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CHAPTER 13
ACCOUNTING FOR LEGAL REORGANIZATIONS
AND LIQUIDATIONS
Chapter Outline
I.
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 7 bankruptcy).
A. A trustee is appointed to oversee termination of business affairs, liquidation of noncash
properties, and distribution of cash resources.
13-1
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B. The trustee prepares a periodic reporting of activities. Historically, that reporting has
been in the form of a Statement of Realization and Liquidation.
1. This statement indicates the book value and classification of remaining assets and
liabilities.
2. It also discloses the effects of all transactions that have occurred to date.
3. This statement is no longer appropriate for external reporting but can still be
produced internally to help monitor the activities.
C. At the point that liquidation becomes imminent, financial reporting must follow the
liquidation basis of accounting.
1. Liquidation is viewed as imminent when a plan has been approved by the court or
by
individuals with that authority.
2. Under the liquidation basis, both a statement of net assets in liquidation and a
statement of changes in net assets in liquidation must be produced.
3. Assets are reported under the liquidation basis at the cash amount that is expected
which will often be lower than fair value. Liabilities are not adjusted until changed
in
some legal fashion.
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. FASBs Accounting Standards Codification, Topic 852, Reorganizations provides
guidance for preparing financial statements during the period that a company goes
through reorganization.
1. Gains, losses, revenues, and expenses that result from reorganization must be
reported separately on the income statement.
2. Professional fees incurred in connection with the bankruptcy must be expensed
immediately.
3. 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.
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Education.
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.
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. Once successful companies can falter and go bankrupt creating huge losses for their
creditors. Thurber needs to assess the risk and take appropriate action.
Many important figures can be gleaned from the companys financial statements including the
amount of 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.
Thurber 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 unless some action is taken, filing an
involuntary petition for bankruptcy may be the wisest decision. However, that procedure should
only be undertaken after adequate study has been made. In the long run, companies do 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 the debtor 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 assets 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 conditionmany cities are filled with such structures) 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 estimate possible.
13-3
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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.
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 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 Dalkon Shield litigation.
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 do 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
1. "Insolvent" refers to a state of financial position whereby a company (or individual) is
unable to pay debts as they come due.
2.
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.
3.
4. 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 $15,325) 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 $15,325.
5. 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.
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6. 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.
7. 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 $12,475 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 $2,775 limit),
Government claims for unpaid taxes.
8. 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.
9. In a Chapter 7 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
7 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.
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
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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.
Because of changes in U.S. GAAP, this statement is normally limited for internal reporting
purposes.
15. A company must follow the liquidation basis of accounting once liquidation becomes
imminent. That point is reached when a plan of liquidation has been approved by the
appropriate court or by individuals who have the authority to make that decision.
16. Liquidation is viewed as imminent (so that the liquidation basis of accounting is necessary)
if a formal plan of liquidation has been approved by the court in charge or by individuals
who have the authority to make that decision.
17. When a company is viewed as being in liquidation, then, at a minimum, a statement of net
assets in liquidation and a statement of changes in net assets in liquidation are required.
18. If the liquidation basis of accounting is applied, assets are reported at the amount of cash
that is expected from that liquidation. Because assets often have to be liquidated rather
quickly, the amount of cash expected is often a lower amount than the fair value of those
assets.
19. If the liquidation basis of accounting is applied, liabilities continue to be reported based on
the amount of each claim. The accountant does not attempt to estimate the amount that
will have to be paid until formal agreements have been reached.
20. 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
legally referred to as the debtor in possession.
21. 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 debtors exclusivity to propose a plan cannot be
extended beyond 18 months. In recent years, debtors have begun to push for quicker
resolutions so that matters can be finalized even if liquidation becomes necessary.
22. Numerous types of proposals are 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 (and the board of
directors) may also be spelled out in an attempt to persuade claimants that the company
will have the ability to overcome 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.
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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.
23. 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.
24. 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.
25. 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 estimate of the settlement figure.
Such estimations are often difficult, if not impossible, to make.
26. 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.
27. Professional fees incurred during reorganization must be expensed as incurred.
Capitalization is not allowed.
28. 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.
29. 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 companys 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.
30. 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.
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31. 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.
13-8
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Education.
Answers to Problems
1. B
2. D
3. B
4. C
5. A
6. D
7. C
8. B
9. C
10. B
11. A
12. A
13. A
14. B
15. C
16. B
17. D
18. B
19. D
20. A
21. C
22. A
23. D
13-9
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Education.
24. C
25. C
13-10
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Education.
$ 35,000
110,000
$145,000
$ 20,000
6,000
8,000
$ 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
13-11
$ 90,000
18,000
$108,000
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Education.
46,000
$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
13-12
$ 50,000
24,000
$ 74,000
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Education.
$60,000
20,000
$80,000
22,800
$57,200
Unsecured Liabilities:
Excess of Partially Secured Liabilities Over
Pledged Assets ($170,000 $140,000)................
Accounts Payable........................................................
Total ......................................................................
$ 30,000
190,000
$220,000
13-13
$140,000
7,800
$147,800
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Education.
$230,000
30,000
70,000
$330,000
60%
$198,000
In order for the holder of Debt 2 to receive exactly $142,000, the other free
assets must be sold for $308,000. With that much money, the liabilities with
priority ($110,000) can be paid with the remaining $198,000 going to help cover
the unsecured debts of $330,000. That is 60 percent coverage of those debts
($198,000/$330,000). This 60 percent figure would insure that the holder of
Debt 2 would get $100,000 from the pledged asset and $42,000 ($70,000 x 60%)
from the free assets.
13-14
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Education.
$370,000
(182,800)
$187,200
$400,000
120,000
$520,000
13-15
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Education.
$ 10,000
60,000
50,000
$120,000
$ 20,000
30,000
$ 50,000
$ 70,000
Unsecured Liabilities
Note Payable A (in excess of value of security) .....
Note Payable B (in excess of value of security) .....
Note Payable C ...........................................................
Accounts Payable ......................................................
Total ......................................................................
$ 20,000
80,000
60,000
120,000
$280,000
$ 70,000
5,000
$ 75,000
$ 40,000
20,000
$ 60,000
$ 15,000
$ 20,000
$ 30,000
$ 30,000
13-16
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Education.
28,000
$160,000
(20,000)
(28,000)
$112,000
$32,000
36,000
64,000
-0-
13-17
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Education.
$30,000
15,000
39,000
10,000
$94,000
(10,000)
$84,000
$90,000
120,000
$210,000
$10,000
$36,000
$110,000
$228,000
13-18
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Education.
13-19
10,000
10,000
100,000
60,000
70,000
110,000
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Education.
37.
13-20
$ 467,000
$ 211,000
16,000
70,000
22,000
24,000
4,000
(109,000)
(71,000)
32,000
(347,000)
120,000
(148,000)
(28,000)
5,600
$(22,400)
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Education.
38. (15 Minutes) (Description of balance sheet for a company emerging from
bankruptcy reorganization)
a. FASB ASC Topic 852 (Reorganizations) states that a company that is exiting
bankruptcy is considered a new entity (so that fair values would be applicable
for reporting purposes) if two criteria are met. Otherwise, the company is
simply considered to be a continuation of the old concern, a company that
should keep reporting its historical cost figures.
The first criterion is that the fair value of the assets of the emerging company
must be less than the allowed claims as of the date of the order for relief (plus
liabilities incurred during reorganization).
The second criterion is that the original owners must be left with less than 50
percent of the voting stock of the emerging company.
Whenever both of these criteria are met, the company's assets should be
reported at their current fair values.
b. Under fresh start accounting, the assets are adjusted to current value on the
date that the company successfully emerges from bankruptcy reorganization.
A reorganization value for the entitys assets as a whole is first determined by
discounting the cash flows that are anticipated. This balance is assigned to
identifiable assets (both tangible and intangible) in the same manner as in a
purchase combination. Any amount of the reorganization value that exceeds
the assigned total is recorded as goodwill.
c. The reorganization value in excess of the value of the identified assets and
liabilities is reported as the intangible asset goodwill. Goodwill is reviewed
each year for impairment.
13-21
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13-22
$ 23,000
45,000
140,000
220,000
154,000
$ 68,000
514,000
$582,000
$ 60,000
210,000
123,000
30,000
22,000
170,000
$ 270,000
345,000
615,000
200,000
(233,000)
$ 582,000
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Education.
40. (40 Minutes) (Prepare journal entries for company emerging from bankruptcy
using fresh start accounting)
Preliminary computations:
BOOK VALUES PRIOR TO EMERGING FROM REORGANIZATION
Total assets at book value = $710,000 ($100,000 + $112,000 + $420,000 +
$78,000)
Total liabilities at book value = $800,000 ($80,000 + $35,000 + $100,000 +
$200,000 + $185,000 + $200,000)
Total common stock = $240,000 (given)
Deficit = $330,000 (given)
Since the above accounts balance, no additional paid-in capital must exist at
this time.
BOOK VALUES AFTER EMERGING FROM REORGANIZATION
Total assets = $780,000 (reorganization value)
Total liabilities = $340,000 ($5,000 + $4,000 + $100,000 + $50,000 + $71,000 +
$110,000)
Total common stock = $240,000 (all 18,000 returned shares are reissued)
Deficit = -0- (eliminated by the reorganization)
Additional paid-in capital = $200,000 (figure needed to balance above accounts
after reorganization)
Because the company will have 30,000 shares outstanding after the
reorganization, the additional paid-in capital equals $6.66 per share
($200,000/30,000)
Because the company has a reorganization value of $780,000 but the assets
have a fair value of only $735,000, goodwill of $45,000 must be recognized
JOURNAL ENTRIES
Land and Buildings ....................................................
Goodwill ......................................................................
Accounts Receivable ............................................
Inventory ................................................................
Equipment ..............................................................
Additional Paid-In Capital (to balance) ...............
To adjust accounts to fair value as part of fresh
start accounting.
Common Stock ...........................................................
Additional Paid-In Capital ....................................
To record shares turned in to the company by the
owners as part of the reorganization plan, 18,000
shares at an $8 per share par value.
13-23
80,000
45,000
20,000
22,000
13,000
70,000
144,000
144,000
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Education.
40. (continued)
Accounts Payable ......................................................
Note Payable .........................................................
Common Stock ($8 per share par value) ............
Additional Paid-In Capital ($6.66 per sharesee
above, or 1/30 of company total) ...................
Gain on Debt Discharge .......................................
To record settlement of accounts payable.
80,000
35,000
200,000
185,000
200,000
134,000
196,000
13-24
5,000
8,000
6,666
60,334
4,000
31,000
50,000
80,000
66,667
3,333
71,000
56,000
46,667
11,333
110,000
90,000
330,000
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Education.
41. (25 Minutes) (Prepare a balance sheet for a company emerging from
bankruptcy reorganization)
a. Smith Corporation must apply fresh start accounting because it meets both
requirements established by FASB:
The reorganization value of $800,000 of the company is less than the
allowed claims of $730,000 ($180,000 + $200,000 + $350,000) plus the
liabilities incurred following the order for relief of $97,000.
The original owners are left with less than 50 percent (40 percent actually)
of the voting stock.
b. Because the company has a reorganization value of $800,000 but only
$653,000 can be assigned to specific assets based on fair value, the remaining
$147,000 is reported as Goodwill.
SMITH CORPORATION
Balance Sheet
December 31, 2015
ASSETS
Current Assets:
Accounts receivable ..................................................
Inventory ......................................................................
Land, Buildings, and Equipment:
Land and buildings ....................................................
Machinery ....................................................................
Intangible Assets:
Patents..........................................................................
Goodwill ......................................................................
Total Assets ...........................................................
$ 18,000
111,000
$129,000
278,000
121,000
399,000
125,000
147,000
13-25
272,000
$800,000
$ 97,000
185,000
$282,000
518,000
$800,000
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Education.
45,000
$126,000
$ 90,000
$ 81,000
Unsecured debts:
Accounts payable........................................................
$283,000
Partially secured liabilities in excess of pledged assets
($180,000 $103,000) ...........................................
77,000
Total unsecured debts ..........................................
$360,000
Percentage of unsecured debts to be paid: $90,000/$360,000 = 25%
Liabilities with priority collect the entire amount of $36,000
Fully secured liabilities collect the entire amount of $200,000
Partially secured liabilities collect $103,000 from the pledged assets and 25%
of the remaining $77,000 ($19,250) for a total of $122,250.
Unsecured liabilities collect 25% of the $283,000 balance or $70,750.
13-26
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Education.
180,000
3,000
65,000
88,000
Assets
Pledged with Fully Secured Creditors:
Land and buildings
$310,000
Less: Notes payable-long-term
(190,000)
Pledged with Partially Secured Creditors:
Equipment
$130,000
Notes payablecurrent
(250,000)
Free Assets:
Cash ..................................................................
Accounts receivable ........................................
Inventory ...........................................................
Total amount available to pay liabilities
with priority and unsecured creditors......
Less: Liabilities with priority
(listed below)...............................................
Available for unsecured creditors .................
Estimated deficiency........................................
$736,000
13-27
Available for
Unsecured
Creditors
$120,000
-03,000
26,000
80,000
$229,000
(42,000)
$187,000
21,000
$208,000
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Education.
43. (continued)
Book
Values
Unsecured
Nonpriority
Liabilities
$ 10,000
190,000
-0-
$120,000
250,000
88,000
198,000
$736,000
Unsecured Creditors:
Accounts payable (other than salaries)
Stockholders' equity........................................
13-28
88,000
- 0$208,000
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Education.
$ 6,000
18,000
31,000
8,000
7,000
$ 70,000
$ 22,000
6,000
10,000
$ 38,000
$ 32,000
Unsecured Liabilities:
Notes Payable (in excess of value of buildings) ..........................
Bonds Payable (in excess of value of equipment) .......................
Accounts Payable ............................................................................
Total ............................................................................................
$ 10,000
80,000
70,000
$160,000
$ 68,000
2,000
$ 70,000
$ 35,000
16,000
$ 51,000
$ 14,000
$ 6,000
$ 10,000
$ 22,000
13-29
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Education.
17,000
5,000
9,000
80,000
31,000
13-30
22,200
57,800
5,000
15,000
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Education.
45. (continued)
Gain on Discharge of Debt ........................................
Additional Paid-In Capital ..........................................
Retained Earnings (deficit) ..................................
To reduce additional paid-in capital balance to
correct figure, to close out gain account, and to
eliminate deficit as a step in establishing fresh
start accounting.
72,800
16,200
89,000
c. The bank will collect a total of $59,000. Obviously, the $50,000 proceeds
generated by the land sale must go to the bank with the remaining $30,000
obligation then being ranked as an unsecured-nonpriority liability. Anteium
(the insolvent company) will have $15,000 of the $26,000 cash left after paying
the $11,000 administrative expenses. Unsecured debts total $50,000 ($30,000
from the note and $20,000 of accounts payable). Thus, 30% of these debts will
be paid ($15,000/$50,000). The bank collects an additional $9,000 ($30,000 x
30%); the accounts payable collect $6,000 ($20,000 x 30%).
13-31
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Education.
LITZ CORPORATION
Statement of Realization and Liquidation
Cash
Balances, 8/8/15
Investments sold
Inventory sold
Payment is made on note from
proceeds of auction
Remaining debt is reclassified
Administrative expenses incurred
Land and buildings all sold
Payment is made on note from
proceeds of sale
Reclassify liabilities with priority
Equipment sold
Receivables collected
Administrative expenses paid
Final balances remaining for
unsecured creditors
$ 16,000
39,000
48,000
Noncash
Assets
$763,000
(32,000)
(69,000)
Liabilities
with
Priority
Fully
Secured
Creditors
Partially
Secured
Creditors
-0-
$259,000
$132,000
(48,000)
(48,000)
(84,000)
StockUnsecured holders'
Nonpriority
Equity
Liabilities (Deficits)
$150,000 $238,000
7,000
(21,000)
84,000
$15,000
315,000
(15,000)
(55,000)
(370,000)
(259,000)
(259,000)
34,000
84,000
34,000
(15,000)
$214,000
(34,000)
(210,000)
(82,000)
(126,000)
(48,000)
(15,000)
-0-
$34,000
-0-
-0-
$200,000 $(20,000)
13-32
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47. (40 Minutes) (Prepare journal entries for company emerging from bankruptcy
using fresh start accounting)
Becket Corporation must use fresh start accounting because the reorganization
value of $650,000 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 = $637,000 (reorganization value of $650,000 plus proceeds from
sale of stock of $77,000 less $90,000 value of land and investments used to
settle two debts)
Total liabilities = $350,000 ($130,000 + $40,000 + $180,000)
Total common stock = $160,000 (10,000 additional shares are issued with a
$10 per share par value so that total outstanding shares = 16,000)
Deficit = -0- (eliminated by the reorganization)
Additional paid-in capital = $127,000 (figure needed to balance above
accounts after reorganization)
Because the company has a reorganization value of $650,000 but the assets
have a fair value of only $623,000, Goodwill must be established for $27,000.
JOURNAL ENTRIES
Investments ..................................................................
Land ..............................................................................
Buildings .......................................................................
Goodwill ........................................................................
Accounts Receivable .............................................
Inventory ..................................................................
Equipment ...............................................................
Additional Paid-In Capital (to balance).................
To adjust accounts to fair value as part of fresh
start accounting.
14,000
23,000
52,000
27,000
20,000
16,000
31,000
49,000
Cash ............................................................................
Common Stock ($10 par value) ...........................
Additional Paid-In Capital ....................................
To record shares sold to new investor.
77,000
Cash ...............................................................................
Investments ...........................................................
Investments sold.
40,000
13-33
70,000
7,000
40,000
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Education.
47. (continued)
Notes PayableCurrent ..............................................
Cash ..........................................................................
Notes Payable (due in 2019) ...................................
Gain on Discharge of Debt .....................................
To record settlement of current notes.
220,000
129,000
325,000
180,187
13-34
40,000
130,000
50,000
40,000
89,000
50,000
180,000
30,000
23,813
41,187
47,187
133,000
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Education.
48. (40 Minutes) (Prepare statement of financial affairs and determine amounts to
be paid in liquidation)
a.
OREGON CORPORATION
Statement of Financial Affairs
Available for
Book
Unsecured
Values
Assets
Creditors
Pledged with Fully Secured Creditors:
$33,000
Land (Plots A and D)
$43,000
Less: Notes payable
(30,000)
$13,000
28,000
6,000
25,000
-06,000
12,000
$31,000
$92,000
28,000
$ 3,000
47,000
$50,000
Book
Values
Unsecured
Nonpriority
Liabilities
$16,000
12,000
$28,000
$30,000
(43,000)
-0-
$30,000
(25,000)
$ 5,000
25,000
20,000
$50,000
13-35
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Education.
48. (continued)
b. According to the statement of financial affairs prepared above, $3,000 cash
should be available for unsecured nonpriority creditors. Unfortunately, $50,000
in unsecured nonpriority liabilities exist. Thus, only 6% of these claims will be
covered ($3,000/$50,000).
Cash of $11,240 will be paid on the note payable that is secured by plot B. The
land is to be sold for $11,000 leaving a $4,000 unsecured debt. Since 6% of
this amount is expected to be paid, the holder will only receive an additional
$240.
c. As indicated in part b, only 6% of the unsecured nonpriority claims can be
satisfied. Thus, just $1,500 will be paid on the unsecured $25,000 note
payable.
d. Selling plot D for $30,000 rather than $27,000 generates an additional $3,000 in
available cash. The statement of financial affairs produced above would then
report $6,000 as the amount available for unsecured nonpriority claims or 12%
of the total ($6,000/$50,000). After plot B is sold for $11,000, the remaining
$4,000 of this note is classified as an unsecured nonpriority liability. Since
12% of this amount is to be paid, an additional $480 is transferred to the
holder of the note for a total of $11,480.
13-36
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Education.
Book
Values
$40,000
14,000
1,000
25,000
100,000
15,000
Assets
Pledged with Fully Secured Creditors:
Land and building
Less: Notes payable
Available for
Unsecured
Creditors
$75,000
(70,000)
$5,000
-0-
Free Assets:
Cash
Accounts receivable
Inventory
Investments
Total available to pay liabilities with
priority and unsecured creditors
Less: Liabilities with priority
(listed below)
Available for unsecured creditors
Estimated deficiency
$195,000
13-37
1,000
15,000
33,000
21,000
$75,000
(22,000)
$53,000
115,000
$168,000
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Education.
49. (continued)
Book
Values
Unsecured
Nonpriority
Liabilities
-0$5,000
1,000
$16,000
5,000
1,000
$22,000
70,000
$70,000
(75,000)
-0-
$150,000
(19,000)
$ 131,000
150,000
33,000
4,000
(68,000)
$195,000
33,000
4,000
$168,000
13-38
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Education.
'1'
50. (30 Minutes) (Prepare a statement of realization and liquidation)
a.
LYNCH, INC.
Statement of Realization and Liquidation
March 14, 2015 to July 23, 2015
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
Partially
Secured
Creditors
StockUnsecured holders'
Nonpriority
Equity
Liabilities (Deficits
$70,000
$150,000
$ 37,000 $(68,000)
10,000
(70,000)
(14,000)
(15,000)
Fully
Secured
Creditors
$81,000
-0-
(3,000)
(11,000)
6,000
(20,000)
20,000
_______
$26,000
(139,000)
-0-
(7,000)
(60,000)
(10,000)
31,000
-0-
139,000
$186,000$(131,000 )
b. The statement of realization and liquidation prepared in (a) indicates that $81,000 in cash remains. $26,000 of
this amount must be distributed to liabilities with priority leaving $55,000 for unsecured nonpriority creditors.
Since (as shown) 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 cash of approximately $300.
13-39
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51. (30 Minutes) (Prepare Journal entries for company emerging from bankruptcy
using fresh start accounting)
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
18,000
140,000
Cash .............................................................................
Common Stock ($5 par value) .............................
Additional Paid-In Capital ....................................
To record shares sold to new investor.
36,000
13-40
18,000
30,000
25,000
6,000
79,000
30,000
6,000
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Education.
50,000
10,000
4,000
12,800
51,200
130,200
1,800
132,000
Research Case 2
13-41
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Education.
This assignment provides the student with the chance to work with actual data
from a real company. Thus, students get a 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 students 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 parts (a) and (b) -- as supplied by the company. This
information can serve as the basis for considerable class discussion.
(a) Plan of Reorganization
On April 30, 2010 (the Effective Date), the Bankruptcy Court entered an order
confirming the Debtors Modified Fourth Amended Joint Plan of Reorganization
(the Plan) and the Debtors emerged from Chapter 11 by consummating their
restructuring through a series of transactions contemplated by the Plan including
the following:
Name Change. On the Effective Date, but after the Plan became effective and
prior to the distribution of securities under the Plan, SFI changed its corporate
name to Six Flags Entertainment Corporation. As used herein, unless the context
requires otherwise, the terms we, our, and Six Flags refer collectively to Six
Flags Entertainment Corporation and its consolidated subsidiaries, and
Holdings refers only to Six Flags Entertainment Corporation, without regard to
the respective subsidiaries. As used herein, SFI means Six Flags, Inc. as a
Debtor or prior to its name change to Six Flags Entertainment Corporation. As
used herein, the Company refers collectively to SFI or Holdings, as the case
may be, and its consolidating subsidiaries.
Common Stock. Pursuant to the Plan, all of SFIs common stock, preferred
stock purchase rights, preferred income equity redeemable shares (PIERS) and
any other ownership interest in SFI including all options, warrants or rights,
contractual or otherwise (including, but not limited to, stockholders agreements,
registration rights agreements and rights agreements) were cancelled as of the
Effective Date.
On the Effective Date, Holdings issued an aggregate of 54,777,778 shares of
common stock at $0.025 par value as follows: (i) 5,203,888 shares of common
stock to the holders of unsecured claims against SFI, (ii) 4,724,618 shares of
common stock to certain holders of the 1214% Notes due 2016 (the 2016
Notes) in exchange for such 2016 Notes in the aggregate amount of $69.5
million, (iii) 34,363,950 shares of common stock to certain accredited investors
that held unsecured claims who participated in a $505.5 million rights offering,
(iv) 6,798,012 shares of common stock in an offering to certain purchasers for an
aggregate purchase price of $75.0 million, (v) 3,399,006 shares of common stock
13-42
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Education.
See Note 8 for a discussion of the terms and conditions of these facilities and
subsequent amendments, early repayments, and terminations from debt
extinguishment transactions.
Fresh Start Accounting. As required by accounting principles generally
accepted in the United States (GAAP), we adopted fresh start accounting
effective May 1, 2010 following the guidance of Financial Accounting Standards
Board (FASB) Accounting Standards Codification (ASC) Topic 852,
Reorganizations (FASB ASC 852). The financial statements for the periods
ended prior to April 30, 2010 do not include the effect of any changes in our
capital structure or changes in the fair value of assets and liabilities as a result of
fresh start accounting.
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. See Note 1(b) for a detailed explanation of the impact
of emerging from Chapter 11 and applying fresh start accounting on our financial
position.
As used herein, Successor refers to the Company as of the Effective Date and
Predecessor refers to SFI together with its consolidated subsidiaries prior to
the Effective Date.
(b) Fresh Start Accounting and the Effects of the Plan
Fresh start accounting results in a new basis of accounting and reflects the
allocation of the Companys estimated fair value to its underlying assets and
liabilities. The Companys estimates of fair value are inherently subject to
significant uncertainties and contingencies beyond the Companys 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 $14.71 per share, as adjusted to
reflect the June 2011 two-for-one stock split described in Note 12. Holdings also
issued stock at $14.71 per share to pay $146.1 million of SFO and SFI claims. The
Companys reorganization value reflected 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
13-44
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Education.
bank borrowings of $1.0 million. See Note 8 for a discussion of the terms and
conditions of the Refinance Loan.
_______________________
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.
The valuations required to determine the fair value of the Companys assets as
presented below represent the results of valuation procedures performed by
independent valuation specialists. The estimates of fair values of assets and
liabilities have been reflected in the Successor Company consolidated balance
sheet as of April 30, 2010.
The adjustments below are to our April 30, 2010 balance sheet. The balance sheet
reorganization adjustments presented below summarize the impact of the Plan
and the adoption of fresh start accounting as of the Effective Date.
4,876
41,164
13-46
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Education.
Inventories . . . . . . . . . . . . . . . . 37,811
Prepaid expenses and
other current assets . . .
49,671
Assets held for sale . . . . . . . . . . . 681
Total current assets . . . . . . . 200,287
(193)
37,618
(9,750)
(31,076)
(456)
4,227
39,465
681
173,438
28,184
40,001
28,184
6,643
6,643
2,753
104,320
147,074
(78,304)
1,429,373
6,978
412,591
(420,841)
$ (75,684)
422,755
630,248
$2,809,866
Other assets:
Debt issuance costs . . . . . . . . 11,817
Restricted-use
investment securities . . . . . . .2,753
Deposits and other assets . . . 97,677
Total other assets . . . . . . . . . 112,247
Property and equipment,
at cost, net . . . . .
1,507,677
Assets held for sale . . . . . . . . . 6,978
Intangible assets, net of
accumulated
amortization(3) . . . . . . . . . . .10,164
Goodwill(4) . . . . . . . . . . . . .1,051,089
Total assets . . . . . . . . . . . $2,888,442
$ (2,892)
$ (20,272)
1,442
19,074
(26,630)
2,883
(317,946)
13-47
$71,926
(5,118)
1,438
(1,324)
16,461
30,448
209
57,074
59,709
5,409
34,677
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(341,449)
190,425
(5,004)
(9,383)
110,955
275,913
1,009,233
37,485
229,776
(151,024)
96,568
1,552,407
(1,745,175)
(1,896,199)
96,568
1,552,407
90,516
446,449
685
Old common stock . . . . . . . . . 2,458
(2,458)
Capital in excess of
par value . . . . . . . . .
1,508,155
(703,049)
805,106
Accumulated deficit . . . . .(2,308,699)
2,598,129
(289,430)
Accumulated other
comprehensive loss . . .
(26,535)
26,535
127
5,219
Total (deficit) equity . . . . . . .(819,529)
1,893,307
(262,768)
811,010
Total liabilities and
equity (deficit) . . . .
$ 2,888,442
$ (2,892)
$ (75,684) $2,809,866
_________________
(1) Represents amounts recorded on the Effective Date for the implementation of
the Plan, including the settlement of liabilities subject to compromise and related
payments, the incurrence of new indebtedness under the Exit Facilities and
repayment of the Prepetition Credit Agreement and Prepetition Notes,
distributions of cash and Holdings common stock and the cancellation of SFI
common stock.
The Plans impact resulted in a net decrease of $21.3 million in cash and cash
equivalents. The significant sources and uses of cash were as follows (in
thousands):
Sources:
Net amount borrowed under the Exit First Lien Term Loan . . . . . . . . . $ 762,300
Net amount borrowed under the Exit Second Lien Loan Facility . . . . . . 246,250
Proceeds from the Equity Offering . . . . . . . . . . . . . . . . . . . . . . . . . . . .
630,500
Total sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,639,050
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Uses:
Repayments of amounts owed:
Prepetition Credit Agreementlong term portion of term loan . . . . . 818,125
2016 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
330,500
Prepetition Credit Agreementrevolving portion . . . . . . . . . . . . . . . . 270,269
Prepetition TW Promissory Note . . . . . . . . . . . . . . . . . . . . . . . . . . .
30,677
Prepetition interest rate hedging derivatives . . . . . . . . . . . . . . . . . . . 19,992
Prepetition Credit Agreementcurrent portion of term loan . . . . . . . 17,000
Payments:
Exit Facilities debt issuance costs . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,700
Accrued interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
96,950
Professional fees and other accrued liabilities . . . . . . . . . . . . . . . . . . 47,163
Total uses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,660,376
Net cash uses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (21,326)
The gain on the cancellation of liabilities subject to compromise, before income
taxes, was calculated as follows:
Extinguishment of the 2010 Notes, 2013 Notes, 2014 Notes and 2015
Notes (collectively, the SFI Senior Notes) . . . . . . . . . . . . . . . . . . .$ 868,305
Extinguishment of the PIERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
306,650
Write-off of the accrued interest on the SFI Senior Notes . . . . . . . . . . . 29,868
Write-off debt issuance costs on the Prepetition Credit Agreement
And the Prepetition TW Promissory Note . . . . . . . . . . . . . . . . . . . . . . .(11,516)
Issuance of Holdings common stock . . . . . . . . . . . . . . . . . . . . . . . . . . (105,791)
Gain on the cancellation of liabilities subject to
compromise, before income taxes . . . . . . . . . . . . . . . . . . . . . .$1,087,516
(2) Reflects the adjustments to assets and liabilities to estimated fair value, or
other measurements specified by FASB ASC 805, in conjunction with the
adoption of fresh start accounting. Significant adjustments are summarized as
follows and all are considered a Level 3 fair value measurement with the
exception of the land values which are Level 2 fair value measurements.
Deposits and other assetsnote receivableAn adjustment of approximately
$7.4 million was recorded to the book value of a note receivable to its $8.4 million
estimated fair value, which was determined based on the discounted cash flow
method over the life of the note.
Deposits and other assetsinvestment in nonconsolidated joint ventureThis
account was adjusted to its estimated fair values based on customary valuation
methodologies, including comparable earnings multiples, discounted cash flows
and negotiated transaction values.
Property and equipment, at costAn adjustment of approximately $78.3 million
was recorded to adjust the net book value of property, plant and equipment to fair
value based on the new replacement cost less depreciation valuation
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$ (178,475)
(3) The following represent the methodologies and significant assumptions used
in determining the fair value of the significant intangible assets, other than
goodwill and all are considered a Level 3 fair value measurement. Certain longlived intangible assets which include trade names, trademarks and licensing
agreements were valued using a relief from royalty methodology. Group-sales
customer relationships were valued using a multi-period excess earnings
method. Sponsorship agreements were valued using the lost profits method.
Certain intangible assets are subject to sensitive business factors of which only
a portion are within control of the Companys management. A summary of the key
inputs used in the valuation of these assets are as follows:
The Company valued trade names, trademarks and its third party licensing
rights using the income approach, specifically the relief from royalty method.
Under this method, the asset values were determined by estimating the
hypothetical royalties that would have to be paid if the trade name was not owned
or the third-party rights not currently licensed. Royalty rates were selected based
on consideration of several factors, including industry practices, the existence of
licensing agreements, and importance of the trademark, trade name and licensed
rights and profit levels, among other considerations. The royalty rate of 4% of
expected adjusted net sales related to the respective trade names and
trademarks was used in the determination of their fair values, and a rate of 1.5%
was used for the third-party license agreement. The expected net sales were
adjusted for certain international revenues, retail, licensing and management
fees, as well as certain direct costs related to the licensing agreement. The
Company anticipates using the majority of the trade names and trademarks for an
indefinite period, while the license agreement intangible asset will be amortized
through 2020. Income taxes were estimated at a rate of 39.5% and amounts were
discounted using a 12% discount rate for trade names and trademarks and 15%
for the third-party license agreement. Trade name and trademarks were valued at
approximately $344 million and the third-party license agreement at
approximately $24 million.
Sponsorship agreements were valued using the lost profits method, also
referred to as with or without method. Under this method, the fair value of the
sponsorship agreements was estimated by assessing the loss of economic
profits under a hypothetical condition where such agreements would not be in
place and would need to be recreated. The projected revenues, expenses and
cash flows were calculated under each scenario and the difference in the annual
cash flows was then discounted to the present value to derive at an indication of
the value of the sponsorship agreements. Income taxes were estimated at a rate
of 39.5% and amounts were discounted using a 12% discount rate, resulting in
approximately $43 million of value allocated to sponsorship agreements.
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The Company valued group sales customer relationships using the income
approach, specifically the multi-period excess earnings method. In determining
the fair value of the group-sales customer relationships, the multi-period excess
earnings approach values the intangible asset at the present value of the
incremental after-tax cash flows attributable only to the customer relationship
after deducting contributory asset charges. The incremental after-tax cash flows
attributable to the subject intangible asset are then discounted to their present
value. Only expected sales from current group sales customers were used which
was calculated based on a two year life. The Company assumed a retention rate
of 50% which was supported by historical retention rates. Income taxes were
estimated at a rate 39.5% and amounts were discounted using a 12% discount
rate. The group-sales customer relationships were valued at approximately $7
million under this approach.
(4) Fresh start accounting eliminated the balance of goodwill and other
unamortized intangible assets of the Predecessor Company and records
Successor Company intangible assets, including reorganization value in excess
of amounts allocated to identified tangible and intangible assets, also referred to
as Successor Company goodwill. The Successor Companys April 30, 2010
consolidated balance sheet reflects the allocation of the business enterprise
value to assets and liabilities immediately following emergence as follows (in
thousands):
Enterprise value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,301,369
Add: Fair value of non-interest bearing liabilities
(non-debt liabilities)
508,497
Less: Fair value of tangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . .(1,756,863)
Less: Fair value of identified intangible assets . . . . . . . . . . . . . . . . . . . (422,755)
Reorganization value of assets in excess of amounts allocated to
identified tangible and intangible assets (Successor Company
goodwill) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 630,248
Analysis Case 1
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,
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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
Companys 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 Companys 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. 2 to the Credit Agreement,
primarily for the purposes of updating certain schedules to the Credit
Agreement and permitting the Companys 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. 2 to the Credit Agreement, which is filed as Exhibit 99.1 to this Report
and the terms of which are incorporated herein by reference.
Item 1.02
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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
Companys 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 Constars Plan of Reorganization, Business Wire, May 4,
2009.
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 2
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 companys website
about a reorganization that is in process. Different companies will undoubtedly
provide widely differing amounts of information.
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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 companys 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.
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
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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
companys 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 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.
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 companys 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 1
A study of almost any large bankrupt organization can lead to a considerable
degree of speculation as to the reasons for the companys 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.
Todays 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.
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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.
Borders ' bankruptcy filing result of failing to keep up with shoppers' book,
music, DVD habits, Associated Press Newswires, February 16, 2011.
COMMUNICATIONS CASE 2
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.
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