Tag Archives: corporate restructuring

Chapter 11 Bankruptcy: Know Fresh-Start Accounting in the Restructuring Process

Fresh-Start Accounting

Not since the Great Depression has the number of business bankruptcies been so prevalent. Bankruptcy is a dramatic experience. It is one thing reading about the recent large bankruptcies of AMR Corp., parent of American Airlines, Kodak, and MF Global Holdings. But for the business leader, understanding and planning a Chapter 11 bankruptcy to save their own company is a whole different “ball of wax.” Securing the professional advice from an accounting firm, not an individual practitioner is advisable. This is because several areas of specialization will be needed. A key question that will be asked is what the company will look like after all is said and done. After all the activities of debt restructuring and redistributing the ownership of the new company, accountants will use fresh start accounting, if it qualifies, to report the new balance sheet of the company. Because many business leaders are new to the process and never heard of fresh start accounting, and although the bankruptcy process and fresh-starting accounting are complex, a simplistic explanation of fresh-start accounting is attempted. Key expertise will be needed from the following areas that will effect the challenging bankruptcy process:

  • Bankruptcy and insolvency
  • Business valuations
  • Taxation
  • Accounting
  • Restructuring

What is Fresh Start Accounting?

Fresh-start accounting means, “the financial statements of the emerged from bankruptcy entity obtains a fresh presentation of its financial position with newly valued assets after the liabilities have been cancelled and/or adjusted.” Under certain conditions, it is recognized that the new users of the financial statements will be better served by re-valuating the balance sheet on a “fair value” basis after the confirmation of the bankruptcy. Accountants are required to follow promulgations of ASC 852 (formerly SOP 90-7) in establishing an opening balance sheet of the successor company.

Fresh start accounting benefits the new shareholders by creating a “clean” balance sheet and favoring a step up in the value of the assets. Business leaders can eliminate losses of the bankrupt company, which enables the new company to come out of bankruptcy stronger. Use of fresh-start accounting is not a standalone process. It is an integral part of the Chapter 11 reorganization procedure designed to create a solvent, operationally viable entity. Certain debts of the bankrupt company are restructured and/or discharged. Then, if the new company qualifies for fresh start accounting treatment, the balance sheet of the new company is reset.

Complexity of Fresh-Start Accounting

The American Institute of Certified Public Accountants developed strict rules for restating and a timeline for implementing fresh start accounting reporting. Determining the fair value of both tangible and intangible assets, the start date for fresh-start reporting, and the best practices in “push down” fresh start adjustments to subsidiaries and underlying ledgers must be understood. Valuation is most critical to the overall process. This can be an enormous burden on the financial, operational and systems teams as well as management. Completing this process will enable management to move forward and focus on the operations of the newly reorganized business.

Many attorneys and accountants boast having bankruptcy experience, however regarding fresh-start reporting, the requirements are beyond most of them. Practitioners and firms with experience in fresh-start accounting, along with other advisers will be needed to support the individual asset valuations to the company’s external auditors. Know that stakes are high; the situation tends to be demanding; and delays will come with penalties, which requires expertise in this area.

Criteria to Qualify for Fresh-Start Accounting

To qualified for fresh-start accounting two requirements must be met:

  1. The new company’s reorganization value must be less than the total claims and the post-bankruptcy petition liability, and
  2. The holders of the pre-bankruptcy confirmation-voting shareholders will receive less than 50 percent of the voting shares of the new emerge company.

These requirements were put into place to prevent solvent companies from filings and to prevent companies to exploiting the bankruptcy code to writing up the carrying value of the assets.

Pro Forma Fresh Start Reporting

The creation of a pro forma balance sheet using fresh start accounting includes two primary considerations:

  1. The recording of the pro forma effects as it relates to:
    1. Extinguish of debt
    2. Cancellation of the pre-bankruptcy common shares
    3. Estimation of the allowed settlement claims
    4. Issuance of the new capital (equity and debt)
    5. Adjusting the balance sheet items to the “fair value” the encompasses:
      1. Writing up and down the values of receivable, inventories, and fixed assets
      2. Adjusting and recording to the balance sheet any reorganization intangible assets
      3. Recording the present value of all surviving post-bankruptcy liabilities
      4. Adjusting any pensions and other post-retirement benefits
      5. Eliminating pre-bankruptcy retained earnings or deficits
      6. Cancellation of debt and any operating loss carry-forwards

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Sample of Fresh Start Reporting

The following provides an example of Fresh-Start in practice:

Fresh-Sart Accounting Reporting
 

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Strategic Management: Defensive Strategies (PART 1)

Some would say that business competitive strategies are analogous to warfare or sports. This is similar to the way business turnarounds and restructurings are often viewed from the standpoint of a medical triage to cure a sick patient. Within the constructs of competitive strategies are the concepts of offensive and defensive strategies:

  • From a sporting perspective: an offensive strategy is to score, whereas a defensive strategy is to keep the opponent from scoring.
  • From a military perspective: an offensive strategy is to achieve victory, whereas a defensive strategy is to prevent defeat.

Now in business, as in sport and war, the purpose of an offensive strategy is to make something desirable happen i.e., the development of a new product or service, or capturing new business territories. The purpose of a defensive strategy is the neutralization of events that may harm the organization. Its aims are to lessen the probability of active assault on the core business, deflect them to less threatening areas, or lessen the intensity of the onslaught. Defensive strategies enhance a company’s competitive strategy making the organization more sustainable.

Defensive Strategies

Defensive strategies tend to require resources. This may include foregoing short-term profitability to enhance sustainability. But unfortunately according to Michael Porter (1985), most defensive strategies are hard to measure. How do you measure the ROI of defensive tactics that void competitors’ actions to enter the market place?

Defensive strategies should be considered as an integral part of strategic planning. Although one can look at defensive strategies to deter a known competitor or external competitors, defensive strategies can fend off unknown forces that can be detrimental to the organization. An example is the introduction of destructive technologies that can make the company’s products obsolete. Take a look at Apples Computer’s introduction of the iPod media player and its negative impact on Sony’s Walkman mp3 player. Sony had an ineffective defensive strategy. Today you hardly hear of anyone talking about a Walkman. The iPod dominates the media player market. Then you can also look at the defensive strategies Apple is employing to deflect Microsoft’s media player, currently Zune HD.  The iPod still rules.

The Risk-Threat Matrix

Overall, a key part of strategic management and planning is identifying and minimizing organizational vulnerabilities. A good starting point is to develop a Risk-Threat Matrix created by Beam and Carey (1991). The matrix is devised into a four-quadrant system with generalized responses in mapping defensive strategies. This will enable the organization to plan for and anticipate problematic situations prior to it happening. Additionally it will enhance management’s sensitivity to unanticipated detriments if one develops.

Beam and Carey Risk-Threat Matrix

Quadrants of Risk-Threat Characteristics:

  • Risks: Risks can be referred to as an undesirable outcome.
  • Threats: Threats can be referred to as a potential force or act that can cause harm to the organization
  • Blindsiding: Threats deliberately not communicated in advanced
  • Trends: Threats that develop gradually, but seldom dramatically.

In designing the Risk-Threat Matrix, the Knowledge of Source and Timing area (the horizontal axis) points out how much is known about future events that can affect the organization. This information is either known or unknown. Then we get to the vertical axis, which connotes specific targets and not specific targets. At the end, we have a four-quadrant matrix, each with its own characteristics for the purpose of defensive strategies. Upon defining the characteristics, appropriate responses for each quadrant is examined.

For free online accounting mini course “http://AccountingMiniCourse.com” designed for entrepreneurs go to http://AccountingMiniCourse.com

References

Beam, H.H. & Carey, T.A. (1991). The Risk-Threat Matrix: Key to Defensive Strategy. The Mid-America Journal of Business. Volume 6, Number 2, page 39-44.

Porter, M. (1985). Competitive Advantage. The Free Press.

 

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What is a Corporate Restructuring or Turnaround?

First, there is no hard rule or definition as to what constitutes a corporate turnaround or a corporate restructuring. The generic term is a company or firm or business unit that exhibits financial performance that in the foreseeable future, unless short-term corrective action is not taken, may fail. Let us say:

  • Corporate restructuring is a tactic used in an attempt to correct a declining financial situation or climbing out of insolvency.

A corporate restructuring or turnaround may be simply defined as a company’s existence is threatened as it moves from economic performance to decline or zone of insolvency. The decline or bankruptcy may take several years, however when extreme events take place, a shorter time frame may put the enterprise into peril.

In some circumstances the term may mean a financial restructuring by reorganizing and/or cleaning up the balance sheet using financing methods that changes the capital structure of the organization.

Surprisingly, a turnaround can be a situation where a company may exist without having a cash crisis. When measuring a company’s performance, as measured by return on capital employed, the turnaround candidate can be an organization that is performing below what is expected for a business in which it is engaged.  It is about recognizing that a company often displays symptoms of failure prior to any crisis beginning. It could be businesses with underutilized assets and poor management. Many companies have survived or stagnated for years in spite of ineffective management. If such stagnation does not change, the crisis situation will succeed because management has not taken the necessary steps to turn the situation.

Crisis situations are often in stable and mature industries and sometime with competitive advantages. Such companies are also firms that are closely held or family controlled. To avoid placing the enterprise in a crisis, it is about early instituting turnaround and restructuring strategies to avoid company trauma. Too often even a growth-oriented company that has grown too fast and is very profitable may experience a severe cash crisis. Alternatively, a company can report a loss in one year does not constitute a turnaround issue. Such a loss may be expected in executing a competitive strategy. However, a loss in one operating unit may place the whole company into a death spiral.

A company can become insolvent if management takes no corrective actions. Even external events may postpone the inevitability on insolvency, but it will not avert it. The outcome of management’s corrective action either will be successful or unsuccessful in which case the insolvency will lead the company into bankruptcy.

Generally, a corporation’s life cycle can be looked at as a humped curve of four stages. From (stage-1) start-up the company grows to a point of (stage-2) maturity then begins to (stage-3) decline until it reaches (stage-4) the zone of insolvency“. Not all businesses follow such life-cycle curve, since organizations can be reborn or transformed anytime. Some companies, in fact, institute competitive strategies that change the shape of the curve to an S-Curve to progression. The corporate turnarounds logically addresses two issues:

  • The measurement of a turnaround performance, and
  • The characterization of a turnaround cycle, which is the decline phase followed by a recovery phase.

Defining turnarounds on the basis of profitability (return of assets or return on investment) alone is problematic. The accrual quality of the turnaround company’s accounting may be low and result in manipulated earnings management. Companies gradually lose competitiveness, but this is often not reflected in deterioration in profitability. Rather, earnings flat line then plummet or the time lag between competitiveness and earnings improvement exist. With management’s “window dressing” a lag in indices showing a distressed state, the signals of impending trouble can be masked.

Simply put, the framework of the turnaround is to avoid the company moving into the “zone of insolvency” and then ultimately into bankruptcy. Taking proactive strategies to control the business is the objective.

Related Posts:

Corporate Strategies—Avoiding the Flawed Strategy

Strategy: Good Strategy or Bad Strategy? 5 Lessons to Follow

 

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An Introduction

My life purpose is to motivate, inspire and empower people and businesses to achieve maximum value through life long training and solutions development.

GaryRushin.com is part of this dream, not just as a Blog site, but as a portal to success creation. Maximum utilization of available resources, both tangible and intangible, is achieved through road maps, which are shared and discussed. It is reached through like-minded, conscious people sharing information in support of a common goal, “the path to success.”

The blog will initially concentrate on:

  • Corporate Strategies
  • Corporate Restructuring
  • Financial Risk Management

My hope is that you frequently use this site for resources, networking, and inspiration, the framework that will empower you to achieve a level of success that you desire.

Gary S. Rushin, CPA/CIRA

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