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Chapter 20 – Corporations in Financial Difficulty
Q20-1 The nonjudicial actions available to a financially distressed company are debt
Q20-2 The major difference between a Chapter 7 action and a Chapter 11 action is that
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
Q20-4 The following items are usually included in the Plan of Reorganization filed as
Q20-7 The financial statements that must be filed by a company during a Chapter 11
Q20-8 The rights of creditors with priority in a Chapter 7 liquidation are to receive any
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
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
assets.
Q20-11 Sales of assets are reported in the statement of realization and liquidation as
Copyright © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized
for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted
on a website in whole or part.
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.
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
C20-2 Research Related to Bankruptcy
The website for the U.S. Bankruptcy Courts is:
http://www.uscourts.gov/FederalCourts/Bankruptcy.aspx
a. The Frequently Asked Questions (FAQs) for the U.S. Courts
(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.
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
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 search with the 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
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
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
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
C20-4 (continued)
Year Ended
December 31, 2001
Year Ended
December 31, 2000
Item:
Revenue
Pre-tax
income (loss)
Revenue
Pre-tax
income (loss)
Previously reported
35,121
2,375
39,020
7,581
Restatement adjustments:
1. Impairment
---
(12,592)
---
(47,180)
2. Improper reduction
of access costs
---
(2,933)
6
(1,827)
3. Purchase accounting
14
(2,273)
(193)
(3,567)
4. Long lived asset
adjustments
---
2,750
---
(1,713)
5. International adjustments
(749)
(899)
18
(487)
6. Revenue related
adjustments
(1,204)
(575)
(36)
(995)
7. Adjustments to
accrued liabilities
---
(823)
---
(732)
8. Embratel and
Avantel acquisitions
5,268
(35)
1,127
(325)
9. Unclassified income/
(expense)
---
383
---
(426)
10. Other
(7)
(506)
4
(750)
Total adjustment items
3,322
(17,503)
926
(58,002)
Discontinued Operations
Adjustment
(775)
1,323
(602)
449
Revenue, as restated
37,668
39,344
Minority interest adjustment
(669)
52
Pre-tax loss, as restated
(14,474)
(49,920)
1. Impairment: The company discovered that impairment tests had not been
2. Improper reduction of access costs: The primary adjustments for this item were
3. Purchase accounting: The company made numerous acquisitions, including the
MCI acquisition, between 1993 and 2001 and a review of these acquisitions
C20-4 (continued)
4. Long lived asset accounting: This item includes adjustments to depreciation and
5. International: Adjustments were made for correcting the U.S. GAAP-based
6. Revenue related adjustments: A number of adjustments were made because of
101. In addition, the company had incorrectly accounted for some contracts as
costs.
7. Adjustments to accrued liabilities: Adjustments were made to eliminate improper
8. Embratel and Avantel acquisitions: A review of the Embratel acquisition showed
an incorrect interpretation with regard to not having control over Embratel and
9. Unclassified income/ (expense): A review of several accrued liability accounts
showed that there was inadequate documentation to support the accruals. Also,
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.
Copyright © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized
E20-1 Multiple-Choice Questions on Chapter 11 Reorganizations [AICPA
Adapted]
1.
c –
Correct
(a) incorrect. A trustee or receiver is not given stewardship over the company in
nonjudical actions.
(b) incorrect. If there are dissenting creditors, the other creditors can choose to
allow those in dissent to still be paid in full.
(d) incorrect. The payment is typically immediate as a result of the creditor not
collecting on the entire debt.
2.
d –
A trustee cannot be designated during a nonjudical action. A court must designate
a trustee.
(a) incorrect. The debtor is the party that submits the petition for temporary
protection from its creditors.
(b) incorrect. Her personal bankruptcy status will not be resolved by the
companies’ bankruptcy proceedings.
(c) incorrect. A plan of reorganization is filed by the debtor.
3.
c –
A reasonable investor or creditor must be able to make an informed judgment
about the worthiness of the plan.
(a) incorrect. This takes place in a Chapter 7 Liquidation
(b) incorrect. By instituting a composition agreement a creditor can accept an
impaired amount of money to satisfy the debt.
(d) incorrect. Not all claims are treated alike in a Chapter 11 reorganization.
4.
d –
The debtor must have 12 creditors, and the required number of creditors signing
the petition must be owed at least $5,000 in total.
5.
c –
The plan must be approved by at least half of all creditors who hold at least two-
thirds of the total debt.
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
Surviving
Debt
Reduction
of Taylor's
Assets
Common
%
$2 par
Stock
Value
Total $
Recovery
%
Post-petition liabilities
(30,000)
(30,000)
(30,000)
100%
Claims/Interest:
Accounts Payable
(80,000)
8,000
(72,000)
(72,000)
90
Notes Payable, 10%
(150,000)
25,000
(125,000)
(125,000)
83
Related Interest Payable
(16,000)
16,000
-0-
0
Bonds Payable, 12%
(200,000)
(200,000)
(200,000)
100
Related Interest Payable
(24,000)
18,000
(6,000)
(6,000)
25
Total
(470,000)
67,000
Common shareholders:
Common Stock
(100,000)
(100,000)
100%
(200,000)
(200,000)
Additional Paid-In
(200,000)
171,000
(29,000)
(29,000)
Retained Earnings
Deficit
178,000
(178,000)
Total
(622,000)
(40,000)
(230,000)
(203,000)
100%
(229,000)
(662,000)
Note: Parentheses indicate credit amount.
