Since 1977
NATIONAL UNIVERSITY ADVAC 1- CORPORATE LIQUIDATION
ELLERY DE LEON 1st Semester SY 2016-2017
LECTURE NOTES CORPORATE LIQUIDATION Business failures take many forms, common one is the inability to settle financial obligations as they become due. If the distressed company liquidates, it enters into bankruptcy procedures that are court administered because of legal ramifications. The process of corporate liquidation would include realization of assets and the distribution of the cash proceeds, first to the different creditors, then the balance to stockholders, if any. Generally, the cash provided would be less than the amount of all the liabilities so a payment deficiency to creditors would occur. These activities are done by a court-appointed trustee under accountability techniques. Actual liquidation, however, is preceded by a court-petition for bankruptcy, voluntary, if filed by the distressed company itself; involuntary if initiated by its creditors. The voluntary petition is submitted to the courts for resolution and a statement exhibiting the petitioner’s debts and assets (at fair values) accompanies the petition. This statement is commonly called the Statement of Affairs. The Statement of Affairs. It is prepared under a quitting-concern assumption and makes the following classifications as to assets and liabilities: Assets: (1) Pledged with Fully Secured Creditors – estimated cash proceeds is equal to or more than the amount of the secured claim. (2) Pledged with Partially Secured Creditors – estimated cash proceeds is less than the amount of the secured claim. (3) Free Asset – any asset of the entity that has not been used to secure the payment of any of the company’s liabilities and therefore any cash proceeds therefrom is available to unsecured creditors. Liabilities (1) Secured Liabilities – that which is covered by a collateral asset (a) Fully-secured – the realizable value of the pledged asset is at least equal to the amount of the claim. (b) Partially-secured liabilities – the realizable value of the pledged asset is less than the amount of the claim. Every partially secured claim has a secured portion, which is covered by the realizable value of the collateral and an unsecured portion, that which is not covered. (2) Unsecured Liabilities – that which is not covered by a pledged asset. (a) Unsecured liabilities with priority – those that are specified under the Bankruptcy Law that must be paid in full ahead of any other type of unsecured liabilities. (b) Unsecured liabilities without priority – is any other type of unsecured liability. Unrecorded assets with market values are included in the statement of affairs under free assets category and are called contingent assets; unrecorded administrative and liquidation expenses are categorized as unsecured
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with priority, and are called contingent liabilities. The statement of affairs measures in estimated terms what payments are to be received by the different types of creditors in the event of liquidation. A full illustration of the Statement of Affairs is prepared for Problem 1. A shorter schedule that could also provide meaningful information is as follows: Estimated cash available(Cash on Hand plus Realizable values of all assets) Px Less prioritized claims: Fully secured creditors Px Secured portion of partially-secured Creditors x Unsecured creditors with priority x (x) (a) Net cash available to unsecured amount Px Less (b) Unsecured amounts: Unsecured portion of partially secured Creditors Px Unsecured creditors without priority x (x) Estimated deficiency to creditors P(x) The estimated recovery rate for unsecured Amounts: (a)/(b) = ER% Another method of estimating the amount of deficiency to unsecured creditors without priority, using a different set of data is as follows: Estimated loss on sale of non-cash assets Plus contingent liabilities Estimated gross loss Less: Estimated gain on sale of non-cash Assets PX Plus contingent assets X (x) Estimated net loss (y) Compare with carrying value of SHE
PX
X PX
(X) P(X) X
IF (x) and (y) are equal amounts, available cash covers exactly outstanding liabilities; no deficiency to creditors AND no amount is recoverable by stockholders. IF (x) is more than (y), the peso amount difference is an Estimated Deficiency to creditors IF (x) is less than (y), the peso amount difference is an estimated amount recoverable by Stockholders. Accounting and Reporting by the Trustee. Accounting would be by simple financial records and reports detailing accountability for the custody of assets and temporary assumption of liabilities. Assets and liabilities taken over are recorded in the trustee’s books at carrying values in the books of the distressed company upon the transfer. Since the stockholders’ equity items are not transferred, a reciprocal account, Estate Equity, is established in the books of the trustee to balance the accounts. In turn, a reciprocal Trustee Account is established in the books of the distressed company in representation of the net assets transferred out to the responsibility of the trustee.
AFAR 2103
EXCEL PROFESSIONAL SERVICES, INC. 1.
The trustee is required to prepare the following periodic statements and reports: (a) Cash receipts and STRAIGHT PROBLEMS
Problem 1 The following information is available on August 1, 2016, for HEARTBREAK COMPANY, which is having difficulty in paying its liabilities as they become due:
Cash Accounts receivable, net, fair value equal to carrying amount Inventories, current fair value , P64,512 pledged on P75,264 of notes payable Machinery and equipment, net, current fair value of P241,562 pledged on mortgage note payable Office supplies, current fair value of P8,960 Wages payable Taxes payable Accounts payable Notes payable, P75,264 of which is secured by inventories Mortgage note payable Common stock, P10 par Retained earnings, deficit
Carrying Amount P 14,336 164,864 139,776 383,488 7,168 20,787 4,301 215,040 143,360 180,634 358,400 212,890
Additional information: (1) Estimated liability to the trustee is P93,184. (2) A delivery van previously given to the supervisor was returned to the company, fair market value, P89,600. REQUIRED: a. Prepare a statement of affairs as of August 1, 2016. b. Compute the estimated recoverable amounts to the different types of creditors in the event of liquidation. c. Prepare a statement of deficiency to unsecured creditors.
Problem 2 The balance sheet of BRAVEHEART ENTERPRISES at June 1, 2016 follows. At this date an interim trustee was appointed by the court to assume control of BRAVEHEART’s estate and liquidate the distressed corporation. Cash P 32,000 Accounts receivable, net 64,000 Inventories 288,000 Land 160,000 Buildings, net 800,000 Intangible assets 208,000 Total P1,552,000 Accounts payable P 400,000 Notes payable 320,000 Deferred revenue 8,000 Wages payable 24,000 Mortgage note payable 640,000 Capital stock 320,000 Retained earnings, deficit (160,000) Total P1,552,000 Additional information: 1. The land and the buildings are pledged as security for the mortgage payable. 2. In January, 2016, BRAVEHEART received P8,000 from a customer as payment in advance for merchandise that is no longer marketed and thus can no longer be provided. 3. Activities of the trustee during June are summarized as follows: a. P57,600 is collected on the receivables. b. Inventories are sold for P155,200. c. Land and buildings bring total of P800,000. d. Nothing is realized from the intangible assets. e. Administrative expenses of P65,600 are incurred by the trustee. REQUIRED: Prepare journal entries in the books of the trustee and in the books of the distressed company for the above transactions.
MULTIPLE CHOICE The following were taken from the statement of affairs of HARASSED COMPANY. Assets pledged with fully secured P71,000 creditors Assets pledged with partially secured 12,500 creditors Free assets 11,000 Preferred creditors 3,000 Fully secured creditors 69,000 Partially secured creditors 20,000 Unsecured creditors without priority 18,000 1. The estimated deficiency to unsecured creditors is a. P 5,000 c. P15,500 b. P12,500 d. P14,500 INSOLBENT, INC. has had severe financial difficulties and is considering the possibility of liquidation. At this time, the distressed company has the following assets (stated at net realizable value) and liabilities: Assets (pledged against debts of P 116,000 P70,000) Assets (pledged against debts of 50,000 P130,000)
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2.
Other assets 80,000 Liabilities with priority 42,000 Unsecured creditors 200,000 In the event of liquidation at this point, how much is the estimated amount recoverable by partially-secured creditors? a. P130,000 c. P 74,000 b. P 50,000 d. P200,000
The following information is available concerning INSOLVENT, INC. on the date the company entered bankruptcy proceedings: Account Cash Accounts receivable Inventory Prepaid expenses Buildings, net Equipment, net Goodwill Wages payable
Balance per Books P3,661 66,893 35,840 550 75,520 7,168 7,232 (3,200)
AFAR 2103
EXCEL PROFESSIONAL SERVICES, INC. Taxes payable Accounts payable Notes payable Common stock Retained earnings, Deficit
(2,317) (101,120) (19,392) (92,160) 21,325
Inventory with a book value of P25,600 is security for notes of P12,800. The other notes are secured by the equipment. Expected realizable values of the assets are: Accounts receivable P56,448 Inventory 23,680 Buildings 28,160 Equipment 2,560 3.
What is the creditors? a. P 11,520 b. P 83,840
estimated
deficiency
to
c. P 92,800 d. P101,120
4.
What is the estimated payment to all creditors? a. P 164,000 c. P 190,000 b. P 344,400 d. P 290,000
5.
Calculate the estimated total amount recoverable on the notes payable. a. P 72,080 c. P 22,720 b. P106,000 d. P 78,480
KAMILANG INC. a closely-held corporation was undergoing liquidation. The total cash value of KAMILANG’s bankruptcy estate after the sale of all assets and payment of administrative expenses is P240,000. KAMILANG has the following creditors: Fracon Bank is owed P120,000 on a mortgage loan secured by KAMILANG’s real property. The property was valued at and sold, in bankruptcy, for P112,000. The BUREAU of INTERNAL REVENUE has a P19,200 recorded judgment for unpaid corporate income tax.
JOG Office Supplies has an unsecured claim of P4,800 that was timely filed. Nanstar Electric Company has an unsecured claim of P16,000 that was timely filed. Liquid Corporation is owed P80,000 in a loan contract secured by KAMILANG’s notes receivable which realized P96,000. Decoy Publications has a claim of P25,600, which is secured by KAMILANG’s inventory that was valued and sold, in bankruptcy, for P3,200. The claim was timely filed.
6.
Calculate the total amount recoverable by partiallysecured creditors: a. P0 c. P130,400 b. P10,400 d. P 19,200
7.
Calculate the total amount recoverable by unsecured creditors with priority: a. P 80,000 c. P130,400 b. P 10,400 d. P 19,200
8.
Calculate the total amount recoverable by fully secured creditors: a. P 80,000 c. P130,400 b. P 5,200 d. P 19,200
9.
Calculate the total amount recoverable by unsecured creditors without priority: a. P0 c. P14,400 b. P10,400 d. P 19,200
unsecured
Items 4 and 5 are based on the following: Because of inability to pay its debts, the WHAHAPEND MANUFACTURING COMPANY has been forced into bankruptcy as of April 30, 2016. The balance sheet on that date shows: ASSETS Cash P 4,320 Accounts Receivable 62,960 Notes Receivable 29,600 Inventories 140,560 Prepaid expenses 1,520 Land and building 98,000 Equipment 78,080 P 415,040 LIABILITIES Accounts payable P 84,000 Notes payable 106,000 Accrued wages 2,960 Accrued taxes 7,440 Mortgage bond payable 144,000 Common stock – P20 par 120,000 Retained earnings (49,360) P415,040 Additional information: a. Accounts receivable of P27,120 and notes receivable of P20,000 are expected to be collectible. The good notes are pledged to P24,000 of the notes payable. b. Inventories are expected to bring in P72,160 when sold under bankruptcy condition. c. Land and buildings have an appraised value of 152,000. they serve as security on the bonds. d. The current value of the equipment, net of disposal cost is P14,400.
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A distressed corporation is to be liquidated and has the following liabilities: Income taxes P 16,000 Notes payable, secured by land 240,000 Accounts payable 166,000 Salary payable, evenly to two employees 12,000 Bonds payable 140,000 Administrative expenses for liquidation 40,000 The said company has the following assets: Book value Current assets P 128,000 Land 160,000 Building and equipment 160,000
Fair value P 67,600 180,000 220,000
10. How much will the holders of notes payable collect following the liquidation? a. P216,000 c. P166,000 b. P180,000 d. P240,000 The GLOOMY COMPANY has the following data in connection with its bankruptcy petition with the Securities and Exchange Commission at the end of 2016. Liabilities without priority Liabilities with priority
P
460,000 220,000
Secured liabilities Debt 1, P420,000; value of pledged asset P 360,000 Debt 2, P340,000, value of pledged asset P 200,000 Debt 3, P240,000, value of pledged asset P 280,000 The company also has a number of other assets that are not pledged in any way. The creditors holding Debt 2 want to receive at least P284,000. 11. For how much do these free assets have to be sold so that Debt 2 would receive exactly P284,000? a. P 616,000 c. P680,000 b. P 396,000 d. P576,000
AFAR 2103
