Chapter 7 cases, a trustee will be elected by unsecured

creditors if a majority of creditors vote for the trustee, and those creditors hold at least 20 percent of the claims Otherwise, an appointed interim trustee serves as trustee In Chapter 11 cases a trustee is appointed only if deemed necessary by the court, but otherwise, the debtor remains in possession of the estate and performs the duties of a trustee Within 30 days from the time the court orders the appointment of a trustee

in a Chapter 11 case, a party in interest may request the election of a trustee

6 The trustee in a liquidation case takes possession of the debtor’s estate, converts estate assets into cash, and

distributes the proceeds as directed by the court They also performs other duties such as investigating the financial affairs of the debtor, providing information about the estate to parties of interest, examining creditor claims and objecting to those that appear improper, operating the debtor’s business if authorized to

do so by the court, providing financial reports and summaries about the estate to the court, and filing reports on trusteeship as directed by the court

7 The priority rankings in a Chapter 7 liquidation case are summarized in Exhibit 18–2 of the text The

priorities recognized for unsecured claims (Rank II) are: (1) administrative expenses, (2) claims incurred between an involuntary filing and appointment of a trustee, (3) salary claims up to $10,000 per individual earned within 90 days of filing, (4) employee benefit plan contribution claims up to $10,000 per individual earned within 180 days of filing, (5) individual claims up to $1,800 for goods and services purchased from, but not provided by the debtor, and (6) claims of governmental units for taxes owed by the debtor (subject

to time restrictions), including taxes collected and withheld for which the debtor is liable

8 Four ranks within the unsecured nonpriority claim category (general unsecured claims) are: (1) claims

allowed that were timely filed, (2) claims allowed where proof was filed late, (3) claims allowed for fines, penalties or forfeitures, or damages, and arising before the court order for relief or appointment of a trustee, and (4) claims for interest on unsecured claims

9 The accountant’s statement of affairs is a financial statement that is designed to provide information about

liquidation values and priority rankings for use by the trustee, the court, creditors, and other interested parties in the debtor’s estate Assets are measured at expected net realizable values in the statement, but book values are also included for reference purposes

10 A debtor corporation’s estate may be liquidated even though the filing is under Chapter 11 This can occur

when the case is transferred to Chapter 7 for liquidation It can also be carried out in accordance with an approved Chapter 11 plan of reorganization that calls for sale and distribution of the proceeds from the debtor corporation’s estate

11 A debtor in possession reorganization case is a Chapter 11 case in which the bankruptcy court does not

appoint a trustee, but instead, allows the debtor corporation to carry out the duties that otherwise would be performed by a trustee

12 A creditor committee can file a plan of reorganization under a Chapter 11 case after 120 days from the date

the court order for relief is granted The order for relief occurs when the debtor or creditor’s filing petition

is approved by the court

13 The approval of a plan of reorganization requires acceptance of the plan by at least two-thirds in dollar

amount and over half in number of claims in each class of claims Further, each class of claims must accept the plan or not be impaired under it A class of claims that would receive nothing if the corporation were liquidated is not impaired if it receives nothing under a plan and, accordingly, acceptance by that class of claims is not required

14 Prepetition liabilities are the liabilities of an enterprise that were incurred prior to a Chapter 11 filing They

are reported at the amounts allowed by the bankruptcy court Prepetition liabilities subject to compromise

are those liabilities that may be impaired by a plan and that are eligible for compromise because they are either unsecured or undersecured

15 Reorganization value is an estimate of the value of the reconstituted entity that will emerge from

reorganization, plus the expected net realizable value of the assets that will be disposed of before reconstitution occurs It is also described as the fair value of the entity before considering liabilities Reorganization value approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring

16 Fresh start reporting should be used by a company emerging from Chapter 11 if the following two

conditions are met: (1) the reorganization value of the assets of the emerging entity immediately before the date of confirmation is less than the total of all postpetition liabilities and allowed claims and (2) holders of existing voting shares immediately before confirmation receive less than 50 percent of the voting shares of the emerging entity

17 Entities not qualifying for fresh start reporting report liabilities compromised by a confirmed

reorganization plan in a manner similar to that of a note issued in a noncash transaction under FASB ASC

835 Forgiveness of debt should be reported as an extraordinary item

SOLUTIONS TO EXERCISES

Solution E18-1 Solution 18-2

Solution E18-3

Amount secured by inventory items at expected recoverable value (50,000)

Unsecured portion of note receivable from Pat 150,000

Expected recovery on the dollar for unsecured claims .35

Expected recovery on unsecured portion of note 52,500

Total expected recovery on note from Pat $102,500

Solution E18-4

1 On the basis of the reorganization value, Bax qualifies for fresh start

reporting because the estimated reorganization value of $2,000,000 is

less than the postpetition liabilities and allowed claims

Liabilities:

Fully secured debt 900,000 3,600,000 Excess liabilities over reorganization value $1,600,000

2 Old stockholders must retain less than a 50% interest in the “new

entity.”

Less: Payment to prepetition claimants 150,000

Reorganized capital structure:

New common stock to prepetition claimants 375,000 2,775,000 New common stock to old stockholders $ (925,000)

Solution E18-5

100,000 Priority claims (administrative expenses and salaries) (20,000) Available for unsecured, nonpriority claims $ 80,000 Unsecured, nonpriority claims:

$80,000 available cash/$160,000 claims = $.50 on the dollar

Schedule of Distribution of Available Cash

Mortgage payable — unsecured portion ($60,000  $.50) 30,000

SOLUTIONS TO PROBLEMS

Solution P18-1

1 Entries on trustee’s books:

March 1, 2011

Accounts receivable — net 8,000

Revenue received in advance 1,000

To record custody of Sco in liquidation

To record collection of receivables and recognize loss

To record sale of inventories at a loss

To record sale of land and buildings at a loss

To write off intangible assets at a loss

To accrue trustee expenses

Solution P18-1 (continued)

at March 31, 2011

Assets

Liabilities And Deficit

Administrative expenses payable — new 8,200

Statement of Cash Receipts and Disbursements

from March 1 to March 31, 2011

Add: Cash receipts

Collections of receivables $ 7,200

Sale of land and buildings 90,000 116,600

Statement of Changes in Estate Equity from March 1 to March 31, 2011

Less:

Loss on uncollectible receivables $ 800 Loss on sale of inventories 16,600 Loss on sale of land and buildings 30,000 Loss on write-off of intangibles 26,000 Administrative expenses 8,200 81,600

Solution P18-1 (continued)

3 Entries on trustee’s books:

To record payment of secured creditors from proceeds from sale of land and buildings

Administrative expenses payable — new $ 8,200

Revenue received in advance 1,000

To record payment of priority liabilities

To record payment of $.32 per dollar to unsecured creditors (available cash of $28,400 divided by unsecured claims of

$90,000)

To write off remaining liabilities and close trustee’s records

Solution P18-2

1 Amount expected to be available for unsecured claims:

Total amount expected to be available for all

Less: Payments to secured and priority claims

Expected to be available for unsecured

2 Expected recovery per dollar of unsecured claims:

Expected to be available (from 1) = $70,000

Unsecured claims ($550,000 - $375,000) = $175,000

Expected recovery on the dollar: $70,000/$175,000 = $.40

3 Expected recovery by class of creditors:

Fully secured — mortgage payable $220,000 Partially secured — note payable $75,000 + ($25,000  $.40) 85,000 Priority unsecured — liabilities to priority creditors 80,000 Unsecured nonpriority creditors — accounts

Solution P18-3

1 Ranking of claims:

8 Holders of first mortgage and related

Unsecured priority:

6 Wages payable up to $4,000 per

employee

47,000

7 Customer claims for merchandise paid

for and not delivered (maximum

$1,800 per individual)

1,500

5 State government for gross

receipts taxes

$ 3,000

3 Local government for property

Total unsecured priority claims 68,000

Unsecured nonpriority:

4 Local bank for principal of loan 30,000

6 President for salary due over $4,000 1,000 130,000

4 Interest on unsecured bank loan 4,500 Total unsecured nonpriority claims 134,500

2 Distribution of available cash:

2nd Administrative expenses (100%) 12,500 3rd Employees (up to $4,000 each) (100%) 47,000 4th Customers for merchandise not delivered

5th State government (100%) $ 3,000

Local government (100%) 4,000 7,000 [Remaining cash ($374,500 - $296,500) of $78,000/$130,000 claim of next rank = $.60 return on dollar]

6th Merchandise creditors ($99,000  60) $59,400

Local bank for loan principal

Company president ($1,000  60) 600 78,000 Total distributed (equal to available cash) $374,500

Solution P18-4

Statement of Affairs

on June 30, 2011

Assets

Values- Liability Offsets

Realizable Value Available for

Pledged for partially secured creditors

Less: Mortgage note payable and accrued interest (31,000) $ 0

Available for priority and unsecured creditors

Total available for priority and unsecured

Less: Priority liabilities 12,000 Total available for unsecured creditors 26,200

Liabilities And Stockholders’ Equity

Priority liabilities

$12,000 Wages payable (assumed under

$4,000 per employee) $12,000

Partially secured creditors

31,000 Note payable and accrued

Less: Equipment pledged

Unsecured creditors

Solution P18-4 (continued)

2 Estimated payments per dollar for unsecured creditors

Distribution to partially secured and unsecured

priority creditors:

Note payable and interest $28,000 Administrative expenses 4,000

Available to unsecured nonpriority

Note payable and interest (unsecured portion) $ 3,000

Unsecured nonpriority claims = B $37,000 A/B = $22,200/$37,000 = $.60 per dollar

Expected recovery for each class of claims

Note payable and interest

Unsecured portion ($3,000  $.60) 1,800 $29,800

Administrative expenses $ 4,000

Accounts payable ($26,400  $.60) $15,840 Rent payable ($7,600  $.60) 4,560 20,400

Solution P18-5

1 Dawn Corporation — in Chapter 7

Statement of Affairs at July 10, 2011

Assets

Realizable Realizable

Fully secured

Less: Notes payable 100,000 $ 60,000

Partially secured

Less: Mortgage and interest

Unsecured

Available for priority and

Equities

Priority liabilities

$ 50,000 Accounts payable $ 50,000

Fully secured

Less: Accounts receivable — net 160,000

(60,000)

Partially secured

205,000 Mortgage and interest payable $205,000

Less: Land and buildings — net 140,000

65,000 $ 65,000

Unsecured

300,000 Capital stock

Solution P18-5 (continued)

Administrative expenses $ 11,000 $ 11,000

Accounts payable 50,000 50,000

Fully secured claims

Partially secured claims

Mortgage and interest payable 205,000 140,000 $ 26,000

39,000

Unsecured

Accounts payable 350,000 210,000 140,000

Calculation of recovery for unsecured nonpriority claims

Less: Paid to fully secured claims (100,000) Less: Paid to partially secured creditors – secured portion (140,000)

A Cash available for unsecured $249,000 Unsecured claims:

Partially secured ($205,000 - $140,000 secured) $ 65,000

A  B = $249,000/$415,000 = $.60 recovery on the dollar

Solution P18-6

Statement of Affairs on June 30, 2011

Assets

Realizable

Offsets for Available for

Pledged for fully secured creditors

$230,000 Land and building $170,000

Less: Mortgage payable and accrued interest (165,000) $ 5,000

Available for priority and unsecured creditors

70,000 Accounts receivable — net 63,000

Total available for priority and unsecured

Less: Priority liabilities 70,000 Total available for unsecured creditors 100,000

Liabilities and Stockholders’ Equity

Priority liabilities

10,000 Property taxes payable 10,000

70,000

Fully secured creditors

150,000 Mortgage payable $150,000

15,000 Interest on mortgage payable 15,000

Unsecured creditors

50,000 Note payable — unsecured 50,000

5,000 Interest payable — unsecured 5,000

Stockholders’ equity

200,000 Capital stock

(100,000) Retained earnings (deficit)