1048 Chapter 20 Corporations in Financial Difficulty

Either the debtor or its creditors may decide that a judicial action is best in the
individual circumstances. The debtor may file a voluntary petition seeking judicial
protection in the form of an order of relief against the initiation or continuation of
legal claims by the creditors against the debtor. Alternatively, creditors may file an
involuntary petition against the debtor but first certain conditions must exist. The
first condition is that the debtor has generally not been paying debts as they become
due or within the last 120 days and has appointed a custodian to take possession of
its assets or other creditors or some other agency has done so. Second, if more than
12 creditors exist, 3 or more must combine to file the petition and must have aggre-
gate unsecured claims of at least $5,000. The debtor is permitted to file an answer to
an involuntary petition.
Once a petition has been filed, the bankruptcy court evaluates the company and deter-
mines whether present management should continue to manage it or should appoint
a trustee. Appointments of trustees are common when creditors make allegations of
management fraud or gross management incompetence.
The Bankruptcy Code provides two major alternatives under the bankruptcy court’s
protection. These two alternatives are often known by the chapters of the Bankruptcy
Code. The first is reorganization under Chapter 11, which provides the debtor judicial
protection for a rehabilitation period during which it can eliminate unprofitable opera-
tions, obtain new credit, develop a new company structure with sustainable operations,
and work out agreements with its creditors. The second alternative is a liquidation under
Chapter 7 of the Bankruptcy Code, which is often administered by a court-appointed
trustee. The debtor’s assets are sold and its liabilities extinguished as the business is liqui-
dated. The major difference between a reorganization and a liquidation is that the debtor
continues as a business after a reorganization whereas the business does not survive a
liquidation. We illustrate both of these alternatives next.

CHAPTER 11 REORGANIZATIONS
LO 20-2 Chapter 11 of the Bankruptcy Code allows for legal protection from creditors’ actions during
Understand Chapter 11
a time needed to reorganize the debtor company and return its operations to a profitable
reorganizations and be able level. The bankruptcy court administers reorganizations and often appoints trustees to direct
to prepare financial state- them. Reorganizations are typically described by four Ps. A company in financial distress
ments for debtors-in- petitions the bankruptcy court for protection from its creditors. If granted protection, the
possession as well as a company receives an order of relief to suspend making any payments on its prepetition
plan of recovery. debt. The company continues to operate while it prepares a plan of reorganization, which
serves as an operating guide during the reorganization. The proceeding includes the
actions that take place from the time the petition is filed until the company completes the
reorganization.
The petition must discuss the alternative of liquidating the debtor and distributing
the expected receipts to creditors. The plan of reorganization is the essence of any
reorganization and must include a complete description of the expected debtor actions
during the reorganization period and the way these actions will be in the best interest of the
debtor and its creditors. A disclosure statement
is transmitted to all creditors and other parties
FYI eligible to vote on the plan of reorganization. The
Lehman Brothers was the fourth largest U.S. investment bank before filing for disclosure statement includes information that
Chapter 11 bankruptcy protection in 2008. With more than $600 billion in would enable a reasonable investor or creditor to
assets, this was the largest bankruptcy proceeding in U.S. history and it had a make an informed judgment about the worthiness
significant impact on the 2007–2009 financial crisis. Barclays, an international
banking and financial services firm based in London, purchased Lehman
of the plan and how it will affect that person’s
Brothers North American businesses in September 2008, shortly after Lehman financial interest in the debtor company. The
filed for Chapter 11 bankruptcy protection. bankruptcy court then evaluates the responses
to the plan from creditors and other parties and
 Chapter 20 Corporations in Financial Difficulty 1049

either confirms or rejects the reorganization

FYI plan. Confirmation of the plan implies that the
GM earned $5.3 billion and $6.2 billion in net income during fiscal years debtor, or an appointed trustee, will fully follow
2013 and 2012, respectively. It is a vastly different company than it was
the plan. The reorganization period may be
prior to the bankruptcy. It is smaller, has less debt, and its contract with
the United Auto Workers is less costly. But it took a nearly $50 billion as short as a few months or as long as several
government bailout and bankruptcy protection in 2009 to cut its bloated years. Most reorganizations require more
costs. Thus, GM’s reorganization as part of its Chapter 11 bankruptcy filing than one year; however, the time span of the
appears to have helped the company to shed less productive assets and proceeding depends on the complexity of the
operations.
reorganization.
ASC 852 provides guidance for financial
reporting for companies in reorganization. The
financial statements issued by a company during Chapter 11 proceedings should dis-
tinguish transactions and events directly associated with the reorganization from those
associated with ongoing operations. Companies in reorganization are required to pres-
ent balance sheets, income statements, and statements of cash flows, but ASC 852
requires these three statements to clearly reflect the unique circumstances related to the
reorganization.
The balance sheet of a company in reorganization has the following special attributes:
1. Prepetition liabilities subject to compromise as part of the reorganization proceeding
should be reported separately from liabilities not subject to compromise. Liabilities
subject to compromise include unsecured debt and other payables that were
incurred  before the company entered reorganization. Liabilities that are not subject
to change by the reorganization plan include fully secured liabilities incurred before
reorganization and all liabilities incurred after the company enters its petition for
reorganization relief.
2. The liabilities should be reported at the expected amount to be allowed by the bank-
ruptcy court. If no reasonable estimation is possible, the claims should be disclosed in
the footnotes.
The income statement of a company in reorganization has the following special requirements:
1. Amounts directly related to the reorganization, such as legal fees and losses on
disposals of assets, should be reported separately as reorganization items in the period
incurred. However, any gains or losses on discontinued operations or extraordinary
items should be reported separately according to ASC 225.
2. Some of the interest income earned during reorganization is a result of not requiring
the debtor to pay debt and thus investing the available resources in interest-bearing
sources. Such interest income should be reported separately as a reorganization item.
The extent to which reported interest expense differs from the contractual interest
on the company’s debt should be disclosed, either parenthetically on the face of the
income statement or within the footnotes.
3. Earnings per share is disclosed as are any anticipated changes to the number of
common shares or common stock equivalents outstanding as a result of the reorganiza-
tion plan.
The statement of cash flows of a company in reorganization has the following special
features:
1. ASC 852 prefers the direct method of presenting cash flows from operations, but if the
indirect method is used, the company also must disclose separately the operating cash
flows associated with the reorganization.
2. Cash flows related to the reorganization should be reported separately from those
from regular operations. For example, excess net interest received as a result
of the company’s not paying its debts during reorganization should be reported
separately.
1050 Chapter 20 Corporations in Financial Difficulty

Fresh Start Accounting

The basic view of a reorganization is that it is a fresh start for the company. However, it
is difficult to determine whether a Chapter 11 reorganization results in a new entity for
which fresh start accounting should be used or if it results in a continuation of the prior
entity. ASC 852 states that fresh start reporting should be used as of the confirmation date
of the plan of reorganization if both the following conditions occur:1
1. The reorganization value of the assets of the emerging entity immediately before the
date of confirmation is less than the total of all postpetition liabilities and allowed
claims.
2. Holders of existing voting shares immediately before confirmation receive less than
50 percent of the emerging entity’s voting shares. This implies that the prior share-
holders have lost control of the emerging company.
Fresh start accounting results in a new reporting entity. First, the company is required
to compute the reorganization value of the emerging entity’s assets. Reorganization value
represents the fair value of the entity before considering liabilities and approximates the
amount a willing buyer would pay for the entity’s assets. The reorganization value is then
allocated to the assets using the value method prescribed in ASC 805. A reorganization
value in excess of amounts assignable to identifiable assets is reported as an intangible
asset called Reorganization Value in Excess of Amounts Allocable to Identifiable Assets.
This excess is then accounted for in conformity with ASC 350. The emerging company
records its liabilities at the present values of the amounts to be paid. Any retained earn-
ings or deficits are eliminated. A set of final operating statements is prepared just prior
to emerging from reorganization. In essence, the company is a new reporting entity after
reorganization.

Companies Not Qualifying for Fresh Start Accounting

Those companies not meeting the two conditions for fresh start accounting should
determine whether their assets are impaired in value. In addition, they should report
liabilities at the present values of the amounts to be paid with any gain or loss on the
revaluation of the liabilities recorded in accordance with ASC 225 as to extraordinary
or ordinary events.
Many companies decide to restructure their operations as part of the reorganization
plan. Those companies not qualifying for fresh start accounting account for restructur-
ing costs such as those for closing a plant and reducing the workforce and combining
some of the remaining operations in accordance with ASC 420. This standard estab-
lishes the recognition of a liability for a cost associated with an exit or disposal activity
when the liability is incurred, not at the earlier time the company makes a commitment
to an exit plan.
The accounting for long-lived assets should be performed in accordance with ASC 360.
The long-lived assets are divided between (1) those to be held and used and (2) those to
be sold. An impairment loss on a long-lived asset to be held and used is recognized only
if its carrying value is less than the asset’s estimated undiscounted cash flows from opera-
tions over its estimated useful life. The amount of the impairment loss is the difference
between the asset’s carrying amount and its fair value. Goodwill is not considered part of
long-lived assets to be tested for impairment under ASC 360. Note that ASC 350 guides
the accounting for any impairment of goodwill.
Individual long-lived assets that will be sold are revalued to their lower of carrying
amount or fair value less the selling costs. In addition, once the use of a long-lived asset
is discontinued and set aside for sale, depreciation is stopped. A management decision to
dispose of a component of the entity is accounted for as a discontinued segment under
ASC 225.

1
ASC 852-10-45-19.
 Chapter 20 Corporations in Financial Difficulty 1051

ASC 310 and 470 do not apply to troubled debt restructurings in which debtors restate
their liabilities generally under the purview of the bankruptcy court. ASC 310 and 470
apply only to specific debt restructuring transactions. This exception is not an issue in the
immediate settlement of debt in which the debtor’s gain or loss is the difference between
the fair value of the consideration given and the carrying value of the debt. The gain or
loss is the same under ASC 310 and 470 as under a general restatement of liabilities in a
reorganization. However, in cases of modification of terms in a reorganization involving
a general restatement of liabilities, the debtor’s restructuring gain is computed as the dif-
ference between the debt’s carrying value and the new principal after restructuring. The
future cash flows from interest payments are not included in the computation of the new
principal. Thus, in most cases of debt restructuring of companies in reorganization proceed-
ings, the debtor’s gain from the debt restructuring is higher than it would have been under
ASC 310 and 470.

Plan of Reorganization
The plan of reorganization is typically a detailed document with a full discussion of all
major actions to be taken during the reorganization period. In addition to these major
actions, management also continues to manufacture and sell products, collect receivables,
and pursue other day-to-day operations. Most plans include detailed discussions of the
following:
1. Disposing of unprofitable operations through either sale or liquidation.
2. Restructuring of debt with specific creditors.
3. Revaluation of assets and liabilities.
4. Reductions or eliminations of original stockholders’ claims and issuances of new
shares to creditors or others.
The plan of reorganization must be approved by at least half of all creditors, who must
hold at least two-thirds of the dollar amount of the debtor’s total outstanding debt,
although the court may still confirm a plan that the necessary number of creditors do not
approve provided the court finds that the plan is in the best interests of all parties and is
equitable and fair to those groups not voting approval.

Illustration of a Reorganization2
Figure 20–1 is a balance sheet for Peerless Products Corporation on December 31,
20X6. On January 2, 20X7, Peerless’ management petitions the bankruptcy court for a
Chapter 11 reorganization to obtain relief from debt payments and time to rehabilitate the
company and return to profitable operations.
The following timeline presents the dates relevant for this example:

Reorganization Proceedings

Jan. 2 July 1 Dec. 31 Jan. 2 Apr. 1

20X7 20X7 20X7 20X8 20X8

Prepetition Petition Plan of End of Plan of Reorganization

period presented reorganization fiscal reorganization completed
filed year approved

2
To view a video explanation of this topic, visit advancedstudyguide.com.
1052 Chapter 20 Corporations in Financial Difficulty

FIGURE 20–1 PEERLESS PRODUCTS CORPORATION

Balance Sheet Balance Sheet
on the Date of December 31, 20X6
Corporate Insolvency
Assets
Cash $ 2,000
Marketable Securities 8,000
Accounts Receivable $ 20,000
Less: Allowance for Uncollectible Accounts (2,000) 18,000
Inventory 45,000
Prepaid Assets 1,000
Total Current Assets $ 74,000
Property, Plant & Equipment:
Accumulated Undepreciated
Cost Depreciation Cost
Land $ 10,000 $ 0 $ 10,000
Plant 75,000 20,000 55,000
Equipment 40,000 4,000 36,000
Total $125,000 $24,000 $101,000 101,000
Total Assets $175,000
Liabilities
Accounts Payable $ 26,000
Notes Payable:
Partially Secured $ 10,000
Unsecured, 10% interest 80,000 90,000
Accrued Interest 3,000
Accrued Wages 14,000
Total Current Liabilities $133,000
Mortgages Payable 50,000
Total Liabilities $183,000
Shareholders’ Equity
Preferred Stock $ 40,000
Common Stock ($1 par) 10,000
Retained Earnings (Deficit) (58,000)
Total Shareholders’ Equity (8,000)
Total Liabilities & Shareholders’ Equity $175,000

The bankruptcy court accepts the petition, and Peerless Products prepares its plan of
reorganization. The plan is filed on July 1, 20X7, and the disclosure statement is sent to
all creditors and other affected parties. On December 31, 20X7, the company presents its
financial statements for the 20X7 fiscal period in which it was in Chapter 11 proceed-
ings. The bankruptcy court approves the reorganization plan on January 2, 20X8, and the
reorganization is completed by April 1, 20X8.
Peerless files the plan of reorganization in Figure 20–2 with audited financial state-
ments and other disclosures requested by the bankruptcy court.
Prior to the approval of the plan of reorganization, Peerless continues to operate
under the protection of the granted petition of relief. The company makes only court-
approved payments on prepetition liabilities. The only court-approved payment on prepe-
tition liabilities is a $2,000 payment on the mortgage payable. On December 31, 20X7, the
company issues financial statements for the fiscal year. ASC 852 prescribes the report-
ing guidelines for companies in reorganization proceedings. A most important report-
ing concern is that the reorganization amounts be reported separately from other
operating amounts. Peerless Products prepares the following financial statements as
of December 31, 20X7: balance sheet (Figure 20–3), income statement (Figure 20–4),
and statement of cash flows (Figure 20–5). Note that Debtor-in-Possession indicates
 Chapter 20 Corporations in Financial Difficulty 1053

FIGURE 20–2 PEERLESS PRODUCTS CORPORATION

Plan of Reorganization Plan of Reorganization under Chapter 11 of the Bankruptcy Code
(Filed July 1, 20X7)
a. The accounts payable of $26,000 will be provided for as follows: (1) $6,000 will be
eliminated, (2) $4,000 will be paid in cash, (3) $12,000 of the payables will be exchanged
for subordinated debt, and (4) $4,000 of the payables are to be exchanged for 4,000
shares of newly issued common stock.
b. The partially secured notes payable of $10,000 will be provided for as follows: (1) $2,000
will be paid in cash and (2) the remaining $8,000 will be exchanged for senior debt secured
by a lien on equipment.
c. The unsecured notes payable of $80,000 will be provided for as follows: (1) $12,000 is to
be eliminated, (2) $14,000 is to be paid in cash, (3) $49,000 is to be exchanged into senior
debt secured by a lien against fixed assets, and (4) $5,000 is to be exchanged into 5,000
shares of newly issued common stock.
d. The accrued interest of $3,000 will be provided as follows: (1) $2,000 will be eliminated
and (2) the remaining $1,000 will be paid in cash.
e. The accrued wages of $14,000 will be provided as follows: (1) $12,000 will be paid in cash and
(2) the remaining $2,000 will be exchanged into 2,000 shares of newly issued common stock.
f. The preferred shareholders will receive 8,000 shares of newly issued common stock in
exchange for their preferred stock.
g. The present common stockholders will receive 1,000 shares of newly issued common stock
in exchange for their present common stock

FIGURE 20–3 PEERLESS PRODUCTS CORPORATION

Balance Sheet for a (Debtor-in-Possession)
Company in Reorganization Balance Sheet
Proceedings December 31, 20X7
Assets
Cash $ 40,000
Income Tax Refund Receivable 12,000
Marketable Securities 8,000
Accounts Receivable $ 6,000
Less: Allowance for Uncollectibles (1,000) 5,000
Inventory 37,000
Total Current Assets $102,000
Property, Plant & Equipment $104,000
Less: Accumulated Depreciation (26,000) 78,000
Total Assets $180,000
Liabilities
Liabilities Not Subject to Compromise:
Current Liabilities (postpetition):
Short-Term Borrowings $ 15,000
Accounts Payable—Trade 10,000
Noncurrent Liability:
Mortgage Payable, Fully Secured 48,000
Total Liabilities Not Subject to Compromise $ 73,000
Liabilities Subject to Compromise (prepetition):
Accounts Payable $ 26,000
Notes Payable, Partially Secured 10,000
Notes Payable, Unsecured 80,000
Accrued Interest 3,000
Accrued Wages 14,000
Total Liabilities Subject to Compromise 133,000
Total Liabilities $206,000
Shareholders’ Equity
Preferred Stock $ 40,000
Common Stock ($1 par) 10,000
Retained Earnings (deficit) (76,000)
Total Shareholders’ Equity (26,000)
Total Liabilities & Shareholders’ Equity $180,000
1054 Chapter 20 Corporations in Financial Difficulty

FIGURE 20–4 PEERLESS PRODUCTS CORPORATION

Income Statement for a (Debtor-in-Possession)
Company in Reorganization Income Statement
Proceedings For the Year Ended December 31, 20X7
Revenue:
Sales $120,000
Cost and Expenses:
Cost of Goods Sold $110,000
Selling, Operating & Administrative 21,000
Interest (contractual interest $6,000) 3,000 134,000
Loss before Reorganization Items & Income
Tax Benefit $ (14,000)
Reorganization Items:
Loss on Disposal of Assets $ (10,000)
Professional Fees (8,000)
Interest Earned on Accumulated Cash
Resulting from Chapter 11 Proceeding 2,000
Total Reorganization Items (16,000)
Loss before Income Tax Benefit $ (30,000)
Income Tax Benefit 12,000
Net Loss $ (18,000)

FIGURE 20–5 PEERLESS PRODUCTS CORPORATION

Statement of Cash (Debtor-in-Possession)
Flows for a Company in Statement of Cash Flows
Reorganization Proceedings For the Year Ended December 31, 20X7
Cash Flows Provided by Operating Activities:
Cash Received from Customers $133,000
Cash Paid to Suppliers & Employees (109,000)
Interest Paid (3,000)
Net Cash Provided by Operating Activities before Reorganization Items $ 21,000
Operating Cash Flows Used by Reorganization Activities:
Professional Fees $ (8,000)
Interest Received on Cash Accumulated Due to Chapter 11 Proceeding 2,000
Net Cash Used by Reorganization Items $ (6,000)
Net Cash Provided by Operating Activities & Reorganization Items $ 15,000
Cash Flows Provided by Investing Activities:
Proceeds from Sale of Assets Due to Chapter 11 Proceeding $ 10,000
Net Cash Provided by Investing Activities $ 10,000
Cash Flows Provided by Financing Activities:
Net Borrowings under Short-Term Financing Plan $ 15,000
Principal Payments on Prepetition Debt Authorized by Court (Mortgage Payable) (2,000)
Net Cash Provided by Financing Activities $ 13,000
Net Increase in Cash $ 38,000
Cash at January 1, 20X7 2,000
Cash at December 31, 20X7 $ 40,000

that Peerless continues to manage its own assets rather than have a court-appointed
trustee manage them.
On January 2, 20X8, the bankruptcy court approves the plan of reorganization as filed.
Peerless carries out the plan as shown in the recovery analysis in Figure 20–6.
An important concept for determining the appropriate accounting for entities in reorga-
nization is calculating reorganization value. Reorganization value is the fair value of the
FIGURE 20–6 Recovery Analysis for Plan of Reorganization

PEERLESS CORPORATION
Plan of Reorganization
Recovery Analysis
Recovery

Common Stock Total Recovery

Elimination of Surviving Senior Subordinated
Debt and Equity Debt Cash Debt Debt % Value $ %
Postpetition Liabilities (73,000) (73,000) (73,000) 100%
Claims/Interest:
Accounts Payable (26,000) 6,000 (4,000) (12,000) 20% (4,000) (20,000) 77
Notes Payable, partially secured (10,000) (2,000) (8,000) (10,000) 100
Notes Payable, unsecured (80,000) 12,000 (14,000) (49,000) 25 (5,000) (68,000) 85
Accrued interest (3,000) 2,000 (1,000) (1,000) 33
Accrued wages (14,000) (12,000) 10 (2,000) (14,000) 100
Total (133,000) 20,000
Preferred Shareholders (40,000) 32,000 40 (8,000) (8,000)
Chapter 20

Common Shareholders (10,000) 9,000 5 (1,000) (1,000)

Retained Earnings Deficit 76,000 (76,000)
Total (180,000) (15,000) (73,000) (33,000) (57,000) (12,000) 100% (20,000) (195,000)

Note: Parentheses indicate credit amount.

Corporations in Financial Difficulty 1055
1056 Chapter 20 Corporations in Financial Difficulty

entity’s assets. Typical methods of determining reorganization value are discounting future
cash flows or appraisals. After extensive analysis, a reorganization value of $195,000 is
determined for Peerless’ assets. Recall that fresh start accounting is appropriate only when
both of the following conditions occur: (1) reorganization value is less than total post-
petition liabilities and allowed claims and (2) holders of existing shares of voting stock
immediately before the plan of reorganization is approved retain less than 50 percent of
the voting shares of the emerging entity. To determine the first condition for Peerless, the
following comparison approves the plan of reorganization:

Postpetition liabilities $ 73,000

Liabilities deferred pursuant to Chapter 11 proceedings 133,000
Total postpetition liabilities & allowed claims $206,000
Reorganization value (195,000)
Excess of liabilities over reorganization value $ 11,000

Note that the first condition for fresh start accounting is present. The second condition for
fresh start accounting also occurs as shown in Figure 20–6. Immediately before the plan
of reorganization is approved, the common shareholders hold only 5 percent of the com-
mon stock of the emerging entity. Therefore, fresh start accounting is used for Peerless.
After intensive study of risk-equivalent companies, the profit potential of the emerging
company, and the present value of future cash flows, the capital structure of the emerging
company is established as follows:

Postpetition current liabilities $ 25,000

Postpetition mortgage payable 48,000
Senior debt 57,000
Subordinated debt 12,000
Common stock (new) 20,000
Total postreorganization capital structure $162,000

Note that for purposes of the illustration, the newly issued common stock is no-par stock;
therefore, no additional paid-in capital is carried forward to the emerging entity. If the
assigned value of the newly issued stock is higher than its par value, an additional paid-in
capital account is credited for the excess. The $162,000 of postreorganization capital is
the reorganization value of $195,000 less the $33,000 paid for the prepetition liabilities
as part of the plan of reorganization.
Peerless Products prepares entries to record the execution of the plan of reorganization
as it transpires between January 1, 20X8, and April 1, 20X8. Figure 20–7 is a worksheet
illustrating the effects of executing the plan of reorganization on Peerless’ balance sheet
accounts. The first journal entry (1) records the debt restructuring and the gain on the
discharge of debt:

January 1, 20X8–April 1, 20X8

(1) Liabilities Subject to Compromise 133,000
Cash 33,000
Senior Debt 57,000
Subordinated Debt 12,000
Common Stock (new) 11,000
Gain on Debt Discharge 20,000
Record debt discharge.

The second journal entry (2) records the exchange of stock for stock. The prior pre-
ferred shareholders receive 8,000 shares of newly issued common stock. The prior com-
mon shareholders receive 1,000 shares of the newly issued common stock:
 Chapter 20 Corporations in Financial Difficulty 1057

January 1, 20X8–April 1, 20X8

(2) Preferred Stock 40,000
Common Stock (old) 10,000
Common Stock (new) 9,000
Additional Paid-In Capital 41,000
Record exchange of stock for stock.

The last journal entry (3) records the fresh start adjustments of the assigned values
of the emerging entity’s assets and the elimination of any retained earnings or deficit.
A comparison between the company’s book values and fair values follows. The fair
values are determined according to the procedures in ASC 360. An impairment loss

FIGURE 20–7 Effect of Plan of Reorganization on Company’s Balance Sheet

Adjustments to Record
Confirmation of Plan
Company’s
Pre- Debt Exchange Fresh Reorganized
confirmation Discharge of Stock Start Balance Sheet
Assets
Cash $ 40,000 $ (33,000) $ 7,000
Income Tax Refund Receivable 12,000 12,000
Marketable Securities 8,000 $ 2,000 10,000
Accounts Receivable (net) 5,000 5,000
Inventory 37,000 (4,000) 33,000
Total $ 102,000 $ 67,000
Property, Plant & Equipment (net) 78,000 7,000 85,000
Reorganization Value in
Excess of Amounts Allocable
to Identifiable Assets 10,000 10,000
Total Assets $ 180,000 $ (33,000) $ 15,000 $ 162,000
Liabilities
Liabilities Not Subject to Compromise:
Current Liabilities:
Short-Term Borrowings $ (15,000) $ (15,000)
Accounts Payable (10,000) (10,000)
Noncurrent Liability:
Mortgage Payable (48,000) (48,000)
Total $ (73,000) $ (73,000)
Liabilities Subject to Compromise: (133,000) $133,000
Senior Debt (57,000) (57,000)
Subordinated Debt (12,000) (12,000)
Total Liabilities $(206,000) $ 64,000 $(142,000)
Shareholders’ Equity
Preferred Stock $ (40,000) $40,000
Common Stock (old) (10,000) 10,000
Common Stock (new) $ (11,000) (9,000) $ (20,000)
Additional Paid-In Capital (41,000) $ 41,000
Retained Earnings (deficit) 76,000 (20,000) 20,000
(76,000) 0
Total Shareholders’ Equity $ 26,000 $ (31,000) 0 $(15,000) $ (20,000)
Total Liabilities & Shareholders’ Equity $(180,000) $ 33,000 0 $(15,000) $(162,000)

Note: Parentheses indicate credit amount.

1058 Chapter 20 Corporations in Financial Difficulty

is measured by the amount that the carrying value of a long-lived asset (or asset
group) exceeds its fair value. Note that Reorganization Value in Excess of Amounts
Allocable to Identifiable Assets is debited for an amount not assignable to other assets.
The reorganization value excess is reported as an intangible asset and accounted
for according to ASC 350, which specifies that intangibles with finite useful
lives should be amortized over their lives. However, for intangible assets determined
to have an indefinite life, no amortization should be taken. Instead these indefinite
life intangibles must be tested for impairment at least annually to determine whether
they are impaired and a loss should be recognized for a reduction in their carrying
amount.
Note that if prior to entering reorganization Peerless had goodwill that was judged to
be impaired, it would recognize any impairment loss on the debtor-in-possession income
statement. Typically, a company in reorganization proceedings is not expected to have
goodwill because it is related to excess earnings potential. A case-by-case examination
must be made, however, to determine whether the company’s recognized goodwill was
impaired.

Book Fair
Value Value Difference
Cash $ 7,000 $ 7,000 $ 0
Income tax refund receivable 12,000 12,000 0
Marketable securities 8,000 10,000 2,000
Accounts receivable (net) 5,000 5,000 0
Inventory 37,000 33,000 (4,000)
Property, plant & equipment 78,000 85,000 7,000
Reorganization value in excess of amounts
allocable to identifiable assets 0 10,000 10,000
Totals $147,000 $162,000 $15,000

The entry to record the fresh start revaluation of assets and elimination of the deficit
follows:

April 1, 20X8
(3) Marketable Securities 2,000
Property, Plant, and Equipment 7,000
Reorganization Value in Excess of Amounts
Allocable to Identifiable Assets 10,000
Gain on Debt Discharge 20,000
Additional Paid-In Capital 41,000
Inventory 4,000
Retained Earnings—Deficit 76,000
Record fresh start accounting and eliminate deficit.

The last column in Figure 20–7 presents the postreorganization, new reporting entity’s
balance sheet.
Some reorganizations are unsuccessful, and the debtor must be liquidated. The
major reason for unsuccessful reorganizations is continuing losses from operations and
no reasonable likelihood of rehabilitation. Another common reason is the inability to
consummate a reorganization plan because of the failure to dispose of an unprofitable
subsidiary, a material default of the plan by either the debtor or a creditor, or the inability
to effect part of the plan as a result of changes in the economic environment. The debtor
company then moves from reorganization into liquidation; the latter is the topic of the
next section of the chapter.