56 ASC 852 REORGANIZATIONS
Corporate Bankruptcy and Reorganizations
Entities operating under and emerging from protection of the bankruptcy laws
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, as set forth by ASC 852-10-45-19. Under prior GAAP, entities emerging from bankruptcy were required to adopt, upon emergence, changes in accounting principles mandated to become effective within twelve months from that date. Early adoption, once commonly permitted by newly promulgated accounting standards, is now more commonly prohibited under new pronouncements. Accordingly, ASC 852-10-45 has been amended to permit, but not require, early adoption of standards scheduled to become effective after its “fresh start,” and then only if the emerging bankrupt entity elects to do so.
DEFINITIONS OF TERMS
Absolute Priority Doctrine. A doctrine that provides that if an impaired class does not vote in favor of a plan, the court may nevertheless confirm the plan under the cram-down provisions of the Bankruptcy Code. The absolute priority doctrine is triggered when the cram-down provisions apply. The doctrine states that all members of the senior class of creditors and equity interests must be satisfied in full before the members of the second senior class of creditors can receive anything, and the full satisfaction of that class must occur before the third senior class of creditors may be satisfied, and so on.
Administrative Expenses. Claims that receive priority over all other unsecured claims in a bankruptcy case. Administrative expenses (sometimes referred to as administrative claims) include the actual, necessary costs and expenses of preserving the estate, including wages, salaries, or commissions for services rendered after the commencement of the case. Fees paid to professionals for services rendered after the petition is filed are considered administrative expenses.
Allowed Claim. The amount allowed by the Bankruptcy Court as a claim against the estate. This amount may differ from the actual settlement amount.
Automatic Stay Provisions. Provisions causing the filing of a petition under the Bankruptcy Code to automatically stay virtually all actions of creditors to collect prepetition debts. As a result of the stay, no party, with minor exceptions, having a security or adverse interest in the debtor's property can take any action that will interfere with the debtor or the debtor's property, regardless of where the property is located or who has possession, until the stay is modified or removed.
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 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.
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.
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.
Confirmed Plan. An official approval by the court of a plan of reorganization under a Chapter 11 proceeding that makes the plan binding on the debtors and creditors. Before a plan is confirmed, it must satisfy 11 requirements in section 1129(a) of the Bankruptcy Code.
Consenting Classes. Classes of creditors or stockholders that approve the proposed plan.
Cram-Down Provisions. Provisions requiring that for a plan to be confirmed, a class of claims or interests must either accept the plan or not be impaired. However, the Bankruptcy Code allows the Bankruptcy Court under certain conditions to confirm a plan even though an impaired class has not accepted the plan. To do so, the plan must not discriminate unfairly and must be fair and equitable to each class of claims or interests impaired under the plan that have not accepted it. The Bankruptcy Code states examples of conditions for secured claims, unsecured claims, and stockholder interests in the fair and equitable requirement.
Debtor-in-Possession. Existing management continuing to operate an entity that has filed a petition under Chapter 11. The debtor-in-possession is allowed to operate the business in all Chapter 11 cases unless the court, for cause, authorizes the appointment of a trustee.
Disclosure Statement. A written statement containing information approved as adequate by the court. It is required to be presented by a party before soliciting the acceptance or rejection of a plan of reorganization from creditors and stockholders affected by the plan. Adequate information means information of a kind, and in sufficient detail, as far as is reasonably practicable in light of the nature and history of the debtor and the condition of the debtor's records, that would enable a hypothetical reasonable investor typical of holders of claims or interests of the relevant class to make an informed judgment about the plan.
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.
Impaired Claims. In determining which class of creditors' claims or stockholders' interests must approve the plan, it is first necessary to determine if the class is impaired. A class of creditors' claims or stockholders' interests under a plan is not impaired if the plan leaves unaltered the legal, equitable, and contractual right of a class, cures defaults that lead to acceleration of debt or equity interest, or pays in cash the full amount of the claim, or for equity interests, the greater of the fixed liquidation preference or redemption price.
Liquidating Bank. A bank with a substantial amount of nonperforming assets may transfer some or all of those assets to a newly created bank whose stock will be distributed to existing shareholders or to new investors. The newly created bank will be a liquidating bank; that is, it will manage the assets it receives and collect cash from loan repayments or dispositions of assets. All cash remaining after paying expenses and debt service, if any, will be distributed to the shareholders of the liquidating bank. The liquidating bank will likely be in the process of liquidation for several years.
Nonconsenting Class. A class of creditors or stockholders that does not approve the proposed plan.
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. 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. Sometimes referred to as a plan of reorganization.
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.
Traditionally, the basic financial statements (statement of financial position, income statement, and statement of cash flows) presented by going concerns were seen as less useful for entities undergoing reorganization. Instead, the statement of affairs, reporting assets at estimated realizable values and liabilities at estimated liquidation amounts, was recommended for use by such organizations. In more recent years, this is less frequently encountered in practice.
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 purchase 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 preexisting 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.