Chapter 18
CORPORATE LIQUIDATIONS and REORGANIZATIONS
Answers to Questions
1
Chapter 7 bankruptcy is where the entity is appointed to sell off assets of the entity and pay claim to the
creditors, so basically, a liquidation would be needed. Meanwhile, chapter 11 bankruptcy involves a
rehabilitation to the debtor entity, in which a reorganization would be expected to happen. Based on the
nature of both bankruptcy, chapter 11 is usually initiated first, where the debtor entity would have the
chance to negotiate to settle all claims and continue to operate. If chapter 11 is failed to carried out then
chapter 7 is initiated where the debtor entity would be liquidated and cease to operate.
2
Order of relief is an order from the court to protect the debtor entity from bankruptcy. If the order is issued
then the debtor entity would be protected against any litigation while the court supervise a reorganization
plan where the creditor and debtor entity negotiate the plan for settling all the claims.
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 of creditors vote for the trustee, and those creditors hold at least 20 percent of the
claims. 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.
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. They 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 18–2 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 $11,725 per individual
earned within 180 days of filing, (4) employee benefit plan contribution claims up to $11,725 per individual
earned within 180 days of filing, (5) individual claims up to $2,600 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,
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18-2
9
10
Corporate Liquidations and Reorganizations
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.
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.
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 dollar
amount of claim holders 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.
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
Since the company is still operating under chapter 11, any income, expenses, gains, and losses due to the
reorganization will be accounted for in the income. These income statement items should be reported
separately as a reorganization items except the ones that should be reported as discontinued operations.
Cash flows related to the reorganization are also to be disclosed separately in the cash flow statement using
a direct method as a recommendation.
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 of the reorganization plan is less than the total of all postpetition liabilities and allowed
claims and (2) holders of existing voting shares immediately before confirmation of the reorganization plan
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 FASB ASC 835.
Forgiveness of debt should be reported as an extraordinary item.
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Chapter 18
18-3
SOLUTIONS TO EXERCISES
Solution E18-1
b
1
d
2
c
3
d
4
Solution 18-2
a
1
d
2
c
3
d
4
Solution E18-3
Total




Foley Ltd. Assets available for secured creditors:
Plant assets
$25,000
Accounts receivable
$15,000
Other current assets
$ 5,000
Notes payable to bank and creditors ($20,000 + $15,000)
Total available for priority and unsecured creditors
Less: priority liabilities to employees
Total available for unsecured creditors (i.e. suppliers)
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$45,000
($35,000)
$10,000
($5,000)
$5,000
Corporate Liquidations and Reorganizations
18-4
Solution E18-4
Partially secured bonds payable
Amount secured by 50% of plant assets realization
(50% x $500,000)
Unsecured portion of bonds payable
$350,000
($250,000)
$100,000
Total available portion of Madeline SA’s plant assets realization
for unsecured creditors
$ 250,000
Total claim of unsecured creditors ($250,000/10%)
$2,500,000
Expected payment for the bonds payable unsecured portion:
= (
= (
=
x total available assets for unsecured creditors)
x $250,000)
$10,000
Total expected payment for the bond payable ($250,000 + $10,000)
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$260,000
Chapter 18
18-5
Solution E18-5
Post-petition liabilities
Allowed claim subject to compromise
Total liabilities
Less: Reorganization value*
Excess liabilities over reorganization value
*Reorganization Value
Postpetition liabilities
Taxes payable
Current portion of senior debt
Senior debt, 11% bonds
Subordinate debt
Common stock
$
100,000
1,000,000
$1,100,000
(
950,000)
$
150,000
$
100,000
50,000
, cash payable
250,000
100,000
400,000
$
950,000
50,000
Having the above, Don SA met the two conditions for a fresh-start reporting,
given that:
1. The excess liabilities over reorganization value indicate that the first
condition of fresh-start reporting is met.
2. The reorganization plan calls for the old equity holders of $300,000
common stock to retain $100,000 new common stocks of the reorganized
entity. This shows that Don SA stockholders own less than 50 per cent of
the emerging company. Therefore the second condition is also met.
SOLUTIONS TO PROBLEMS
Solution P18-1 [In thousands]
Allowed claim subject to compromise
Total liabilities
Less: Reorganization value*
Excess liabilities over reorganization value
*Reorganization Value
Taxes payable
Current portion of senior debt, cash payable
Senior debt, 12% bonds
Subordinate debt
Common stock
1,500
$1,500
(1,250)
$
250
$100
50
150
300
650
$1,250
Having the above calculations, Tessa Ltd. met the two conditions for a freshstart reporting, given that:
1. The excess liabilities over reorganization value indicate that the first
condition of fresh-start reporting is met.
2. The reorganization plan calls for the old equity holders of $900 common
stock to retain $250 new common stocks of the reorganized entity. This
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Corporate Liquidations and Reorganizations
18-6
shows that Don SA stockholders own less than 50 per cent of the emerging
company. Therefore the second condition is also met.
Solution P18-2
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
60,000
payable ($150,000  $.40)
Total
$445,000
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Chapter 18
18-7
Solution P18-3
1
Ranking of claims:
Fully secured:
8.
Holders of first mortgage and
related interest
$228,500
Unsecured priority:
1.
Administrative expenses
6.
Wages payable up to $11,725 per
employee($48,000 – ($12,275 $11,725))
7.
Customer claims for merchandise paid
for and not delivered (maximum
$2,600 per individual)
5.
State government for gross
receipts taxes
$ 3,000
3.
Local government for property
taxes
4,000
Total unsecured priority claims
Unsecured nonpriority:
2.
Merchandise creditors
4.
Local bank for principal of loan
6.
President for salary due over
$11,725
4.
Interest on unsecured bank loan
Total unsecured nonpriority claims
47,450
1,500
7,000
68,450
$99,000
30,000
550
Total all claims
2
$ 12,500
129,550
4,500
134,050
$431,000
Distribution of available cash:
1st
Mortgage holders (100%)
$228,500
2nd
Administrative expenses (100%)
12,500
3rd
Employees (up to $11,725 each) (100%)
47,450
4th
Customers for merchandise not delivered
(100%)
5th
State government (100%)
Local government (100%)
1,500
$ 3,000
4,000
7,000
[Remaining cash ($374,500 - $296,950) of $77,550/$129,550 claim of next
rank = $.5986 return on dollar]
6th
Merchandise creditors ($99,000  .5986)
Local bank for loan principal
($30,000  .5986)
Company president ($550  .5986)
Total distributed (equal to available cash)
*Rounding error; should be $374,500.
$59,261
17,958
329
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77,548
$374,498*
Corporate Liquidations and Reorganizations
18-8
Solution P18-4 [In Thousands]
1. POP INC. STATEMENT OF AFFAIRS
Pop Inc. Statement of Affairs on August 1, 2014
Assets
Book
Value
$775
Pledged for secured creditors
Fixed Assets - net
Less: Bond payable
Estimated
Realizable
Values Less
Secured
Creditor
Liabilities
Estimated
Realizable
Value
Available for
Unsecured
Creditors
$475
(500)
$0
250
150
200
______
$1,375
Book
Value
$500
Available for priority and unsecured
creditors
Cash and equivalents
Accounts receivable
Inventories
Total available for priority and
unsecured creditors
Less: Priority liabilities
Total available for unsecured
creditors
Estimated deficiency
Liabilities and Stockholders’ Equity
Secured and
Priority
Claims
Fully secured
creditors
Bond payable
$500
Less: fixed assets
(475)
pledged as
security
150
Priority liabilities
Wages payable
200
125
Unsecured creditors
Account payable
Interest payable
550
(150)
$1,375
250
125
100
475
(150)
325
25
$350
Unsecured Nonpriority
Claims
$25
150
650
Stockholders’ equity
Common stock
Retained earnings
Total unsecured non-priority claims
2. ESTIMATED PAYMENTS PER DOLLAR TO EACH CLASS OF CLAIMS:
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$200
125
______
$350
Chapter 18
18-9
Cash Available
$950
Distribution to partially secured and priority creditors:
Bond payable (secured portion)
$475
Administrative expense
250
Wages payable
150
875
Available to unsecured non-priority creditors (A)
$75
Unsecured non-priority creditors:
Account payable
Bond payable (unsecured portion)
Interests payable
Total unsecured non-priority claims (B)
200
25
125
$350
Per dollar pro rata distribution for unsecured non-priority creditors:
A/B = $75/$350 = $0.21
a. Payments for partially secured class
Bond payable
(secured portion)
Bond payable (unsecured portion)
$0.21x$25
b. Payments for unsecured priority class
Administrative expense
Wages payable
Total unsecured priority class payment
c. Payments for unsecured non-priority class
Account payable ($0.21x$200)
Interests payable ($0.21x$125)
Total unsecured non-priority payment
$475
5.25
$480.25
$250
150
$400
42
26.25
$68.25
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Corporate Liquidations and Reorganizations
18-10
Solution P18-4 (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
Available to unsecured nonpriority
creditors = A
44,000
$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
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$66,200
Chapter 18
18-11
Solution P18-5
1
Dawn Corporation — in Chapter 7
Statement of Affairs at July 10, 2011
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
UnsecuredNonpriority
Claims
$ 50,000
24,000
76,000
150,000
$100,000
160,000
(60,000)
$205,000
140,000
65,000
Unsecured
Accounts payable
Capital stock
Retained earnings deficit
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$ 65,000
350,000
_________
$415,000
Corporate Liquidations and Reorganizations
18-12
Solution P18-5 (continued)
Claims by
Priority Ranks
2
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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Chapter 18
18-13
Solution P18-6
1
Everlast Window Corporation
Statement of Affairs on June 30, 2011
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)
Priority liabilities
Wages payable
Property taxes payable
Fully secured creditors
Mortgage payable
Interest on mortgage payable
$ 60,000
10,000
70,000
$150,000
15,000
165,000
Unsecured creditors
Accounts payable
Note payable — unsecured
Interest payable — unsecured
Stockholders’ equity
Capital stock
Retained earnings (deficit)
$110,000
50,000
5,000
________
$165,000
$500,000
2
Unsecured
Non-priority
Claims
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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Corporate Liquidations and Reorganizations
18-14
Solution P18-7
1
The reorganization is eligible for fresh start accounting because the
liabilities on June 30, 2011 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 18
18-15
Solution P18-7(continued)
3
Lowstep Corporation
Final Balance Sheet
as of July 8, 2011
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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