Solution manual advanced accounting 10e by beams ch17

Chapter 17
CORPORATE LIQUIDATIONS and REORGANIZATIONS
Answers to Questions
1

Equity insolvency occurs when a debtor is unable to pay its debts as they come due. Bankruptcy
insolvency occurs when a debtor’s liabilities exceed the fair value of all assets.

2

A bankruptcy proceeding is designated voluntary if the debtor corporation files the petition to place
itself under the protection of the bankruptcy court and involuntary if creditors file the petition to bring
the debtor into bankruptcy court. An involuntary petition may be filed by a single creditor with an
unsecured claim of $12,300 or more if there are fewer than twelve unsecured creditors. Otherwise, three
or more entities with unsecured claims totaling at least $12,300 must file in order to commence an
involuntary case. The requirements are the same for Chapter 7 and Chapter 11 cases.

3

The duties of the U.S. trustee are to maintain and supervise a panel of private trustees eligible to serve in
Chapter 7 cases, to serve as trustee or interim trustee in some bankruptcy cases, to supervise the
administration of bankruptcy cases, and to preside over creditor meetings. Bankruptcy judges still
supervise cases in districts without U.S. trustees.

4

The debtor corporation in a bankruptcy case has the following duties: (1) to file a list of creditors, a
schedule of assets and liabilities, and a statement of the debtor’s financial affairs; (2) to cooperate with
the trustee so that the trustee may perform his duties; (3) To surrender all property, including books,
documents, records, and so on, to the trustee; and (4) to appear at hearings of the bankruptcy court as
required.

5

A trustee is not appointed in all Title 11 cases. In Chapter 7 cases a trustee will be elected by unsecured
creditors if a majority vote in amount of holders with at least 20 percent of the claims is obtained.
Otherwise, an appointed interim trustee serves as trustee. In Chapter 11 cases a trustee is appointed only
if deemed necessary by the court, but otherwise, the debtor remains in possession of the estate and
performs the duties of a trustee. Within 30 days from the time the court orders the appointment of a
trustee in a Chapter 11 case, a party in interest may request the election of a trustee.

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17-2

Corporate Liquidations and Reorganizations

6

The trustee in a liquidation case takes possession of the debtor’s estate, converts estate assets into cash,
and distributes the proceeds as directed by the court. He also performs other duties such as investigating
the financial affairs of the debtor, providing information about the estate to parties of interest, examining
creditor claims and objecting to those that appear improper, operating the debtor’s business if authorized
to do so by the court, providing financial reports and summaries about the estate to the court, and filing
reports on trusteeship as directed by the court.

7

The priority rankings in a Chapter 7 liquidation case are summarized in Exhibit 17–2 of the text. The
priorities recognized for unsecured claims (Rank II) are: (1) administrative expenses, (2) claims incurred

between an involuntary filing and appointment of a trustee, (3) salary claims up to $10,000 per
individual earned within 90 days of filing, (4) employee benefit plan contribution claims up to $10,000
per individual earned within 180 days of filing, (5) individual claims up to $1,800 for goods and services
purchased from, but not provided by the debtor, and (6) claims of governmental units for taxes owed by
the debtor (subject to time restrictions), including taxes collected and withheld for which the debtor is
liable.

8

Four ranks within the unsecured nonpriority claim category (general unsecured claims) are: (1) claims
allowed that were timely filed, (2) claims allowed where proof was filed late, (3) claims allowed for
fines, penalties or forfeitures, or damages, and arising before the court order for relief or appointment of
a trustee, and (4) claims for interest on unsecured claims.

9

The accountant’s statement of affairs is a financial statement that is designed to provide information
about liquidation values and priority rankings for use by the trustee, the court, creditors, and other
interested parties in the debtor’s estate. Assets are measured at expected net realizable values in the
statement, but book values are also included for reference purposes. (The Bankruptcy Act refers to a
statement of affairs, but that statement is a questionnaire that includes various financial and nonfinancial
and legal section

10

A debtor corporation’s estate may be liquidated even though the filing is under Chapter 11. This can
occur when the case is transferred to Chapter 7 for liquidation. It can also be carried out in accordance
with an approved Chapter 11 plan of reorganization that calls for sale and distribution of the proceeds
from the debtor corporation’s estate.

11

A debtor in possession reorganization case is a Chapter 11 case in which the bankruptcy court does not
appoint a trustee, but instead, allows the debtor corporation to carry out the duties that otherwise would
be performed by a trustee.

12

A creditor committee can file a plan of reorganization under a Chapter 11 case after 120 days from the
date the court order for relief is granted. The order for relief occurs when the debtor or creditor’s filing
petition is approved by the court.

13

The approval of a plan of reorganization requires acceptance of the plan by at least two-thirds in amount
and over half in number of claims in each class of claims. Further, each class of claims must accept the
plan or not be impaired under it. A class of claims that would receive nothing if the corporation were
liquidated is not impaired if it receives nothing under a plan and, accordingly, acceptance by that class of
claims is not required.

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Chapter 17

17-3

14

Prepetition liabilities are the liabilities of an enterprise that were incurred prior to a Chapter 11 filing.

They are reported at the amounts allowed by the bankruptcy court. Prepetition liabilities subject to
compromise are those liabilities that may be impaired by a plan and that are eligible for compromise
because they are either unsecured or undersecured.

15

Reorganization value is an estimate of the value of the reconstituted entity that will emerge from
reorganization, plus the expected net realizable value of the assets that will be disposed of before
reconstitution occurs. It is also described as the fair value of the entity before considering liabilities.
Reorganization value approximates the amount a willing buyer would pay for the assets of the entity
immediately after the restructuring.

16

Fresh start reporting should be used by a company emerging from Chapter 11 if the following two
conditions are met: (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 and (2)
holders of existing voting shares immediately before confirmation receive less than 50 percent of the
voting shares of the emerging entity.

17

Entities not qualifying for fresh start reporting report liabilities compromised by a confirmed
reorganization plan in a manner similar to that of a note issued in a noncash transaction under APB
Opinion No. 21. Forgiveness of debt should be reported as an extraordinary item.

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17-4

Corporate Liquidations and Reorganizations

SOLUTIONS TO EXERCISES
Solution E17-1
1
b
2
d
3
c
4
d
5
d
6
c
7
a
8
d
9
c
10
d
11
c
12
d
13

c

Solution 17-2
1
a
2
d
3
c
4
d

Solution E17-3
Note receivable from Patriots Supply
Amount secured by inventory items at expected recoverable value

$100,000
(30,000)

Unsecured portion of note receivable from Patriots Supply
Expected recovery on the dollar for unsecured claims

70,000
.35

Expected recovery on unsecured portion of note
Add: Secured portion

24,500
30,000

Total expected recovery on note from Patriots Supply

$ 54,500

Solution E17-4
1

On the basis of the reorganization value, Baxter Hardware qualifies for
fresh start reporting because the estimated reorganization value of
$2,000,000 is less than the postpetition liabilities and allowed claims.
Estimated reorganization value
Liabilities:
Postpetition liabilities
Prepetition liabilities
Fully secured debt
Excess liabilities over reorganization value

2

$2,000,000
$1,200,000
1,500,000
900,000

3,600,000
$1,600,000

Old stockholders must retain less than a 50% interest in the “new
entity.”

Reorganization value
Less: Payment to prepetition claimants
Reorganized capital structure:
Postpetition liabilities
Notes payable
Fully secured debt

$2,000,000
150,000
1,850,000
$1,200,000
300,000
900,000

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Chapter 17

17-5

New common stock to prepetition claimants
New common stock to old stockholders

375,000
$ (925,000)

2,775,000

Solution E17-5

Cash available for distribution
Mortgage payable (secured portion)
Priority claims (administrative expenses and salaries)
Available for unsecured, nonpriority claims

$100,000
(50,000)
50,000
(10,000)
$ 40,000

Unsecured, nonpriority claims:
Balance of mortgage payable
Accounts payable
Unsecured, nonpriority claims

$ 30,000
50,000
$ 80,000

$40,000 available cash/$80,000 claims = $.50 on the dollar
Schedule of Distribution of Available Cash
Mortgage payable — secured portion
Unsecured, priority claims
Mortgage payable — unsecured portion ($30,000 ´ $.50)
Accounts payable ($50,000 ´ $.50)
Total cash distributed

$ 50,000
10,000

15,000
25,000
$100,000

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17-6

Corporate Liquidations and Reorganizations

SOLUTIONS TO PROBLEMS
Solution P17-1
1

Entries on trustee’s books:
March 1, 2008
Cash
$ 4,000
8,000
Accounts receivable — net
Inventories
36,000
Land
20,000
100,000
Buildings — net
Intangible assets
26,000
Accounts payable

$50,000
40,000
Note payable — unsecured
Revenue received in advance
1,000
Wages payable
3,000
Mortgage payable
80,000
Estate equity
20,000
To record custody of Scott Corporation in liquidation.
March 2008
Cash
$ 7,200
Estate equity
800
$ 8,000
Accounts receivable — net
To record collection of receivables and recognize loss.
Cash
Estate equity
Inventories
To record sale of inventories at a loss.

$ 19,400
16,600
$36,000

Cash

$ 90,000
Estate equity
30,000
Land
Buildings — net
To record sale of land and buildings at a loss.
Estate equity
$ 26,000
Intangible assets
To write off intangible assets at a loss.
Estate equity
Administrative expenses
payable — new
To accrue trustee expenses.

$

$ 20,000
100,000

$ 26,000

8,200
$

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8,200

Chapter 17

17-7

Solution P17-1 (continued)
2

Scott Corporation in Trusteeship
Balance Sheet
at March 31, 2008
Assets
Cash

$120,600

Liabilities And Deficit
Accounts payable
Note payable — unsecured
Revenue received in advance
Wages payable
Mortgage payable
Administrative expenses payable — new
Total liabilities
Less: Estate deficit

$ 50,000
40,000
1,000
3,000
80,000

8,200
182,200
(61,600)

Total liabilities less deficit

$120,600

Statement of Cash Receipts and Disbursements
from March 1 to March 31, 2008
Cash balance, March 1, 2008
Add: Cash receipts
Collections of receivables
Sale of inventories
Sale of land and buildings

$
$ 7,200
19,400
90,000

Less: Cash disbursements (none)
Cash balance, March 31, 2008

4,000

116,600
120,600
0
$120,600

Statement of Changes in Estate Equity
from March 1 to March 31, 2008
Estate equity, March 1, 2008

$20,000

Less:
Loss on uncollectible receivables
Loss on sale of inventories
Loss on sale of land and buildings
Loss on write-off of intangibles
Administrative expenses
Estate deficit, March 31, 2008

$

800
16,600
30,000
26,000
8,200

81,600
$61,600

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17-8

Corporate Liquidations and Reorganizations

Solution P17-1 (continued)
3

Entries on trustee’s books:
April 2008
Mortgage payable
$80,000
Cash
$80,000
To record payment of secured creditors from proceeds from sale of
land and buildings.
$ 8,200
Administrative expenses payable — new
Revenue received in advance
1,000
Wages payable
3,000
Cash
To record payment of priority liabilities.

$12,200

Accounts payable
$15,800
12,600
Note payable — unsecured
Cash

$28,400
To record payment of $.32 per dollar to unsecured creditors
(available cash of $28,400 divided by unsecured claims of
$90,000).
Accounts payable
$34,200
27,400
Note payable — unsecured
Estate equity
$61,600
To write off remaining liabilities and close trustee’s records.

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Chapter 17

17-9

Solution P17-2
1

Amount expected to be available for unsecured claims:
Total amount expected to be available for all
claims
Less: Payments to secured and priority claims
Mortgage payable
Note payable
Priority claims

$445,000
$220,000
75,000
80,000

Expected to be available for unsecured
nonpriority claims
2

375,000
$ 70,000

Expected recovery per dollar of unsecured claims:
Expected to be available (from 1) = $70,000
Unsecured claims ($550,000 - $375,000) = $175,000
Expected recovery on the dollar: $70,000/$175,000 = $.40

3

Expected recovery by class of creditors:
$220,000
Fully secured — mortgage payable
85,000
Partially secured — note payable $75,000 + ($25,000 ´ $.40)
80,000
Priority unsecured — liabilities to priority creditors
Unsecured nonpriority creditors — accounts
payable ($150,000 ´ $.40)
60,000
Total

$445,000

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17-10

Corporate Liquidations and Reorganizations

Solution P17-3
1

Ranking of claims:
Fully secured:
Holders of first mortgage and related
interest

$228,500

Unsecured priority:
1.
Administrative expenses
3.
Wages payable up to $4,000 per
employee
5.
Customer claims for merchandise paid
for and not delivered (maximum
$1,800 per individual)

6.
State government for gross
$ 3,000
receipts taxes
Local government for property
taxes
4,000
Total unsecured priority claims
Unsecured nonpriority:
1.
Merchandise creditors
$99,000
Local bank for principal of loan
30,000
President for salary due over $4,000 1,000
4.
Interest on unsecured bank loan
Total unsecured nonpriority claims

$ 12,500
47,000
1,500

7,000
68,000

130,000
4,500
134,500
$431,000

Total all claims
2

Distribution of available cash:
1st

Mortgage holders (100%)

2nd

Administrative expenses (100%)

12,500

3rd

Employees (up to $4,000 each) (100%)

47,000

4th

Customers for merchandise not delivered
(100%)

5th

State government (100%)
Local government (100%)

$228,500

1,500
$ 3,000
4,000

7,000

[Remaining cash ($374,500 - $296,500) of $78,000/$130,000 claim of next
rank = $.60 return on dollar]
6th

Merchandise creditors ($99,000 ´ .60)
Local bank for loan principal
($30,000 ´ .60)
Company president ($1,000 ´ .60)
Total distributed (equal to available cash)

$59,400
18,000
600

78,000
$374,500

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Chapter 17

17-11

Solution P17-4
1

Hanna Corporation
Statement of Affairs
on June 30, 2008
Assets
Realizable
ValuesLiability
Offsets
for Secured
Creditors

Book
Value
$55,000

2,200
15,000
20,000

Pledged for partially
secured creditors
Equipment — net
Less: Mortgage note payable
and accrued interest

Realizable
Value
Available for
Unsecured
Creditors

$28,000
(31,000)

$

0

Available for priority
and unsecured creditors
Cash
Accounts receivable — net
Inventories

2,200
13,500
22,500

Total available for priority and unsecured
creditors
Less: Priority liabilities

38,200
12,000

Total available for unsecured creditors
Estimated deficiency
$92,200

26,200
10,800
$37,000

Liabilities And Stockholders’ Equity
Book
Value
$12,000

31,000

26,400
7,600
55,000
(39,800)
$92,200

Secured and
Unsecured NonPriority Claims priority Claims
Priority liabilities
Wages payable (assumed under
$4,000 per employee)
Partially secured creditors
Note payable and accrued
interest
Less: Equipment pledged

as security
Unsecured creditors
Accounts payable
Rent payable

$12,000

$31,000
(28,000)

$ 3,000
26,400
7,600

Stockholders’ equity
Capital stock
Retained earnings (deficit)
$37,000

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17-12

Corporate Liquidations and Reorganizations

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Chapter 17

17-13

Solution P17-4 (continued)
2

Estimated payments per dollar for unsecured creditors
Cash available

$66,200

Distribution to partially secured and unsecured
priority creditors:
Note payable and interest
Administrative expenses
Wages payable

$28,000
4,000
12,000

44,000

Available to unsecured nonpriority
creditors = A

$22,200

Note payable and interest (unsecured portion)
Accounts payable

Rent payable

$ 3,000
26,400
7,600

Unsecured nonpriority claims = B

$37,000

A/B = $22,200/$37,000 = $.60 per dollar
Expected recovery for each class of claims
Partially secured
Note payable and interest
Secured portion
Unsecured portion ($3,000 ´ $.60)

$28,000
1,800

$29,800

$ 4,000
12,000

16,000

$15,840
4,560

20,400

Unsecured priority
Administrative expenses
Wages payable
Unsecured nonpriority
Accounts payable ($26,400 ´ $.60)
Rent payable ($7,600 ´ $.60)
Total payments

$66,200

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17-14

Corporate Liquidations and Reorganizations

Solution P17-5
Dawn Corporation — in Chapter 7
Statement of Affairs at July 10, 2008

1
Assets
Book
Value
$210,000
250,000

80,000
200,000
150,000
10,000

Fully secured
Accounts receivable — net
Less: Notes payable
Partially secured
Land and buildings — net
Less: Mortgage and interest
payable
Unsecured
Cash
Inventories
Equipment — net
Intangible assets
Available for priority and
unsecured
Priority liabilities
Available for nonpriority
unsecured
Estimated deficiency

Realizable
ValueLiability
Offsets

Realizable
Value

Available for
Unsecured

$160,000
100,000

$ 60,000

$140,000
205,000

0
80,000
210,000
60,000
0
410,000
150,000
260,000
155,000
$415,000

$900,000
Equities
Secured and
Priority
Claims

Book
Value

$ 50,000
24,000
76,000

Priority liabilities
Accounts payable
Wages payable
Taxes payable

100,000

Fully secured
Note payable
Less: Accounts receivable — net

205,000

Partially secured
Mortgage and interest payable
Less: Land and buildings — net

350,000
300,000
(205,000)
$900,000

Unsecured
Accounts payable
Capital stock
Retained earnings deficit

UnsecuredNonpriority
Claims

$ 50,000
24,000
76,000
150,000
$100,000
160,000
60,000
$205,000
140,000
65,000

$ 65,000
350,000
$415,000

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Chapter 17

17-15

Solution P17-5 (continued)
2

Claims by

Priority Ranks
Priority claims
Administrative expenses
Accounts payable
Wages payable
Taxes payable
Fully secured claims
Note payable
Partially secured claims
Mortgage and interest payable
Unsecured
Accounts payable

Amounts to Amounts to Be
Be Paid
Written Off

$ 11,000
50,000
24,000
76,000

$ 11,000
50,000
24,000
76,000

100,000

100,000

205,000

140,000
39,000

$ 26,000

350,000
$816,000

210,000
$650,000

140,000
$166,000

Calculation of recovery for unsecured nonpriority claims
Cash available
Less: Paid to priority claims
Less: Paid to fully secured claims
Less: Paid to partially secured creditors – secured portion

$650,000
(161,000)
(100,000)
(140,000)

A

$249,000

Cash available for unsecured

Unsecured claims:
Partially secured ($205,000 - $140,000 secured)
Accounts payable — nonpriority

$ 65,000
350,000

B

$415,000

Total unsecured claims

A ¸ B = $249,000/$415,000 = $.60 recovery on the dollar

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17-16

Corporate Liquidations and Reorganizations

Solution P17-6
1

Everlast Window Corporation

Statement of Affairs on June 30, 2008
Assets
Realizable
ValuesRealizable
Liability
Value
Offsets for Available for
Secured
Unsecured
Creditors
Creditors

Book
Value
$230,000

40,000
70,000
50,000
60,000
50,000

Pledged for fully
secured creditors
Land and building
$170,000
Less: Mortgage payable
and accrued interest
(165,000)
Available for priority

and unsecured creditors
Cash
Accounts receivable — net
Inventories
Machinery — net
Goodwill
Total available for priority and unsecured
creditors
Less: Priority liabilities
Total available for unsecured creditors
Estimated deficiency

$500,000

$

5,000
40,000
63,000
42,000
20,000
0

170,000
70,000
100,000
65,000
$165,000

Liabilities and Stockholders’ Equity

Secured and
Priority
Claims

Book
Value
$ 60,000
10,000
150,000
15,000
110,000
50,000
5,000
200,000
(100,000)
$500,000
2

Priority liabilities
Wages payable
Property taxes payable
Fully secured creditors
Mortgage payable
Interest on mortgage payable
Unsecured creditors
Accounts payable
Note payable — unsecured
Interest payable — unsecured
Stockholders’ equity
Capital stock

Retained earnings (deficit)

Unsecured
Non-priority
Claims

$ 60,000
10,000
70,000
$150,000
15,000
165,000
$110,000
50,000
5,000

$165,000

Settlement per dollar of rank 1 unsecured creditors is $.6250 ($100,000
available for unsecured/$160,000 accounts and notes payable). No payment
is made for the $5,000 unsecured interest claim.
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Chapter 17

17-17

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17-18

Corporate Liquidations and Reorganizations

Solution P17-7
1

The reorganization is eligible for fresh start accounting because the
liabilities on June 30, 2008 of $16,500 exceed the reorganization value
of $16,000 by $500. Also, the common stock of the new entity is
allocated $5,000 to prepetition creditors and $2,000 to Lowstep’s old
stockholders, so that the old stockholders have less than a 50 percent
interest in the new entity.

2

Entries to adjust Lowstep’s accounts for the reorganization plan:
Prepetition liabilities
$12,500
Accounts payable (old)
$ 800
Wages payable (old)
400
Note payable (new)
3,800
Common stock (new)
5,000
Gain on debt restructuring
2,500

To adjust prepetition liabilities to conform with the plan.
Loss on asset adjustments to fair values
Inventories
Land
Buildings — net
Patent
To adjust assets to their fair values.

$ 4,000
400
1,000

Common stock (old)
Common stock (new)
Additional paid-in capital
To record exchange of common stock.

$ 7,000

$1,400
4,000

Gain on debt discharge
$
Additional paid-in capital
Reorganization value in excess of fair value
Loss on asset adjustments to fair
values
Deficit
To eliminate deficit and record adoption of

$2,000
5,000
2,500
5,000
1,000
$4,000
4,500
fresh start reporting.

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Chapter 17

17-19

Solution P17-7
3

(continued)
Lowstep Corporation
Final Balance Sheet
as of July 8, 2008

Assets
Cash
Trade receivables — net
Inventories
Land

Buildings — net
Equipment — net
Reorganization value in excess of fair values
Total assets

$ 6,700
1,000
2,000
2,000
1,500
1,800
1,000
$16,000

Liabilities and Stockholders’ Equity
Accounts payable
Accounts payable (old)
Wages payable
Wages payable (old)
Notes payable (new)
Total liabilities
Common stock (new)
Total liabilities and stockholders’ equity

$ 3,000
800
1,000
400
3,800
9,000

7,000
$16,000

Note: The final balance sheet of Lowstep Corporation will be the same as
the beginning balance sheet of Highstep Corporation.

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