solution manual advanced financial accounting 8th edition baker chap020

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Chapter 20 - Corporations in Finanacial Difficulty

CHAPTER 20
CORPORATIONS IN FINANCIAL DIFFICULTY
ANSWERS TO QUESTIONS
Q20-1 The nonjudicial actions available to a financially distressed company are debt
restructuring arrangements and creditor's committee management. The judicial actions
available are corporate liquidation (Chapter 7) and corporate reorganization (Chapter
11).
Q20-2 The major difference between a Chapter 7 action and a Chapter 11 action is that
the debtor continues as a business after a Chapter 11 reorganization whereas the
business does not survive a Chapter 7 liquidation.
Q20-3 Under two circumstances an involuntary petition for relief may be filed. The first
circumstance is that the debtor is generally not paying debts as they become due. The
second circumstance is that within the last 120 days a custodian has been appointed by
other creditors, by the debtor, or by some other agency to take possession of the
debtor's assets. If more than 12 creditors exist, then three or more creditors must
combine to file the petition. These three or more creditors must have aggregate
unsecured claims of at least $5,000.
Q20-4 The following items are usually included in the Plan of Reorganization filed as
part of a Chapter 11 reorganization:
All major actions to be taken during the reorganization:
(1) Discontinuances of unprofitable operations
(2) Restructuring of debt with specific creditors
(3) Revaluation of assets and liabilities
(4) Changes in the par value of outstanding stock, or realignment of
stockholders' equity with newly issued shares of voting common stock.
Q20-5 The account Reorganization Value in Excess of the Amount Assigned to
Identifiable Assets is established during a Chapter 11 fresh start accounting to record
the excess of the reorganization value that is not assigned to specific assets. The

account is an intangible asset and is accounted for in accordance with FASB 142.
Q20-6 A company in Chapter 11 reorganization qualifies for fresh start accounting if
both of the following occur:
1. The reorganization value of the entity's assets of the emerging entity immediately
before the date of confirmation is less than the total of all post-petition liabilities and
allowed claims; and
2. Holders of existing voting shares immediately before confirmation receive less than
50% of the voting shares of the emerging entity.
Companies using fresh start accounting revalue their assets to fair values, using the
procedures in FASB 141. An account called Reorganization Value in Excess of the
Amount Assigned to Identifiable Assets is used to record any excess in reorganization
value not assigned to specific assets.

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Chapter 20 - Corporations in Finanacial Difficulty

Q20-7 The financial statements that must be filed by a company during a Chapter 11
reorganization include a complete set of audited financial statements. SOP 90-7
established specific guidelines for these statements, noting that amounts associated with
reorganization should be reported separately.
Q20-8 The rights of creditors with priority in a Chapter 7 liquidation are to receive any
assets available to unsecured creditors after the secured creditors have been satisfied.
Q20-9 The statement of affairs is the basic accounting report made at the beginning of
the liquidation process to present the expected realizable amounts from disposal of the
assets, the order of creditors' claims, and the expected amount unsecured creditors will
receive as a result of the liquidation. In addition, the statement of affairs presents the
book values of the debtor company's balance sheet accounts and the estimated

deficiency to the general unsecured creditors. As a final point, the statement of affairs is
not a going concern report.
Q20-10* A trustee who takes title to the debtor's assets in a liquidation must make a
periodic financial report to the bankruptcy court reporting on the progress of the
liquidation and on the fiduciary relationship held. When the trustee accepts the assets, a
new set of books is opened for the debtor and a new account is created to recognize the
debtor's interest in the net assets accepted by the trustee. A statement of realization and
liquidation is prepared on a monthly basis for the bankruptcy court showing the results of
the trustee's fiduciary actions’ beginning at the point the trustee accepts the debtor's
assets.
Q20-11* Sales of assets are reported in the statement of realization and liquidation as
assets realized in the assets section of the statement.

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Chapter 20 - Corporations in Finanacial Difficulty

SOLUTIONS TO CASES
C20-1 Creditors' Alternatives
The options to the creditors are (1) form a creditors' committee, (2) a Chapter 11
reorganization, and (3) a Chapter 7 liquidation. The eventual decision must rest upon the
creditors' assessment of the viability of the rehabilitation of the debtor versus the
liquidation values of the debtor's assets.
Most creditors do not want to see the liquidation of a debtor because, as creditors, they
are in the business of loaning monies, not trying to manage a business or attempting to
obtain as much of a liquidation dividend as possible in a liquidation. Most creditors will
work with the debtor's management as long as possible. Secured creditors have greater
protection of their receivables than do unsecured creditors. However, even most secured

creditors prefer to see a debtor company be rehabilitated after a time of financial
difficulty rather than see the debtor liquidated. The timing of the cash flows is somewhat
dependent on the amount of reduction in debt the creditors are willing to absorb. If the
creditors are willing to work with the debtor, the creditors may eventually realize a
greater percentage of their debt, but it usually takes a longer time to receive the
payments from the debtor.
The creditors' committee is a nonjudicial action that provides for flexibility to both the
creditors and the debtor. The creditors' committee typically works with the debtor
company to enact a plan of settlement of the debtor's indebtedness. In some cases, the
creditors may assume management control of the company, but most creditors are
reluctant to do this because of the added risk of legal action if the company does enter
bankruptcy. Creditors may eventually receive a substantial part, or possibly all, of their
receivables as the debtor is able to "work down" its debt over time.
Chapter 11 reorganization offers the creditors a chance to continue having a customer
once the customer solves its immediate financial problems. A reorganization is an
acceptable option if the creditors feel the company would have the basic operating and
financial foundations after the reorganization to become a going concern. Creditors often
accept reduced amounts as settlements of their receivables, or will modify the terms of
existing debt as part of the reorganization agreement.
Chapter 7 liquidations are the final step. The creditors must go through the judicial
process that may take a long time to complete. Liquidation should be used only if no
other alternative is viable. Creditors often receive a smaller portion of their receivables
because of the forced liquidation of the assets and the extensive legal and administrative
costs involved in a liquidation.

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Chapter 20 - Corporations in Finanacial Difficulty

C20-2 Research Related to Bankruptcy
The website for the U.S. Bankruptcy Courts is: www.uscourts.gov/bankruptcycourts.html
a. The Frequently Asked Questions (FAQs) for the U.S. Bankruptcy Courts state that a U.S.
bankruptcy judge is a district court judicial officer who is appointed by the majority of
judges of the U.S. appeals court to have jurisdiction over bankruptcy matters. As
bankruptcy cases come before a district court, a bankruptcy judge is assigned to the
case. Some courts assign judges based on random assignment while other courts have
a chief judge who seeks to select a judge to assign based on a judge’s experience or
special expertise relevant to the case. Each court will have a written plan or system for
assigning cases.
b. The U.S. Bankruptcy Court’s Website has a link to Official Bankruptcy Forms to be used
in filings before the courts. The forms and instructions for a Voluntary Petition are
available in Part I of the Bankruptcy Forms Manual page. The official form is FORM B1
for a voluntary petition.
A voluntary petition is initiated by the debtor and therefore the information required is
principally related to the debtor, such as name, address, and location of the principal
assets of the debtor. The debtor must declare such items as the number of creditors, the
estimated assets, the estimated debts, the type of petition (i.e., Chapter 7, Chapter 11,
etc.), if sufficient funds will be available to satisfy the unsecured creditors. The debtor
may also be required to file additional exhibits (Exhibit A for publicly traded companies,
Exhibit B is used in personal filings and Exhibit C to describe any property that might
pose a threat of identifiable harm to public health or safety).
c The United States Bankruptcy Courts Website presents a link to Bankruptcy Statistics
that are presented in .pdf format. Statistics are presented for various time periods such
as quarters, fiscal years and calendar years. Note that Case 20-3 asks for the most
recent calendar year ending on December 31.
(1) Total business filings are presented at the top of the form for business and
nonbusiness filings for the twelve month period ended for the most recent year.
Statistics for prior years are also available. Business filings are typically about

34,000 but do fluctuate slightly based on economic conditions. Approximately sixty
percent of these filings are under Chapter 7, about twenty-eight percent under
Chapter 11, and the remainder under various other chapters of the Bankruptcy
Code.
(2) Students should find the Federal judicial district in which their educational institution
is located. The larger states typically have several districts and students may have
to make an assumption for which district they are located. It is instructive to see
that the numbers of filings vary widely by district. The number of filings may differ
due to different economic factors for specific parts of the United States, the nature
of the industrial base in a specific district, the size of a district, and other factors
reflecting business factors across court districts. Students might reflect on why the
number of filings in their Federal court district are different from those in other
districts in other circuits.

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Chapter 20 - Corporations in Finanacial Difficulty

C20-3* Selection of Bankruptcy Trustee and Trustee’s Responsibilities
Title 11 of the United States Code may be obtained from several sources through using
a web browser and the search term, “Title 11 of the U.S. Code.” The case asks about
trustees for a Chapter 7 bankruptcy filing.
a. Subchapter 1 of Chapter 7 of Title 11 of the U.S. Code specifies the administration of
a Chapter 7 bankruptcy filing. Section 701 states that the United States Trustee
shall appoint an interim trustee who is a member of the panel of private trustees
established under federal law. Private trustees are persons who have prior financial
expertise and experience and have been approved by a formal review process. After
the appointment of an interim trustee, Section 702 describes how creditors may elect

a trustee under the circumstances in which creditors holding at least twenty percent
of the unsecured claims request that an elected trustee administer the Chapter 7
bankruptcy. A candidate must receive the votes of creditors holding a majority of the
claims of the unsecured creditors.
b. Section 704 of Subchapter 1 of Chapter 7 of Title 11 of the U.S. Code defines the
duties of the trustee. The trustee is responsible for administering the business, is
accountable for all property received, and must evaluate the claims of the creditors to
make sure the claims are valid prior to settlement. The trustee also prepares
periodic reports and summaries of the operations of the business which it provides to
the United States Trustee or Bankruptcy Court. Upon completion of the operations,
the trustee must file a final report on the administration of the estate with the court
and with the United States Trustee.

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Chapter 20 - Corporations in Finanacial Difficulty

C20-4 The Bankruptcy of WorldCom
Overall, the 2002 bankruptcy of WorldCom resulted in a cumulative net reduction to their
shareholders’ equity of $70.8 billion as of December 31, 2001, and a reduction in
previously reported net income of $17.1 billion and $53.1 billion for the years ended
December 31, 2001, and 2000 respectively. Goodwill of $44.9 billion was reduced to
zero at December 31, 2001. The WorldCom bankruptcy and resultant adjustments
made during the reorganization process are certainly one of the most significant
bankruptcies in U.S. business history.
The following information is taken from WorldCom Inc.’s 10-K for the fiscal year 2002
that was filed with the SEC on March 12, 2004.
a. (Source: Item 3, Legal Proceedings) WorldCom filed a voluntary petition for

bankruptcy on July 21, 2002, under Chapter 11, Reorganization.
b. (Source: Item 3, Legal Proceedings and the MD&A) The primary reason seems to
be that management and the Board of Directors had been informed of very
significant accounting irregularities and needed time to investigate the possible
irregularities, and to protect the company from lawsuits from creditors and others.
For example, on June 26, 2002, the SEC filed a civil suit against the company for its
past financial reports. On April 29, 2002, Bernard Ebbers resigned as President and
Chief Executive Officer. The company undoubtedly felt it needed the protection of
bankruptcy to give it time to study the breadth of its financial and accounting
problems and to reorganize to recover from those problems without additional legal
pressure from its creditors.
c. (Source: Item 3, Legal Proceedings) On June 25, 2002, the company publicly
announced that an internal audit found a number of transfers from line cost expenses
(referred to as access cost expenses) to capital accounts, thus decreasing expenses
and increasing assets. For the year 2001 and the first quarter of 2002, this amount
of transfer was $3.9 billion. In addition to this item, the company was improperly
accounting for impairment tests on its long-lived assets, its acquisitions, its revenue
contracts and several other irregularities. However, it was the accounting for the
access costs as assets when they were clearly expenses that were the primary
accounting irregularity that initiated the internal review.
d. (Source: Item 7, Management’s Discussion and Analysis) Item 7 of the company’s
2002 10-K presents a section titled “Restatements and Reclassifications of
Previously Issued Consolidated Financial Statements”. A table is presented that
summarizes the restatement items on revenue and pre-tax income or loss for the
years ended December 31, 2001 and 2000. The major categories of income
statement restatement adjustments are presented below (in $millions), with a brief
explanation of each category following the table: (Parentheses used for decreases in
reported amounts)

20-6

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Chapter 20 - Corporations in Finanacial Difficulty

C20-4 (continued)

Item:
Previously reported
Restatement adjustments:
1. Impairment
2. Improper reduction
of access costs
3. Purchase accounting
4. Long lived asset
adjustments
5. International adjustments
6. Revenue related
adjustments
7. Adjustments to
accrued liabilities
8. Embratel and
Avantel acquisitions
9. Unclassified income/
(expense)
10. Other
Total adjustment items
Discontinued Operations
Adjustment
Revenue, as restated

Minority interest adjustment
Pre-tax loss, as restated

Year Ended
December 31, 2001
Pre-tax
Revenue
income (loss)
35,121
2,375

Year Ended
December 31, 2000
Pre-tax
Revenue
income (loss)
39,020
7,581

-----

(12,592)
(2,933)

--6

(47,180)
(1,827)

14

---

(2,273)
2,750

(193)
---

(3,567)
(1,713)

(749)
(1,204)

(899)
(575)

18
(36)

(487)
(995)

---

(823)

---

(732)

5,268

(35)

1,127

(325)

---

383

---

(426)

(7)
3,322
(775)

(506)
(17,503)
1,323

4
926
(602)

(750)

(58,002)
449

37,668

39,344
(669)
(14,474)

52
(49,920)

Because most of the accounting personnel, including the Chief Financial Officer and
the controller, were terminated shortly after the large scope of the accounting
irregularities were discovered, the company determined that it could not objectively
restate periods prior to the 2000 fiscal year. However, a minor adjustment decrease
of $.7 billion was made to the ending shareholders’ equity as of December 31, 1999.
A brief explanation of each of the 10 adjustment categories above is summarized
from the disclosures in Item 6 of WorldCom’s 2002 10-K.
1. Impairment: The company discovered that impairment tests had not been
performed for goodwill and long-lived assets even though FASB 121 triggers had
occurred. The application of these impairment tests resulted in very significant
writedowns for both 2000 and 2001.
2. Improper reduction of access costs: The primary adjustments for this item were
due to the improper capitalization of access costs that should have been
expensed as incurred in accordance with GAAP.
3. Purchase accounting: The company made numerous acquisitions, including the
MCI acquisition, between 1993 and 2001 and a review of these acquisitions
concluded that a number of errors were found in the application of purchase
accounting valuations and procedures that overstated the amounts capitalized for

the acquisitions.

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Chapter 20 - Corporations in Finanacial Difficulty

C20-4 (continued)
4. Long lived asset accounting: This item includes adjustments to depreciation and
amortization, changes in the estimated useful lives of long-lived assets, including
those acquired in the MCI combination, and other costs that had been
inappropriately capitalized as long-lived assets that should have been expensed.
5. International: Adjustments were made for correcting the U.S. GAAP-based
statements from the foreign accounting principles. In addition, a review of the
functional currency rules resulted in changing the functional currencies for many
of the international subsidiaries from the local currency to the U.S. dollar.
6. Revenue related adjustments: A number of adjustments were made because of
lack of documentation to support the company’s deferral of income under SAB
101. In addition, the company had incorrectly accounted for some contracts as
sales when in fact the company had acted as an agent and should have recorded
just the net of the amounts as income rather than record gross sales and gross
costs.
7. Adjustments to accrued liabilities: Adjustments were made to eliminate improper
accruals of liabilities for items such as legal reserves, employee benefits and tax
liabilities.
8. Embratel and Avantel acquisitions: A review of the Embratel acquisition showed
an incorrect interpretation with regard to not having control over Embratel and
that Embratel should have been consolidated rather than reported net as an
investment. A review of the Avantel relationship to WorldCom resulted in

changing the accounting from an equity investment to a full consolidation.
9. Unclassified income/ (expense): A review of several accrued liability accounts
showed that there was inadequate documentation to support the accruals. Also,
there were other accrued assets and some liabilities recorded on the historical
balance sheet for which there was either no, or inadequate, documentation to
support that the company owned the assets or owed the liabilities.
10. Other: The company made a number of reclassifications, revaluations of
derivatives, intercompany balances, and certain capitalized costs such as
interest, labor and overhead for capital projects.
These adjustments were also carried through the restated balance sheet and
statement of cash flows for 2001 and 2000.
e. (Source: Item 7 of WorldCom’s 2002 10-K) From the date the bankruptcy petition
was filed, July 21, 2002, through the entire reorganization period, the company used
the provisions of SOP 90-7 for accounting and financial reporting purposes. The
“Debtors-In-Possession” heading informs readers of the financial statements that the
company is in bankruptcy reorganization but management still controls the company
under the administration of a bankruptcy trustee. The balance sheet reports prepetition liabilities separately from others and liabilities not subject to compromise are
reported separately in both the current and noncurrent sections of the balance sheet.
The income statement separately reports the reorganization gain or loss realized
during the reorganization period.
f.

(Source: Item 7 of WorldCom’s 2002 10-K) Towards the beginning of Item 7, the 10K reports that the company will adopt fresh-start accounting under the provisions of
SOP 90-7 as of the fresh-start reporting date. The company will revalue its assets
and liabilities, allocate the reorganization value to the assets and liabilities, eliminate
the accumulated deficit in shareholders’ equity, and the company’s new debt and
equity will be recorded.

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Chapter 20 - Corporations in Finanacial Difficulty

SOLUTIONS TO EXERCISES
E20-1

Multiple-Choice Questions on Chapter 11 Reorganizations [AICPA
Adapted]

1.

c

2.

d

3.

c

4.

d

5.

c

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Chapter 20 - Corporations in Finanacial Difficulty

E20-2 Recovery Analysis for a Chapter 11 Reorganization
a.

Recovery analysis for plan of reorganization:
Taylor Companies, Inc.
Plan of Reorganization
Recovery Analysis
December 31, 20X1
Recovery
Elimination
of Debt
and Equity

Post-petition liabilities

(30,000)

Claims/Interest:
Accounts Payable

(80,000)

8,000

Notes Payable, 10%
Related Interest Payable

(150,000)
(16,000)

25,000
16,000

Bonds Payable, 12%
Related Interest Payable

(200,000)
(24,000)

18,000

(470,000)

67,000

Total
Common shareholders:
Common Stock
Additional Paid-In
Retained Earnings
Deficit
Total

Surviving

Debt

Reduction
of Taylor's Common
Assets
%

$2 par
Stock
Value

(30,000)

(100,000)
171,000

178,000
(622,000)

(178,000)
(40,000)

100%

(72,000)

(72,000)

90

(125,000)

(125,000)
-0-

83
0

(200,000)
(6,000)

100
25

(6,000)

(230,000)

Note: Parentheses indicate credit amount.

20-10

Recovery
%

(30,000)

(200,000)

(100,000)

(200,000)

Total
$

(203,000)

100%

(200,000)
(29,000)

(200,000)
(29,000)

100%

(229,000)

(662,000)


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Chapter 20 - Corporations in Finanacial Difficulty

E20-2 (continued)
b.

Journal entries to record reorganization:
(1)

(2)

Accounts Payable
Notes Payable, 10%
Interest Payable
Cash
Accounts Receivable (net)
Land
Gain on Disposal of Land
Gain on Discharge of Debt
Record discharge of debt.

80,000
150,000
40,000

Common Stock ($1 par)
Additional Paid-In Capital
Gain on Disposal of Land
Gain on Discharge of Debt
Common Stock ($2 par)
Retained Earnings
Record change in par value of stock
and elimination of deficit.

100,000
171,000
40,000
67,000

E20-3 Multiple-Choice Questions on Chapter 7 Liquidations
1.

c

2.

a

3.

d

4.

a

5.

c

20-11

6,000
72,000
85,000
40,000
67,000

200,000
178,000


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Chapter 20 - Corporations in Finanacial Difficulty

E20-4 Chapter 7 Liquidation
a.

Schedule to calculate amount available for general unsecured creditors:
Total estimated fair values
Claims of secured creditors:
Notes payable and interest
(Receivables and Inventory)
Bonds payable and interest
(Land and Building)

$471,000
$115,000
231,000

Claims of creditors with priority:
Wages payable
Taxes payable
Available to general unsecured creditors

b.

Accounts payable

Notes payable and interest
Less: Secured by receivables and inventory
Total unsecured claims

Estimated dividend:

c.

$

9,500
14,000

(346,000)
$125,000
(23,500)
$101,500

$ 95,000
$195,000
(115,000)

80,000
$175,000

$101,500
= 58%
$175,000

Group

Credit

Percentage

Distributed

Accounts Payable
Wages Payable
Taxes Payable
Notes Payable
and Interest
Bonds Payable
and Interest

$ 95,000
9,500
14,000
80,000
115,000

58%
100
100
58
100

$ 55,100
9,500
14,000

46,400
115,000

231,000

100

231,000
$471,000

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Chapter 20 - Corporations in Finanacial Difficulty

E20-5* Statement of Realization and Liquidation
Pace Corporation
Statement of Realization and Liquidation
Assets
Assets to be Realized
Old Receivables, net
Marketable Securities
Old Inventory
Depreciable Assets, net

Assets Realized
$ 38,000
12,000
60,000

96,000

Assets Acquired

Old Receivables
New Receivables
Marketable Securities
Sales of Inventory

$ 21,000
47,000
10,500
75,000

Assets Not Realized

New Receivables

75,000

Old Receivables, net
New Receivables, net
Depreciable Assets

17,000
28,000
80,000

Supplementary Items
Supplementary Charges

Trustee's Fee

Supplementary Credits
$

4,300

Net Loss

$

6,800

Liabilities

Liabilities Liquidated
Old Current Payables

Liabilities to be Liquidated
$ 22,000

Liabilities Not Liquidated
Old Current Payables

Old Current Payables

$ 48,000

Liabilities Incurred
26,000

$333,300

20-13

$333,300


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Chapter 20 - Corporations in Finanacial Difficulty

SOLUTIONS TO PROBLEMS
P20-6 Chapter 11 Reorganization
a.

Recovery analysis for plan of reorganization:
Polydorous Corporation
Plan of Reorganization
Recovery Analysis
Recovery
PreConfirmation

Elimination
of Debt
and Equity

Surviving
Debt

Cash

Post-petition liabilities

(10,000)

Claims/Interest:
Accounts Payable

(160,000)

20,000

(40,000)

Interest Payable

(20,000)

10,000

(10,000)

(340,000)

60,000

(10,000)

(520,000)

90,000

Preferred Shareholders

(100,000)

Common Shareholders

Notes Payable, 10%
Total

Retained Earnings Deficit
Total

12%
Secured
Notes

Common
%

Stock
Value

(10,000)
(100,000)

100%

(140,000)

88

(10,000)

50
82

(30,000)

(280,000)

50,000

50

(50,000)

(50,000)

(150,000)

130,000

20

(20,000)

(20,000)

80,000

(80,000)
100%

(100,000)

510,000

190,000

(10,000)

(60,000)

(340,000)

Pre-confirmation total equities of $700,000 includes $690,000 pre-petition and $10,000 post-petition increase.
Note: Parentheses indicate credit amount.

20-14

Recovery
%

(10,000)

30

(700,000)

(240,000)

Total
$


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Chapter 20 - Corporations in Finanacial Difficulty

P20-6 (continued)
b.

Analysis for evaluating qualifications for fresh start accounting:
First condition:
Post-petition liabilities
Liabilities deferred pursuant to Chapter 11 proceedings
Total post-petition liabilities and allowed claims
Reorganization value
Excess of liabilities over reorganization value
Second condition:
Holders of existing voting shares immediately before confirmation
receive 20% of voting shares of emerging entity.
Therefore, both conditions for a fresh start occur, and fresh
start accounting is used to account for the company.

20-15

$ 10,000
520,000
$530,000

(510,000)
$ 20,000


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Chapter 20 - Corporations in Finanacial Difficulty

P20-6 (continued)
c.

Entries for execution of plan of reorganization:
(1)

(2)

(3)

Liabilities Subject to Compromise
Cash
Notes Payable, 12%, secured
Common Stock (new)
Gain on Debt Discharge
Record debt discharge.

520,000

Preferred Stock
Common Stock (old)
Common Stock (new)
Additional Paid-In Capital

Record exchange of stock for stock.

100,000
150,000

60,000
340,000
30,000
90,000

70,000
180,000

Reorganization Value in Excess of Amounts
Allocable to Identifiable Assets
Gain on Debt Discharge
Additional Paid-In Capital
Accounts Receivable (net)
Inventory
Property, Plant, and Equipment
Retained Earnings - Deficit
Record fresh start accounting and eliminate
deficit.

30,000
90,000
180,000
30,000
7,000
183,000

80,000

Schedule to support allocation of reorganization value:
Book
Value
Cash
Accounts Receivable (net)
Inventory
Property, Plant, and
Equipment (net)
Reorganization Value in Excess
of Amounts Allocable to
Identifiable Assets
Total
Note:

Fair
Value

Difference

$ 30,000
140,000
25,000

$ 30,000
110,000
18,000

$

-0(30,000)
(7,000)

445,000

262,000

(183,000)

-0$640,000

30,000
$450,000

30,000
$(190,000)

The post-reorganization total fair value is the reorganization value of
$510,000 less the $60,000 paid to fulfill the plan of reorganization.

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Chapter 20 - Corporations in Finanacial Difficulty

P20-6 (continued)
d. Fresh start balance sheet workpaper for company emerging from reorganization: (Worksheet
not required)

Preconfirmation
Assets:
Cash
Accounts Receivable (net)
Inventory
Property, Plant,
and Equipment (net)
Reorganization Value In
Excess of Amounts
Allocable to
Identifiable Assets
Total Assets
Liabilities:
Liabilities Not Subject
to Compromise:
Current Liabilities
Liabilities Subject
to Compromise
Notes Payable, 12%, secured
Total Liabilities
Shareholders' Equity:
Preferred Stock
Common Stock (old)
Common Stock (new)
Additional Paid-In Capital
Retained Earnings
Total Shareholders' Equity
Total Liabilities and
Shareholders’ Equity

90,000
140,000
25,000
255,000

Adjustments to Record
Confirmation of Plan
Debt
Exchange
Fresh
Discharge
of Stock
Start
(60,000)
(60,000)

-0-

445,000

700,000

(60,000)

-0-

(30,000)
(7,000)
(37,000)

30,000
110,000
18,000
158,000

(183,000)

262,000

30,000
(190,000)

30,000
450,000

(10,000)
(520,000)
(530,000)

(10,000)
520,000
(340,000)
180,000

(100,000)
(150,000)
(30,000)
80,000

(90,000)

(170,000)

(120,000)

(700,000)

Company's
Reorganized
Balance
Sheet

60,000

Note: Parentheses indicate credit amount.

20-17

-0100,000
150,000
(70,000)
(180,000)

-0-

(340,000)
(350,000)

(100,000)

-0-

180,000
90,000
(80,000)
190,000

-0(100,000)

-0-

190,000

(450,000)


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Chapter 20 - Corporations in Finanacial Difficulty

P20-6 (continued)
d. Balance sheet for company emerging from Chapter 11 reorganization with fresh start
accounting:

Polydorous Company
Balance Sheet
Emerging Date
Assets:
Cash
Accounts Receivable (net)

Inventory
Total Current Assets

$ 30,000
110,000
18,000
$158,000

Property, Plant, and Equipment (net)
Reorganization Value In Excess of Amounts
Allocable to Identifiable Assets
Total Assets

30,000
$450,000

Liabilities:
Accounts Payable
Notes Payable, 12%, secured
Total Liabilities

$ 10,000
340,000
$350,000

Shareholders' Equity:
Common Stock
Total Shareholders' Equity
Total Liabilities and Shareholders' Equity

100,000
$100,000
$450,000

20-18

262,000


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Chapter 20 - Corporations in Finanacial Difficulty

P20-7 Chapter 7 Liquidation, Statement of Affairs
a.

Name Brand Company
Statement of Affairs
July 31, 20X1
Assets

Estimated
Current
Values

Book
Value
(1)
$ 50,000

80,000

162,000

Assets pledged with fully secured
creditors:
Accounts receivable (net)
Less: 12% note payable and
interest
Land
Plant and equipment (net)
Less: Mortgages payable
and interest

(2)
30,000

79,000
(3)
5,000
55,000
81,000
7,000
250,000
72,000

(44,000)

$ 6,000

$110,000
150,000

$260,000

Assets pledged with partially
secured creditors:
Marketable securities
Less: 10% note payable
and interest

$ 22,000

Inventory
Less: Accounts payable

$ 75,000
(105,000)

Estimated amount available
Less: Creditors with priority
Net available to unsecured creditors
Estimated deficiency

Estimated
Gain
(Loss) on
Realization

$ 50,000

(234,600)

Free assets:
Cash
Accounts receivable (net)
Inventory
Prepaid insurance
Plant and equipment (net)
Franchises

Estimated
Amount
Available
to
Unsecured
Claims

$

30,000
(12,000)

25,400

(8,000)

(29,400)

$

5,000
55,000

76,000
1,500
190,000
30,000

(4,000)

5,000
55,000
76,000
1,500
190,000
30,000

(5,000)
(5,500)
(60,000)
(42,000)

$388,900
(45,000)
$343,900
82,500

$871,000

$(106,500)
Total unsecured debt

$426,400

20-19


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Chapter 20 - Corporations in Finanacial Difficulty

P20-7 (continued)
Equities
Estimated
Amount
Unsecured

Book
Value
(1)
$ 44,000
234,600

(2)
29,400
105,000
(3)

(4)
160,000
212,000
17,000
(5)

b.

Partially secured creditors:
10% note payable and interest
Less: Marketable securities
Accounts payable
Less: Inventory

-020,000
12,000

240,000
(203,000)
$871,000

Fully secured creditors:
12% note payable and interest
Mortgages payable and interest

$ 44,000
234,600
$278,600

$ 29,400
(22,000)
$105,000
(75,000)

Creditors with priority:
Estimated liquidation expenses

Wages payable
Taxes payable

$

7,400
30,000

$ 13,000
20,000
12,000
$ 45,000

Unsecured creditors:
Accounts payable
Notes payable
Interest payable

160,000
212,000
17,000

Stockholders' equity:
Common stock
Retained earnings (deficit)
$426,400

Percentage to unsecured creditors:

$343,900 = 80.65%

$426,400

20-20


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Chapter 20 - Corporations in Finanacial Difficulty

P20-8 Chapter 7 Liquidation, Statement of Affairs [AICPA Adapted]
a.

Tower, Inc.
Statement of Affairs
December 31, 20X1
Assets

Estimated
Current
Values

Book
Value
(1)
$ 40,000
13,000
90,000
140,000

Assets pledged with fully secured
creditors:

Accounts receivable
Land
Building (net)
Machinery (net)
Less: Fully secured claims
from liability side:
Note payable-bank
$ 30,000
Mortgage payable and
related interest
132,400

(2)
20,200

Assets pledged with partially
secured creditors:
Marketable securities
Accrued interest
Less: Notes payable (to bank)

(3)
1,500
35,000
60,000
40,000
5,000

Free assets:
Cash

Accounts receivable (after
reclassifying $5,000 of credit
balances to accounts payable)
Finished goods
Raw materials (net of $10,000
of conversion costs)
Prepaid expenses

Estimated
Amount
Available to
Unsecured
Claims

$ 40,000
25,000
110,000
75,000
$250,000

(162,400)

$ 12,000
20,000
(65,000)

$ 87,600

$ 19,000
200

$ 19,200
(20,000)
$

(1,000)

1,500

1,500

35,000
50,000

35,000
50,000

60,000
-0-

60,000

Estimated amount available for unsecured
creditors, including creditors with priority
Less: Liabilities with priority
Estimated amount available for unsecured creditors
Estimated deficiency to unsecured
creditors (plug)

Estimated
Gain

(Loss) on
Realization

(10,000)
20,000
(5,000)

$234,100
(41,500)
$192,600
18,200

$444,700

$(29,000)
Total unsecured debt

$210,800

20-21


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Chapter 20 - Corporations in Finanacial Difficulty

P20-8 (continued)
Book
Value

Amount

Unsecured

Liabilities and Stockholders' Equity
(1)

$ 30,000
132,400
(2)
20,000

(3)
15,000
15,500
(4)
70,000

85,000
5,000
50,000
21,800 (5)

Fully secured creditors:
Notes payable- bank
Mortgage payable and interest
Total (deducted on asset side)

$ 30,000
132,400
$162,400

Partially secured creditors:
Notes payable-bank
Less: Pledged marketable
securities and interest
(from asset side)

$ 20,000
(19,200)

Liabilities with priority:
Estimated liquidation expenses
Wages payable
Payroll taxes payable
Total (deducted on asset side)

$

800

$ 11,000
15,000
15,500
$ 41,500

Unsecured creditors:
Accounts payable (after excluding $15,000
of payroll taxes payable and including
$5,000 of credit balances reclassified
from accounts receivable)
Notes payable

Audit fee of prior year
Contingent liability on damage suit

70,000
85,000
5,000
50,000

Stockholders' equity, after giving effect
to unrecorded items that are properly
bookable as of December 31, 20X1*
($100,000 - $20,000 - $500 + $200
- $500 - $2,400 - $5,000 - $50,000)

$444,700
Total unsecured debt
*

b.

$210,800

Common stock, $100,000; retained earnings deficit, ($20,000); cash expended for
travel, ($500); accrued interest receivable, $200; unrecorded employer's payroll
taxes, ($500); unrecorded interest on mortgage, ($2,400); bill for last year's audit,
($5,000); and probable damage suit judgment, ($50,000).
Estimated settlement per dollar of unsecured liabilities:
Estimated amount available for
unsecured creditors
Total unsecured debt

20-22

$192,600
= $0.914
$210,800


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Chapter 20 - Corporations in Finanacial Difficulty

P20-9 Financial Statements for a Firm in Chapter 11 Proceedings
a.

Income statement for a company in reorganization proceedings:
Hobbes Company
(Debtor-in-Possession)
Income Statement
For the Year December 31, 20X2

Revenue:
Sales

$246,000

Cost and Expenses:
Cost of Goods Sold
Selling, Operating, and Administrative
Interest (contractual interest $51,000)

170,000
50,000
4,000
$224,000

Earnings before Reorganization Items and
Income Taxes
Reorganization Items:
Professional Fees
Interest Earned on Accumulated Cash
Resulting from Chapter 11 Proceeding
Total Reorganization Items

$ 22,000
$(15,000)
3,000
(12,000)

Income before Income Tax and
Discontinued Operations

$ 10,000

Income Tax

(5,000)

Income before Discontinued Operations

$

Discontinued Operations:
Operating Loss, Net-of-Tax
Gain on Sale of Assets, Net-of-Tax
Net Discontinued Operations

5,000

$(16,000)
9,000
(7,000)

Net Loss

$ (2,000)

20-23


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Chapter 20 - Corporations in Finanacial Difficulty

P20-9 (continued)
b.

Statement of cash flows for a company in reorganization proceedings:
Hobbes Company
(Debtor-in-Possession)
Statement of Cash Flows
For the Year December 31, 20X2

Cash Flows from Operating Activities:
Cash Received from Customers
Cash Paid to Suppliers and Employees
Interest Paid
Net Cash Provided by Continuing Operating
Activities before Reorganization Items

$ 264,000
(206,000)
(4,000)
$

54,000

Operating Cash Flows from Reorganization Activities:
Professional Fees
Interest Received on Cash Accumulated Because
of Chapter 11 Proceeding
Net Cash Used by Reorganization Items

3,000
$ (12,000)

Operating Cash Flows from Discontinued Operations:
Net Cash Used by Discontinued Operations

$

Net Cash Provided by Operating Activities

$ 39,000

Cash Flows Provided by Investing Activities:
Proceeds from Sale of Assets Due to
Chapter 11 Proceeding
Net Cash Provided by Investing Activities

$ 18,000
$ 18,000

Cash Flows Provided by Financing Activities:
Net Borrowings under Short-Term Financing Plan
Principal Payments on Pre-petition Debt
Authorized by Court (Bonds Payable)
Net Cash Provided by Financing Activities
Net Increase in Cash
Cash at January 1, 20X2
Cash at December 31, 20X2

$ (15,000)

(3,000)

$ 10,000
$

(10,000)
-0-

$ 57,000
15,000
$ 72,000

20-24


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Chapter 20 - Corporations in Finanacial Difficulty

P20-9 (continued)
c.

Balance sheet for a company in reorganization proceedings:
Hobbes Company
(Debtor-in-Possession)
Balance Sheet
December 31, 20X2
Assets

Cash
Accounts Receivable (net)
Inventory
Total Current Assets
Property, Plant, and Equipment (net)
Total Assets

$ 72,000
47,000
88,000

$207,000
460,000
$667,000

Liabilities
Liabilities Not Subject to Compromise:
Current Liabilities (post petition):
Short-Term Borrowings
Accounts Payable - Trade
Total Liabilities Not Subject to Compromise
Liabilities Subject to Compromise (pre-petition):
Accounts Payable
Notes Payable, 10%
Bonds Payable, 12%
Accrued Interest Payable
Total Liabilities Subject to Compromise
Total Liabilities
Shareholders' Equity
Preferred Stock
Common Stock ($1 par)
Additional Paid-In Capital
Retained Earnings (Deficit)
Total Shareholders' Equity
Total Liabilities and Shareholders' Equity
*

$ 10,000
7,000
$ 17,000
$ 138,000

170,000
240,000*
47,000
595,000
$612,000
$ 50,000
50,000
75,000
(120,000)
$ 55,000
$667,000

$10,000 payment approved by the Court, reducing pre-petition bonds payable from
$250,000 to $240,000.

20-25