Chapter 11 Reorganization
During the recent recession, Polydorous Inc. accumulated a deficit in retained earnings. Although still operating at a loss, the company posted better results during 20X1. Polydorous is having trouble paying suppliers on time and paying interest when it is due. The company files for protection under Chapter 11 of the Bankruptcy Code and has the following liabilities and stockholders’ equity accounts at the time the petition is filed:
Accounts Payable Interest Payable Notes Payable, 10%, unsecured Preferred Stock Common Stock, $5 par Retained Earnings (deficit) | $160,000 20,000 340,000 100,000 150,000 (80,000) |
Total | $690,000 |
A plan of reorganization is filed with the court, which approves it after review and after obtaining creditor and investor votes. The plan of reorganization includes the following actions:
1. The prepetition accounts payable will be restructured according to the following: (a) $40,000 will be paid in cash; (b) $20,000 will be eliminated; and (c) the remaining $100,000 will be exchanged for a five-year, secured note payable paying 12 percent interest.
2. The interest payable will be restructured as follows: $10,000 of the interest will be eliminated and the remaining $10,000 will be paid in cash.
3. The 10 percent, unsecured notes payable will be restructured as follows: (a) $60,000 of the notes will be eliminated; (b) $10,000 of the notes will be paid in cash; (c) $240,000 of the notes will be exchanged for a five-year, 12 percent secured note; and (d) the remaining $30,000 will be exchanged for 3,000 shares of newly issued common stock having a par value of $10.
4. The preferred shareholders will exchange their stock for 5,000 shares of newly issued $10 par common stock.
5. The common shareholders will exchange their stock for 2,000 shares of newly issued $10 par common stock.
After extensive analysis, the company’s reorganization value is determined to be $510,000 prior to any payments of cash required by the reorganization plan. An additional $10,000 in current liabilities have been incurred since the petition was filed. After the reorganization is completed, the capital structure of the company will be as follows:
Current liabilities (postpetition) | $ 10,000 |
Notes payable, 12%, secured | 340,000 |
Common stock ($10 par) | 100,000 |
Postreorganization capital structure | $450,000 |
An evaluation of the fair values of the assets was made after the company completed its reorganization, immediately prior to the point the company emerged from the proceedings. The following information is available:
| Book Value | Fair Value |
Cash Accounts receivable (net) Inventory Property, plant, and equipment (net) | $ 30,000 140,000 25,000 445,000 | $ 30,000 110,000 18,000 262,000 |
Total | $640,000 | $420,000 |
Required
a. Prepare a plan of reorganization recovery analysis for the liability and stockholders’ equity accounts of Polydorous Inc. on the day the plan of reorganization is approved. (Hint: The liabilities on the plan’s approval day are $530,000, which is $520,000 from prepetition payables plus $10,000 in additional accounts payable incurred postpetition.)
b. Prepare an analysis showing whether the company qualifies for fresh start accounting as it emerges from the reorganization.
c. Prepare journal entries for execution of the plan of reorganization with its general restructuring of debt and capital.
d. Prepare the balance sheet for the company on completion of the plan of reorganization.
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