BBL Chapter Thirteen

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BBL Chapter Thirteen

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  • A basic assumption of accounting is that a business is a going concern (will remain in business).
    Occasionally, a business becomes insolvent (unable to pay debts as they come due).
    An insolvent business can either cease to exist, or can seek a legal remedy called bankruptcy.
  • What happens to a business when it fails?
    Who gets the assets?
    If the assets are sold, who gets the money?
    Are the creditors protected?
    How is the business failure reported?
  • Size of Recent American Bankruptcies
    Total Assets
    Company Bankruptcy Date (in Billions)
    Lehman Brothers 07/15/2008 $691.1
    Washington Mutual 09/26/2008 327.9
    WorldCom 07/21/2002 103.9
    General Motors 06/01/2009 91.1
    Enron 12/02/2001 65.5
    Conseco 12/17/2002 61.4
    Chrysler 04/30/2009 39.3
    Thornburg Mortgage 05/01/2009 36.5
    Pacific GE 04/06/2001 36.2
    Texaco 04/12/1987 35.0
  • The Act strives to achieve two goals in connection with insolvency cases:
    1) the fair distribution of assets to creditors, and
    2) the discharge of an honest debtor from debt.
  • Involuntary Bankruptcy
    Creditors file petition with the court.
    Can force company into liquidation under Chapter 7 or receiving protection under Chapter 11.
    Voluntary Bankruptcy
    Company files a petition with courts requesting bankruptcy.
    When facing prospect of severe losses or a difficult operating environment, companies will seek voluntary Chapter 11.
  • Criteria for Forcing Involuntary Bankruptcy
    When there are 12 or more unsecured creditors:
    At least 3 must sign the petition
    Those that sign must have total unsecured debts of at least $14,425
    If there are fewer than 12:
    Only 1 must sign
    The minimum debt limit remains $14,425
    (Debt limit balances are adjusted every three years based on the Consumer Price Index)
  • Court Response to the Petition
    Neither a voluntary nor involuntary petition automatically creates a bankruptcy.
    Bankruptcy Court may reject voluntary petitions if the action is considered detrimental to the creditors.
    Bankruptcy Court may reject involuntary petitions unless evidence indicates the debtor’s inability to meet obligations as they come due (slowness of payment is NOT sufficient cause!!)
  • Court Response to the Petition
    If the court accepts the petition, it grants an order for relief.
    The order for relief halts all actions against the debtor.
    The automatic stay prohibits creditors from collecting debts without the court’s permission
    A trustee is appointed to oversee the bankruptcy process.
  • Each level must be paid in full prior to making distributions to the next level.
    Fully Secured
    Net realizable value of collateral
    is greater than the debt.
    Partially Secured
    Net realizable value of collateral
    is less than the debt.
    Unsecured With Priority
    All other claims are unsecured;
    some have priority over others.
    Stockholders get what’s left over.
  • Administrative costs related to liquidation
    Debts arising between the filing date and the issuance of an order of relief.
    Employee claims for wages earned and/or benefit plan contributions earned during the 180 days prior to filing (limit $11,725 per employee, each claim).
    Customer deposits. Limited to $2,600 per customer.
    Government claims for unpaid taxes.
  • How will the debtor be discharged from its obligations?
    Under Chapter 7, the debtor’s assets will be liquidated and the proceeds distributed to creditors (based on their priority status) OR
    Under Chapter 11, the debtor will be permitted to reorganize and continue operations.
    (These “chapters” refer to the relevant sections of the Bankruptcy Reform Act)
  • Statement helps creditors decide between reorganization and liquidation for debtor.
    Assets labeled as:
    Pledged with fully secured creditors.
    Pledged with partially secured creditors.
    Available for priority liabilities and unsecured creditors.
    Debts labeled as:
    Liabilities with priority.
    Fully secured creditors.
    Partially secured creditors.
    Unsecured creditors.
  • Interim Trustee is appointed by court.
    Changes locks, and secures assets and records.
    Posts notices that assets are in possession of US trustee.
    Compiles all financial records.
    Obtains possession of all corporate records.
    An advisory committee of 3 - 11 unsecured creditors is appointed.
  • Committee of Creditors
    Consults with the trustee concerning estate administration
    Makes recommendations regarding the trustee’s performance
    Submits to the court questions affecting estate administration
    (The selection of this committee is to help ensure fairness and to protect the creditor group’s interests.)
  • Charged with preserving the assets and Preventing loss of the estate
    Has possession and control of the debtor’s assets.
    Can void property transfers made 90 days prior to the petition filing.
    Appointed by the court; approved by the creditors.
    Prepares the statement of realization and liquidation.
  • Trustee tracks the liquidation of a company’s assets (form not specified by GAAP).
    Included Information
    Account balances at the date on which the Order for Relief was filed.
    Cash receipts generated by sale of property.
    Cash disbursements by the trustee.
    Write-offs and recognition of previously unrecorded liabilities.
  • A legal way to “salvage” a company rather than liquidate it.
    The company is temporarily protected from its creditors.
    Creditors are encouraged to negotiate new terms with the company.
  • ReorganizationChapter 11 Bankruptcy
    Workers keep their jobs.
    Suppliers keep their customers.
    Customers maintain their source of supply.
  • ReorganizationChapter 11 Bankruptcy
    A plan of reorganization must be put forth within 120 days and approved within 180 days by the debtor in possession.
    Examples include Plans:
    Proposing changes in company’s operations.
    For generating additional monetary resources.
    For changes in management of the company.
    To settle debts that existed when the order of relief was issued.
  • ReorganizationChapter 11 Bankruptcy
    Acceptance of a reorganization plan requires approval of:
    2/3 of the $ amount and more than 1/2 of the creditors who cast votes
    2/3 of each class of stockholders who cast votes
    Confirmation by the court
    The court can also force acceptance of a plan that was voted down (known as a “cram down”).
    As a final alternative, the court can convert a Chapter 11 Bankruptcy to a Chapter 7 Liquidation at any time.
  • Financial Reporting During Reorganization
    FASB’s Accounting Standards Codification Topic 852, Reorganizations, requires financial statements be prepared
    During the reorganization and
    When entity emerges from reorganization.
    Gains, losses, revenues and expenses of the reorganization are reported separately.
    Liabilities are restated.
    Current versus noncurrent classification not applicable.
  • Fresh Start Reporting
    When a company emerges from Chapter 11, GAAP permits fresh start reporting if two conditions are met:
    The reorganization (or market) value of the assets are greater than the total of the allowed claims as of the date of the order for relief plus any subsequent liabilities.
    The original owners are left with less than 50% of the voting stock.
  • Fresh Start Accounting
    Fresh Start Accounting
    Assets are restated to current market value.
    Liabilities are stated at the discounted present value of future cash payments.
    Retained Earnings is set to zero.
    Normally, APIC is adjusted to balance.
  • Summary
    Bankruptcy laws are intended to provide an orderly settlement to cases of insolvency, by assuring fair distribution of remaining assets while discharging the obligations of an honest debtor.
    Bankruptcy may be voluntary or involuntary, and the result may be either liquidation (Chapter 7) or reorganization (Chapter 11).
    Many companies emerging from liquidation are able to apply “fresh start” accounting.
  • BBL Chapter Thirteen

    1. 1. Chapter Thirteen Accounting for Legal Reorganizations and Liquidations McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
    2. 2. LO 1 Bankruptcy A basic assumption of accounting is that a business is a going concern (will remain in business). Occasionally, a business becomes insolvent (unable to pay debts as they come due). An insolvent business can either cease to exist, or can seek a legal remedy called bankruptcy. 13-2
    3. 3. Accounting for Legal Reorganizations and Liquidations What happens to a business when it fails? Who gets the assets? If the assets are sold, who gets the money? Are the creditors protected? How is the business failure reported? 13-3
    4. 4. Size of Recent American Bankruptcies Company Bankruptcy Date Lehman Brothers 07/15/2008 Washington Mutual 09/26/2008 WorldCom 07/21/2002 General Motors 06/01/2009 Enron 12/02/2001 Conseco 12/17/2002 Chrysler 04/30/2009 Thornburg Mortgage 05/01/2009 Pacific GE 04/06/2001 Texaco 04/12/1987 Total Assets (in Billions) $691.1 327.9 103.9 91.1 65.5 61.4 39.3 36.5 36.2 35.0 13-4
    5. 5. Bankruptcy Reform Act of 1978 The Act strives to achieve two goals in connection with insolvency cases: 1) the fair distribution of assets to creditors, and 2) the discharge of an honest debtor from debt. 13-5
    6. 6. LO 2 Bankruptcy Reform Act of 1978 Involuntary Bankruptcy Voluntary Bankruptcy Creditors file petition with the court. Company files a petition with courts requesting bankruptcy. Can force company into liquidation under Chapter 7 or receiving protection under Chapter 11. When facing prospect of severe losses or a difficult operating environment, companies will seek voluntary Chapter 11. 13-6
    7. 7. Criteria for Forcing Involuntary Bankruptcy When there are 12 or more unsecured creditors: At least 3 must sign the petition Those that sign must have total unsecured debts of at least $14,425 If there are fewer than 12: Only 1 must sign The minimum debt limit remains $14,425 (Debt limit balances are adjusted every three years based on the Consumer Price Index) 13-7
    8. 8. Court Response to the Petition  Neither a voluntary nor involuntary petition automatically creates a bankruptcy.  Bankruptcy Court may reject voluntary petitions if the action is considered detrimental to the creditors.  Bankruptcy Court may reject involuntary petitions unless evidence indicates the debtor’s inability to meet obligations as they come due (slowness of payment is NOT sufficient cause!!) 13-8
    9. 9. Court Response to the Petition If the court accepts the petition, it grants an order for relief. The order for relief halts all actions against the debtor. The automatic stay prohibits creditors from collecting debts without the court’s permission A trustee is appointed to oversee the bankruptcy process. 13-9
    10. 10. LO 3 Classification of Creditors Each level must be paid in full prior to making distributions to the next level. Top Priority Fully Secured Partially Secured Unsecured With Priority Unsecured 13-10
    11. 11. Unsecured Liabilities Having Priority 1. Administrative costs related to liquidation 2. Debts arising between the filing date and the issuance of an order of relief. 3. Employee claims for wages earned and/or benefit plan contributions earned during the 180 days prior to filing (limit $11,725 per employee, each claim). 4. Customer deposits. Limited to $2,600 per customer. 5. Government claims for unpaid taxes. 13-11
    12. 12. LO 4 Reorganization or Liquidation? How will the debtor be discharged from its obligations?  Under Chapter 7, the debtor’s assets will be liquidated and the proceeds distributed to creditors (based on their priority status) OR  Under Chapter 11, the debtor will be permitted to reorganize and continue operations.  (These “chapters” refer to the relevant sections of the Bankruptcy Reform Act) 13-12
    13. 13. LO 5 Statement of Financial Affairs Statement helps creditors decide between reorganization and liquidation for debtor. Assets labeled as:  Pledged with fully secured creditors.  Pledged with partially secured creditors.  Available for priority liabilities and unsecured creditors. Debts labeled as:  Liabilities with priority.  Fully secured creditors.  Partially secured creditors.  Unsecured creditors. 13-13
    14. 14. Liquidation – Chapter 7 Bankruptcy LO 6 1. Interim Trustee is appointed by court.  Changes locks, and secures assets and records. Posts notices that assets are in possession of US trustee. Compiles all financial records. Obtains possession of all corporate records.    2. An advisory committee of 3 - 11 unsecured creditors is appointed. 13-14
    15. 15. Committee of Creditors  Consults with the trustee concerning estate administration  Makes recommendations regarding the trustee’s performance  Submits to the court questions affecting estate administration  (The selection of this committee is to help ensure fairness and to protect the creditor group’s interests.) 13-15
    16. 16. Role of the Trustee Charged with preserving the assets and preventing loss of the estate 13-16
    17. 17. Statement of Realization and Liquidation Trustee tracks the liquidation of a company’s assets (form not specified by GAAP). Included Information 1. Account balances at the date on which the Order for Relief was filed. 2. Cash receipts generated by sale of property. 3. Cash disbursements by the trustee. 4. Write-offs and recognition of previously unrecorded liabilities. 13-17
    18. 18. LO 7 Reorganization Chapter 11 Bankruptcy A legal way to “salvage” a company rather than liquidate it.  The company is temporarily protected from its creditors.  Creditors are encouraged to negotiate new terms with the company. 13-18
    19. 19. Reorganization Chapter 11 Bankruptcy Control of the company is normally maintained by the owners (“debtor in possession”)  Workers keep their jobs.  Suppliers keep their customers.  Customers maintain their source of supply. 13-19
    20. 20. Reorganization Chapter 11 Bankruptcy A plan of reorganization must be put forth within 120 days and approved within 180 days by the debtor in possession. Examples include Plans:  Proposing changes in company’s operations.  For generating additional monetary resources.  For changes in management of the company.  To settle debts that existed when the order of relief was issued. 13-20
    21. 21. Reorganization Chapter 11 Bankruptcy Acceptance of a reorganization plan requires approval of: 2/3 of the $ amount and more than 1/2 of the creditors who cast votes 2/3 of each class of stockholders who cast votes Confirmation by the court  The court can also force acceptance of a plan that was voted down (known as a “cram down”).  As a final alternative, the court can convert a Chapter 11 Bankruptcy to a Chapter 7 Liquidation at any time. 13-21
    22. 22. LO 8 Financial Reporting During Reorganization  FASB’s Accounting Standards Codification Topic 852, Reorganizations, requires financial statements be prepared During the reorganization and When entity emerges from reorganization.  Gains, losses, revenues and expenses of the reorganization are reported separately.  Liabilities are restated.  Current versus noncurrent classification not applicable. 13-22
    23. 23. LO 9 Fresh Start Reporting When a company emerges from Chapter 11, GAAP permits fresh start reporting if two conditions are met:  The reorganization (or market) value of the assets is less than the total of the allowed claims as of the date of the order for relief plus any subsequent liabilities.  The previous owners are left with less than 50% of the voting stock. 13-23
    24. 24. Fresh Start Accounting Fresh Start Accounting  Assets are restated to current market value.  Liabilities are stated at the discounted present value of future cash payments.  Retained Earnings is set to zero.  Normally, APIC is adjusted to balance. 13-24
    25. 25. Summary  Bankruptcy laws are intended to provide an orderly settlement to cases of insolvency, by assuring fair distribution of remaining assets while discharging the obligations of an honest debtor.  Bankruptcy may be voluntary or involuntary, and the result may be either liquidation (Chapter 7) or reorganization (Chapter 11).  Many companies emerging from liquidation are able to apply “fresh start” accounting. 13-25

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