BSA 3101 CORPORATE LIQUIDATION & REORGANIZATION

Learning Objectives:
1. Define insolvency, statement of affairs, creditors with
priority, deficiency to unsecured creditors.
2. Explain the importance of the statement of affairs

3. Compute for amount available, rate of estimated

payments and deficiency to unsecured creditors.
4. Prepare a statement of affairs using the conventional
and the alternative forms and the deficiency statement.

I. INTRODUCTION
 When a company is insolvent, creditors
would want to know the relative position of
their claims and/ or estimated amount that
they can recover/collect on their claims.

 Insolvency is governed by the provisions of

the Civil Code and the Insolvency Law
(otherwise known as Act No. 1956, as
amended).
 Insolvency has been defined as “the
condition of a man whose assets, if all made
available, would not be sufficient to
discharge his liabilities. It is the inability or
lack of means to pay one’s debt, or the
condition of a person who is unable to pay
his debts as they fall due” (Perez 377).

 A corporation is said to be insolvent when

its liabilities exceed its assets resulting to
financial difficulty in paying off debts. In
legal sense, INSOLVENCY is different from
ILLIQUIDITY. Illiquidity is the inability to pay
debts because of lack of cash or other liquid
assets. Being insolvent is worse than being
 illiquid because even if all assets of an
insolvent corporation are sold, the proceeds
will still not be enough to pay all of the
claims of both the creditors and owners.

 When an entity’s assets exceed its

liabilities but it finds difficulty in meeting
them, it may apply for suspension of
payments so it may gain time to pay all its
debts without impairing its business. When
assets are inadequate, there may be
voluntary or involuntary insolvency.
 There is voluntary insolvency when the
insolvent entity itself petitions the Regional
Trial Court that it be declared as insolvent.

 In the case of Involuntary insolvency, the

petition is made by three or more creditors.
Both the petitions for suspension of
payments and for voluntary insolvency shall
include a schedule and inventory of all the
debtor’s assets and liabilities,
encumbrances, existing pledges, liens,
mortgages, etc.
 When a debtor entity is declared insolvent,
its assets and liabilities are placed within
the jurisdiction and control of the court in
insolvency without affecting the liens of
mortgages and pledges. An assignee is
subsequently elected to take care of the
liquidation process.
II. POSSIBLE RECOURSE OF AN INSOLVENT CORPORATION
1. LIQUIDATION
2. REORGANIZATION

II. 1 CORPORATE LIQUIDATION

Liquidation – is the termination of business
operation or the winding up of affairs. It is a process by
which
1. The assets of the business are converted
into cash
2. The liabilities of the business are settled,
and
3. Any remaining amount is distributed to the
owners.

II.2 MEASUREMENT BASIS

 The PFRSs are applicable only to entities

which are of “going concern.” Accordingly,
the measurement bases prescribed in the
Conceptual Framework and in the PFRSs do
not apply to liquidating entities.
 For entities undergoing liquidation, the
appropriate measurement basis is
REALIZABLE VALUE. For assets, REALIZABLE
VALUE is estimated selling price less
estimated cost to sell. For liabilities,
REALIZABLE VALUE is the expected net
settlement amount.

III.3 FINANCIAL REPORTS

 Liquidating entities usually prepare
the following classes of financial
reports:
1. Statement of Affairs
2. Statement of realization and
liquidation
 3. Additional statements such as
note disclosures and summary of cash
receipts and disbursements may also
be prepared.

III. STATEMENT OF AFFAIRS

The statement of affairs is a statement showing
the relative position of creditors with respect to the assets of a
business. It is prepared from a “quitting concern” point of view,
that is, the business firm is assumed to undergo ( or is in the
process of ) liquidation. Assets are therefore reported at their
estimated realizable values and the liabilities, at their balance
sheet amounts or present values.

Considering the limited liability of stockholders for

the liabilities of a corporation, the aggregate amount of loss
that they can shoulder is limited only to the amount of
stockholder’s equity after adjustments are made for assets and
liabilities from the “quitting concern” point of view. If the total
of liabilities exceeds the total realizable value of the assets,
stockholder’s equity must be negative. Such negative balance
is the deficiency to unsecured creditors or the amount of loss to
be borne by them.

The order of preference as stipulated by law is

observed:
 The liens on assets are first deducted before
the excess of the asset values is earmarked
for debts with priority.
III.1 CLASSIFICATION OF ASSETS IN THE STATEMENT OF
AFFAIRS.
1. ASSETS PLEDGE TO FULLY SECURED CREDITORS =
these are assets with realizable values equal to or greater
than the realizable values of the related liabilities for
which these assets have been pledged as a security.

Example:
 A building with a realizable value of
P1,000,000 that secures a bank loan with
an outstanding balance of P800,000. The
bank is said to be fully secured because it is
guaranteed the total amount due on the
loan of P800,000. After the bank loan is
paid, the excess of P200,000 is available to
unsecured creditors.

2. ASSETS PLEDGE TO PARTIALLY SECURED

CREDITORS - these are assets with realizable values less
than the realizable values of the related liabilities for
which these assets have been pledged as a security.

Example:
 An equipment with a realizable value of
P500,000 that secures a bank loan with an
outstanding balance of P600,000. The bank
is said to be partially secured because it is
guaranteed a payment of P500,000 out of
the P600,000 loan balance. The deficiency
of the loan payment must come from the
proceeds of other assets.

3. FREE ASSETS -- these assets that have not been

pledged as security of liabilities. These also include the
excess of realizable values of assets pledged to fully
secured creditors over the realizable values of related
liabilities for which these assets have been pledged.
 Example:
 Cash on Hand of P20,000 that can be used
at the discretion of the corporation.

 The amount of excess of the realizable

value of assets pledged to fully secured
creditors.

III.2 CLASSIFICATION OF LIABILITIES IN THE STATEMENT

OF AFFAIRS

1. UNSECURED LIABILITIES WITH PRIORITY these are

liabilities that although not secured by any asset, are
mandated by law to be paid first before any other unsecured
liabilities.

a. Administrative expenses
Examples:
 filing fees, Attorney’s fees,
referee’s fee, trustee’s fees,
and wages and commissions
of personnel directly
involved in arranging the
commencement of the
insolvency proceedings.

b. Unpaid employee salaries and other

benefits

c. Taxes and assessments.

2. FULLY SECURED CREDITORS - these are liabilities
secured by assets with realizable values equal to or greater
than the realizable values of such liabilities.

3. PARTIALLY SECURED CREDITORS --- these are

liabilities secured by assets with realizable values less than the
realizable values of such liabilities.
Example:
A creditor of a note payable with an
outstanding balance of P800,000 that is
secured by a building with a realizable value
of P500,000 is said to be a partially secured
creditor(e.g., of the P800,000 total amount
due, P500,000 is a secured claim while
P300,000 is an unsecured claim).

4. UNSECURED LIABILITIES WITHOUT PRIORITY --

all other liabilities not classified under (1), (2) or (3) above.