 Hello and welcome to this session. This is Professor Farhad and this session we're going to be looking at an example that deals with Accounting for chapter 11 reorganization. This topic is covered in advanced accounting as well as on the CPA exam far and to a degree Regulation as always I would like to remind you to connect with me on LinkedIn YouTube is where you would like what I want you to subscribe. I have over 1500 plus accounting auditing and tax lectures Please like them if you like them share them put them in the playlist Let the world know about them if you're benefiting from my YouTube It means someone else might benefit as well share the wealth. This is my Instagram account This is my Facebook account, and this is my website on my website I always have all I'll try to always have some sort of a CPA offer right now Becker is running a thousand dollar off of their best gold standard CPA prep course in the world This is unlimited access. So once you sign, you're good to go until you pass. I Strongly suggest you go for it. You may not be studying for the CPA now You might be starting in the fall buy it now It has unlimited access because in the fall that offer might go away Also, if you're taking college courses, it will help you tremendously as a supplemental tool Please go to my website and I have the offer listed there Let's talk about this company box company So we have this company and what they did is they filed for chapter 11 reorganization And this is what their balance sheet looks like now. So this is the original balance sheet We're gonna go through a series of transactions through the reorganization process Then we'll compare this balance sheet to the balance sheet after the reorganization So let's take a look real quick at what they have so we have a good idea of what's going on They have cash of 86,000 They have a receivable minus the allowance one for 107 inventory They have property plant and equipment total of 405 net lend help for an investment Then they have a bunch of liabilities And this is where the problem lies when you have too much debt accounts payable secured by inventory accounts payable That's unsecured notes payable. That's unsecured accrued expenses with priority Then other accrued accrued interest expense and they have a bond of 450,000 total debt of 918 And this is what we're gonna be doing most of the work because to get out of bankruptcy To get out of chapter 11. You want to get out mean lean and no fat? No fat means that you want to get rid of that debt This is what we're gonna be doing. They do have common stock of half a million and the retained earnings is obviously negative deficit of 600,000 and that's why they were getting into trouble because Because they're not generating enough profit for the business Why because maybe the debt is eaten up all the profit so overall total equity is negative 98,000 So we're gonna be looking at series of transaction. That's gonna get them out of this situation So let's take a look at the first transaction and see what's happening. So what happened is this now We're gonna be negotiating with those creditors because we want to get rid of those of those of these debts So the first thing we're gonna do is creditors represented the unsecured accounts payable. So we are talking about We're talking about this group here the unsecured Accounts payable 134,000 this group Agreed to accept our account receivable in full settlement of their claim. They said guess what give me your account receivable Give up your receivable. I'll collect your money and I don't have to bill you anymore And I will call I will tell you that you are even when it comes to accounts payable Well, the fair value of the receivable Not guaranteed by the company is 100,000. What does that mean? It means we have a receivable on the books for 107, but it's really worth 100,000 Now remember what we learned about earlier when you When you give up an asset the first thing you have to do is you have to write the asset to market value Well, the asset is right now worth 107. It's supposed to be only worth a hundred thousand And since you are getting root of the receivable, there's no need for the allowance So you get rid of the allowance So what does that mean first you you adjust your receivable to the market value Therefore you debit the allowance 13,000 to get rid of the allowance You debit the loss of 7,000 Why the loss debit 7,000 because you need to reduce your receivable by 20,000 your receivable need to be reduced by 20,000 So you reduce your receivable you remove the allowance and you book the loss now you have a receivable now You're receivable your account receivable is only 100,000 100,000 your receivable is 100,000 Okay, we debit the allowance because it's a contra asset. It has a credit balance Therefore we debit it to make the allowance go down to zero. So simply put in this transaction I get rid of this and I made this 100,000 therefore my receivable is 100,000 now Okay, my receivable is 100,000. That's the first thing then once my once I adjusted my receivable They said they will take the receivable. So and they would remove my payable. Well, if they remove my payable I'm gonna debit my payable the unsecured payable 134 I'm gonna debit my receivable 100,000. So I gave them something that's worth 100,000 and they said they're gonna forgive me for 134. I like this I'm gonna have a gain on the battery structuring of 34. Therefore, I have a gain on this So simply put what happened here if we go back to this picture here Simply put after this transaction a count receivable is gone and this debt here is gone Okay, notice we are trimming down the balance sheet. Okay, and we booked again of 34,000. Okay Let's see what happened next Let's see what happened next now again. I could not change the balance sheet constantly, but imagine then this is gone and This is gone. Just kind of imagine The next thing that happened is we're gonna have to pay the accrued interest with priority. So we have accrued interest of 24,000 and those are with priority and they said we should pay them. Well, when we pay them, we're gonna debit the expense the accrued expense and credit cash simply put This is gone And we reduce our expense our cash by 24,000 so 86 is reduced by 24,000. Okay Next a creditor holding $120,000 note agreed to accept the land health as an investment in fully settlement of the note plus accrued interest of 8,000 The land has value of 95. Let's look at the balance sheet We have notes of 200,000 we have loans of 200,000 one of the individuals that hold this note says Which is holds only 120 they said well if you give me this piece of land Land health as an investment. I have this land. I will I would reduce your loan I would remove your loan now the land health for investment. It's worth on the books of 80 but it's worth 95 The first thing we have to do is we have to write it up and book again Then after we book the game, we have to remove 120,000 of the liabilities and they also would we would remove also there is some accrued interest and we would remove 8,000 of this accrued interest so we're going to reduce our accrued interest by 8,000 and reduce this by 120 But as a result we're going to get rid of we're going to give up this land. So let's do this transaction So we're going to debit land credit gain. This should be the credit credit game. Okay Then we're going to have to debit the note for at 120 debit the accrued interest payable of 8,000 Credit the land at fair value because now the land had a value for 95 This should be a credit moved forward and credit the gain. This should be moved forward at 33,000 Okay, so this is the entry. This is the debit And this is the credit so simply put what happened here is now of the one of the 200,000. We still have 80,000 This is gone This is gone This is gone and we no longer have this land. So all these accounts are gone and our interest payable now is Interest accrued interest payable is only 42 because we reduced it by 8 only 42 not minus 42 It's only 42 okay All right Now we book also again. So notice as we're booking the gain those gains are going and eventually they are You know, they are they are changing retained earning They are bringing retained earning towards zero because now we're below zero because it's increasing our retained earning Okay, so just I want you to look at this because at the end you're going to see the completed balance sheet Now another creditor holding 80,000 note on which for $4,000 interest agreed to extend the maturity Date of the note for two years and reduce the interest I told you we still owe 80,000 dollar in notes the individual that holds this note Plus they also for this note, there's a $4,000 of accrued interest involved here They said what we will do we would We would not forgive we will extend the the term Basically, we would remove the old note and we'll issue a new note for the amount Okay, so basically we remove the old note We remove the accrued interest related to that note and we credit a new note called restructured that so basically we replace the note And as a result now it's going to give us more time to pay our bill now for this transaction We're not going to have no gain Because the cash flow from this note, which is you don't have to worry about it. It's going to be 92,800 and the loan is worth 84 Therefore, there is no gain So you know why I did not book again because my future cash flow for that note that include interest will be 92,800 Which is more than the book value of the note now. Therefore, there is no gain So what we did in this picture we basically this this whole note is gone But now we have a new debt new debt of 84,000 a new debt of 84,000 And accrued interest now is reduced by an additional 4,000 just kind of you know kind of keep up with this So this way when you see the last balance sheet, you are not surprised Now we still have this bond here 450 which is it's a huge Hey, guess what the bondholder agreed to accept equity interest in the company of 150,000 share in exchange for the bond and accrued interest of 38 So the bondholder says guess what you give me 150,000 shares of your stocks. I will exchange it for the bond I would get rid of the bond the market value of the stock is dollar 25. So let's take look at this. I'm going to debit the bond Credit common stock because I'm issuing common stock. How much do I credit common stock? The number of shares Times the power value times one in whatever's left Is the other contributed capital and I credit again. Why did I credit again? I only gave up Stocks that's worth one eighty seven five hundred. That's the fair market value of the stocks Which is one hundred and fifty thousand shares times dollar 25 If my math is right one eighty seven five hundred One eighty seven five hundred and I get rid of a note Of four hundred and fifty thousand Okay Therefore I have a gain of two sixty two Okay, two sixty two So I have a gain And guess what this bond now is gone But now common stock went up And retained earning went down because I booked some gain. Okay Last bankruptcy administration expense totaling sixteen thousand are paid in cash I have to pay the lawyers the accountant that paid on the bankruptcy they work on the bankruptcy So bankrupt's expense is sixteen thousand debit and expense which is with increase retained earning Reduce retained earning. Sorry reduce retained earning and credit cash with which would reduce cash And this is what we look like after all Things said and done our cash now is 46 because we had to make certain payment. We did not touch inventory It seems we wanted to keep our inventory Our property plant and equipment. I believe they stayed the same. We did not touch those. Let me see Yeah, we did not touch those. I don't remember touching those So we did not touch those Okay Notice account receivable is gone. I told you that was transaction one So now this is our assets now. We still have cash inventory and property plant and equipment You remember the land health for investment is gone too. So this is what our assets looks like now Accounts payable we did not touch this accounts payable. You remember we get rid of other payables we get rid of We get rid of This payable we did not touch this we got rid of this notes We got rid of the priority priority Accrued interest as well priority Priority accrued we still have accrued interest of 38 000. That's the only thing that's left. Those are the only current liabilities that left Now we have a new loan of 84 000 newly loan restructure. Also, we get rid of the bond The common stock was 500 000 now we issued an additional 150 Now we have other contributed capital because we issued new stocks and retained earning was 5 98 We increased it by 16 we reduced it by 8 and we increased it by 3 29 500 Those are the gains and the losses that we booked throughout the transaction So we still have a deficit of 276 500 However, the total equity now is positive Now we now we came out kind of better than what we started with right so you could compare this balance sheet To this bloated balance sheet bloated with that Okay, so basically we used to have 9 18 worth of that. Now the only that we have is Wow, not bad 182 182 so not bad at all Why I think there's something wrong restructure thing this is Yeah, 182 182 worth of that 182 worth of that, which is pretty good. Okay So remember that the net gain on the transfer of the asset will be reported as part of income and the gain on the restructuring would also be reported part of income So the gain and the losses will be reported part as for income Notice the sheer the stockholders deficiency has been eliminated, but we still have deficiency in retained earning Now we can we can basically debit retained earning for this amount and Yes, I'm sorry credit retained earning We can credit retained earning and debit capital stock and other contributed capital to make it go down to zero We do have this option so of the desired by the parties the interest the organization plan could have included a provision to decrease the power value of the common stock and eliminate the deficit You could also do that as well if you chose to okay. Hopefully this this This this example showed you how we go through a chapter 7 reorganization If you have any questions about this topic email me if you happen to visit my website for additional lectures Please consider donating if you're studying for your CPA exam as always study hard It's worth it and see you on the other side of success