Solution manual advanced accounting 11th edition joe ben hoyle chap013

Chapter 13 - Accounting for Legal Reorganizations and Liquidations 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, at least, 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 every creditor 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 All remaining unsecured creditors will receive assets from the debtor only after all of 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) 13-1 Chapter 13 - Accounting for Legal Reorganizations and Liquidations 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 bankruptcy court B Reorganization plans normally lay out 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 is important to allow parties to follow the progress being made A FASB’s Accounting Standards Codification, Topic 852, Reorganizations provides guidance for preparing financial statements during the period that 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 on the balance sheet based on the expected amount of the allowed claims VIII Fresh start accounting is often 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 must be set at zero to indicate that a new entity has been formed 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 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 13-2 Chapter 13 - Accounting for Legal Reorganizations and Liquidations 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 face-to-face 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 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 frequently present fair value as if it were a known number that was easily determined Students may view an asset’s fair value as if getting that much money was virtually assured Thus, they 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 net realizable value might actually be no more than a wild guess Obviously, the value of most stocks and many bonds can be determined with accuracy However, 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 estimation possible 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 13-3 Chapter 13 - Accounting for Legal Reorganizations and Liquidations 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 US saw a rash of bankruptcies that were filed to resolve major financial problems Previously, 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 As with many of the discussion questions in this book, this case is 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 $14,425) 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 $14,425 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 13-4 Chapter 13 - Accounting for Legal Reorganizations and Liquidations 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, — 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 $11,725 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 $2,600 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 Because of this possibility, 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 13-5 Chapter 13 - Accounting for Legal Reorganizations and Liquidations 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 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 that is then 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, 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, closing stores, 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 liquidation 13-6 Chapter 13 - Accounting for Legal Reorganizations and Liquidations 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 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 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 13-7 Chapter 13 - Accounting for Legal Reorganizations and Liquidations 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 Answers to Problems B D B C A D C B C 10 B 11 A 12 A 13 A 14 B 15 C 13-8 Chapter 13 - Accounting for Legal Reorganizations and Liquidations 16 A 17 C 18 A 19 D 20 C 21 C 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 13-9 $ 90,000 18,000 $108,000 Chapter 13 - Accounting for Legal Reorganizations and Liquidations 23 (5 Minutes) (Distribution of assets from a liquidation) Liabilities with Priority Paid first—administrative expense Paid second—wages: total for Rankin but only up to a maximum of $11,725 for Key Total priority claims All remaining money available— government claims to unpaid taxes Total of free assets $2,450 16,950 19,400 5,800 $25,200 No payments will be made in connection with the remainder of the salaries and government claims No payments will be made on any of the unsecured accounts payable since no money is left 24 (8 Minutes) (Distribution of assets to partially secured creditors) Free Assets: Other Assets Excess from Assets Pledged with Fully Secured Creditors ($116,000 – $70,000) Total 46,000 $126,000 Liabilities with Priority $ 42,000 Free Assets after Payment of Liabilities with Priority ($126,000 – $42,000) $ 84,000 Unsecured Liabilities: Excess of Partially Secured Liabilities Over Pledged Assets ($130,000 – $50,000) Unsecured Creditors Total $ 80,000 200,000 $280,000 $ 80,000 Percentage of Unsecured Liabilities to Be Paid: $84,000/$280,000 = 30% Payment on Partially Secured Debt: Value of Pledged Asset 30% of Remaining $80,000 Total to be Collected by holders 13-10 $ 50,000 24,000 $ 74,000 Chapter 13 - Accounting for Legal Reorganizations and Liquidations '1' 46 (30 Minutes) (Prepare a statement of realization and liquidation) a LYNCH, INC Statement of Realization and Liquidation March 14, 2013 to July 23, 2013 Book balances, 3/14/13 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 Cash Noncash Assets Liabilities with Priority $ 1,000 $194,000 $6,000 18,000 40,000 (25,000) (100,000) 71,000 (70,000) 11,000 (40,000) (11,000) 21,000 StockUnsecured holders' Nonpriority Equity Liabilities (Deficits $70,000 $150,000 $ 37,000 $(68,000) (70,000) (7,000) (60,000) (10,000) 31,000 (3,000) (11,000) 6,000 (20,000) 20,000 _ 13-35 Partially Secured Creditors 10,000 (14,000) (15,000) Fully Secured Creditors (139,000) 139,000 Chapter 13 - Accounting for Legal Reorganizations and Liquidations Final balances remaining for unsecured creditors $81,000 -0 - $26,000 -0 - -0 - $186,000$(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 13-36 Chapter 13 - Accounting for Legal Reorganizations and Liquidations 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 plus 10,000 existing shares so 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 required APIC 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 13-37 18,000 30,000 25,000 6,000 79,000 30,000 6,000 Chapter 13 - Accounting for Legal Reorganizations and Liquidations — 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 Develop Your Skills 50,000 10,000 4,000 12,800 51,200 130,200 1,800 132,000 Research Case This case allows the student to review the official information provided by the Securities and Exchange Commission in connection with bankrupt organizations, 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 13-38 Chapter 13 - Accounting for Legal Reorganizations and Liquidations This assignment provides the student with the chance to work with actual data from a real company Thus, students can get the feel for the process of retrieving information of interest about a company that is going through bankruptcy In addition, this assignment can help them 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 – all of part (a) and the first portion of part (g) as supplied by the company This information can serve as the basis for considerable class discussion Chapter 11 Reorganization (a) Plan of Reorganization General The Plan included (i) the Exit Facilities (as defined below) of $1.140 billion; (ii) the assignment to SFI of SFO’s 121⁄4% Notes due 2016 (the ‘‘2016 Notes’’) held by certain holders of Prepetition Notes (the ‘‘SFO Equity Conversion’’) in an aggregate amount of $69.5 million in exchange for a number of shares of common stock of Holdings (the ‘‘Common Stock’’), representing 8.625% of the equity of Holdings on the Effective Date, in full satisfaction of their claims arising under such assigned 2016 Notes; (iii) a $505.5 million rights offering (the Common Stock on the Effective Date, to the holders of certain unsecured claims (‘‘Allowed Unsecured Claims’’) specified in the Plan, that were ‘‘Accredited Investors,’’ as defined in Rule 501(a) of Regulation D under the Securities Act of 1933, as amended (‘‘Eligible Holders’’); except that if the net proceeds from the Offering were less than $505.5 million, the parties who agreed to backstop the Offering (the ‘‘Backstop Purchasers’’) pursuant to the terms and conditions set forth in the commitment agreement executed by the Debtors and the Backstop Purchasers, agreed to subscribe for any amount of Common Stock offered but not purchased pursuant to the Offering; (iv) an offering (the ‘‘Direct Equity Purchase’’) to the Backstop Purchasers for an aggregate purchase price of $75.0 million (the ‘‘Direct Purchase Amount’’) of a number of shares of Common Stock on the Effective Date, representing 12.410% of the Common Stock; and (v) an offering (the ‘‘Additional Equity Purchase’’) to certain Backstop Purchasers for an aggregate purchase price of $50.0 million (the ‘‘Additional Purchase Amount’’), on the same pricing terms as the Offering, a number of shares of Common Stock, representing 6.205% of the Common Stock on the Effective Date The Plan also contemplated the TW Loan (as defined below) and the Delayed Draw Equity Purchase (as defined 13-39 Chapter 13 - Accounting for Legal Reorganizations and Liquidations below) In addition, as required by the Plan, on June 3, 2010 the Company paid $295,718 to holders of unsecured claims against SFI who certified to the Company that they were not accredited investors as of April 7, 2010 Summary of Classification and Treatment of Claims and Preconfirmation Equity Interests Pursuant to the Plan, the Preconfirmation SFTP Equity Interests (as such term is defined in the Plan) were unimpaired by the Plan, and each holder of a Preconfirmation SFTP Equity Interest was conclusively presumed to accept the Plan and was not entitled to vote to accept or reject the Plan On the Effective Date, Preconfirmation SFTP Equity Interests were reinstated and rendered unimpaired in accordance with the Bankruptcy Code The classification and treatment of all Claims (as such term is defined in the Plan) against the Debtors is more fully described in Article III of the Plan (g) Fresh Start Accounting and Effects of the Plan (first portion of this part of note 1) As required by generally accepted accounting principles in the United States (‘‘GAAP’’), effective as of May 1, 2010, we adopted fresh start accounting following the guidance of Financial Accounting Standards Board (‘‘FASB’’) Accounting Standards Codification (‘‘ASC’’) Topic 852, ‘‘Reorganizations’’ (‘‘FASB ASC 852’’) Fresh start accounting results in a new basis of accounting and reflects the allocation of the Company’s estimated fair value to its underlying assets and liabilities The Company’s estimates of fair value are inherently subject to significant uncertainties and contingencies beyond the Company’s reasonable control Accordingly, there can be no assurance that the estimates, assumptions, valuations, appraisals and financial projections will be realized, and actual results could vary materially The implementation of the Plan and the application of fresh start accounting results in financial statements that are not comparable to financial statements in periods prior to emergence Fresh start accounting provides, among other things, for a determination of the value to be assigned to the equity of the emerging company as of a date selected for financial reporting purposes, which for the Company is April 30, 2010, the date that the Debtors emerged from Chapter 11 The Plan required the contribution of equity from the creditors representing the unsecured senior noteholders of SFI, of which $555.5 million was raised at a price of $29.42 per share Holdings also issued stock at $29.42 per share to pay $146.1 million of SFO and SFI claims The Company’s reorganization value reflects the fair value of the new equity and the new debt, the conditions of which were determined after extensive arms-length negotiations between the Debtors’ creditors, which included the input of several independent valuation experts representing different creditor interests, 13-40 Chapter 13 - Accounting for Legal Reorganizations and Liquidations who used discounted cash flow, comparable company and precedent transaction analyses The analysis supporting the final reorganization value was based upon expected future cash flows of the business after emergence from Chapter 11, discounted at a rate of 11.5% and assuming a perpetuity growth rate of 3.0% The reorganization value and the equity value are highly dependent on the achievement of the future financial results contemplated in the projections that were set forth in the Plan The estimates and assumptions made in the valuation are inherently subject to significant uncertainties The primary assumptions for which there is a reasonable possibility of the occurrence of a variation that would have significantly affected the reorganization value include the assumptions regarding revenue growth, operating expense growth rates, the amount and timing of capital expenditures and the discount rate utilized The four-column consolidated statement of financial position as of April 30, 2010 reflects the implementation of the Plan Reorganization adjustments have been recorded within the condensed consolidated balance sheets as of April 30, 2010 to reflect effects of the Plan, including discharge of liabilities subject to compromise and the adoption of fresh start accounting in accordance with FASB ASC 852 The reorganization value of the Company of approximately $2.3 billion was based on the equity value of equity raised plus new indebtedness and fair value of Partnership Parks ‘‘put’’ obligations as follows (in thousands): Equity value based on equity raised(1) $ 805,791 Add: Redeemable noncontrolling interests(2) 446,449 Add: Exit First Lien Facility 770,000 Add: Exit Second Lien Facility 250,000 Add: Other debt(3) 35,360 Add: Noncontrolling interests 5,219 Less: Net discounts on Exit Facilities (11,450) Total emergence enterprise value $2,301,369 (1) Equity balance is calculated based on 27,388,889 shares of Common Stock at the price of $29.42 per share pursuant to the Plan (2) Redeemable noncontrolling interests are stated at fair value determined using the discounted cash flow methodology The valuation was performed based on multiple scenarios with a certain number of ‘‘put’’ obligations assumed to be put each year The analysis used a 9.8% rate of return adjusted for annual inflation for the annual guaranteed minimum distributions to the holders of the ‘‘put’’ rights and a discount rate of 7% (3) Other debt includes a $33.0 million refinance loan (the ‘‘Refinance Loan’’) with Deutsche Bank Mortgage Capital, L.L.C for HWP Development, LLC (‘‘HWP’’), 13-41 Chapter 13 - Accounting for Legal Reorganizations and Liquidations related to a hotel and indoor water park venture in Lake George, New York, in which we own an approximate 41% interest, $32.2 million of which was outstanding as of April 30, 2010, as well as capitalized leases of approximately $2.1 million and short-term bank borrowings of $1.0 million Under fresh start accounting, the total Company value is adjusted to reorganization value and is allocated to our assets and liabilities based on their respective fair values in conformity with the purchase method of accounting for business combinations in FASB ASC Topic 805, Business Combination (‘‘FASB ASC 805’’) The excess of reorganization value over the fair value of tangible and identifiable intangible assets and liabilities is recorded as goodwill Liabilities existing as of the Effective Date, other than deferred taxes, were recorded at the present value of amounts expected to be paid using appropriate risk adjusted interest rates Deferred taxes were determined in conformity with applicable income tax accounting standards Predecessor accumulated depreciation, accumulated amortization, retained deficit, common stock and accumulated other comprehensive loss were eliminated 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 Constar International Here is a press release obtained at www.constar.net: Philadelphia, PA - June 1, 2009 Constar International Inc., a leading global producer of PET (polyethylene terephthalate) plastic containers for food and beverages, announced that the Company and its affiliated debtors completed their financial restructuring and successfully emerged from Chapter 11 on Friday, May 29, 2009 The reorganization was completed approximately five months from the filing of their Chapter 11 petitions on December 30, 2008 In conjunction with its emergence from Chapter 11, Constar also announced that it had converted its debtor-in-possession financing into an exit facility to provide the Company with ongoing liquidity 13-42 Chapter 13 - Accounting for Legal Reorganizations and Liquidations Michael Hoffman, President and Chief Executive Officer of Constar, commented, "On behalf of our Board and the management team, I want to thank our unsecured bond holders for their support and their willingness to restructure our debt At the same time I want to express my appreciation to our loyal customers, committed suppliers and dedicated employees who have supported us and encouraged us throughout the process We emerge a revitalized company with an improved balance sheet Combining our improved financial condition with our strong technologies, we are better positioned than ever to provide our customers with the product quality, innovation and service they have come to expect from Constar." As required by the Plan approved by the Bankruptcy Court, Constar's old common stock (which has recently traded with the symbol CNSTQ) was cancelled in connection with the emergence from Chapter 11 Holders of the old common stock will not receive a distribution of any kind and no further transfers will be recorded on the Company's books In accordance with the Plan, holders of the $175 million of Constar's prePetition Subordinated Notes will convert 100% of their face amount into new common stock of the reorganized Company This common stock is initially expected to trade over-the-counter The Company estimates that following the distribution of the new shares, there will be approximately 1.75 million shares of the new common stock outstanding (exclusive of approximately 195,000 additional shares reserved for issuance under equity incentive plans) Cautionary Note Regarding Forward-Looking Statements Except for historical information, all information in this news release consists of forward-looking statements within the meaning of the federal securities laws, including statements regarding the intent, belief or current expectations of the Company and its management which are made with words such as "will," "expect," "believe," and similar words These forward-looking statements involve a number of risks, uncertainties and other factors, which may cause the actual results to be materially different from those expressed or implied in the forward-looking statements Important factors that could cause the actual results of operations or financial condition of the company to differ from expectations are identified from time to time in the Company's reports filed with the SEC, including the risk factors identified in its Annual Report on Form 10-K for the year ended December 31, 2008, and in subsequent filings made prior to, on or after today The Company does not intend to review, revise, or update any particular forward-looking statements in light of future events 13-43 Chapter 13 - Accounting for Legal Reorganizations and Liquidations A second source of information is the Securities and Exchange Commission According to the SEC website, using an EDGAR search, Constar International filed a Form 8-K on the same date as the above press release that made public the following: Item 1.01 Entry into a Material Definitive Agreement On May 29, 2009 (the “Effective Date”), Constar International Inc (the “Company”), together with certain of its affiliates (each, a “Debtor” and collectively, the “Debtors”) consummated the transactions contemplated by the Debtors’ Second Amended Joint Plan of Reorganization, as Further Modified, Pursuant to Chapter 11 of the Bankruptcy Code, as confirmed by the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) on May 14, 2009 (as confirmed, the “Plan”) In connection with the consummation of the Plan, on the Effective Date, the Company’s existing Senior Secured Super-Priority Debtor in Possession and Exit Credit Agreement, dated as of December 31, 2008 (the “Credit Agreement”) was converted into exit financing in accordance with its terms For a description of the Credit Agreement, reference is made to the description of such agreement in the Company’s Current Report on Form 8K filed with the Securities and Exchange Commission (the “Commission”) on January 6, 2009, which description is incorporated by reference herein Also in connection with the consummation of the Plan, the Company and its lenders entered into Amendment No to the Credit Agreement, primarily for the purposes of updating certain schedules to the Credit Agreement and permitting the Company’s Dutch subsidiary, Constar International Holland (Plastics) B.V., which is neither a party to nor a guarantor of the Credit Agreement, to enter into separate financing arrangements The foregoing is not a complete description of Amendment No to the Credit Agreement, which is filed as Exhibit 99.1 to this Report and the terms of which are incorporated herein by reference 13-44 Chapter 13 - Accounting for Legal Reorganizations and Liquidations Item 1.02 Termination of a Material Definitive Agreement In connection with the Company’s reorganization and emergence from bankruptcy, all existing shares of the Company’s capital stock were canceled pursuant to the Plan In addition, in the same connection, all of the Company’s Senior Subordinated 11% Notes Due 2012 were canceled and the related indenture was terminated (except for purposes of allowing the noteholders to receive distributions under the Plan) The holders of the Class Senior Subordinated Note Claims (as defined in the Plan) received 10 shares of new Common Stock per $1,000 face amount of the Senior Subordinated Notes pursuant to the Plan In addition, upon the Effective Date, the following incentive plans were terminated (and any and all awards granted under such plans were terminated and will no longer be of any force or effect): (1) the 2007 NonEmployee Directors’ Equity Incentive Plan; (2) the 2007 Stock-Based Incentive Compensation Plan; (3) Constar International Inc Non-Employee Directors’ Equity Incentive Plan; (4) Constar International Inc 2002 StockBased Incentive Compensation Plan; (5) the Amended and Restated Constar International Inc Supplemental Executive Retirement Plan; and (6) the Amended and Restated Constar International Inc Annual Incentive and Management Stock Purchase Plan The 2007 Incentive Plan was replaced by the Constar International Inc Annual Incentive Plan, adopted May 26, 2009 (the “AIP”) For a description of the AIP, please see the Company’s Current Report on Form 8-K filed with the Commission on June 1, 2009 Finally, a search of on-line journals finds a number of articles discussing the bankruptcy reorganization of Constar International including: “Moody's Lowers PDR of Constar to D; CFR to Ca,” Moody's Investors Service Press Release, December 30, 2008 “Bottle Maker Constar Files for Bankruptcy,” Plastics News, January 5, 2009 “Constar International Inc Receives Delisting Notice from NASDAQ Stock Market,” Business Wire, January 6, 2009 “Court Confirms Constar’s Plan of Reorganization,” Business Wire, May 4, 2009 13-45 Chapter 13 - Accounting for Legal Reorganizations and Liquidations “Constar International Inc - CNSTQ: Completes Restructuring and Emerges from Chapter 11 Bankruptcy,” Market News Publishing, June 1, 2009 “Constar International Inc Completed Its Financial Restructuring and Emerged From Chapter 11,” Business Wire, June 1, 2009 There are obviously many ways available to investors who are trying to get information about a bankruptcy reorganization plan Analysis Case While a company is going through 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 The following (along with a string of periodic press releases) was posted on the Web site of Borders (www.borders.com) Borders Group Files for Reorganization Relief Under Chapter 11 Secures Commitment for $505 Million in Debtor-in-Possession Financing Borders to Continue to Conduct Business in Ordinary Course Chapter 11 Provides Borders with Best Route to Reorganize and Reposition Company for the Long-Term Ann Arbor, Mich Feb 16, 2011 —“It has become increasingly clear that in light of the environment of curtailed customer spending, our ongoing discussions with publishers and other vendor related parties, and the company’s lack of liquidity, Borders Group does not have the capital resources it needs to be a viable competitor and which are essential for it to move forward with its business strategy to reposition itself successfully for the long term To position Borders to remedy this condition, Borders Group, with the authorization of its board of directors, has filed a petition for reorganization relief under Chapter 11 of the Bankruptcy Code This decisive action will give Borders the opportunity to achieve a proper infusion of capital in order to have the opportunity to have the time to reorganize in order to reposition itself to be a successful business for the long term,” said Mike Edwards, Borders Group President 13-46 Chapter 13 - Accounting for Legal Reorganizations and Liquidations “In this regard, operating under Chapter 11, Borders has received commitments for $505 million in Debtor-in-Possession (DIP) financing led by GE Capital, Restructuring Finance This financing should enable Borders to meet its obligations going forward so that our stores continue to be competitive for customers in terms of goods, services and the shopping experience It also affords Borders the opportunity to move forward in implementing the appropriate business strategy designed to reposition Borders to be a potentially vibrant, national retailer of books and other products,” Mr Edwards emphasized The company said that it is serving customers in the normal course, including honoring its Borders Rewards program, gift cards and other customer programs Additionally, the company expects to make employee payroll and continue its benefits programs for its employees Borders said that it has many strengths upon which to build a solid plan of reorganization and implement a new business model for Borders to address the changing needs of the American reader “For decades, Borders has been a beacon of engagement — a highly frequented destination for consumers and a significant venue for authors and vendors to showcase new books and merchandise We have the ability, based on our brick and mortar presence nationally; the on-line capabilities we have in place; the loyalty of, and access to, our customers; and the products and services we offer to be an important and easy access destination of exploration and purchase for readers across the country,” commented Mr Edwards The company noted that, among other initiatives and subject to court approval, Borders plans to undertake a strategic Store Reduction Program to facilitate reorganization and its repositioning Borders has identified certain underperforming stores — equivalent to approximately 30 percent of the company’s national store network — that are expected to close in the next several weeks At the same time, the company noted that a major strength of Borders is its national presence, and its extensive network of remaining stores as well as http://www.Borders.com, will continue to run in normal course The company emphasized that the closings were a reflection of economic conditions, cost structures and viability of locations, among other factors, and not on the dedication and productivity of the workforce in these stores 13-47 Chapter 13 - Accounting for Legal Reorganizations and Liquidations “We are confident that, with the protection afforded under Chapter 11 and with the support of employees, publishers, suppliers and creditors, and the reading public, a successful reorganization can be achieved enabling Borders to emerge from the process as a stronger and more vibrant book seller,” concluded Mr Edwards "We are very pleased to be able to make this commitment to Borders as support for their plan to reorganize the company," said Tim Tobin, Managing Director, Retail Restructuring, GE Capital, Restructuring Finance The Chapter 11 petition for relief was filed in the U.S Bankruptcy Court, Southern District of New York Completion of the company’s DIP financing arrangements is subject to approval of the Bankruptcy Court and the satisfaction of certain conditions provided in the financing commitments received by the company from the lenders providing such financing 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 Borders Group Because the company was widely known, its bankruptcy has been closely followed by the press “Today’s Corporate Restructuring Requires a NEW Approach,” Financial Executive, April 2011 “For Borders, a Scramble to Be Lean.” Wall Street Journal, March 14 2011 “Bookseller Borders Begins a New Chapter 11.” Wall Street Journal, February 17, 2011 “When One of the Giants Falls.” New York Times, February 17 2011 “Borders bankruptcy: 200 store closings point to the rise of e-books,” The Christian Science Monitor, February 16, 2011 “Borders Bankruptcy to Ripple Through Industry,” Publishers Weekly, February 21, 2011 “Borders Bankruptcy Shines Light on Continued Weakness of Power Centers,” Penton Insight, February 16, 2011 13-48 Chapter 13 - Accounting for Legal Reorganizations and Liquidations “Borders ' bankruptcy filing result of failing to keep up with shoppers' book, music, DVD habits,” Associated Press Newswires, February 16, 2011 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 13-49 ... Initially, in fresh start accounting, retained earnings must be reported at a zero balance 13-7 Chapter 13 - Accounting for Legal Reorganizations and Liquidations 24 Fresh start accounting is used by... 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... branch Professional fees Interest revenue Loss before income tax benefit Income tax benefit (20 percent) Net loss 13-16 $ 467,000 $ 211,000 16,000 70,000 22,000