Accounting for Companies in Chapter 11 Reorganization
ACCOUNTING FOR COMPANIES IN CHAPTER 11 REORGANIZATION Reorganizations under the Bankruptcy Code are one of the few areas in financial reporting still untouched by standard setters. Recognizing this void in the face of increased bankruptcy filings, the American Institute of CPAs accounting standards executive committee (AsSEC) issued an exposure draft of a statement of position (SOP) on the subject in April 1990. The final version has now been issued and will mean unique reporting treatment for these reorganizations. Bankruptcy filings for both individuals and businesses in the United States are increasing, due in large part to rising interest rates and consumer debt. New filings are expected to increase 8% this year, to 810,000 cases; a 9.8% increase, to 890,000 cases, is expected in 1992. This prediction comes from the Administrative Office of the U.S. Courts in Washington, D.C. When many individuals hear the word bankruptcy, they think of people losing their homes, cars and life savings - virtually everything except the clothes on their backs - in the face of mounting debts. They also may think of companies being liquidated and creditors paid 10 cents on the dollar - if they're lucky. Many accountants have similar negative perceptions about bankruptcy. Until now, the accounting literature has provided little guidance about how to report on a liquidation. And it has provided no guidance at all on how to report on reorganizations. Accountants for companies being reorganized under the Bankruptcy Code, or for those just coming out of such reorganizations, had to prepare, review and audit the financial reports of these companies without authoritative guidelines. REORGANIZATION Reorganization under the federal Bankruptcy Code is a way to salvage a company, not liquidate it. While it's true that the original owners of a company rescued in this way are often left without anything, others whose livelihoods depend on the company's fortunes may come out with their interests intact. The company's creditors, for example, may take over as the new owners. Its suppliers still may count on the company as a customer. Its customers still may count on the company as a supplier. And perhaps most important, many of its employees may be able to keep the jobs that otherwise would have been sacrificed in a liquidation. THE FOUR Ps OF REORGANIZATION The Bankruptcy Reform Act of 1978, which is currently`effective, gives a company in reorganization a better break than previous U.S. laws or the laws`of other countries. Unlike the United States, in most foreign jurisdictions, for example, secured creditors have veto power over debtor activities. The 1978 act established a new federal Bankruptcy Code for the United States. Key chapters are chapter 7 on liquidations and chapter 11 on reorganizations. The SOP relates solely to chapter 11, which describes the four Ps of reorganization: the petition, protection, the plan and the proceedings. A company in distress petitions the bankruptcy court to obtain protection from its creditors. If granted protection, the company or its trustees can continue to operate while a plan of reorganization is devised, avoiding the substantial additional losses that usually result from liquidation. What happens to a company from the acceptance of the petition until it comes out of reorganization is called the proceedings. See the sidebar on page 78 for the characteristics of a chapter 11 reorganization. CHARACTERISTICS OF A CHAPTER 11 REORGANIZATION * The bankrupt entity (the debtor) usually controls the business during reorganization. * The business continues to operate while in reorganization. * The debtor attempts to formulate a plan of reorganization. * Once a plan is adopted by the court, the debt payments are limited to the schedule and amounts provided in the plan. * The proceedings can be complex (depending, for example, on the number and classes of creditors or the amount of assets) and may last several years. …