Chapter 20 – CORPORATIONS IN FINANCIAL DIFFICULTY
CHAPTER 20
CORPORATIONS IN FINANCIAL DIFFICULTY
OVERVIEW OF CHAPTER
Chapter 20 presents the actions available to corporations experiencing financial
difficulty. A series of nonjudicial actions are available, including debt restructuring, creditor’s
committee management, and voluntary asset assignments. Judicial actions are typically termed
by the chapter number in The Bankruptcy Code. A Chapter 11 reorganization may precede a
Chapter 7 liquidation. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
(Bankruptcy Reform Act of 2005) made several changes for business filings, but most of the act
pertained to personal filings. The chapter uses Peerless Corporation to illustrate the accounting
and financial reporting for companies experiencing financial difficulty.
A Chapter 11 reorganization requires a plan of reorganization that specifies the steps the
company will take to reorganize. ASC 852 establishes the accounting and financial reporting
requirements for a firm engaged in a Chapter 11 reorganization, including the criteria for fresh
start accounting. Companies not qualifying for fresh start accounting account for restructuring
costs in accordance with ASC 420.
A Chapter 7 liquidation frequently is managed by a trustee of the bankruptcy court. A
receivership is formed in which the trustee takes title to the debtor’s assets and makes every
effort to realize the greatest amount possible from the assets and to settle the debtor’s liabilities.
In liquidation, the rights of creditors must be strictly followed. Secured creditors have first claim
to the secured assets. Other creditors with priority are specified in the bankruptcy act. The
statement of affairs is a financial report prepared by the trustee to report on the progress of the
liquidation.
The Additional Considerations portion of the chapter discusses trustee accounting and
reporting with illustrations.
LEARNING OBJECTIVES
When students finish studying this chapter, they should be able to:
LO 20-1 Understand the courses of action available to financially distressed firms.
LO 20-2 Understand Chapter 11 reorganizations and be able to prepare financial statements
for debtors-in-possession as well as a plan of recovery.
LO 20-3 Understand Chapter 7 liquidations and be able to prepare a statement of affairs.
LO 20-4 Understand trustee accounting and reporting.
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SYNOPSIS OF CHAPTER 20
Chapter 20
Corporations in Financial Difficulty
GM in Financial Distress
LO 20-1 Understand the courses of action available to financially distressed firms.
Courses of Action
Nonjudicial Actions
Judicial Actions
LO 20-2 Understand Chapter 11 reorganizations and be able to prepare financial statements
for debtors-in-possession as well as a plan of recovery.
Chapter 11 Reorganizations
Fresh Start Accounting
Plan of Reorganization
Illustration of a Reorganization
LO 20-3 Understand Chapter 7 liquidations and be able to prepare a statement of affairs.
Chapter 7 Liquidations
Classes of Creditors
Secured Creditors
Creditors with Priority
General Unsecured Creditors
Statement of Affairs
LO 20-4 Understand trustee accounting and reporting.
Additional Considerations
Trustee Accounting and Reporting
NOTES ON POWERPOINT SLIDES
We have attempted to provide PowerPoint slides that will be useful to a broad set of users. Since
instructors often have different styles and preferences, we have attempted to include slides that
will accommodate different approaches and that can be adapted to classes with different levels of
preparation. For example, some instructors prefer to introduce the material before students have
read the chapter. We have tried to facilitate these types of introductory discussions by including
slides that replicate key points from the chapter. Other instructors expect students to have read
the chapter and attempted homework problems before coming to class. As a result, they may not
find it useful to review all of the topics in the chapter or to include slides that simply review
Chapter 20 – CORPORATIONS IN FINANCIAL DIFFICULTY
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many of the details they expect students to study before class. However, instructors following
this approach often like to use sample exercises and problems built into the slides that allow
them to have extended discussions or to facilitate group interaction in class.
If instructors elect to spend two class periods on the same subject, they might find a combination
of both styles to be useful by first introducing foundational material before students have read
the chapter and studied the topic, followed by an extended discussion the next class period after
students have read the chapter and attempted homework problems.
We have tried to develop slides that can facilitate a flexible approach to allow instructors to
select the slides that best match their objectives and style for class discussions. This is the reason
we are including over 100 slides for some chapters in the text. We do not expect all instructors
to use all slides, but the slide files should help support different teaching approaches and allow
instructors to select the subset of slides that best matches their specific discussion objectives.
The slides are organized by learning objective. We have included a slide at the beginning of
each learning objective to show where the new material begins. Instructors may or may not want
to use these learning objective slides in class. We provide them primarily as a way of organizing
the material. We also include short multiple-choice questions at the end of most learning
objectives. Some instructors find it useful to pause periodically during class to assess students’
level of understanding. For this reason, we include several “practice quiz questions” that can be
used throughout class discussions to engage students, help them focus on key points, or to
facilitate group interaction. Finally, we provide longer exercises and problems that many
instructors find useful in assessing understanding and encouraging group learning.
LO 20-1 Understand the courses of action available to financially distressed firms.
• Slides 3-7 summarize the various alternatives companies in financial distress have
and point out that bankruptcy is only one of the possible alternatives.
• Slides 8-9 introduce the judicial actions available to financially distressed firms.
LO 20-2 Understand Chapter 11 reorganizations and be able to prepare financial statements for
debtors-in-possession as well as a plan of recovery.
• Slides 15-17 briefly introduce Chapter 11 reorganizations.
• Slides 18-22 summarize fresh start accounting.
• Slide 23 outlines the components of a plan of reorganization required in a Chapter 11
reorganization.
• Slides 26-28 provide a brief illustration of a reorganization.
• Slides 29-32 explain the financial reporting procedures for a company in
reorganization proceedings and gives examples of the financial statements.
• Slides 33-35 explain recovery analysis concepts, including reorganizational value and
postreorganization capital structure.
• Slides 36-40 provide an illustration of a Reorganization.
• Slides 41-44 summarize E20-2 illustrating a plan of reorganization.
LO 20-3 Understand Chapter 7 liquidations and be able to prepare a statement of affairs.
• Slide 46 introduces Chapter 7 liquidations.
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• Slides 47-48 explain the differences between secured and unsecured creditors.
• Slides 49-50 summarize the statement of affairs required in a Chapter 7 liquidation.
• Slides 53-58 summarize E20-4 illustrating a Chapter 7 liquidation
• Slides 59-61 summarize P20-7 illustrating a Chapter 7 Statement of Affairs
LO 20-4 Understand trustee accounting and reporting.
• Slides 63-68 provide an overview of trustee accounting and reporting for both
Chapter 11 reorganizations and Chapter 7 liquidations.
• Slides 69-72 provide an illustration of trustee accounting and reporting.
TEACHING IDEAS
1. The daily business press often prints articles on companies that have entered Chapter 7
liquidation, or filed for protection under Chapter 11. Students should be assigned to
locate a recent business article on a company entering bankruptcy proceedings and
prepare a brief written memo summarizing the proceedings for the company.
2. Ask students to determine the number of companies that have entered bankruptcy within
the last year, and compare that number to prior years. This number may be obtained by
reference to business sources such as Barrons or to the Department of Commerce
publication, Survey of Current Business.
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DESCRIPTIONS OF CASES, EXERCISES, AND PROBLEMS
C20-1
LO 20-1
25 min.
E
Creditors’ Alternatives
Students are presented with three options to the creditors of a financially
distressed debtor. The case requires a discussion of the advantages and
disadvantages of each option.
C20-2
LO 20-1
35 min.
E
Research Related to Bankruptcy
This research case asks students to obtain current information from the U.S.
Bankruptcy Courts and recent data on corporate bankruptcy filings.
C20-3
LO 20-4
35 min.
M
Selection of Bankruptcy Trustee and Trustee’s Responsibilities
Students must research information on the selection of a trustee and the trustee’s
responsibilities in a Chapter 7 bankruptcy filing.
C20-4
LO 20-2
35 min.
M
The Bankruptcy of WorldCom
This case requires the analysis of WorldCom’s December 31, 2002 10-K. The
student must provide answers to six questions referencing the sections of the 10-
K used to find the information.
E20-1
LO 20-1,
LO 20-2
15 min.
M
Multiple-Choice Items on Chapter 11 Reorganizations [AICPA Adapted]
Five conceptual multiple-choice questions on the provisions of the Bankruptcy
Reform Act of 1978 and for working with creditors’ committees.
E20-2
LO 20-2
45 min.
M
Recovery Analysis for a Chapter 11 Reorganization
Students must prepare a recovery analysis for a plan of reorganization and
prepare the journal entries for the discharge of debt and restructuring of common
equity.
E20-3
LO 20-1,
LO 20-3
15 min.
E
Multiple-Choice Items on Chapter 7 Liquidations
Five multiple-choice questions on the Chapter 7 Liquidations and priority of
claims.
E20-4
LO 20-3
30 min.
E
Chapter 7 Liquidation
Students must prepare a schedule to calculate the net estimated amount available
for general unsecured creditors, compute the percentage dividend to general
unsecured creditors. They should also prepare a schedule showing the amount to
be paid each of the creditor groups upon distribution of the estimated realizable
amount.
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E20-5
LO 20-4
40 min.
M
Statement of Realization and Liquidation
A short statement of realization and liquidation is required for the liquidation of
a small company.
P20-6
LO 20-2
55 min.
H
Chapter 11 Reorganization
Students must prepare a recovery analysis, determine if the firm qualifies for
fresh start accounting, prepare journal entries for the reorganization, and prepare
the balance sheet for the company as it emerges from the reorganization.
P20-7
LO 20-3
75 min.
H
Chapter 7 Liquidation, Statement of Affairs
Students must prepare a formal statement of affairs for a Chapter 7 liquidation
that includes both fully secured and partially secured assets.
P20-8
LO 20-3
75 min.
H
Chapter 7 Liquidation, Statement of Affairs [AICPA Adapted]
An extensive problem requiring a statement of affairs. Included are unrecorded
liabilities, some creditors with priority, and a pending damage legal suit.
Students should also compute the estimated settlement per dollar of unsecured
liabilities.
P20-9
LO 20-2
50 min.
H
Financial Statements for a Firm in Chapter 11 Proceedings
Students must prepare the income statement, the statement of cash flows, and the
balance sheet for a company in Chapter 11 proceedings.
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OTHER RESOURCES
Structure of the Bankruptcy Code
(The Primary Legal Structure Guiding Bankruptcies)
Chapter 1 General Provisions
Chapter 3 Case Administration
Chapter 5 Creditors, the Debtor, and the Estate
Chapter 7 Liquidation
Chapter 9 Adjustment of Debts of a Municipality
Chapter 11 Reorganization
Chapter 12 Adjustments of Debts of a Family Farmer with Regular Annual Income
Chapter 13 Adjustment of Debts of an Individual with Regular Income