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Dosen: Molina, SE., M.Si., Ak., CA

10
Insolvency—Liquidation and
Reorganization

Advanced Accounting, Fifth Edition

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.
Contractual 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.

LO 5 Contractual agreements.
Reorganization Under Reform Act (Chapter 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.

LO 7 Chapter 1 versus Chapter 11.

Reorganization – Transfer of 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 Company’s books to
record the transfer of the copyright.

LO 7 Chapter 1 versus Chapter 11.

Reorganization – Transfer of Assets

E10-3 a. Prepare the journal entries on Bar Company’s

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 15,000
Accumulated Amortization – Copyright 55,000
Copyright ($100,000 + $50,000) 150,000
Gain on Debt Restructuring 70,000

LO 7 Chapter 1 versus Chapter 11.

Reorganization – Transfer of 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.

LO 7 Chapter 1 versus Chapter 11.

Reorganization – Transfer of 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

Accrued Interest Payable 15,000
Accumulated Amortization – Copyright 55,000
Copyright ($100,000 - $15,000) 85,000
Gain on Debt Restructuring ($165,000 - $30,000) 135,000

LO 7 Chapter 1 versus Chapter 11.

Reorganization – Modification of 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.

LO 7 Chapter 1 versus Chapter 11.

Reorganization – Modification of 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.

LO 7 Chapter 1 versus Chapter 11.

Reorganization – Modification of Terms

E10-4 b. Prepare the entry that should be made on Spain

Company’s books on the date of restructure.

Note Payable 900,000

Accrued Interest Payable 95,000
Restructured Debt 995,000

LO 7 Chapter 1 versus Chapter 11.

Reorganization Under Reform Act (Chapter 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.
LO 7 Chapter 1 versus Chapter 11.
Reorganization Under Reform Act (Chapter 11)

E10-7: Ball Company is facing bankruptcy proceedings. A balance

sheet and other information are presented below:
Ball Company Balance Sheet - June 30, 2012
Cash $ 20,400 Accounts payable $ 350,000
Accounts receivable 170,000 Accured wages 120,000
Inventory 180,000 Notes payable 200,000
Property and Equipment, net 430,000 Common stock 400,000
Retained earnings (deficit) (269,600)
$ 800,400 $ 800,400
Estimated realizable values:
Accounts receivable $ 95,000
Inventory 110,000
Property and Equipment, net 320,000

Accounts receivable and inventory are each pledged as security on

individual notes payable in the amount of $100,000 each.

LO 7 Chapter 1 versus Chapter 11.

Reorganization Under Reform Act (Chapter 11)

E10-7: Statement of Affairs

Book Realizable Deficiency
Value Assets Value Account
(Loss) / Gain
Assets Pledged with Fully Secured Creditors:
$ 180,000 Inventory $ 110,000 $ (70,000)
Note Payable 100,000 10,000

Assets Pledged with Partially Secured Creditors:

170,000 Accounts Receivable 95,000 (75,000)
Note Payable 100,000

Free Assets
20,400 Cash 20,400
430,000 Property and Equipment 320,000 (110,000)
Total Net Realizable Value 350,400
Liabilities having Priority – Wages 120,000
Net Free Assets 230,400

Estimated Deficiency to Unsecured Creditors 124,600

$ 800,400 $ 355,000 $ (255,000)
Reorganization Under Reform Act (Chapter 11)

E10-7: Statement of Affairs

Book Realizable Deficiency
Value Equities Value Account
Liabilities Having Priority: (Loss) / Gain
$ 120,000 Accrued Wages $ 120,000

Fully Secured Creditors:

100,000 Note Payable 100,000

Partially Secured Creditors:

100,000 Note Payable 100,000
` 95,000 5,000

Unsecured Creditors:
350,000 Accounts Payable 350,000

Stockholders’ Equity
400,000 Common Stock 400,000
(269,600) Retained Earnings (deficit) (269,600)
$ 800,400 $ 355,000 $ 130,400
Estimated deficiency * $ (124,600)

* ($255,000) loss - $130,400 gain = $124,600 deficiency

Reorganization Under Reform Act (Chapter 11)

E10-7: Deficiency Account

BALL COMPANY
Deficiency Account

Estimated Losses Estimated Gains

Accounts Receivable $ 75,000 Common Stock $400,000
Inventory 70,000 Retained Earnings (269,600)
Property and Equipment 110,000 Estimated Deficiency to
Unsecured Creditors 124,600
$ 255,000 $255,000
Trustee Accounting and Reporting

Trustee (appointed to assume responsibility of managing

the debtor’s business while the reorganization plan is
developed or the business is liquidated) takes title to
the debtor’s assets and is accountable to the court, the
creditors, and other parties for the subsequent
utilization or realization of the assets.
If new books are opened (frequently used approach):
 Trustee records the assets at their book values.
 No existing liabilities are recorded by the trustee.
 Payment of preexisting debts reduces the assets.

LO 7 Chapter 1 versus Chapter 11.

 Trustee Accounting and 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, 2012:
Cash $ 26,700 Allowance for uncollectibles $ 16,000
Accounts receivable 130,400 Accumulated depreciation 211,500
Inventory 191,900 Accounts payable 308,400
Property and Equipment, net 590,400 Capital stock 800,000
Retained earnings (deficit) (396,500)
$ 939,400 $ 939,400

Required: Prepare journal entries to record the following

on the trustee set of books.

LO 7 Chapter 1 versus Chapter 11.

Trustee Accounting and Reporting

E10-9: Record the receipt of TRX Company assets.

Cash 26,700
Accounts Receivable (old) 130,400
Inventory 191,900
Property and Equipment 590,400
Allowance for Uncollectibles (old) 16,000
Accumulated Depreciation 211,500
TRX Company – in Receivership * 711,900

* ($939,400 – $16,000 - $211,500)

LO 7 Chapter 1 versus Chapter 11.
Trustee Accounting and Reporting

E10-9: 1. Sales were made in the amount of $296,000, of

which $31,500 were cash sales.

Cash 31,500
Accounts Receivable (new) 264,500
Sales 296,000

LO 7 Chapter 1 versus Chapter 11.

Trustee Accounting and Reporting

E10-9: 2. Receivables were collected in the following

amounts:
Old receivables $ 76,800
New receivables 242,200

Cash 319,000
Accounts Receivable (old) 76,800
Accounts Receivable (new) 242,200

LO 7 Chapter 1 versus Chapter 11.

Trustee Accounting and Reporting

E10-9: 3. Additional inventory was purchased on account

in the amount of $127,500.

Purchases 127,500
Accounts Payable (new) 127,500

LO 7 Chapter 1 versus Chapter 11.

Trustee Accounting and Reporting

E10-9: 4. Cash payments were made as follows:

On old accounts payable $206,500
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 327,100

LO 7 Chapter 1 versus Chapter 11.

Trustee Accounting and 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.

Bad Debt Expense 21,600

Allowance for Uncollectibles (old) 13,000
Allowance for Uncollectibles (new) 8,600

LO 7 Chapter 1 versus Chapter 11.

Trustee Accounting and 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.

Depreciation expense 32,400

Accumulated Depreciation 32,400

Allowance for Uncollectible (old) 21,000

Account Receivable (old) 21,000

LO 7 Chapter 1 versus Chapter 11.