CHAPTER 14 BANKRUPTCY: LIQUIDATION AND REORGANIZATION The title of each problem is followed by the estimated time in minutes required for completion and by a difficulty rating. The time estimates are applicable for students using the partially filled-in working papers. Pr. 14–1 Re-Org Company (25 minutes, easy) Preparation of journal entries to record the reorganization of a business enterprise under Chapter 11 of the Bankruptcy Code. Pr. 14–2Dodge Company (40 minutes, easy) Prepare a statement of affairs and a working paper to compute percentage of claims to be received by each group of creditors in a Chapter 7 bankruptcy liquidation. Pr. 14–3Robaire Corporation (50 minutes, easy) Journal entries for one month for a trustee in bankruptcy liquidation. Preparation of statement of realization and liquidation and a trial balance for trustee. Pr. 14–4Javits Corporation (50 minutes, medium) Preparation of correcting journal entries and a statement of affairs in a bankruptcy liquidation. Pr. 14–5Laurel Company (60 minutes, medium) Preparation of a statement of affairs in a bankruptcy liquidation. Pr. 14–6Bilbo Corporation (60 minutes, medium) Prepare journal entries to give effect to a bankruptcy reorganization plan and a balance sheet at end of first month of operations following reorganization. ANSWERS TO REVIEW QUESTIONS 1. The Bankruptcy Code defines insolvency for an entity other than a partnership or a municipality as a financial state in which the current fair value of the entity's property, exclusive of property withheld from creditors, is less than the amount of the entity's liabilities. 2. Federal Rules of Bankruptcy Procedure are prescribed by the U.S. Supreme Court for the various legal practices and procedures under the Bankruptcy Code. The McGraw-Hill Companies, Inc., 2006 Solutions Manual, Chapter 14 405
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CHAPTER 14BANKRUPTCY: LIQUIDATION AND REORGANIZATION
The title of each problem is followed by the estimated time in minutes required for completion and by a difficulty rating. The time estimates are applicable for students using the partially filled-in working papers.
Pr. 14–1 Re-Org Company (25 minutes, easy)
Preparation of journal entries to record the reorganization of a business enterprise under Chapter 11 of the Bankruptcy Code.
Pr. 14–2 Dodge Company (40 minutes, easy)
Prepare a statement of affairs and a working paper to compute percentage of claims to be received by each group of creditors in a Chapter 7 bankruptcy liquidation.
Pr. 14–3 Robaire Corporation (50 minutes, easy)
Journal entries for one month for a trustee in bankruptcy liquidation. Preparation of statement of realization and liquidation and a trial balance for trustee.
Pr. 14–4 Javits Corporation (50 minutes, medium)
Preparation of correcting journal entries and a statement of affairs in a bankruptcy liquidation.
Pr. 14–5 Laurel Company (60 minutes, medium)
Preparation of a statement of affairs in a bankruptcy liquidation.
Pr. 14–6 Bilbo Corporation (60 minutes, medium)
Prepare journal entries to give effect to a bankruptcy reorganization plan and a balance sheet at end of first month of operations following reorganization.
ANSWERS TO REVIEW QUESTIONS
1. The Bankruptcy Code defines insolvency for an entity other than a partnership or a municipality as a financial state in which the current fair value of the entity's property, exclusive of property withheld from creditors, is less than the amount of the entity's liabilities.
2. Federal Rules of Bankruptcy Procedure are prescribed by the U.S. Supreme Court for the various legal practices and procedures under the Bankruptcy Code.
3. The classes of creditors whose claims are dealt with in a bankruptcy liquidation are as follows: (a) unsecured creditors having priority (as prescribed in the Bankruptcy Code), (b) fully secured creditors, partially secured creditors, and (c) creditors having unsecured claims without priority.
4. Liquidation under Chapter 7 of the Bankruptcy Code involves the realization (sale) of the assets of a debtor and the distribution of the cash proceeds to creditors.
5. A debtor’s petition is filed by any debtor except entities such as a railroad, insurance, bank, credit union, or savings and loan association. The debtor's petition is a plea for the court to grant an order for relief to the petitioner in bankruptcy. A creditors’ petition is filed by creditors of a debtor other than those excluded by the Bankruptcy Code. The creditors must claim that the debtor owes debts aggregating $10,000 or more and is not paying debts as they come due or has a custodian in possession of the debtor's property.
6. Corporations that are prohibited by the Bankruptcy Code from filing a debtor's bankruptcy petition include railroad, insurance, credit union, and banking corporations. Savings and loan associations also are not permitted to file a debtor’s bankruptcy petition.
The McGraw-Hill Companies, Inc., 2006Solutions Manual, Chapter 14 405
7. A creditors’ petition for a bankruptcy liquidation may be filed by three or more “outsider” creditors, having unsecured claims aggregating $10,000 or more, of a debtor with 12 or more unsecured creditors. If there are fewer than 12 unsecured creditors involved, one or more creditors having unsecured claims of $10,000 or more in the aggregate may file the petition.
8. A statement of financial affairs under the Bankruptcy Code is a form filed with a debtor's petition that contains a series of questions answered by the debtor concerning all aspects of the financial condition and operations of the debtor.
9. Debts that have priority over other unsecured debts under the provisions of the Bankruptcy Code are as follows:
(1) Administrative costs
(2) Claims arising after the commencement of bankruptcy proceedings under a creditors' petition but before appointment of a trustee or order for relief
(3) Claims for wages and like remuneration not in excess of $4,000 per claimant, earned within 90 days of the filing of the petition
(4) Claims for contributions to employee benefit plans, subject to time and amount limitations
(5) Claims by producers of grain against a grain storage facility or by fishermen against a fish storage or processing facility, not in excess of $4,000 per claimant
(6) Claims for cash deposited for goods or services for the personal, family, or household use of the depositor, not in excess of $1,800 per claimant
(7) Claims for alimony, maintenance, or support of a spouse, former spouse, or child of the debtor, under a separation agreement, divorce decree, or court order
(8) Claims of governmental entities for various taxes or duties, subject to varying time limitations
10. Claims for wages, salaries, and similar compensation earned within 90 days of the filing of the bankruptcy petition and not in excess of $4,000 per claimant, are third in priority among the unsecured liabilities of the debtor that have priority.
11. A bankruptcy trustee may invalidate a preference under provisions of the Bankruptcy Code and recover from the creditor the cash or property constituting the preference, for inclusion in the debtor's estate.
12. A discharge in bankruptcy liquidation proceedings releases the debtor from all unliquidated debts, except for specific debts enumerated in the Bankruptcy Code.
13. The financial statement known as a statement of affairs shows the financial position of a debtor enterprise on a quitting-concern or liquidation basis. The statement is used by the bankruptcy trustee to estimate the cash that will be available to unsecured, nonpriority creditors.
14. Under the accountability method of accounting used by a trustee in a bankruptcy liquidation, the assets and liabilities of a debtor's estate for which the trustee is responsible are entered in the accounting records of the trustee at their statement of affairs valuations, with an offset to a memorandum-type ledger account with a title such as Estate Deficit.
15. An examiner might be appointed for an enterprise that has unsecured liabilities, other than payables for goods, services, or taxes, exceeding $5 million, for which a trustee was not appointed.
16. The Securities and Exchange Commission may review a plan for reorganization and may be heard in the bankruptcy court's consideration of the plan.
17. No, all classes of creditors need not accept a reorganization plan. The bankruptcy court may nonetheless confirm the plan if it is fair and equitable to the nonacceptors.
18. Fresh start reporting for a business enterprise reorganized under Chapter 11 of the Bankruptcy Code involves valuing the enterprise's assets and liabilities at current fair values and writing off a retained earnings deficit against additional paid-in capital. Fresh start reporting is appropriate for
The McGraw-Hill Companies, Inc., 2006406 Modern Advanced Accounting, 10/e
a reorganized enterprise whose former stockholders no longer control the enterprise; it is essentially a new reporting enterprise.
SOLUTIONS TO EXERCISES
Ex. 14–1 1. c 10. c2. b 11. c3. c 12. c4. d 13. b5. d 14. b6. b 15. b7. b [$10,000 + ($40,000 x 0.50) = $30,000] 16. d8. b 17. b9. a
Ex. 14–2 Estimated amount of assets expected to be received by creditors of Downside Company, Dec. 18, 2006:
Fully secured liabilities (100%) $ 80,000Unsecured liabilities with priority (100%) 60,000Partially secured liabilities [$40,000 + ($10,000 x 0.80)] 48,000Unsecured liabilities without priority ($90,000 x 0.80) 72,000
Total assets ($100,000 + $40,000 + $120,000) $260,000
Ex. 14–3 Computation of total estimated deficiency to unsecured, nonpriority creditors of Foldup Company, Apr. 30, 2006:
Estimated amount available [$280,000 + ($80,000 – $60,000)] $300,000Less: Unsecured liabilities with priority 40,000Estimated amount available to unsecured, nonpriority creditors (72 cents on
the dollar) $260,000Estimated deficiency to unsecured, nonpriority creditors (28 cents on the
Less: Unsecured liabilities with priority 20,000Amount available for unsecured liabilities without priority $180,000Total unsecured liabilities without priority ($260,000 +
$40,000) $300,000Proportionate recovery percentage ($180,000 $300,000) 0.60Proportionate recovery on $40,000 ($40,000 x 0.60) 24,000
Cash received by partially secured creditors $84,000
Ex. 14–7 Computation of amount that Stark Company should receive from trustee of Wick Corporation:
Amount owed to Stark Company: Note payable plus accrued interest of $940 $23,940Less: Current fair value of inventories pledged as collateral on note 19,200
Amount unsecured, payable at approximately $0.78 on the dollar $ 4,740Estimated amount to be received by Stark Company: Current fair value of inventories pledged $19,200
Balance ($4,740 x 0.78) 3,697Total amount that Stark Company should receive $22,897
Ex. 14–8 Computation of cash available to pay Decker Company’s unsecured liabilities without priority, Aug. 15, 2006:
Free assets, at current fair value $160,000Addition from assets pledged for fully secured liabilities ($185,000 –
$130,000) 55,000Subtotal $215,000
Less: Unsecured liabilities with priority 35,000Cash available for unsecured liabilities without priority $180,000
The McGraw-Hill Companies, Inc., 2006408 Modern Advanced Accounting, 10/e
Ex. 14–9 Computation of estimated amount expected to be paid to each class of creditors of Kent Corporation:
Total amount available $ 85,000Less: Unsecured liabilities with priority 7,000Amount available for unsecured, nonpriority creditors $ 78,000Partially secured liabilities $60,000Less: Assets pledged for partially secured liabilities 52,000
Amount unsecured $ 8,000Unsecured liabilities without priority 112,000
Total unsecured liabilities $120,000
Percentage available to unsecured creditors: $78,000 $120,000 = 65%
Creditors will receive payment as follows:Unsecured creditors with priority, 100% $ 7,000Fully secured creditors, 100% 30,000Partially secured creditors [$52,000 + ($8,000 x 0.65)] 57,200Unsecured creditors without priority ($112,000 x 0.65) 72,800
Total to be received by creditors ($75,000 + $52,000 + $40,000)
$167,000
Ex. 14–10 Assets side of statement of affairs for Progress Book Company, May 31, 2006:
Carrying amount Assets
Current fair
value
Estimated amount
available
Loss or (gain) on
realizationa. Assets pledged for fully secured
liabilities:$70,000 Furniture and fixtures $60,500 $9,500
Ex. 14–13 Journal entries for Kolb Company, July 27, 2006:Common Stock, no-par 600,000
Common Stock, $5 par (50,000 x $5) 250,000Paid-in Capital in Excess of Par 350,000
Trade Accounts Payable 70,000Common Stock, $5 par (10,000 x $5) 50,000Paid-in Capital in Excess of Par 20,000
Trade Accounts Payable 60,000Cash ($60,000 x 0.80) 48,000Gain from Discharge of Indebtedness in Bankruptcy 12,000
The McGraw-Hill Companies, Inc., 2006410 Modern Advanced Accounting, 10/e
Ex. 14–14 Journal entries for Hayward Company, Jan. 20, 2006:
(1) Common Stock, $100 par 100,000Common Stock, $5 par 5,000Paid-in Capital in Excess of Par 95,000
(2) Notes Payable 2,500Interest Payable 500
Common Stock, $5 par (200 x $5) 1,000Paid-in Capital in Excess of Par (200 x $5) 1,000Gain from Discharge of Indebtedness in Bankruptcy 1,000
(3) Trade Accounts Payable 10,000Cash 8,000Gain from Discharge of Indebtedness in Bankruptcy 2,000
CASES
Case 14–1 The recognition of an intangible asset “Reorganization value in excess of amounts allocable to identifiable assets,” sanctioned by paragraph 38 of Statement of Position 90-7, appears to be inconsistent with the definition of assets in Statement of Financial Accounting Concepts No. 6, paragraph 25. The existence of probable future economic benefits related to the reorganization value is questionable, given that the amount recognized for the so-called intangible asset is a residual obtained by subtracting the current fair values assigned to identifiable tangible and intangible assets of the reorganized enterprise from its reorganization value. That value is defined in paragraph 9 of Statement of Position 90-7 as “fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring.” One would deduce that the assets referred to in the foregoing definition are identifiable assets, not speculative ones. To treat reorganization value essentially the same as acquired goodwill appears to violate the spirit, if not the letter, of FASB Statement No. 142, which requires in paragraph 10 that internally developed unidentifiable assets' costs should be recognized as expenses when incurred. To borrow a portion of the dissent of Robert T. Sprouse to the issuance of FASB Statement No. 87, “ . . . recognition practices [for reorganization value] can be neither reconciled with the [Financial Accounting Standards] Board’s conceptual framework nor readily understood by financial statement users.”
Case 14–2 a. The $25,000 income tax assessment applicable to 2005 generally would be accounted for as a prior period adjustment (correction of an error of a prior period) and debited to the Retained Earnings ledger account. However, the general rule applicable in a reorganization requires that, when material items that should have been adjusted in the restatement of assets and liabilities are found to have been accounted for incorrectly, any corrections subsequently required should be made to additional paid-in capital created in the reorganization. Such corrections should not be considered a part of the earnings accumulated after the reorganization. In "fresh start" accounting for a reorganization, asset carrying amounts should be restated in conformity with estimates of current fair value. Such restatements should include write-ups of values, when justified, as well as write-downs. The income tax assessment applicable to 2005 has no relationship to the earnings of the past six months; the assessment should have been estimated at the time of the reorganization.
b. Because the disposal of the equipment took place within six months of the date of the reorganization, the appraised value on the date of the reorganization seems to have been in error. The gain of $48,000 should have been credited to an additional paid-in capital ledger account, not to the Retained Earnings account.
The McGraw-Hill Companies, Inc., 2006Solutions Manual, Chapter 14 411
c. The fire loss of $15,000 should be displayed in the income statement, not debited directly to the Retained Earnings ledger account. The relevant issue, however, is that the loss should not be debited to a paid-in capital account.
d. A declaration of a cash dividend is a proper debit to the Retained Earnings ledger account if the dividend does not exceed the accumulated earnings since the date of reorganization.
e. Net income earned subsequent to a reorganization is credited to the Retained Earnings ledger account; therefore, this item was recorded correctly.
Case 14–3 a. Assets pledged for partially secured liabilities are displayed at both carrying amount and current fair value on the assets side of the statement of affairs. In addition, the current fair value of the assets is deducted from the related partially secured liabilities on the liabilities side of the statement.
b. Unsecured liabilities with priority are displayed at carrying amount and totaled on the liabilities side of the statement of affairs. The total of the liabilities is deducted from the total of the "Estimated amount available" column on the assets side of the statement.
c. Stockholders’ equity is a balancing amount in the “Carrying amount” column of the liabilities and stockholders’ equity side of the statement of affairs.
The McGraw-Hill Companies, Inc., 2006412 Modern Advanced Accounting, 10/e
25 Minutes, EasyRe-Org Company Pr. 14–1
Re-Org Company
Journal Entries
20 06
July 24 Costs of Bankruptcy Proceedings 5 0 0 0 0
Cash with Escrow Agent 5 0 0 0 0
24 Common Stock, no par 5 8 0 0 0 0
Common Stock, $1 par (60,000 x $1) 6 0 0 0 0
Paid-in Capital in Excess of Par 5 2 0 0 0 0
24 10% Note Payable 1 2 0 0 0 0
Interest Payable ($120,000 x 0.10 x 3/12) 3 0 0 0
12% Note Payable 1 2 3 0 0 0
24 Trade Accounts Payable 1 0 0 0 0 0
Cash ($100,000 x 0.80) 8 0 0 0 0
Gain from Discharge of Indebtedness in
Bankruptcy 2 0 0 0 0
24 Paid-in Capital in Excess of Par 2 9 0 0 0 0
Gain from Discharge of Indebtedness in Bankruptcy 2 0 0 0 0
Retained Earnings 2 6 0 0 0 0
Costs of Bankruptcy Proceedings 5 0 0 0 0
The McGraw-Hill Companies, Inc., 2006Solutions Manual, Chapter 14 413
40 Minutes, EasyDodge Company Pr. 14–2
a. Dodge CompanyStatement of Affairs
October 31, 2006
Estimated Loss orCarrying Current fair amount (gain) on Carrying Amountamount Assets value available realization amount Liabilities & Stockholders’ Equity unsecured
The McGraw-Hill Companies, Inc., 2006414 Modern Advanced Accounting, 10/e
50 Minutes, EasyRobaire Corporation Pr. 14–3
a. Robaire Corporation, in Bankruptcy
Charles Stern, Trustee
Journal Entries
20 07
Jan 2 Cash 7 0 0
Trade Accounts Receivable (including assigned
accounts of $10,000) 2 0 4 5 0
Inventories 1 8 9 5 0
Public Service Company Bonds 9 0 0
Land 2 0 0 0 0
Buildings 3 0 0 0 0
Machinery and Equipment 1 8 0 0 0
Estate Deficit 1 0 0 0 0
Wages Payable 1 5 0 0
FICA and Income Taxes Withheld and Accrued 8 0 0
Estimated Administrative Costs 3 2 0 0
Mortgage Note Payable 4 2 0 0 0
Interest Payable 5 0 0
Notes Payable—Bank 2 5 0 0 0
Notes Payable—Suppliers 2 0 0 0 0
Trade Accounts Payable 2 6 0 0 0
To record current fair values of assets and liabilities
of Robaire Corporation, in bankruptcy (filed
Jan. 2, 2007).
7 Cash 5 2 0 0 0
Land 2 0 0 0 0
Buildings 3 0 0 0 0
Estate Deficit 2 0 0 0
To record realization of land and buildings for $2,000
in excess of the current fair value on date bankruptcy
petition filed.
7 Mortgage Note Payable 4 2 0 0 0
Interest Payable 5 0 0
Estate Deficit 5 0
Cash 4 2 5 5 0
To record payment of principal and interest on
mortgage note, including $50 interest accrued in
January.
10 Wages Payable 1 5 0 0
FICA and Income Taxes Withheld and Accrued 8 0 0
Estimated Administrative costs 6 0 0
Inventories 4 0 0
Cash 3 3 0 0
To record payment of unsecured liabilities with priority
and costs to complete inventories.
(Continued on page 416.)
The McGraw-Hill Companies, Inc., 2006Solutions Manual, Chapter 14 415
Robaire Corporation (continued) Pr. 14–3
Robaire Corporation, in Bankruptcy
Charles Stern, Trustee
Journal Entries (concluded)
20 07
Jan 31 Cash 3 6 4 2 0
Estate Deficit 1 3 3 0
Trade Accounts Receivable 1 7 5 0 0
Inventories 1 9 3 5 0
Public Service Company Bonds 9 0 0
To record collections of accounts receivable and
realization of assets at net loss of $1,330 ($1,350 –
$20 = $1,330).
31 Estimated Administrative Costs 1 2 5 0
Notes Payable—Bank ($10,000 + $7,500) 1 7 5 0 0
Notes Payable—Suppliers 1 0 0 0 0
Trade Accounts Payable 1 3 0 0 0
Cash 4 1 7 5 0
To record cash payments, including $30,500 ($0.50 on
the dollar) to unsecured creditors without priority.
b. Robaire Corporation, in Bankruptcy
Charles Stern, Trustee
Statement of Realization and Liquidation
For Month Ended January 31, 2007
Estate deficit, Jan. 2, 2007 $ 1 0 0 0 0
Assets realized:
Current Fair
Value, Jan. 2, Realization Loss or
2007 Proceeds (Gain)
Land and buildings $50,000 $52,000 $ ( 2 0 0 0 )
Trade accounts
receivable 17,500 17,500
Inventories 19,350* 18,000 1 3 5 0
Public Service
Company bonds 900 920 ( 2 0 )
Totals $87,750 $88,420 ( 6 7 0 )
Liabilities liquidated:
Wages payable $ 1 5 0 0
FICA and income taxes withheld and accrued 8 0 0
Estimated administrative costs 1 8 5 0
Mortgage note payable (including accrued
interest of $550) 4 2 5 5 0 5 0
Notes payable—banks 1 7 5 0 0
Notes payable—suppliers 1 0 0 0 0
Trade accounts payable 1 3 0 0 0
Total $ 8 7 2 0 0
Estate deficit, Jan. 31, 2007 $ 9 3 8 0
*$18,950 + $400 = $19,350
The McGraw-Hill Companies, Inc., 2006416 Modern Advanced Accounting, 10/e
Robaire Corporation (concluded) Pr. 14–3
c. Robaire Corporation, in Bankruptcy
Charles Stern, Trustee
Trial Balance, January 31, 2007
Debit Credit
Cash ($700 + $88,420 – $87,600) $ 1 5 2 0
Trade accounts receivable 2 9 5 0
Machinery and equipment 1 8 0 0 0
Estate deficit 9 3 8 0
Estimated administrative costs $ 1 3 5 0
Notes payable—bank 7 5 0 0
Notes payable—suppliers 1 0 0 0 0
Trade accounts payable 1 3 0 0 0
Totals $ 3 1 8 5 0 $ 3 1 8 5 0
The McGraw-Hill Companies, Inc., 2006Solutions Manual, Chapter 14 417
50 Minutes, MediumJavits Corporation Pr. 14–4
a. Javits Corporation
Correcting Journal Entries
July 10, 2006
Retained Earnings 5 0 0
Cash 5 0 0
To remove expended travel advance from cash.
Interest Receivable 2 0 0
Retained Earnings 2 0 0
To accrue interest on U.S. government bonds.
Trade Accounts Payable 1 5 0 0 0
Retained Earnings 5 0 0
FICA and Income Taxes Payable 1 5 5 0 0
To remove FICA and income taxes payable from
accounts payable and to accrue unrecorded FICA
taxes.
Retained Earnings 2 4 0 0
Interest Payable 2 4 0 0
To accrue interest on mortgage note payable.
Retained Earnings 5 0 0 0 0
Estimated Liability under Pending Litigation 5 0 0 0 0
To record loss contingency that is probable.
Retained Earnings 5 0 0 0
Trade Accounts Payable 5 0 0 0
To record liability for fee for Apr. 30, 2006, annual
audit.
Retained Earnings 1 0 0 0
Short-term Investments ($10,000 – $9,000) 1 0 0 0
To write down short-term investments in Owens
Company common stock to fair value of $9,000 (500 x
$18 = $9,000) from cost of $10,000 ($20,000 – $10,000
= $10,000).
The McGraw-Hill Companies, Inc., 2006418 Modern Advanced Accounting, 10/e
Javits Corporation Pr. 14–4
b. Javits CorporationStatement of Affairs
July 10, 2006
The McGraw-Hill Companies, Inc., 2006Solutions Manual, Chapter 14 419
Estimated Loss orCarrying Current fair amount (gain) on Carrying Amountamount Assets value available realization amount Liabilities & Stockholders’ Equity unsecured
Assets pledged for fully secured Unsecured liabilities with priority: liabilities: Estimated liquidation costs $ 1 0 0 0 0
The McGraw-Hill Companies, Inc., 2006420 Modern Advanced Accounting, 10/e
40 Minutes, MediumLaurel Company Pr. 14–5
Laurel CompanyStatement of Affairs
June 30, 2006
Estimated Loss orCarrying Current fair amount (gain) on Carrying Amountamount Assets value available realization amount Liabilities & Stockholders’ Equity unsecured
Assets pledged for fully Unsecured liabilities with priority: secured liabilities: Estimated liquidation costs $ 4 5 0 0
$ 2 5 5 0 0 Notes receivable, including $ 1 4 0 0 Wages payable 1 4 0 0 interest of $500 $ 2 5 5 0 0 4 3 0 FICA and income taxes withheld & accrued 4 3 0