Intercompany Sales and Foreign Exchange Transactions

Chapter 5:
Intercompany Profit
Transactions Inventories
to accompany
Advanced Accounting, 11th edition
by Beams, Anthony, Bettinghaus, and Smith
Copyright 2012 Pearson Education, Inc.
Publishing as Prentice Hall
5-1
Intercompany Profits Inventories: Objectives

1. Understand the impact of intercompany profit in
inventories on preparing consolidation
workpapers.
2. Apply the concepts of upstream versus
downstream inventory transfers.
3. Defer unrealized inventory profits remaining in the
ending inventory.
4. Recognize realized, previously deferred, inventory
profits in the beginning inventory.

5-2
Objectives (cont.)
5. Adjust the calculations of noncontrolling interest
amounts in the presence of intercompany
inventory profits.

5-3
Intercompany Profit Transactions Inventories
1: INTERCOMPANY INVENTORY
PROFITS

5-4
Intercompany Transactions
For consolidated financial statements
intercompany balances and transactions shall be eliminated. [FASB
ASC 810-10-45-1]
Show income and financial position as if the intercompany
transactions had never taken place.

5-5
Intercompany Sales of Inventory

Profits on intercompany sales of inventory
Recognized if goods have been resold to outsiders
Deferred if the goods are still held in inventory
Previously deferred profits in beginning inventory are
recognized in the period the goods are sold. Assuming FIFO
Beginning inventories are sold
Ending inventories are from current purchases

5-6
No Intercompany Profits in Inventories

During 2011, Pet sold goods costing $1,000 to its
subsidiary, Sim, at a gross profit of 30%. Sim had
none of this inventory on hand at the end of 2011. The
worksheet entry for 2011:
Sales (-R, -SE)
1,429
Cost of sales (-E, +SE)
Eliminate intercompany sales = $1,000 / (1-30%) = $1,429
1,429
All intercompany sales of inventories have been resold

to outside parties, so remove the full sales price from
both sales and cost of sales.
Pet's sales are reduced $1,429.
Sim's cost of sales are reduced $1,429.
The same entry is used if Sim sells to Pet.
5-7
Intercompany Profits Only in Ending Inventories

Last year, 2011, Pal sold goods costing $500 to its
subsidiary, Sal, at a gross profit of 25%. Sal had
none of this inventory on hand at the end of 2011.
During 2012, Pal sold additional goods costing
$900 to Sal at a gross profit of 40%. Sal has $200
of these goods on hand at 12/31/2012. Worksheet
entries for 2012:
Sales (-R, -SE)
1,500
Eliminate intercompany sales = $900 / (1-40%) = $1,500
Cost of sales (E, -SE)
80
Inventory (-A)
Publishing
Prentice
Defer profit in ending inventory
=as$200
x Hall
40%
1,500
80
5-8
Intercompany Profits Beginning and Ending Inventories

Last year, 2011, Pam sold goods costing $300 to its subsidiary, Sir, at
mark-up of 25%. Sir had $120 of this inventory on hand at the end of
2011.
During 2012, Pam sold additional goods costing $500 to Sir at a 30%
mark-up. Sir has $260 of these goods on hand at 12/31/2012. Worksheet
entries for 2012:
Sales (-R, -SE)

650
650
Eliminate intercompany sales = $500 + 30%($500) = $650

Inventory (-A)
60
60
Defer profits in ending inventory = $260 x 30%/130%
Investment in Subsidiary (+A)

Copyright
Cost of sales (-E,
+SE)2012 Pearson Education, Inc.
24
24
5-9
2: UPSTREAM & DOWNSTREAM

INVENTORY SALES

5-10
Upstream and Downstream Sales

Downstream Sales
Parent
Parent sells to
subsidiary
Subsidiary
1
Subsidiary
2
Subsidiary sells to
parent
Subsidiary
3
Upstream Sales

5-11
Intercompany Inventory Sales

The worksheet entries for eliminating intercompany
profits for downstream sales
Sales (-R, -SE)
XXX
XXX
For the intercompany sales price

Inventory (-A)
XX
XX
For the profits in ending inventory
Investment in Subsidiary (+A)

XX
Cost of salessales,
(-E, +SE)
For upstream
the last entry would include a XX
For theto
profits
in beginning inventory
debit
noncontrolling
interest, sharing the realized
profit between controlling and noncontrolling interests.
5-12
Data for Example

For the year ended 12/31/2011:
Subsidiary income is $5,200
Subsidiary dividends are $3,000
Current amortization of acquisition price is $450
Intercompany (IC) sales information:
IC sales during 2011 were $650
IC profit in ending inventory $60
IC profit in beginning inventory $24

5-13
Income Sharing with Downstream Sales PARENT

Makes Sale
Subsidiary net income
$5,200
Current amortizations
(450)
Adjusted income
$4,750
CI 80% share
$3,800
(60)
24
Defer profits in EI
(60)
Recognize profits in BI
24
Income recognized
$4,714
$3,764
$2,400
Subsidiary
dividends
$3,000
When parent
makes the IC
sale,
the impact of deferring and
recognizing profits falls all to the
parent.
Income from subsidiary
NCI 20% share

$950
$600
5-14
Income Sharing with Upstream Sales SUBSIDIARY

Makes Sale
Subsidiary net income
$5,200
(450)
Adjusted income
$4,750
CI 80% share
$3,800
(48)
19.2
Defer profits in EI
Recognize profits in BI
Income recognized
(60)
$3,771.2
Income from subsidiary
24
$4,714
$2,400
Subsidiary
dividends makes the
$3,000
When subsidiary
IC sale, the
impact of deferring and recognizing
profits is split among controlling and
noncontrolling interests.
NCI 20% share

$950.0
(12.0)
4.8
$942.8
$600
5-15
3: UNREALIZED PROFITS IN ENDING

INVENTORIES

5-16
Ending Inventory on Hand

Intercompany profits in ending inventory
Eliminate at year end
Working paper entry
Inventories (-A)
For the unrealized profit

XXX
XXX
5-17
Parent Accounting
Pot owns 90% of Sot acquired at book value (no
amortizations). During the current year, Sot reported
$10,000 income. Pot sold goods to Sot during the year
for $15,000 including a profit of $6,250. Sot still holds
40% of these goods at the end of the year.
Unrealized profit in ending inventory
40%(6,250) = $2,500
Pot's Income from Sot
90%(10,000) 2,500 unrealized profits = $6,500
Noncontrolling interest share
10%(10,000) = $1,000
5-18
Entries
Pot's journal entry to record income
Investment in Sot (+A)
Income from Sot (R, +SE)
6,500
6,500
Worksheet entries to eliminate intercompany sale and

unrealized profits
Sales (-R, -SE)
Cost of goods sold (-E, +SE)
Cost of goods sold (E, -SE)
Inventory (-A)
15,000

15,000
2,500
2,500
5-19
Worksheet Income Statement

Sales
Income from Sot
Pot
Sot
DR
$100.0
$50.0
15.0
$135.0
6.5
0.0
6.5
Cost of sales
(60.0)
(35.0)
Expenses
(15.0)
(5.0)

Controlling interest share
2.5
CR
15.0
(82.5)
(20.0)
1.0
$31.5
Consol
$7.5
(1.0)
$31.5
There would be a credit adjustment to Inventory for $2.5 on the

balance sheet portion of the worksheet.

5-20
What if?
If the sales had been upstream, by Sot to Pot:
Unrealized profits in ending inventory
40%(6,250) = $2,500
Pot's Income from Sot
90%(10,000 2,500) = $6,750
10%(10,000 2,500) = $750
Upstream profits impact both:
Controlling interest share
5-21
4: RECOGNIZING PROFITS FROM

BEGINNING INVENTORIES

5-22
Intercompany Profits in Beginning Inventory

Unrealized profits in
ending inventory one year
Become
Profits to be recognized in the beginning
inventory of the next year!
5-23
5: IMPACT ON NONCONTROLLING
INTEREST

5-24
Direction of Sale and NCI

The impact of unrealized profits in ending inventory and
realizing profits in beginning inventory depends on the
direction of the intercompany sales
Downstream sales
Full impact on parent
Upstream sales
Share impact between parent and noncontrolling interest

5-25
Calculating Income and NCI

Downstream sales:
Income from sub
= CI%(Sub's NI) Profits in EI + Profits in BI

= NCI%(Sub's NI)
Upstream sales:
Income from sub
= CI%(Sub's NI Profits in EI + Profits in BI)

= NCI%(Sub's NI Profits in EI + Profits in BI)

5-26
Upstream Example with Amortization

Perry acquired 70% of Salt on 1/1/2011 for $420 when Salt's equity consisted of $200
capital stock and $200 retained earnings. Salt's inventory was understated by $50 and
building, with a 20-year life, was understated by $100. Any excess is goodwill.
2011
2012
Perry
Salt Perry
Salt
Separate income
$1,250
$705 $1,500
$745
Dividends
$600 at a$280
$600 $240
$300of these goods were
During 2011, Salt sold
goods for $700 to Perry
20% markup.
in Perry's ending inventory.

In 2012, Salt sold goods for $900 to Perry at a 25% markup and Perry still had $100 on
hand at the end of the year.
5-27
Analysis and Amortization

Cost of 70% of Salt
$420
Implied value of Salt 420/.70
$600
Book value 200 + 200
400
Excess
$200
Unamort
Amort
Unamort
Amort
Unamort
1/1/11
2011
1/1/12
2012
12/31/12
Inventory
50
(50)
Building
100
(5)
95
(5)
90
Goodwill
50
50
50
200
(55)
145
(5)
140
Allocated to:

5-28
2011 Income Sharing (Upstream)

Salt's net income
Adjusted income
$705
CI 70% share
(55)
$455
$650
($28)
$427
Defer profits in EI
Income recognized
Income from Salt
(40)
$610
$196
NCI 30% share
$195
Subsidiary dividends
$280
($12)
$183

$84
5-29
Perry's 2011 Equity Entries

Investment in Salt (+A)
Cash (-A)
For acquisition of 70% of Salt
Cash (+A)
Investment in Salt (-A)
For dividends received
Income from Salt (R, +SE)
For share of income
420
420
196
196
427
427
5-30
2011 Worksheet Entries (1 of 3)

1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Sales (-R, -SE)
Cost of Sales (E, -SE)
Inventory (-A)
700
700
40
40
3. Eliminate income & dividends from sub. and bring Investment account
to its beginning
Incomebalance
from Salt (-R, -SE)
427
Dividends (+SE)
196
231
5-31
2011 Entries (2 of 3)
4. Record noncontrolling interest in sub's earnings & dividends
Noncontrolling interest share (-SE)
183
Dividends (+SE)
5. Eliminate reciprocal
Investment
Noncontrolling
interest (+SE)& sub's equity balances
Capital stock (-SE)
200
Retained earnings (-SE)
200
Inventory (+A)
50
Building (+A)
100
Goodwill (+A)
50
Investment in SaltCopyright
(-A) 2012 Pearson Education, Inc.
84
99
420
5-32
6. Amortize fair value/book value differentials
Inventory (-A)
Depreciation expense (E, -SE)
Building (-A)
50
50
5
5
7. Eliminate other reciprocal balances none

5-33
2012 Income Sharing (Upstream)

Salt's net income
Adjusted income
Defer profits in EI
Realize profits from BI
Income recognized
Subsidiary dividends
$745
(5)
$740
(20)
40
$760
CI 70% share
$518
($14)
$28
$532
$210
$300
Income from Salt

NCI 30% share
$222
($6)
$12
$228

$90
5-34
Perry's 2012 Equity Entries

Cash (+A)
For dividends received
Income from Salt (R, +SE)
For share of income

210
210
532
532
5-35
2012 Worksheet Entries (1 of 3)

1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Sales (-R, -SE)
900
Cost of Sales (E, -SE)
900
20
Inventory (-A)
20
28
Noncontrolling interest (-SE)
12

3. Eliminate income & dividends from sub. and bring
Income from Salt
(-R, -SE)
Investment
account
to its beginning balance 532
Dividends (+SE)
Copyright 2012 Pearson

Education, Inc. Publishing as
40
210
322
5-36
4. Record noncontrolling interest in sub's earnings & dividends
Noncontrolling interest share (-SE)
228
Dividends (+SE)
90
Noncontrolling
interest (+SE)
5. Eliminate reciprocal
Investment
& sub's equity balances
Capital stock (-SE)
200
Retained earnings (-SE)
625
Inventory (+A)
Building (+A)
95
Goodwill (+A)
50

Noncontrolling interest (+SE)
138
679
291
5-37
6. Amortize fair value/book value differentials
Depreciation expense (E, -SE)
Building (-A)
5
5
7. Eliminate other reciprocal balances none

5-38
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system, or transmitted, in any form or by any means, electronic, mechanical,
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publisher. Printed in the United States of America.
5-39
Chapter 6: Intercompany Profit

Transactions Plant Assets
by Jeanne M. David, Ph.D., Univ. of Detroit Mercy
to accompany

by Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn
Pearson Education, Inc. publishing as Prentice Hall
6-40
Intercompany Profits Plant

Assets: Objectives
1. Assess the impact of intercompany profit on
transfers of plant assets in preparing
consolidations working papers.
2. Defer unrealized profits on asset transfers by
either the parent or subsidiary.
3. Recognize realized, previously deferred profits
on asset transfers by the parent or subsidiary.
4. Adjust the calculation of noncontrolling interest
amounts in the presence of intercompany profits
on asset transfers.
6-41
Intercompany Profit Transactions Plant Assets
1: Transfers of Plant Assets
6-42
Intercompany Fixed Asset Sales

Intercompany sales of nondepreciable fixed assets:
In year of intercompany sale
Defer any gain or loss
Restate fixed asset to cost
In years of continued ownership
Adjust investment account to defer gain or loss (adjust
noncontrolling interest too, if upstream sale)
Restate fixed asset to cost
In year of sale to outside entity
Adjust investment account (and noncontrolling interest if
upstream sale)
Recognize the previously deferred gain or loss
6-43
Intercompany Sale of Land

Park owns 90% of Stan, acquired at cost equal to fair value. In
2009, Park sells (downstream) land to Stan and records a $10
gain. In 2013, Stan sells the land to an outside entity at a $15
gain. Stan's separate income was $70 in 2009, $80 per year for
2010 to 2012, and $90 in 2013.
6-44
2009 Calculations
Defer the unrealized gain, with full effect to Park
Park's Income from Stan
90%(70) 10 = $53
10%(70) = $7
Elimination entry for 2009 Worksheet
Gain on sale of land
Land
10
10
6-45
2010 to 2012 Calculations

Continue to defer gain, with full effect to Park
90%(80) = $72
10%(80) = $8
Elimination entry for Worksheets in 2010 to 2012
Investment in Stan
Land
10
10
6-46
2013 Calculations
Recognize the previously deferred gain, with full
effect to Park
90%(90) + 10 = $91
10%(90) = $9
Investment in Stan
10
Gain on sale of land
10
6-47
2: Deferring Unrealized Profits
6-48
Unrealized Profits on Fixed Assets

Unrealized profit or loss on nondepreciable fixed assets
Defer in year of intercompany sale
Continue deferring by adjusting the investment in subsidiary
(and noncontrolling interest if upstream)
Recognize full profit or loss upon resale to outside entity
6-49
Depreciable Fixed Assets

Gains and losses on intercompany sales of depreciable fixed assets
Defer in period of intercompany sale
Recognize gain or loss over remaining life of asset
Adjust asset and depreciation down for gains
Adjust asset and depreciation up for losses
Recognize any unamortized gain or loss upon sale to outside
entity
6-50
Downstream Example
Perry owns 80% of Soper, acquired at cost equal to fair value. On
1/1/09, Perry sells equipment to Soper at a $30 profit. The
equipment has a remaining life of 5 years from 1/1/09. Soper
disposes of the equipment at book value at the end of 5 years.
Soper's income is $70 in 2009, $80 per year for 2010 to 2012, and
$90 in 2013.
6-51
2009 Calculations
Defer the unrealized gain and amortize it over 5
years with full effect to Perry
30 gain / 5 years = $6
Perry's Income from Soper
80%(70) 30 + 6 = $32
20%(70) = $14
Gain on sale of equipment
Equipment
Accumulated depreciation
Depreciation expense
30
30
6
6-52
3: Recognizing Realized, Previously

Deferred Profits
6-53
Previously Deferred Gains/Losses

Recognize over the life of the depreciable asset
Downstream sales
Adjust investment in subsidiary account
Upstream sales
Adjust investment in subsidiary account and
noncontrolling interest, proportionately
Intercompany sales at a gain
Adjust asset and depreciation down
Intercompany sales at a loss
Adjust asset and depreciation up
6-54

Continue to recognize part of the gain, with full
effect to Perry
80%(80) + 6 = $70
20%(80) = $16
Elimination entry for Worksheets in 2010
Investment in Soper
24
6
Equipment
30
6
6
6-55
Entries (cont.)
Worksheet entries for 2011
Investment in Soper
Equipment
18
12
Investment in Soper
Equipment
12
18
30
6
6
30
6
6
6-56
2013 Calculations
Recognize the remaining deferred gain, with full
effect to Perry
80%(90) + 6 = $78
20%(90) = $18
Elimination entries for 2013 Worksheet
Investment in Soper
6
24
Equipment
30
6
Depreciation
expense
6
Pearson Education, Inc. publishing
as Prentice Hall
6-57
4: Impact on Noncontrolling Interest
6-58
Sharing Unrealized Gain or Loss

Upstream sales of fixed assets require:
Deferring the gain or loss on the sale
Recognizing a portion of the gain or loss as the asset
depreciates
Writing off any unrecognized gain or loss upon the sale of the
asset
Sharing the gains and losses between the controlling and
noncontrolling interests
Upstream sales impact noncontrolling interests!
6-59
Upstream Example
Pail owns 70% of Shovel, acquired at cost equal to fair value. On
1/1/09, Shovel sells equipment to Pail at a $40 profit. The
equipment has a remaining life of 5 years from 1/1/09. Pail Uses
the equipment for four years, then sells it at a profit at the start
of 2013. Shovel's income is $70 in 2009, $80 per year for 2010 to
2012, and $90 in 2013.
6-60
2009 Calculations
Defer the unrealized gain and amortize it over 5
years sharing the gain
40 gain / 5 years = $8
Pail's Income from Shovel
70%(70 40 + 8) = $26.6
30%(70 40 + 8) = $11.4
40
Equipment
40
8
8
6-61

Continue to recognize part of the gain, sharing its
effect between the controlling and
noncontrolling interests
70%(80 + 8) = $61.6
30%(80 + 8) = $26.4
6-62
2010 Worksheet Entries

Elimination entry for Worksheets in 2010
Investment in Shovel
Noncontrolling interest
Equipment
22.4
9.6
8.0
40.0
8.0
8.0
6-63

Noncontrolling interests
Equipment
16.8
7.2
16.0
40
8.0
8.0
6-64

Noncontrolling interest
Equipment
11.2
4.8
24.0
40.0
8.0
8.0
6-65
2013 Calculations
Recognize the remaining deferred gain, sharing the impact
with controlling and noncontrolling interests
Unamortized gain = 1 year at $8
70%(90 + 8) = $68.6
30%(90 + 8) = $29.4
Elimination entries for 2013 Worksheet
5.6
Noncontrolling interests
2.4
32.0
Equipment
40.0
8.0
6-66
8.0
Sale at Other Than Fair Value

Intercompany sales of fixed assets at prices other
than fair value
Deserve scrutiny by shareholders
Sales above fair value move additional
cash to the seller
Sales below fair value transfer valuable
goods to the buyer
There is a transfer of wealth between the
affiliated companies, and between the
controlling and noncontrolling interests
6-67
Inventory Items Fixed Assets

An intercompany sale of inventory which is
acquired as a fixed asset
Unrealized profit is removed from cost of
sales in year of sale
Profit is recognized over the fixed asset's life
Cost of sales
Equipment
XXX
XXX
X
X
6-68
All rights reserved. No part of this publication may be reproduced,

stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording, or
otherwise, without the prior written permission of the publisher.
Printed in the United States of America.

6-69
Chapter 18
Corporate Liquidations
and Reorganizations
to accompany
by Beams, Anthony, Bettinghaus, and Smith
18-70
Corporate Liquidations and

Reorganizations: Objectives
1. Understand differences among types
of bankruptcy filing.
2. Comprehend trustee responsibilities
and accounting during liquidation.
3. Understand financial reporting during
reorganization.
4. Understand financial reporting after
emerging from reorganization,
including fresh-start accounting.
18-71
Corporate Liquidations and Reorganizations
1: TYPES OF BANKRUPTCIES

18-72
Insolvency
Equity insolvency
Inability to pay debts on time
May avoid bankruptcy proceedings
Negotiate directly with creditors
Bankruptcy insolvency
Having total debts in excess of the fair value
of assets
May be liquidated, or
Reorganized
18-73
Types of Bankruptcies
Chapter 7: Liquidation
Trustee appointed to sell assets of
business
Chapter 9: Adjustment of Debt of a Municipality
Chapter 11: Reorganization

Debtor is expected to be rehabilitated
Chapter 12: Farmers
Chapter 13: Adjustment of Debts of an Individual
18-74
Characteristics
Voluntary bankruptcy proceedings
Filed by debtor
Involuntary bankruptcy proceedings
Filed by creditor or group of creditors
Court action
Dismiss a case
Accept the petition
Change form
Chapter 11 reorganization
Chapter 7 liquidation

18-75
2: TRUSTEE RESPONSIBILITIES AND

ACCOUNTING

18-76
Duties of Debtor Corporation

In both liquidation and reorganization cases,
the debtor corporation must
File a list of creditors, a schedule of assets
and liabilities, and a statement of financial
affairs
Cooperate with trustee
Surrender property to the trustee, including
records
Appear at court hearings
18-77
Duties of Trustee
Trustee serves in liquidation cases
Investigate debtor's financial affairs
Provide information
Examine, perhaps object to, creditor claims
File report on trusteeship
If authorized to operate debtor's business,
other period reports are required
In reorganization cases, in addition to above
Filing reorganization plan or statement why
one cannot be filed
18-78
Ranking of Claims: Liquidation

18-79
Statement of Affairs
Legal document prepared for bankruptcy
court
Assets at expected net realizable values
Classified on basis of availability for classes
of creditors
Liabilities are classified
Priority, fully secured, partially secured,
unsecured
Historical values included for reference
18-80

18-81

18-82
Trustee Accounting
At start of case, trustee creates a new set of
books.
During the case,
Records transactions
Statement of cash receipts and disbursements
Statement of changes in estate equity
Balance sheet
Statement of realization and liquidation
At close of case,
Final settlement of claims
Trustee is dismissed
18-83
Debtor in Possession
Unless there is a reason to appoint a
trustee, the debtor corporations
management is permitted to continue to
run the company while in bankruptcy.
The Debtor in Possession has the same
responsibilities as a trustee in a
reorganization case.
18-84
Creditors Committee
The Creditors Committee is elected in a
liquidation case, and is appointed in a
reorganization case from the largest
unsecured creditors.
Makes decisions on behalf of all
creditors
Reviews ongoing transactions of the
debtor in possession and can object
Handles negotiations with any creditor
regarding settlement or continued
business.
18-85
Benefits of Chapter 11
Benefits of being the Debtor in Possession
include:
Rejecting executory contracts
Cancelling unexpired leases
Legal protection from creditor action, such
as lawsuits or repossession of property
However, day-to-day operations may become
more difficult as lenders, suppliers, customers,
and employees are aware of the bankruptcy
filing.
18-86
Reorganization Plan
A plan may be filed at the time of the bankruptcy
filing (prepackaged bankruptcy) or by the
debtor corporation within 120 days of filing.
Other interested parties may file proposed plans
after 120 days.
Identify classes of claims
Specify the expected payout of each class
Claims within a given class must be treated
alike
Define the expected requirements for
execution of the plan
Must be fair and equitable
18-87
3: FINANCIAL REPORTING DURING

REORGANIZATION

18-88
Chapter 11: Balance Sheet

Prepetition liabilities subject to compromise
are reported as a separate line item in liabilities
Arose before filing
Include unsecured and under-secured liabilities
Likely to be paid at an amount less than face value
Prepetition secured liabilities and post petition
liabilities reported in normal fashion
Prepetition claims discovered after filing
Included at court-allowed amounts
18-89
Chapter 11: Other Statements

Reorganization costs shown separately
Interest to be paid or probable amount
Differences from contractual amounts
should be noted
Expected stock or stock equivalent
issuances should be disclosed
Cash flow items related to reorganization
shown separately
18-90
Combined Financial Statements

Condensed combined financial
statements are prepared for all entities in
reorganization proceedings as
supplementary information
Intercompany receivables and payables
Write-down if necessary

18-91
4: EMERGING FROM REORGANIZATION

18-92
Reorganization Value
Approximates fair value of entity without
considering liabilities
Discounted future cash flows of reorganized
business
Consider business and financial risk
Reorganization value determines how much
creditors recover
Emerging business will either use
1. Fresh start reporting
2. Report liabilities at present value and
forgiveness of debt as extraordinary item
18-93
Fresh-Start Reporting
Fresh-Start Reporting recognizes that the
emerging company is a new entity.
To qualify,
1. Revaluation value immediately before the
reorganization plan is confirmed must be less
than post-petition liabilities and allowed
claims, and
2. Holders of existing voting shares receive less
than 50% of emerging entity
18-94
Apply Fresh Start Reporting

Allocated reorganization value to identifiable
assets
Unallocated amount is an intangible called
Reorganization value in excess of amounts allocated
to identifiable assets
Liabilities at current value at confirmation date
Deferred tax benefits are first applied to reduce any
intangible asset recorded
Prepare final reports of old entity
The effects of adjustments to asset and liability
accounts are shown, so that ending balance sheet
of old entity
= beginning
balance
Copyright
2012 Pearson Education,
Inc. sheet of new entity
18-95
Continued Reporting of Old Company

If a company does not qualify for Fresh-Start
Reporting, then
Report liabilities at the appropriate interest
rate under GAAP
Report debt forgiveness as an extraordinary
item

18-96
Reorganization Example
Tig files for protection under Chapter 11 on
January 5, 2011. Accordingly, it
reclassifies prepetition liabilities
obtains short-term financing
acquires additional equipment
continues operations through June 30, 2012
when the plan is approved, with a
reorganization value of $2,200
First, we'll look at the statements pre and post
reorganization. Then we'll go through the
entries and adjustments that occurred.
18-97
Balance Sheet Assets

Fair
Filed
FYE Before
Revalue
1/5/11 12/31/11 6/30/12 valuation 6/30/12
Cash
50
150
300
0
Accounts receivable
500
350
335
0
Inventory
300
370
350
25
Other current assets
50
50
30
0
Land
200
200
200
100
Building, net
500
450
425
(75)
Equipment, net
300
330
290
(30)
Patent
200
150
125
(125)
Reorganization value in excess of identifiable assets
as Prentice
Hall
2,100 Publishing
2,050
2,055
(105)
300
335
375
30
300
350
260
0
1,950
AFTER
6/30/12
300
335
375
30
300
350
260
0
250
2,200
18-98
Changes to Assets
Fair values and revaluation amounts are shown on 6/30/12 for
comparison.
Tig continues operations, records depreciation, and

even acquires equipment from filing on 1/5/11 to
reorganization on 6/30/12.
The reorganization revalues the assets to their fair
value on that date. Patents are completely written
off.
Tig records an intangible "Reorganization value in
excess of identifiable assets" of $250. Not all
reorganizations result in this intangible.
18-99
Balance Sheet - Liability & Equity

Short-term borrowing (post)
Accounts payable (pre/post)
Filed
1/5/11
FYE
12/31/11
Before
6/30/12
AFTER
6/30/12
600
150
100
75
125
75
125
50
55
55
Wages payable (post)

Taxes payable (pre)
150
Accrued bond interest (pre)
90
Note payable (pre)

Subordinated debt (post)
12% bonds payable current (post)
12% bonds payable (post)
15% bonds payable (pre)
260
395
100
500
1,200
Liabilities subject to compromise

Capital stock (old)
150
500

2,300
2,300
500
500
18-100
Changes to Liabilities
Upon filing on 1/5/11, Tig reclassifies the
unsecured and partially secured liabilities at that
point as Pre-petition Liabilities Subject to
Compromise.
Pre-petition Liabilities Subject to Compromise
are then reclassified or settled according to the
plan.
Accounts payable on 12/31/11 does not include
any of the $600 due prior to filing.
Taxes payable are still to be paid, and eventually
recorded againCopyright
in full.
2012 Pearson Education, Inc.
18-101
Changes to Equity
Some of the creditors receive stock in the
reorganized firm. The old shareholders also
receive stock, but now own only $100 of $800 of
the stock at book value.
Although some APIC was recorded in
reorganizing, it was subsequently eliminated. If
it had been sufficient to wipe out the deficit, no
intangible "reorganization value in excess of
identifiable assets" would be recorded.
The Deficit is removed!
18-102
Can Tig Use Fresh Start?

Post-petition liabilities
Allowed claims
Total liabilities
Less reorganization value
Excess liabilities
$255
2,300
$2,555
(2,200)
$355
On 6/30/12 there were $255 in post-petition

liabilities. All $2,300 pre-petition liabilities were
allowed by the courts. Firm value is $2,200.
1. Liabilities exceed reorganization value
2. Old shareholders retain less than 50%
Yes, fresh start is appropriate.
18-103
Reorganization Plan: 6/30/12

Pre-petition
Liabilities and Equity
15% partially secured
bonds, $1200
Priority tax claims $150
New Agreements
$500 new stock, $500
senior 12% bonds, and
another $100 bonds due
12/31/12
To be paid cash once
confirmed
Debt Discharge
$100
$0
Remaining unsecured claims, $950:
$600 accounts payable
$275 subordinated debt

and $140 new stock
$90 accrued interest
Forgiven
$260 note
$120 subordinated debt
and $60 new stock
Total debt discharged
Old stock
$100 new stock
$185
$90
$80
$455
Equity
18-104
Record New Debt Agreements

Liabilities subject to compromise (pre)
Taxes payable
12% senior debt
12% senior debt - current
Subordinated debt
Common stock (new)
Gain on debt discharge
settlement of prepetition claims
2,300
150
500
100
395
700
455
This entry reclassifies the pre-petition debt

according to the reorganization plan.
18-105
Give Shareholders New Shares

Common stock (old)
Common stock (new)
Additional paid in capital
exchange of stock with owners
500
100
400
They will lose control since creditors have

$700 of common stock.

18-106
Revalue Assets
Inventory
25
Land
100
Loss on asset revaluation
105
Buildings, net
75
Equipment, net
30
Patent
125
revalue assets to fair value
A loss is recorded in revaluing the assets. Refer

back to the Asset side of the balance sheet.
18-107
Calculate Balance in Retained

Earnings (Deficit)
Deficit, 6/30/12
Final measure of deficit, 6/30/12
Write-off Additional paid in capital
Reorganization value in excess of
identifiable assets (intangible asset)
(1,000)
455
(105)
($650)
400
($250)
If sufficient APIC had existed, there would be

no intangible asset, and excess APIC would
remain on the balance sheet.
18-108
Eliminate Deficit in Equity

Reorganization value in excess of
identifiable assets
Additional paid in capital
Deficit
250
455
400
105
1,000
The $1,000 deficit on 6/30/12 is adjusted for

the gain on debt discharge and loss on asset
revaluation. The net $650 deficit eliminates
all of the APIC and creates a $250 intangible.
18-109
Simplifying Assumptions
All transactions are recorded on
6/30/12.
Generally this takes some time.
Creditors may have interest between
submission and approval of plan.
All pre-petition debt is approved.
The $2,200 reorganization value of the
firm probably used a discounted cash
flow firm valuation model.
18-110
Disclosures
Adjustments to historical values
Assets
Liabilities
Debt forgiveness
Prior retained earnings or deficit eliminated
Significant factors in determining the
reorganization value
18-111
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18-112
Corporate Liquidations
and Reorganizations
Chapter 17
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
17 - 113
Learning Objective 1
Understand differences among
types of bankruptcy filings.
17 - 114
Bankruptcy Reform Act of 1978

Prior to 1898, state government legislation
governed bankruptcy procedures.
The 1898 Bankruptcy Act, a federal law,
preempted the state legislation.
The 1898 Act was repealed when Congress
enacted the Bankruptcy Reform Act of 1978.
17 - 115
Bankruptcy Law
The bankruptcy law facilitates debt relief to
individuals and corporations under various
provisions, called chapters.
17 - 116
Description
Type
Chapter 7
Liquidation
Chapter 9
Adjustments
of debts of a
municipality
A trustee is appointed to sell off

assets of the individual or company
and pay claims to creditors.
Municipalities (not covered here).
17 - 117
Description
Type
Chapter 11
Reorganization
A debtor corporation is expected to be

rehabilitated and the reorganization of
the corporation is anticipated.
Either a trustee is appointed or the
company performs the duties of a
trustee (debtor in possession).
A plan of reorganization is negotiated.
17 - 118
Description
Type
Chapter 12
Farmers
Chapter 13
Adjustments
of debts of an
individual with
regular income
Family farmers with regular income

(not covered here).
Exclusively applies to individuals,
including sole proprietorships.
Unsecured debts less than $250,000
and secured debts less than $750,000
(not covered here).
17 - 119
Payment of Claims
I. Secured Claims
Claims secured by valid liens.
II. Unsecured Priority Claims
1. Administrative expenses incurred in preserving and
liquidating the estate.
2. Claims incurred between the date of filing and the
date an interim trustee is appointed.
3. Claims for wages, salaries, and commissions.
4. Claims for contributions to employee benefit plans.
5. Claims of individuals regarding property or services.
6. Claims of governmental units (taxes, duties, etc.).
17 - 120
Payment of Claims
III.
Unsecured Nonpriority Claims

1. Allowed claims that were timely filed.
2. Allowed claims where proof of claims was filed late.
3. Allowed claims for any fine, penalty, or forfeiture, or
for charges arising prior to the order for relief.
4. Claims for interest on the unsecured priority claims
or the unsecured nonpriority claims.
IV.Stockholders Claims
Remaining assets are returned to the debtor corporation
or its stockholders.
17 - 121
Comprehend trustee
responsibilities and accounting
during liquidation.
17 - 122
Duties of the Trustee

in Liquidation Cases
The filing of a case creates an estate.
The trustee takes possession of the estate,
converts the assets into cash, and distributes
the proceeds according to the priority of
claims, as directed by the bankruptcy court.
17 - 123
Statement of Affairs
This statement is a legal
document prepared for the
bankruptcy court.
It emphasizes liquidation value.
17 - 124
Trustee Accounting
The Bankruptcy Act

does not cover
procedural accounting
details.
17 - 125
Trustee Accounting
Statement of Cash Receipts and Disbursements
Statement of Changes in Estate Equity
Balance Sheet
Statement of Realization and Liquidation
17 - 126
Understand financial reporting
during reorganization.
17 - 127
Reorganization
Less than 30% of business bankruptcy cases
are filed under Chapter 11 each year.
A Chapter 11 reorganization case is
initiated voluntarily or involuntarily.
17 - 128
Trustee or Debtor in Possession
A private trustee may be appointed.
The debtor corporation may continue in possession.
17 - 129
The Duties of a Trustee

Including the Following:
Being accountable for the debtors property
Filing a list of creditors, schedules of assets
and liabilities, and a financial statement
Furnishing information to the court
Examining creditor claims for authenticity
Filing a reorganization plan
Filing final papers on the trusteeship
17 - 130
Committee Representation
Creditors committees are responsible

for protecting the interests of the
creditors they represent.
17 - 131
Operating Under Chapter 11
Possible Benefits
Protection of the debtor

in possession allowing
possible cost reductions
Disadvantages
Losing the confidence

of its lenders, suppliers,
customers, and employers
17 - 132
The Plan of Reorganization Must:

Identify class of claims
Specify any class of claims that is not impaired
Specify any class of claims that is impaired
Treat all claims within a particular class alike
Provide adequate means for the plans execution
Prohibit the issuance of nonvoting securities
Prohibit the issuance of nonvoting securities
17 - 133
Financial Reporting During

Reorganization
The reorganization process
can take several years.
The corporation must still prepare
financial statements and filings
for the SEC during this time
period and after it emerges
from reorganization.
17 - 134
Effects of Chapter 11 on the

Balance Sheet
Unsecured liabilities and undersecured

liabilities incurred before the company
entered Chapter 11 are prepetition
liabilities subject to compromise.
17 - 135

Income Statement
Professional fees and similar expenses
related directly to the Chapter 11
proceedings are expensed as incurred.
Reorganization items should be reported.
17 - 136

Statement of Cash Flows
Cash flow items relating to reorganization

are disclosed separately from cash flow
items relating to the ongoing
operations of the business.
17 - 137
Supplementary Combined
Financial Statements
SOP 90-7 requires that condensed combined

financial statements for all entities in
reorganization proceedings be presented
as supplementary financial information.
17 - 138
Understand financial reporting
after emerging from
reorganization including
fresh-start accounting.
17 - 139
Financial Reporting for

the Emerging Company
Ordinarily, a corporate reorganization
involves a restructuring of liabilities and
capital accounts and a revaluation of assets.
For many companies, their reorganization
plan includes the sale of the company.
17 - 140
Reorganization Value
Generally, the reorganization value is
determined by discounting future cash
flows for the reconstituted business
plus the expected proceeds from sale of
assets not required in the new business.
17 - 141
Fresh-start reporting results in
a new reporting entity with no
retained earnings or deficit balance.
The SOP provides two conditions that
must be met for fresh-start reporting:
17 - 142
1. The reorganization value of the emerging
entitys assets immediately before the date of
confirmation of the reorganization plan is less
than the total of all postpetition liabilities
and allowed claims.
2. Holders of existing voting shares immediately
before confirmation of the reorganization plan
receive less than 50% of the emerging entity.
17 - 143
Fresh-Start Reporting Results

in a New Reporting Entity
Allocating the reorganization value
to identifiable assets
Reporting liabilities
Final statement of old entity
Disclosures in initial financial
statements of new entity
Comparative financial statements
17 - 144
Reporting by Entities That Do Not

Qualify for Fresh-Start Reporting
Liabilities are reported at present values
using appropriate interest rates.
Forgiveness of debt should be reported
as an extraordinary item.
Quasi-reorganization accounting is not used.
17 - 145
Illustration of a Reorganization Case

Tiger Corporation files for protection from
creditors under Chapter 11 on January 5, 2003.
During 2003, no prepetition liabilities are
paid and no interest is accrued on the
bank note or the bonds payable.
17 - 146

The bankruptcy court allows Tiger to invest
$100,000 in new equipment in August 2003.
The new equipment has a useful life of
five years, and is depreciated over a five
year period to the nearest half-year.
17 - 147

Building depreciation:
Old equipment:
Patent amortization:
$50,000 per year

$60,000 per year
$50,000 per year
17 - 148

(Tiger Balance Sheet)
Current assets
Cash
Accounts receivable, net
Inventory
Plant assets
Land
Building, net
Equipment, net
Patent
$ 50,000
500,000
300,000
50,000 $ 900,000
$200,000
500,000
300,000
200,000
1,200,000
$2,100,000
17 - 149

(Tiger Balance Sheet)
Current liabilities
Accounts payable
Taxes payable
Accrued interest on bonds
Note payable to bank
15% bonds payable
(partially secured)
Stockholders deficit
Capital stock
Deficit
$600,000
150,000
90,000
260,000
$1,100,000
1,200,000
500,000
700,000
200,000
$2,100,000
17 - 150
Reclassification of Liabilities
Subject to Compromise
(000)
Accounts Payable
600
Taxes Payable
150
Accrued Interest on 15% Bonds
90
Note Payable to Bank
260
15% Bonds Payable (partially secured) 1,200
Liabilities Subject to Compromise
To reclassify liabilities subject to compromise
2,300
17 - 151
Income and Retained Earnings

Statement for the Year 2003
Sales
Cost of sales
Wages and salaries
Depreciation and amortization
Other expenses
Earnings before reorganization items
Professional fees related to bankruptcy
Net loss
Beginning deficit
Deficit December 31, 2003
$ 1,000,000
(430,000)
(250,000)
(170,000)
(50,000)
100,000
(450,000
(350,000)
(700,000)
$(1,050,000)
17 - 152
Tiger Balance Sheet

at December 31, 2003
Current assets
Cash
Accounts receivable, net
Inventory
Plant assets
Land
Building, net
Equipment, net
Patent
$150,000
350,000
370,000
50,000 $ 920,000
$200,000
450,000
330,000
150,000
1,130,000
$2,050,000
17 - 153
Tiger Balance Sheet

at December 31, 2003
Current liabilities
Short-term borrowings
Accounts payable
Wages and salaries payable
Liabilities subject to
compromise
Stockholders deficit
Capital stock
Deficit
$ 150,000
100,000
50,000
$ 300,000
2,300,000
500,000
1,050,000
550,000
$2,050,000
17 - 154
The Reorganization Plan

1. Tigers 15% bonds payable were secured with the
land and building. The bondholders agree to accept
$500,000 new common stock, $500,000 senior debt
of 12% bonds and $100,000 cash payable 12/31/03.
2. The priority tax claims of $150,000 will be paid in
cash as soon as the reorganization plan is confirmed.
3. The remaining unsecured, nonpriority, prepetition
claims of $950,000 will be settled as follows:
17 - 155
The Reorganization Plan

a. Creditors represented by the accounts payable
will receive $275,000 subordinated debt and
$140,000 common stock.
b. The $90,000 accrued interest on the 15% bonds
will be forgiven.
c. The $260,000 note payable to the bank will be
exchanged for $120,000 subordinated debt
and $60,000 common stock.
4. Equity holders will exchange their stock for $100,000
common stock of the emerging company.
17 - 156
The reorganization value is compared with the total
postpetition liabilities and court-allowed claims at June 30
to determine if fresh-start reporting is appropriate.
Postpetition liabilities
$ 255,000
Allowed claims subject to compromise
2,300,000
Total liabilities on June 30, 2004
2,555,000
Less: Reorganization value
2,200,000
Excess liabilities over reorganization value
$ 355,000
17 - 157
Proposed Reorganized
Capital Structure
Postpetition liabilities
Taxes payable
Current portion of senior debt,
due December 2004
Senior debt, 12% bonds
Subordinated debt
Common stock
$ 255,000
150,000
100,000
500,000
395,000
800,000
$2,200,000
17 - 158
Comparative Balance Sheets

at June 30, 2004 (000)
Preconfirmation
Balance Sheet
Assets
Cash
Accounts receivable
Inventory
Land
Building
Equipment
Patent
Reorganization excess
$ 300
335
350
30
200
425
290
125
$2,055
Adjustments
Debits
Credits
a 25
b 100
c 75
d 30
c 125
f 250
Reorganized
Balance Sheet
$ 300
335
375
30
300
350
260
250
$2,200
17 - 159

at June 30, 2004 (000)
Preconfirmation
Balance Sheet
Equities (claims)
Short-term bank loan
Accounts payable
Wages payable
Prepetition claims
Accounts payable, old
Taxes payable
Interest
Bank note
15% bonds payable
Adjustments
Debits
Credits
75
125
55
600
150
90
260
1,200
Reorganized
Balance Sheet
$ 75
125
55
h
600
i
j
g
90
260
1,200
150
17 - 160

at June 30, 2004 (000)
Preconfirmation
Balance Sheet
Stockholders Equity
Capital stock, old
Deficit
500
(1,000)
Adjustments
Debits
Credits
k 500
c 75
d 30
e 125
a 25
b 100
f 250
g 100
h 185
i 90
j 80
k 400
Reorganized
Balance Sheet
17 - 161

at June 30, 2004 (000)
Preconfirmation
Balance Sheet
New Equities
Current portion, bonds
12% senior debt
Subordinated debt
Common stock, new
Retained earnings, new
Adjustments
Debits
Credits
g 100
g 500
h 275
j 120
g 500
h 140
j 60
k 100
$2,055
Reorganized
Balance Sheet
100
500
395
800
$2,200
17 - 162
Chapter 10163
10
10
InsolvencyLiquidation and
Reorganization
Advanced Accounting, Third Edition

Chapter 10164
Learning
Learning Objectives
Objectives
Chapter 10165
1.
Distinguish between a Chapter 7 and a Chapter 11

bankruptcy.
2.
Describe the five priority categories of unsecured claims

and list the order in which they are settled.
3.
Distinguish between a voluntary and involuntary

bankruptcy petition.
4.
Distinguish among fully secured, partially secured, and

unsecured claims of creditors.
5.
Describe contractual agreements that the debtor and its

creditors may enter into outside of formal bankruptcy
proceedings to resolve the debtors insolvent position.
Insolvency
Insolvency
When a business becomes insolvent, it generally has three
possible courses of action:
1. Debtor and its creditors may enter into a contractual
agreement, outside bankruptcy;
2. Debtor or its creditors may file a bankruptcy petition,
after which the debtor is liquidated under Chapter 7 of
the Bankruptcy Reform Act; or
3. Debtor or its creditors may file a petition for
reorganization under Chapter 11 of the Bankruptcy
Reform Act.
Chapter 10166
Insolvency
Insolvency
Review:
Insolvency means that a debtor has more
current liabilities than current assets.
False
Chapter 10167
Contractual
Contractual Agreements
Agreements
A business that is unable to pay its obligations may reach
an accommodation with its creditors. Possibilities generally
include:
1. An extension of payment periods.
2. Composition agreements.
3. Formation of a creditors committee.
4. Voluntary assignment of assets.
Chapter 10168
LO 5 Contractual agreements.
Contractual
Agreements
Extension of Payment Periods
Statement of Financial Accounting Standard No. 15
Provides that where a debt restructuring involves only a
modification of terms of payment, the debtor should
account for the restructuring prospectively and not change
the carrying amount of the payable, unless the carrying
amount exceeds the total future cash payments of principal
and interest specified by the new terms.
No gain is recognized.
Chapter 10169
Contractual
Agreements
Composition Agreements
(Creditors Accept Less Than Full Amount)

Creditors are often given some immediate cash payment,
and the amount of the remaining debts and their interest
rates are renegotiated.
Formation of a Creditors Committee

Committee is responsible for managing the debtors
business affairs for the period during which plans are
developed to rehabilitate, reorganize, or liquidate the
business.
Chapter 10170
Contractual
Agreements
Voluntary Assignment of Assets
A debtor may elect to place its property under the control
of a trustee for the benefit of its creditors.
Any proceeds remaining after payment of the creditors,
are returned to the debtor.
Chapter 10171
Bankruptcy
Bankruptcy
Provisions of the Bankruptcy Reform Act apply to
individuals, corporations, and partnerships, as well as to
municipalities seeking voluntary relief from their creditors.
A business unable to pay its obligations, may attempt to
negotiate with its creditors. If an agreement cannot be
reached, a legal petition for bankruptcy will be initiated by
either the
debtor (a voluntary petition) or its
creditors (an involuntary petition).
Chapter 10172
LO 3 Voluntary vs. involuntary petitions.
Bankruptcy
Bankruptcy
Voluntary Petitions
A debtor may file a voluntary petition with a bankruptcy
court for;
liquidation under Chapter 7 or for
reorganization under Chapter 11.
Filing a voluntary petition constitutes an order for relief.
The bankruptcy petition (either voluntary or involuntary) is
an official form that initiates bankruptcy proceedings and
establishes an estate consisting of the debtors assets.
Chapter 10173
Bankruptcy
Bankruptcy
Involuntary Petitions
Creditors initiate the action by filing a petition for
liquidation or reorganization with the bankruptcy court.
The bankruptcy court will generally enter an order for
relief against the debtor only if evidence indicates that
the debtor, in fact, has not been paying its debts as they
become due.
Chapter 10174
Bankruptcy
Bankruptcy
Secured and Unsecured Creditors
Secured creditors are those whose claims are secured by
liens or pledges of specific assets.
If the proceeds from the sale of a pledged asset(s)
exceed the secured claim, the excess proceeds are
available for distribution to unsecured creditors.
Chapter 10175
LO 4 Secured and unsecured creditors.
Bankruptcy
Bankruptcy
Review:
Voluntary bankruptcy petitions may be filed
under either Chapter 7 or Chapter 11 of the
Reform Act.
True
Chapter 10176
Bankruptcy
Bankruptcy
Review:
Unsecured creditors with priority will
receive full satisfaction before secured
creditors are paid.
False
Chapter 10177
Liquidation
Liquidation (Chapter
(Chapter 7)
7)
A voluntary or involuntary petition for liquidation may be
filed under Chapter 7 of the Reform Act.
Upon filing, the bankruptcy court must decide whether to
accept or dismiss the petition.
Dismissals occur infrequently.
Debtor may dispute an involuntary petition.
If accepted,
an order for relief is entered and
the bankruptcy court will appoint an interim
trustee until a permanent trustee is selected.
Chapter 10178
LO 7 Chapter 1 versus Chapter 7.
Reorganization
Reorganization Under
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
Creditors of an insolvent debtor may believe their interests
would be served by rehabilitating or reorganizing the
debtor.
In such a case:
Creditors and debtor may agree to a plan for
reorganization.
Debtor or creditors may prefer to file with the
bankruptcy court a petition for reorganization under
Chapter 11 of the Reform Act.
Chapter 10179
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
Fresh Start Accounting and Quasi Reorganization
When firms emerge from bankruptcy, SOP 90-7 provides
for fresh start accounting.
Assets and liabilities are reported at fair values.
Beginning retained earnings is reported at zero.
Two conditions must exist:
Fair value of assets must be less than the post
liabilities and allowed claims, and
Original owners must own less than 50% of the voting
stock after reorganization.
Chapter 10180
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
Fresh Start Accounting and Quasi Reorganization
Quasi reorganization
Per Accounting Research Bulletin No. 43, three steps are
required:
1. Authorization from creditors and stockholders is
required.
2. All assets are revalued to fair values with losses
recorded in retained earnings.
3. The deficit in retained earnings is eliminated by
charging to (reducing) paid-in capital.
Chapter 10181
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
Accounting for Reorganization Troubled Debt
Debt may be restructured in any one (or a combination) of
the following methods:
1. The debtor may transfer assets in full settlement of
the payable.
2. The debtor may give an equity interest in its firm in
full settlement of the payable.
3. The creditor may modify terms of the payable.
Chapter 10182
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
Transfer of Assets
A debtor that transfers assets to a creditor in full
settlement of a payable recognizes a gain.
The gain is measured by the excess of the carrying value
of the payable over the fair value of the assets
transferred.
The difference between the fair value and the carrying
amount of the assets transferred is a gain or loss and is
reported as a component of net income for the period of
transfer.
Chapter 10183
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
Grant of an Equity Interest
A debtor that issues an equity interest in its firm to a
creditor in full settlement of a payable shall account for
the equity interest at its fair value.
Difference between the fair value of the equity interest
issued and the carrying amount of the payable is reported
as a gain on restructuring.
Debtor determines its gain based on undiscounted cash
flows.
Chapter 10184
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
Modification of Terms
A debtor, in a troubled debt restructuring involving only
modification of terms of a payable, accounts for the
effects of the restructuring prospectively from the time
of restructuring.
The carrying value of the payable is not changed at the
time of restructuring unless the carrying value exceeds
the total future cash payments specified by the new
terms.
Chapter 10185
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
Review:
In a reorganization involving a transfer of
assets, the debtor will recognize a gain on
restructuring measured by the excess of
the carrying value of the payable settled
over the book value of the assets
transferred.
False
Chapter 10186
Reorganization
Reorganization Transfer
Transfer of
of Assets
Assets
E10-3 Bar Company, which is in financial difficulty and
in the process of a voluntary reorganization, has agreed
to transfer to a creditor a copyright it owns in full
settlement of a $150,000 note payable and $15,000 in
accrued interest. The copyright, which originally cost
$100,000, has an accumulated amortization balance of
$55,000 and a current fair value of $95,000.
Required:
a. Prepare the journal entries on Bar Companys books
to record the transfer of the copyright.
Chapter 10187
Reorganization
Transfer of
of Assets
Assets
E10-3 a. Prepare the journal entries on Bar Companys
books to record the transfer of the copyright.
Copyright
50,000
Gain on Transfer of Assets
50,000
Revalue copyright to fair value. $95,000 ($100,000 - $55,000)
Notes Payable
150,000
Accrued Interest Payable
Chapter 10188
15,000
Accumulated Amortization Copyright
55,000
Copyright ($100,000 + $50,000)
150,000
Gain on Debt Restructuring
70,000
Reorganization
Transfer of
of Assets
Assets
E10-3 b. Explain the proper treatment of any gain or
loss recognized in (A).
The gain on transfer of assets ($50,000) should be
reported as a separate component (assuming
material in amount) of operating income; the gain
on restructuring ($70,000) should also be reported
as a separate component of operating income.
Chapter 10189
Reorganization
Transfer of
of Assets
Assets
E10-3 c. Assuming the fair value of the copyright was
$30,000, repeat the requirement in (A).
Loss on Transfer of Assets
15,000
Copyright
15,000
Revalue copyright to fair value. $30,000 ($100,000 - $55,000)
Notes Payable
150,000
15,000
Accumulated Amortization Copyright

Copyright ($100,000 - $15,000)
55,000
85,000
Gain on Debt Restructuring ($165,000 - $30,000) 135,000

Chapter 10190
Reorganization
Reorganization Modification
Modification of
of Terms
Terms
E10-4 Lake Company, a major creditor of financially
troubled Spain Company, has agreed to modify the
terms of a debt owed to Lake Company. The debt
consists of a $900,000, 12% note that is due currently
along with accrued interest of $95,000. Lake Company
agreed to extend the due date of the note and accrued
interest for three years and to reduce the interest
rate to 5% per annum (on both maturity value and
accrued interest), with interest to be paid annually.
Required:
a. Should a gain on restructuring be recognized by
Spain Company? Explain.
Chapter 10191
Reorganization
Modification of
of Terms
Terms
E10-4 a. Should a gain on restructuring be recognized
by Spain Company? Explain.
No gain should be recognized because the total
future cash payments specified by the new terms
of $1,144,250 ($995,000 carrying value plus 3
years interest at $49,750 per year) exceed the
current carrying value of the debt, $995,000.
Chapter 10192
Reorganization
Modification of
of Terms
Terms
E10-4 b. Prepare the entry that should be made on
Spain Companys books on the date of restructure.
Note Payable
Restructured Debt
Chapter 10193
900,000
95,000
995,000
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
Review:
Restructuring gains that arise from troubled
debt restructurings are reported by the
debtor as extraordinary gains.
False
Chapter 10194
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
The Accounting Statement of Affairs
A plan for reorganization must show that creditors will
receive as much as if the debtor were liquidated.
The Statement of Affairs is an accounting report that is
designed to permit the user to determine:
the total expected amounts that could be realized on
the disposition of the assets,
the priorities in the use of the realization proceeds in
satisfying claims, and
the potential net deficiency that would result if the
assets were realized and claims liquidated.
Chapter 10195
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
E10-7 Ball Company is facing bankruptcy proceedings. A balance
sheet and other information are presented below:
Ball Company Balance Sheet - June 30, 2009
Cash
Accounts receivable
Inventory
Property and Equipment, net
$ 20,400
170,000
180,000
430,000
$ 800,400
Accounts payable
$ 350,000
Accured wages
120,000
Notes payable
200,000
Common stock
400,000
Retained earnings (deficit)
124,600
$ 1,194,600
Estimated realizable values:

Accounts receivable
$ 95,000
Inventory
110,000
320,000
Accounts receivable and inventory are each pledged as security on

individual notes payable in the amount of $100,000 each.
Chapter 10196
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
E10-7 Statement of Affairs
Book
Value
$ 180,000
170,000
20,400
430,000
Assets
Assets Pledged with Fully Secured Creditors:
Inventory
$ 110,000
Note Payable
100,000
Chapter 10197
Deficiency
Account
(Loss) / Gain
$
Free Assets
Cash
Property and Equipment
Total Net Realizable Value
Liabilities having Priority Wages
Net Free Assets
(70,000)
10,000
Assets Pledged with Partially Secured Creditors:

Accounts Receivable
95,000
Note Payable
100,000
Estimated Deficiency to Unsecured Creditors

$ 800,400
Realizable
Value
(75,000)
20,400
320,000
350,400
120,000
230,400
124,600
$ 355,000
(110,000)
(255,000)
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
E10-7 Statement of Affairs
Book
Value
Equities
Liabilities Having Priority:
Accrued Wages
$ 120,000
100,000
Fully Secured Creditors:

Note Payable
100,000
Partially Secured Creditors:

Note Payable
`
350,000
400,000
(269,600)
$ 800,400
Unsecured Creditors:
Accounts Payable
Deficiency
Account
(Loss) / Gain
$ 120,000
100,000
100,000
95,000
5,000
350,000
Stockholders Equity
Common Stock
Retained Earnings (deficit)
$ 355,000
Estimated deficiency *
Chapter 10198
Realizable
Value
400,000
(269,600)
130,400
(124,600)
* ($255,000) loss - $130,400 gain = $124,600 deficiency
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
E10-7 Deficiency Account
BALL COMPANY
Deficiency Account
Estimated Losses
Accounts Receivable
$ 75,000
Inventory
70,000
110,000
$ 255,000
Chapter 10199
Estimated Gains
Common Stock
$400,000
Retained Earnings
(269,600)
Estimated Deficiency to
Unsecured Creditors
124,600
$255,000
Reorganization
Under Reform
Reform Act
Act (Chapter
(Chapter 11)
11)
Review:
The statement of affairs is a report
designed to estimate the amount expected
to be earned by a debtor company during the
time period needed to complete a
reorganization.
False
Chapter 10200
Trustee
Trustee Accounting
Accounting and
and Reporting
Reporting
Trustee takes title to the debtors assets and is
accountable to the court, the creditors, and other
parties for the subsequent utilization or realization of
the assets.
Trustee records the assets at their book values.
No existing liabilities are recorded by the trustee.
Payment of preexisting debts reduces the assets.
Chapter 10201
Trustee
Trustee Accounting
Accounting and
and Reporting
Reporting
E10-9 TRX Company has been forced into receivership.
The trustee has decided to open a new set of books to
distinguish between transactions occurring before and
after the appointment. The following account balances
were reported on September 1, 2009:
Cash
Accounts receivable
Inventory
26,700
130,400
191,900
590,400
$ 939,400
Allowance for uncollectibles

Accounts payable
Capital stock
Retained earnings (deficit)
16,000
211,500
308,400
800,000
(396,500)
$ 939,400
Required: Prepare journal entries to record the following

on the trustee set of books.
Chapter 10202
Trustee
Trustee Accounting
Accounting and
and Reporting
Reporting
E10-9 Record the receipt of TRX Company assets.
Cash
26,700
Accounts Receivable (old)
130,400
Inventory
191,900
590,400
Allowance for Uncollectibles (old)

Accumulated Depreciation
16,000
211,500
TRX Company in Receivership *
711,900
* ($939,400 $16,000 - $211,500)

Chapter 10203
Trustee
Trustee Accounting
Accounting and
and Reporting
Reporting
E10-9 1. Sales were made in the amount of $296,000, of
which $31,500 were cash sales.
Cash
Accounts Receivable (new)
Sales
Chapter 10204
31,500
264,500
296,000
Trustee
Trustee Accounting
Accounting and
and Reporting
Reporting
E10-9 2. Receivables were collected in the following
amounts:
Old receivables $ 76,800

New receivables 242,200
Cash
Accounts Receivable (old)
Accounts Receivable (new)
Chapter 10205
319,000
76,800
242,200
Trustee
Trustee Accounting
Accounting and
and Reporting
Reporting
E10-9 3. Additional inventory was purchased on account in
the amount of $127,500.
Purchases
Accounts Payable (new)
Chapter 10206
127,500
127,500
Trustee
Trustee Accounting
Accounting and
and Reporting
Reporting
E10-9 4. Cash payments were made as follows:
On old accounts payable
On new accounts payable
61,600
For operating expenses
46,000
For trustee fees
13,000
TRX Company in Receivership
206,500
Accounts Payable (new)
61,600
Operating Expenses
46,000
Trustee Expenses
13,000
Cash
Chapter 10207
$206,500
327,100
Trustee
Trustee Accounting
Accounting and
and Reporting
Reporting
E10-9 5. Journal entries were made to record:
Bad debt expense of $21,600, of which $8,600 related

to new accounts receivable.
Bad Debt Expense
Chapter 10208
21,600
13,000
Allowance for Uncollectibles (new)
8,600
Trustee
Trustee Accounting
Accounting and
and Reporting
Reporting
E10-9 5. Journal entries were made to record:
a. Bad debt expense of $21,600, of which $8,600 related
to new accounts receivable.
b. Depreciation expense of $32,400.
c. Write-off of old accounts receivable of $21,000.
32,400
Accumulated Depreciation
Account Receivable (old)
Chapter 10209
32,400
21,000
21,000
Realization
Realization and
and Liquidation
Liquidation Account
Account
The court expects to receive periodic reports summarizing
the realization and distribution activities of the trustee.
The report, realization and liquidation account, has three
main sectionsassets, liabilities, and revenues and expenses.
The asset section consists of four parts, illustrated as
follows:
Assets
Chapter 10210
Assets to be realized
Assets realized
Assets acquired
Assets not realized
Realization
Realization and
and Liquidation
Liquidation Account
Account
The court expects to receive periodic reports summarizing
the realization and distribution activities of the trustee.
The report, realization and liquidation account, has three
main sectionsassets, liabilities, and revenues and expenses.
The liabilities section consists of four parts, illustrated as
follows:
Liabilities
Chapter 10211
Liabilities liquidated
Liabilities to be liquidated
Liabilities not liquidated
Liabilities incurred
Copyright
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Chapter 10212

Intercompany Sales and Foreign Exchange Transactions

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Intercompany Sales and Foreign Exchange Transactions

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Chapter 5:

Intercompany Profits Inventories: Objectives

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Copyright 2012 Pearson Education, Inc.

Intercompany Profit Transactions Inventories

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Intercompany Sales of Inventory

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No Intercompany Profits in Inventories

All intercompany sales of inventories have been resold

Intercompany Profits Only in Ending Inventories

Intercompany Profits Beginning and Ending Inventories

Sales (-R, -SE)

Eliminate intercompany sales = $500 + 30%($500) = $650

Cost of sales (E, -SE)

Defer profits in ending inventory = $260 x 30%/130%

Investment in Subsidiary (+A)

Intercompany Profit Transactions Inventories

2: UPSTREAM & DOWNSTREAM

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Upstream and Downstream Sales

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Intercompany Inventory Sales

Cost of sales (E, -SE)

For the profits in ending inventory

Investment in Subsidiary (+A)

Data for Example

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Income Sharing with Downstream Sales PARENT

Income from subsidiary

NCI 20% share

Income Sharing with Upstream Sales SUBSIDIARY

Income from subsidiary

NCI 20% share

Intercompany Profit Transactions Inventories

3: UNREALIZED PROFITS IN ENDING

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Ending Inventory on Hand

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Worksheet entries to eliminate intercompany sale and

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Worksheet Income Statement

Noncontrolling interest share

There would be a credit adjustment to Inventory for $2.5 on the

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Intercompany Profit Transactions Inventories

4: RECOGNIZING PROFITS FROM

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Intercompany Profits in Beginning Inventory

Intercompany Profit Transactions Inventories

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Direction of Sale and NCI

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Calculating Income and NCI

Noncontrolling interest share

Noncontrolling interest share

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Upstream Example with Amortization

in Perry's ending inventory.

Analysis and Amortization

Implied value of Salt 420/.70

Book value 200 + 200

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