Corporations in Financial Difficulty
-
Upload
henry-roman -
Category
Documents
-
view
57 -
download
0
description
Transcript of Corporations in Financial Difficulty
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Chapter 20
Corporations in Financial Difficulty
20-2
Learning Objective 1
Understand the courses of action available to
financially distressed firms.
20-3
Overview
A company in financial difficulty has a large number of alternatives. Bankruptcy is only a final course.
A company may petition the courts for bankruptcy to protect itself from an onslaught of legal suits. Some have also attempted to void union
contracts by petitioning for bankruptcy. U.S. auto industry?
20-4
Courses of Action
Nonjudicial Actions Formal agreements between the company and
its creditors are legally binding but are not administered by a court.
Bankruptcy is the final step for a financially distressed business.
20-5
Nonjudicial Actions
Debt Restructuring Arrangements Extension of due dates of its debt Decrease of the interest rate on the debt Modification of other terms of the debt contract
Composition agreement Creditors agree to accept less than the face
amount of their claims
20-6
Nonjudicial Actions
Creditors’ committee management Creditors may agree to “assist” the debtor in
managing the most efficient payment of creditors’ claims.
Most creditors’ committees are advisory . Counsel closely with the debtor
Do not want to assume additional liabilities and problems of actual operation of the debtor
Usually initiated with a plan of settlement proposed by the debtor
20-7
Nonjudicial Actions
Transfer of assets Debtors may transfer assets to obtain quick cash
Example: Factoring receivables
Assets may be sold “with recourse” or “without recourse”
A transfer of financial assets is considered a sale only if the transferor has surrendered control over the transferred assets. SFAS 140
20-8
Judicial Actions
Bankruptcy is a judicial action administered by bankruptcy courts and bankruptcy judges using the guidance provided in Title 11 of the United States Bankruptcy Code.
Chapters of the Bankruptcy CodeChapter 1 General Provisions
Chapter 3 Case Administration
Chapter 5 Creditors, the Debtor, and the Estate
Chapter 7 Liquidation
Chapter 9 Adjustment of Debts of a Municipality
Chapter 11 Reorganization
Chapter 12 Adjustment of Debts of a Family Farmer with Regular Annual Income
Chapter 13 Adjustment of Debts of an Individual with Regular Income
20-9
Judicial Actions
Either the debtor or its creditors may decide that a judicial action is best. The debtor may file a voluntary petition
seeking judicial protection in the form of an order of relief against the initiation or continuation of legal claims by the creditors.
Creditors may file an involuntary petition against the debtor. Certain conditions must exist before creditors
may file a petition.
20-10
Practice Quiz Question #1
Which of the following is usually NOT one of the debt restructuring arrangements available to companies in distress?
a. Extension of due dates.b. Extension of additional loans from
the same lenders to pay off current debt.
c. A decrease in interest rates.d. Modification of debt terms.e. None of the above.
20-11
Practice Quiz Question #2
Which of the following statements is true?a. A Chapter 11 bankruptcy leads to the
liquidation of the corporation.b. A Chapter 7 bankruptcy leads to the
reorganization of the corporation’s debt.
c. A Chapter 11 bankruptcy leads to the reorganization of the corporation’s debt.
d. A Chapter 7 bankruptcy leads to the adjustments of debt for an individual.
20-12
Learning Objective 2
Understand Chapter 11 reorganizations and be able
to prepare financial statements for debtors-in-
possession as well as a plan of recovery.
20-13
Chapter 11 Reorganizations
Temporary protection from creditors Allows time needed to
reorganize the debtor company return its operations to a profitable level
If granted protection, the company receives an order of relief to suspend making any payments on its prepetition debt
Bankruptcy court administers reorganizations. Can appoint trustees to direct the reorganization
20-14
Chapter 11 Reorganizations
The company continues to operate while it prepares a plan of reorganization.
A disclosure statement is transmitted to all creditors and other parties eligible to vote on the plan of reorganization.
The bankruptcy court then evaluates the responses to the plan from creditors and other parties and either confirms the plan of reorganization or rejects it.
20-15
Chapter 11 Reorganizations
Statement of Position No. 90-7 Provides guidance for financial reporting for
companies in reorganization Financial statements should distinguish between
transactions and events directly associated with the reorganization and
those associated with ongoing operations
20-16
Chapter 11 Reorganizations
Fresh start accounting SOP 90-7 states that fresh start reporting should
be used as of the confirmation date of the plan of reorganization if both the following conditions occur:
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.
2. Holders of existing voting shares immediately before confirmation receive less than 50 percent of the voting shares of the emerging entity.
20-17
Chapter 11 Reorganizations
Fresh start accounting
Compute the reorganization value of the emerging entity’s assets Fair value of the entity before considering liabilities
and approximates the amount a willing buyer would pay for the entity’s assets
The reorganization value is then allocated to the assets using the allocation of value method
20-18
Chapter 11 Reorganizations
Fresh start accounting A reorganization value in excess of amounts
assignable to identifiable assets is reported as an intangible asset
The emerging company’s liabilities are recorded at the present values of the amounts to be paid
Any retained earnings or deficits are eliminated A set of final operating statements is prepared
just prior to emerging from reorganization In essence, the company is a new reporting
entity after reorganization
20-19
Chapter 11 Reorganizations
Companies not qualifying for fresh start accounting should: Determine whether assets are impaired Report liabilities at the present values of
the amounts to be paid Any gain or loss on the revaluation of the
liabilities can be extraordinary or ordinary Unusual and infrequent = extraordinary
20-20
Chapter 11 Reorganizations
Companies not qualifying for fresh start accounting should: Recognize a liability for a cost associated
with an exit or disposal activity when the liability is incurred, not at the earlier time the company makes a commitment to an exit plan
LT assets are divided between1. Those to be held and used and2. Those to be sold
20-21
Chapter 11 Reorganizations
Plan of reorganization – Components1. Disposing of unprofitable operations
2. Restructuring of debt with specific creditors
3. Revaluation of assets and liabilities
4. Reductions or eliminations of claims of original stockholders and issuances of new shares to creditors or others
20-22
Practice Quiz Question #3
Which of the following statements is true about fresh start accounting?
a. Fresh start accounting focuses on pre-bankruptcy book values.
b. Fresh start accounting allows management to revalue assets to any value they feel is “fair and normal.”
c. Fresh start accounting is no longer legal in the U.S.
d. Fresh start accounting focuses the fair value of assets a willing buyer would pay to acquire them.
20-23
Chapter 11 Reorganizations
PRACTICE—E20-2
20-24
Plan of Reorganization
Elimination Reduction $2 par
of Debt Surviving of Common Stock Total Recovery
and Equity Debt Assets % Value $ %
Post-petition liabilities (30,000) (30,000) (30,000) 100%
Claims/Interest:
Accounts Payable (80,000) 8,000 (72,000) (72,000) 90
Notes Payable, 10% (150,000) 25,000 (125,000) (125,000) 83
Related Int. Payable (16,000) 16,000 -0- 0
Bonds Payable, 12% (200,000) (200,000) (200,000) 100
Related Interest Payable
(24,000) 18,000 (6,000) (6,000) 25
Total (470,000) 67,000
Common shareholders:
Common Stock (100,000) (100,000) 100% (200,000) (200,000)
Additional Paid-In (200,000) 171,000 (29,000) (29,000)
Retained Earnings
Deficit 178,000 (178,000)
Total (622,000) (40,000) (230,000) (203,000) 100% (229,000) (662,000)
20-25
(1) Accounts Payable 80,000Notes Payable, 10% 150,000Interest Payable 40,000 Cash 6,000 Accounts Receivable (net) 72,000 Land 85,000 Gain on Disposal of Land 40,000 Gain on Discharge of Debt 67,000 Record discharge of debt.
Journal entries to record reorganization
20-26
(1) Accounts Payable 80,000Notes Payable, 10% 150,000Interest Payable 40,000 Cash 6,000 Accounts Receivable (net) 72,000 Land 85,000 Gain on Disposal of Land 40,000 Gain on Discharge of Debt 67,000 Record discharge of debt.
(2) Common Stock ($1 par) 100,000Additional Paid-In Capital 171,000Gain on Disposal of Land 40,000Gain on Discharge of Debt 67,000 Common Stock ($2 par) 200,000 Retained Earnings 178,000 Record change in par value of stock and elimination of deficit.
Journal entries to record reorganization
20-27
Learning Objective 3
Understand Chapter 7 liquidations and be able to
prepare a statement of affairs.
20-28
Chapter 7 Liquidations
Liquidations are administered by the bankruptcy courts in the interests of the corporation’s creditors and shareholders.
The intent in liquidation is to maximize the net dollar amount recovered from disposal of the debtor’s assets.
20-29
Chapter 7 Liquidations
Classes of creditors Secured creditors
Have liens, or security interests, on specific assets, often called “collateral”
A creditor with such a legal interest in a specific asset has the highest priority claim on that asset
Creditors with priority Unsecured creditors having no collateral
claim against specific assets but have priority over other unsecured creditors
20-30
Chapter 7 Liquidations
Classes of creditors Unsecured creditors
The lowest priority is given to these claims Paid only after secured creditors and
unsecured creditors with priority are satisfied
Often receive less than the full amount of their claim
20-31
Chapter 7 Liquidations
Statement of Affairs The basic accounting report made at the
beginning of the process. Presents the expected realizable amounts from
Disposal of the assets,
The order of creditors’ claims, and
The expected amount that unsecured creditors will receive as a result of the liquidation.
A different report, also entitled the “Statement of Affairs,” is a list of questions the debtor must answer as part of the bankruptcy petition.
20-32
Chapter 7 Liquidations
Statement of Affairs An important planning report for the anticipated
liquidation of a company. The Statement of Affairs includes
Book values of the debtor company’s balance sheet accounts,
Estimated fair market values of the assets,
Order of the claims, and
Estimated deficiency to the general unsecured creditors.
20-33
Practice Quiz Question #4
Which of the following is NOT one of the classes of creditors that could be paid in a Chapter 7 liquidation?
a. Secured creditors.b. Unsecured creditors.c. Creditors in jeopardy.d. Creditors with priority.
Chapter 7 Liquidations
PRACTICE—E20-4
20-34
a. Schedule to calculate amount available for general unsecured creditors:
Total estimated fair values $471,000
Claims of secured creditors:
Notes payable and interest
(Receivables and Inventory) $115,000
Bonds payable and interest
(Land and Building) 231,000 (346,000)
$125,000
Claims of creditors with priority:
Wages payable $ 9,500
Taxes payable 14,000 (23,500)
Available to general unsecured creditors $101,500
E20-4 Solution
20-35
b. Accounts payable $ 95,000 Notes payable and interest $195,000 Less: Secured by receivables and inventory
(115,000) 80,000
Total unsecured claims $175,000
Estimated dividend:
$101,500= 58%$175,000
E20-4 Solution
20-36
b. Accounts payable $ 95,000 Notes payable and interest $195,000
Less: Secured by receivables and inventory
(115,000) 80,000
Total unsecured claims $175,000
Estimated dividend:
$101,500= 58%$175,000
c. Group Credit Percentage Distributed
Accounts Payable $ 95,000 58% $ 55,100
Wages Payable 9,500 100 9,500Taxes Payable 14,000 100 14,000Notes Payable 80,000 58 46,400 and Interest 115,000 100 115,000
Bonds Payable and Interest 231,000 100 231,000
$471,000
E20-4 Solution
20-37
Book Values Fair Values
Amt Avail to Unsecured
ClaimsEstimated G/L on Realization
ASSETS:(1) Assets pledged with fully secured creditors
100,000Land 80,000 (20,000)220,000Building (net) 160,000 (60,000)
240,000 Less Bond Payable (220,000)Less Interest on Bonds Payable (11,000) 9,000
(2) Assets pledged with partially secured creditors60,000Receivables 50,000 (10,000)90,000Inventory 65,000 (25,000)
115,000 Less Notes Payable (190,000)Less Interest on Notes Payable (5,000)
(3) Free assets:16,000Cash 16,000 16,000 0
250,000Equipment 100,000 100,000 (150,000)Estimated Amount Available 125,000 Less Creditors with Priority (23,500)
(a) Net estimated amount available to unsecured creditors: 101,500 Estimated Deficiency 73,500
736,000 (265,000)Total Unsecured Debt from liabilities 175,000
(b) Percent paid out to unsecured creditors: 0.58cents on the dollar
E20-4 Solution
20-38
Estimated Amount
UnsecuredLIABIITLIES AND STOCKHOLDERS' EQUITY:
(1) Fully Secured Creditors220,000 Bond Payable 220,000 11,000 Interest Payable 11,000
(2) Partially secured creditors190,000 Notes Payable 190,000
5,000 Interest Payalbe 5,000
Less receivables and inventory (115,000)
80,000
(3) Creditors with Priority9,500 Wages Payable 9,500
14,000 Taxes Payable 14,000 23,500
(4) Remaining unsecured creditors
95,000 Accounts Payable
95,000
(5) Stockholders' equity191,500 BV of Stockholders' Equity (736,000 - 544,500)
736,000 (Carry up to asset section) 175,000
E20-4 Solution
20-39
Chapter 7 Liquidations
PRACTICE—P20-7
20-40
Assets EstimatedAmount
Available Estimated Estimated to Gain
Book Current Unsecured (Loss) on Value Values Claims Realization
(1) Assets pledged with fully secured creditors:
$ 50,000 Accounts receivable (net) $ 50,000 Less: 12% note payable and interest (44,000) $ 6,000
80,000 Land $110,000 $ 30,000 162,000 Plant and equipment (net) 150,000 (12,000)
$260,000 Less: Mortgages payable and interest (234,600) 25,400
(2) Assets pledged with partially secured creditors:
30,000 Marketable securities $ 22,000 (8,000) Less: 10% note payable and interest (29,400)
79,000 Inventory $ 75,000 (4,000) Less: Accounts payable (105,000)
(3) Free assets:5,000 Cash $ 5,000 5,000
55,000 Accounts receivable (net) 55,000 55,000 81,000 Inventory 76,000 76,000 (5,000)
7,000 Prepaid insurance 1,500 1,500 (5,500)250,000 Plant and equipment (net) 190,000 190,000 (60,000)
72,000 Franchises 30,000 30,000 (42,000)
Estimated amount available $388,900 Less: Creditors with priority (45,000)Net available to unsecured creditors $343,900
Estimated deficiency 82,500 $871,000 $(106,500)
Total unsecured debt $426,400
20-41
Liabilities and EquitiesEstimated
Book Amount Value Unsecured
(1) Fully secured creditors:$ 44,000 12% note payable and interest $ 44,000
234,600 Mortgages payable and interest 234,600 $278,600
(2) Partially secured creditors:29,400 10% note payable and interest $ 29,400
Less: Marketable securities (22,000) $ 7,400
105,000 Accounts payable $105,000 Less: Inventory (75,000) 30,000
(3) Creditors with priority:-0- Estimated liquidation expenses $ 13,000
20,000 Wages payable 20,000 12,000 Taxes payable 12,000
$ 45,000
(4) Unsecured creditors:160,000 Accounts payable 160,000212,000 Notes payable 212,000
17,000 Interest payable 17,000
(5) Stockholders' equity:240,000 Common stock
(203,000) Retained earnings (deficit) $871,000 $426,400
b. % to unsecured creditors:
$343,900 = 80.65%
$426,400
20-42
20-43
Learning Objective 4
Understand trustee accounting and reporting.
20-44
Additional Considerations
Trustee accounting and reporting Chapter 11 reorganization: Bankruptcy courts
appoint trustees to manage a company under Management fraud,
Dishonesty,
Incompetence, or
Gross mismanagement
The trustee then attempts to rehabilitate the business
20-45
Additional Considerations
Trustee accounting and reporting Chapter 7 liquidations: the trustee
expeditiously Liquidates the company and
Pays creditors in conformity with the legal status
In some cases, the court appoints a trustee to operate the company for a short time in an effort to obtain a better price for the company in entirety rather than selling it piecemeal
20-46
Additional Considerations
Trustee accounting and reporting Trustees examine the proof of all creditors’
claims against the debtor company Sometimes the trustee receives title to all assets
as a receivership, Becomes responsible for the actual management of
the debtor, and
must direct a plan of reorganization or liquidation
20-47
Additional Considerations
Trustee accounting and reporting The general form of the trustee’s opening entry,
accepting the assets of the debtor company, is as follows:
Assets XXXDebtor Company – In Receivership XXX
20-48
Additional Considerations
Trustee accounting and reporting Statement of realization and liquidation
a monthly report prepared for the bankruptcy court
shows the results of the trustee’s fiduciary actions
20-49
Additional Considerations
Sections of the statement of realization and liquidation
20-50
Practice Quiz Question #5
Which of the following is NOT true about bankruptcy trustees?
a. Trustees are often appointed in a Chapter 11 bankruptcy when management cannot be trusted.
b. Trustees can be considered voluntary employees of the company.
c. In a Chapter 7 bankruptcy, the trustee liquidates the company and pays the creditors.
d. In a Chapter 11 bankruptcy, the trustee attempts to rehabilitate the business.
Conclusion
The EndThe End
20-51