Corporate Liquidation and Reorganization

Pertemuan 19-20

Mata kuliah : F0074 - Akuntansi Keuangan Lanjutan IITahun : 2010

1: Types of Bankruptcies1: Types of BankruptciesCorporate Liquidations and Reorganizations

Insolvency• Equity insolvency

– Inability to pay debts on time• May avoid bankruptcy proceedings• Negotiate directly with creditors

• Bankruptcy insolvency– Having total debts in excess of the fair value of assets

• May be liquidated, or• Reorganized

Types of BankruptciesChapter 7: Liquidation• Trustee appoint to sell assets of business Chapter 9: Adjustments of Debts of a Municipality

Chapter 11: Reorganization• Debtor is expected to be rehabilitatedChapter 12: FarmersChapter 13: Adjustment of Debts of an Individual with

Regular Income

Characteristics• Voluntary bankruptcy proceedings

– Filed by debtor

• Involuntary bankruptcy proceedings– Filed by creditor or group of creditors

• Court action– Dismiss a case– Accept the petition– Change form

Chapter 11 reorganization Chapter 7 liquidation

Duties of TrusteeTrustee in liquidation cases• Investigate debtor's financial affairs• Provide information • Examine, perhaps object to, creditor claims• File report on trusteeship• If authorized to operate debtor's business, other period

reports are requiredIn reorganization cases, in addition to above• Filing reorganization plan or statement why one cannot be

filed

Ranking of Claims: Liquidation

2: Corporate Liquidation2: Corporate LiquidationCorporate Liquidations and Reorganizations

Statement of Affairs• Legal document prepared for bankruptcy court

– Assets at expected net realizable values– Classified on basis of availability for classes of creditors– Liabilities are classified

• Priority, fully secured, partially secured, unsecured

– Historical values included for reference

Trustee Accounting

• At start of case– New set of books

• Through case– Records transactions– Statement of cash receipts and disbursements– Statement of changes in estate equity– Balance sheet– Statement of realization and liquidation

• At close of case– Final settlement of claims– Trustee is dismissed

3: Corporate Reorganization3: Corporate ReorganizationCorporate Liquidations and Reorganizations

Chapter 11: Balance Sheet• Prepetition liabilities subject to compromise are

reported as a separate line item in liabilities– Arose before filing– Include

• Unsecured and under-secured liabilities

• Prepetition secured liabilities and post petition liabilities reported in normal fashion

• Prepetition claims discovered after filing – Included at court allowed amounts

Chapter 11: Other Statements• Reorganization costs shown separately• Interest to be paid or probable amount

– Differences from contractual amounts should be noted

• Expected stock or stock equivalent issuances should be disclosed

• Cash flow items related to reorganization shown separately

Combined Financial Statements• Condensed combined financial statements are

prepared for all entities in reorganization proceedings as supplementary information– Intercompany receivables and payables– Write-down if necessary

4: Emerging from Reorganization4: Emerging from ReorganizationCorporate Liquidations and Reorganizations

Reorganization ValueApproximates fair value of entity without

considering liabilities– Discounted future cash flows of reorganized

business– Consider business and financial risk

Reorganization value determines how much creditors recover

Emerging business will either use1. Fresh start reporting2. Report liabilities at present value and

forgiveness of debt as extraordinary item

Qualify for Fresh Start Reporting• Just before confirmation of the plan,

– Revaluation value must be less than post petition liabilities and allowed claims, and

– Holders of existing voting shares receive less than 50% of emerging entity

Apply Fresh Start Reporting• Allocated reorganization value to identifiable

assets– Unallocated amount is an intangible

• Reorganization value in excess of amounts allocated to identifiable assets

• Liabilities at current value at confirmation date• Deferred taxes follow FASB No. 109

• Prepare final reports of old entity

Reorganization Example

• Tiger files for protection under Chapter 11 on

1/5/08. Accordingly, it reclassifies prepetition liabilities.

• It obtains short term financing, acquires additional equipment and continues operations

through 6/31/09 when the plan is approved.

First, we'll look at the statements pre and post reorganization. Then we'll go through the entries and adjustments that occurred.

Balance Sheet Assets

 Filed

1/5/08

FYE 12/31/0

8

Before

6/30/09

Fair value

6/30/09

Revalu-

ationAFTER

6/30/09Cash 50 150 300 300   300 Accounts receivable 500 350 335 335   335 Inventory 300 370 350 375 25 375 Other current assets 50 50 30 30   30 Land 200 200 200 300 100 300 Building, net 500 450 425 350 (75) 350 Equipment, net 300 330 290 260 (30) 260 Patent 200 150 125 0 (125) 0 Reorganization value in excess of identifiable assets   250   2,100 2,050 2,055 1,950 (105) 2,200

Changes to AssetsFair values and revaluation amounts are shown on

6/30/09 for comparison.

• Tiger continues operations, records depreciation and even acquires equipment from filing on 1/5/08 to reorganization on 6/30/09.

• The reorganization revalues the assets to their fair value on that date. Patents are completely written off.

• Tiger records an intangible "Reorganization value in excess of identifiable assets" of $250. Not all reorganizations result in this intangible.

 Filed

1/5/08

FYE 12/31/0

8Before

6/30/09

AFTER 6/30/0

9Short term borrowing (post) 150 75 75 Accounts payable (pre/post) 600 100 125 125

Wages payable (post) 50 55 55

Taxes payable (pre) 150   150

Accrued bond interest (pre) 90  

Note payable (pre) 260  Subordinated debt (post)       395 12% bonds payable – current (post)       100 12% bonds payable (post)       500

15% bonds payable (pre) 1,200  Liabilities subject to compromise   2,300 2,300

Capital stock (old) 500 500 500 Capital stock (new)       800 Additional paid in capital       0 Deficit (700) (1,050) (1,000) 0   2,100 2,050 2,055 2,200

Balance Sheet – Liability & Equity

What Happened to Liabilities?• Upon filing on 1/5/08, Tiger reclassifies the unsecured

and partially secured liabilities at that point as Pre-petition Liabilities subject to compromise.

• Pre-petition Liabilities subject to compromise are reclassified or settled according to the plan.

• Accounts payable on 12/31/08 does not include any of the $600 due prior to filing.

• Taxes payable are still to be paid, and eventually recorded again in full.

Changes in Equity

• Some of the creditors receive stock in the reorganized firm. The old shareholders also receive stock, but now own only $100 of $800 of the stock at book value.

• Although some APIC was recorded in reorganizing, it was subsequently eliminated. If it had been sufficient to wipe out the deficit, no intangible "reorganization value in excess of identifiable assets" would be recorded.

• The Deficit is removed: Fresh Start!

Can Tiger Use Fresh Start?

On 6/30/09 there were $255 in post-petition liabilities. All $2,300 pre-petition liabilities were allowed by the courts. Firm value is $2,200.1. Liabilities exceed reorganization value2. Old shareholders retain less than 50%

Yes, fresh start is appropriate.

Post-petition liabilities $255 Allowed claims 2,300 Total liabilities $2,555 Less reorganization value (2,200)Excess liabilities $355

Reorganization Plan: 6/30/09Pre-petition Liabilities and Equity

New Agreements Debt Dis-charge

15% partially secured bonds, $1200

$500 new stock, $500 senior 12% bonds, and another $100 bonds due 12/31/09 $100

Priority tax claims $150 To be paid cash

once confirmed $0

Remaining unsecured claims, $950:$600 accounts payable

$275 subordinated debt and $140 new stock $185

$90 accrued interest Forgiven $90

$260 note$120 subordinated debt and $60 new stock $80Total debt discharged $455

Old stock $100 new stock Equity

Record New Debt Agreements

This entry reclassifies the pre-petition debt according to the reorganization plan.

Liabilities subject to compromise (pre) 2,300  

Taxes payable   150

12% senior debt   500

12% senior debt - current   100

Subordinated debt   395

Common stock (new)   700

Gain on debt discharge   455

settlement of prepetition claims    

Give Shareholders New Shares

They will lose control since creditors have $700 of common stock.

Common stock (old) 500  

Common stock (new)   100

Additional paid in capital   400

exchange of stock with owners    

Revalue Assets

A loss is recorded in revaluing the assets. Refer back to the Asset side of the balance sheet.

Inventory 25  

Land 100  

Loss on asset revaluation 105  

Buildings, net   75

Equipment, net   30

Patent   125

revalue assets to fair value    

Calculate Balance in Retained Earnings (Deficit)

If sufficient APIC had existed, there would be no intangible asset, and excess APIC would remain on the balance sheet.

Deficit, 6/30/09 (1,000)

Gain on debt discharge 455

Loss on asset revaluation (105)

Final measure of deficit, 6/30/09 ($650)

Write-off Additional paid in capital 400

Reorganization value in excess of identifiable assets (intangible asset) ($250)

Eliminate Deficit in Equity

The $1,000 deficit on 6/30/09 is adjusted for the gain on debt discharge and loss on asset revaluation. The net $650 deficit eliminates all of the APIC and creates a $250 intangible.

Reorganization value in excess of identifiable assets 250  

Gain on debt discharge 455  

Additional paid in capital 400  

Loss on asset revaluation   105

Deficit   1,000

Simplifying Assumptions• All transactions are recorded on 6/30/09.

Generally this takes some time.• Creditors may have interest between submission

and approval of plan. • All pre-petition debt is approved.• The $2,200 reorganization value of the firm

probably used a discounted cash flow firm valuation model.

Disclosures• Adjustments to historical values

– Assets– Liabilities

• Debt forgiveness• Prior retained earnings or deficit eliminated• Significant factors in determining the

reorganization value