As your entity, or any entity, begins the process of emerging from bankruptcy under a plan of reorganization, it’s important to determine whether fresh start accounting should apply to the new company. Fresh start accounting is where balance sheet items are adjusted to fair values and gives an entity a “new beginning” — and can considerably impact the accounting and presentation of the financial statements.
As previously discussed in our post on pre- and post-bankruptcy accounting issues, fresh start accounting is applicable when both of the following items occur:
- The reorganization value of the emerging entity immediately before the date of confirmation is less than the total of all post-petition liabilities and allowed claims; AND
- The holders of existing voting shares immediately before confirmation receive less than 50% of the voting shares of the emerging entity. The loss of control contemplated by the plan must be substantive and permanent. That is, the new controlling interest must not revert to the shareholders existing immediately before the plan was filed or confirmed.
Below offers insights to better understand the process for determining your reorganization value and using the fresh start reporting method.
Step 1: Understanding Reorganization Value and Why It’s Important
ASC 852 states that reorganization value is: “The value attributed to the reconstituted entity, as well as the expected net realizable value of those assets that will be disposed of before reconstitution occurs. Therefore, this value is viewed as the value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring.” More plainly said, reorganization value is what you could sell your company for once the restructuring is complete.
The primary factor in determining whether you can apply fresh start reporting lies with the reorganization value of the assets, which, as mentioned, must be less than the post-petition liabilities and allowed claims. The reorganization value is determined as part of the plan of reorganization, which is approved by the court to emerge from bankruptcy. Reorganization value approximates the value of the entity’s assets immediately after the restructuring or immediately before the courts approve the plan and includes assets that will be disposed of prior to emergence from bankruptcy. Value related to assets that are expected to be disposed of before reconstitution occurs is included in reorganization value, because the proceeds from the sale of those assets will be used to satisfy some portion of the allowed claims.
Note that, in some cases, the court may establish a range for reorganization value, rather than a single stated amount. This can happen for a number of reasons, but, regardless, when reorganization value is not established as a single amount you should use all available information to estimate the reorganization value for financial reporting purposes. For example, you could do so by using a discounted cash flow approach.
Step 2: Understanding Why Reorganization Value is Not the Same Thing as Fair Value or Enterprise Value
Many people initially assume a short cut to determining or understanding reorganization value is to look to the fair value or enterprise value of the company. Although there are many correlations, it is important not to use fair value or enterprise value as the proxy for determining the single amount.
How Is Fair Value Different from Reorganization Value?
Fair value may differ from reorganization value due to the use of market participant assumptions in determining fair value pursuant to ASC 820, as opposed to the use of court-determined or negotiated assumptions in determining reorganization value. The goal of the reorganization value is the future viability of the restructured entity.
How Does Enterprise Value Differ from Reorganization Value?
Enterprise value represents the fair value of an entity’s debt and equity. The reorganization value can usually be derived from the enterprise value by adding back liabilities other than interest-bearing debt. However, reporting entities should evaluate the inputs and assumptions used in determining the enterprise value to appropriately reconcile to the reorganization value. For example, there could be items such as non-core assets, cash balances, environmental liabilities and working capital deficiencies/surpluses that need to be considered.
Step 3: Applying Fresh Start Accounting
Once you determine your reorganization value, the next step is to compare that established amount to the sum of the post-petition and allowed claims. If the reorganization value is less than that combined amount, you must determine if a change in control also occurred. If both of those criteria are met, then you would proceed with applying fresh start accounting.
The reorganization value of the emerging entity is then assigned to the entity’s assets and liabilities in conformity with the business combinations guidance. From that point on, fresh-start accounting is effectively treated as a business combination in which the reorganization value serves as the consideration transferred. The fresh start adjustments are reflected in the predecessor entity’s final statement of operations.
If there is a remaining portion of the reorganization value that cannot be allocated to specific tangible or identifiable intangible assets, the excess should be reported as goodwill.
The information above provides a general understanding of reorganization value. Within the applicable financial reporting rules and guidance there are additional nuances to consider and fully prepare for. It’s imperative to understand all of the rules to ensure the accuracy and completeness of your financial statements.
Contact Gino Scipione at firstname.lastname@example.org or a member of your service team to discuss this topic further.
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Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.