 Hello and welcome to the session. This is Professor Farhad and this session we're going to be looking at contractual agreement. This topic is stubborn and advanced accounting course. This topic is a introductory for reorganization and liquidation for chapter seven and chapter 11. The topic is covered on the reg exam CPA reg and somehow it's covered when it comes to journal entries on the far exam. As always I would like you to connect with me on LinkedIn. If you don't have a LinkedIn account, make sure you create one. It's very important for your professional image. YouTube is where you would need to subscribe. I have over 1500 lessons, accounting, tax, audit. Make sure you take advantage of those. They're available on YouTube. If you like my YouTube, please like them, share them, put them in the playlist, let the word know about them. This is my website as well. I have an Instagram account. And this is my Facebook page. So let's talk about contract contractual agreement. And when do we have to deal with this type of situation? What is the prerequisite for bankruptcy? The prerequisite for bankruptcy is when you cannot enable to pay your debt, unable to pay your obligations. When a business is unable to pay its obligation, the business may attempt first to reach an accommodation with the creditors. So first we're going to look at what are the options for the business before they restore to legal recourse, legal action to the creditor as well as for the debtor. So the debtor and the creditor, the creditor are the party that lend you the money. Debtor is the party that borrowed the money. The creditors think of banks. Just think of banks. They don't have to be banks. They can be anyone, but think of banks. Banks lend you money. The debtor and the creditor meet and develop a voluntary agreement. Notice here we are dealing with voluntary agreement. Basically they sit together and they will try to work some sort of a settlement, some sort of a settlement. What could the settlement include? The settlement could include extension of payments. That's one option. It could include something called composition agreement. It could include formation of creditors committee and it could also include voluntary assignments of assets. Now if you are, if you watch my lectures, you know that every time I have a list, I'm going to go over this list in detail. The first thing is I'm going to talk about extension of payment period. So when does extension of payment period occur? Well, it occurred when the debtor and the creditor, especially the creditor believed it's not in their best interest to force the debtor, to force the borrower into liquidation. So the financial difficulties, they believe they're temporary. It just, this is only for this year or for this six month, then the business will pick up. It's in the best interest of the creditor to wait, maybe extend the payment. When the payment is extended, interest would still be accrued. So interest on the debt continue to accrue as normal. Okay. Usually this type of arrangement is good with small businesses, small group of creditors too. You cannot have too many creditors. Now you have to negotiate with each one separately. So a small, small group of creditors will work. Notes, the financial statements should indicate the extension of the agreement. So if you did go through an extension, the notes in the financial statements, obviously that that's about right, we'll have to disclose the notes and the notes, the agreement. That's handled prospectively. You don't have to go back and change anything. And generally speaking, no journal entry is required. If it's only extension of period, basically it's extension of time, unless, as a result, the payable now exceeds the carrying amount of the payable exceeds the cash payment and interest specified by the new term. So now you're payable, the book value of your payable is more than the cash flow you have to pay. Simply put, you're going to have to pay less to settle than you're going to have some sort of a gain at that point. Okay. Another option is to have something called composition agreement. It's an agreement between the debtor and the creditor where creditor agrees to accept less than the full amount of their claims. Similarly, here the creditor says, you know what? Why don't you pay me one option is you owe me $300,000, pay me 180 and we'll call it even. We'll let it go. Okay. Or they cancel the interest. Okay. Forget about the interest. I don't want the interest. Just pay me my principle. Or what they do, they can lower the rate. Now I'm challenging you 8%, I'm going to challenge you 4%. Okay. So, but here in return, the creditor expect to receive an immediate payment. Okay. Which will be, which should be more than, which should be more than if the debtor were first to liquidate. So here the creditor thinking, give me my money. Let me get out. Basically cut my losses here. What the creditor saying, let me cut my losses. Let me accept this payment and we'll move on. Also, this is good for small group of creditors. Again, no gain or loss is recognized until unless the carrying amount of the remaining payable, okay, exceeds the total future cash payment of principle and interest. So now what you have to pay on books is less than what's on the book to assume you're going to have on the books. It's a million dollar, but you can satisfy it with 800,000. Well, you have a game because you owe a million on the books, but you only have to pay 800,000. Another option is to form a creditors committee. Now what you do is you bring a group of people and they will kind of, in a sense, they will form to manage the debtor's business affair. So they will try to manage your affair. Basically, it's a committee. It's called the debt committee. So they make plans to either rehab the business, reorganize or liquidate. Okay. So it could be they might extend the period, they might have a composition agreement. Somehow this committee will decide on what should happen. Now if they decided to go into reorg or liquidation, if they're going to go down that way and we will talk about both of these later on reorganization is basically chapter 11 and liquidating is chapter seven. Once if they happen to make that decision, the business that the debtor property may be turned to a trustee who's responsible for conducting the affair of the business. So it leaves the committee and goes to a trustee. And at that point, during that period will conduct the organization or liquidation again we'll talk about three organization and liquidation later on. The last option is voluntary assignment of asset here. The debtor would the debtor would say the debtor would say okay, I owe you the money I have these assets. What I'm going to do I'm going to put the asset with the control of someone else a trustee. I'll give you the property and give you the proceeds. Okay, and at that point, we'll call it even that's what's going to happen. I voluntarily assigned my asset to someone who's going to sell the assets with basically we will have to agree to them. Now if anything left, any remaining money left after the sale of the proceeds and go back to the debtor it goes back to the business. This is basically an introduction to the chapter seven and chapter 11. In the next session we would look at basically bankruptcy in general what are the bankruptcies, voluntary petition versus unvoluntary petition, so on and so forth. If you have any questions about this topic. Please email me. If you happen to visit my website for additional lectures, please consider donating. Good luck.