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ASC 852 Reorganizations
Perspective and Issues
Subtopics
ASC 852, Reorganizations, contains three subtopics:
- ASC 852-10, Overall, which provides guidance for entities that have filed petitions in the Bankruptcy Court and expect to reorganize under Chapter 11
- ASC 852-20, Quasi-Reorganizations
- ASC 852-740, Income Taxes.
Scope and Scope Exceptions
ASC 852-10 applies to all entities except governmental organizations and does not apply to debt restructurings outside of Chapter 11 and reorganizations consisting of liquidation or adoption of plans of liquidation under the Bankruptcy Code.
ASC 852-20 applies only to “readjustments in which the current income, or retained earnings or accumulated deficit account, or the income account of future years is relieved of charges that would otherwise be made against it.…” Further, it does not apply to:
- “Quasi-reorganizations involving only deficit reclassifications
- Charges against additional paid-in capital in other types of readjustments such as readjustments for the purpose of correcting erroneous credits made to additional paid-in capital in the past
- Financial reporting for entities that enter and intend to emerge from Chapter 11 reorganization, at the time of such reorganization.”
(ASC 852-20-15-3)
Overview
Entities expected to reorganize as going concerns under Chapter 11 of the Bankruptcy Code employ so-called “fresh start” accounting if:
- 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
- Holders of existing voting shares immediately before confirmation receive less than 50 percent of the voting shares of the emerging entity.”
(ASC 852-10-45-19)
Definitions of Terms
Source: 851-10-20
Allowed Claim. The amount allowed by the Bankruptcy Court as a claim against the estate. This amount may differ from the actual settlement amount.
Bankruptcy Code. A federal statute, enacted October 1, 1979, as title 11 of the United States Code by the Bankruptcy Reform Act of 1978, that applies to all cases filed on or after its enactment and that provides the basis for the current federal bankruptcy system.
Bankruptcy Court. The United States Bankruptcy Court is an adjunct of the United States District Courts. Under the jurisdiction of the District Court, the Bankruptcy Court is generally responsible for cases filed under Chapters 7, 11, 12, and 13 of the Bankruptcy Code.
Chapter 7. A liquidation, voluntarily or involuntarily initiated under the provisions of the Bankruptcy Code, that provides for liquidation of the business or the debtor's estate.
Chapter 11. A reorganization action, either voluntarily or involuntarily initiated under the provisions of the Bankruptcy Code, that provides for a reorganization of the debt and equity structure of the business and allows the business to continue operations. A debtor may also file a plan of liquidation under Chapter 11.
Claim. As defined by Section 101(4) of the Bankruptcy Code, a right to payment, regardless of whether the right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, secured, or unsecured, or a right to an equitable remedy for breach of performance if such breach results in a right to payment, regardless of whether the right is reduced to a fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured right.
Emerging Entity. An entity (sometimes referred to as the reorganized entity), that has had its plan confirmed and begins to operate as a new entity.
Obligations Subject to Compromise. Includes all prepetition liabilities (claims) except those that will not be impaired under the plan, such as claims in which the value of the security interest is greater than the claim.
Petition. A document filed in a court of bankruptcy, initiating proceedings under the Bankruptcy Code.
Plan of Reorganization An agreement formulated in Chapter 11 proceedings under the supervision of the Bankruptcy Court that enables the debtor to continue in business. The plan, once confirmed, may affect the rights of undersecured creditors, secured creditors, and stockholders as well as those of unsecured creditors. Before a plan is confirmed by the Bankruptcy Court, it must comply with general provisions of the Bankruptcy Code. Those provisions mandate, for example, that the plan is feasible, the plan is in the best interest of the creditors, and, if an impaired class does not accept the plan, the plan must be determined to be fair and equitable before it can be confirmed.
Postpetition Liabilities. Liabilities incurred after the filing of a petition that are not associated with prebankruptcy events. Thus, these liabilities are not considered prepetition liabilities.
Prepetition Liabilities. Liabilities that were incurred by an entity before its filing of a petition for protection under the Bankruptcy Code, including those considered by the Bankruptcy Court to be prepetition claims, such as a rejection of a lease for real property.
Reorganization Items. Items of income, expense, gain, or loss that are realized or incurred by an entity because it is in reorganization.
Reorganization Proceeding. A Chapter 11 case from the time at which the petition is filed until the plan is confirmed.
Reorganization Value. The value attributed to the reconstituted entity, as well as the expected net realizable value of those assets that will be disposed of before reconstitution occurs. Therefore, this value is viewed as the value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring.
Secured Claim. A liability that is secured by collateral. A fully secured claim is one in which the value of the collateral is greater than the amount of the claim.
Terminal Value. A component of reorganization value. Reorganization value calculated based on the discounting of cash flows normally consists of three parts: the discounted cash flows determined for the forecast period, the residual value or terminal value, and the current value of any excess working capital or other assets that are not needed in reorganization. Terminal or residual value represents the present value of the business attributable to the period beyond the forecast period.
Trustee. A person appointed by the Bankruptcy Court in certain situations based on the facts of the case, not related to the size of the entity or the amount of unsecured debt outstanding, at the request of a party in interest after a notice and hearing.
Undersecured Claim. A secured claim whose collateral is worth less than the amount of the claim. Sometimes referred to as an undersecured claim liability.
Unsecured Claim. A liability that is not secured by collateral. In the case of an undersecured creditor, the excess of the secured claim over the value of the collateral is an unsecured claim, unless the debtor elects in a Chapter 11 proceeding to have the entire claim considered secured. The term is generally used in bankruptcy to refer to unsecured claims that do not receive priority under the Bankruptcy Code. Sometimes referred to as an unsecured claim liability.
Concepts, Rules, and Examples
Corporate Bankruptcy and Reorganizations
Entities Operating Under and Emerging from Protection of the Bankruptcy Laws
The going concern assumption is one of the basic postulates underlying generally accepted accounting principles and is responsible for, among other things, the historical cost convention in financial reporting. For entities that have entered bankruptcy proceedings, however, the going concern assumption will no longer be of central importance.
ASC 852 sets forth certain financial reporting standards for entities undergoing and emerging from reorganization under the bankruptcy laws. Under its provisions, assets are presented at estimated realizable values. Liabilities are set forth at the estimated amounts to be allowed in the statement of financial position, and liabilities subject to compromise are to be distinguished from those that are not. Furthermore, the codification requires that in both the statements of income and cash flows, normal transactions be differentiated from those that have occurred as a consequence of the entity's being in reorganization. While certain allocations to the latter category are rather obvious, such as legal and accounting fees incurred, others are less clear. For example, the codification suggests that if the entity in reorganization earns interest income on funds that would normally have been used to settle obligations owed to creditors, such income will be deemed to be income arising as a consequence of the bankruptcy action.
Another interesting aspect of ASC 852 is the accounting to be made for the emergence from reorganization (known as confirmation of the plan of reorganization). The ASC provides for “fresh start” financial reporting in such instances. This accounting is similar to that applied to acquistion business combinations, with the total confirmed value of the entity upon its emergence from reorganization being analogous to the purchase price in an acquisition. In both cases, this total value is to be allocated to the identifiable assets and liabilities of the entity, with any excess being allocated to goodwill. In the case of entities emerging from bankruptcy, goodwill (called reorganization value in excess of amounts allocable to identifiable assets) is measured as the excess of liabilities existing at the plan confirmation date, computed at present value of future amounts to be paid, over the reorganization value of assets. Reorganization value is calculated with reference to a number of factors, including forecasted operating results and cash flows of the new entity.
ASC 852 applies only to entities undergoing formal reorganization under the Bankruptcy Code. Less formal procedures may still be accounted for under quasi-reorganization accounting procedures.
Quasi-reorganizations
Generally, this procedure is applicable during a period of declining price levels. It is termed “quasi” since the accumulated deficit is eliminated at a lower cost and with less difficulty than a legal reorganization.
Per ASC 852-20, the procedures in a quasi-reorganization involve the:
- Proper authorization from stockholders and creditors where required
- Revaluation of assets to their current values: all losses are charged to retained earnings, thus increasing any deficit
- Elimination of any deficit by charging paid-in capital:
- First, additional paid-in capital to the extent it exists
- Second, capital stock when additional paid-in capital is insufficient: the par value of the stock is reduced, creating the extra additional paid-in capital to which the remaining deficit is charged.
No retained earnings may be created by a reorganization. Any excess created by the reduction of par value is credited to “Paid-in capital from quasi-reorganization.”
ASC 852-20 requires that retained earnings be dated for ten years (less than ten years may be justified under exceptional circumstances) after a quasi-reorganization takes place. Disclosure similar to “since quasi-reorganization of June 30, 20XX” is appropriate.