Ch17 Beams10e TB

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Chapter 17 Test Bank CORPORATE LIQUIDATIONS, REORGANIZATIONS, AND DEBT RESTRUCTURINGS FOR FINANCIALLY DISTRESSED CORPORATIONS Multiple Choice Questions LO1 1.

When the bankruptcy court grants an order for relief a. creditors may not seek payment for their claims directly from the debtor corporation. b. the reorganization plan was accepted by creditors having at least one-half of the total number of claims and the claims represent at least two-thirds of the total amount owed. c. the bankruptcy court confirms that the reorganization plan is fair and equitable to creditors. d. the court discharges the debtor except for those claims provided for in the reorganization plan.

LO1 2.

Which of the following must approve a Chapter 11 plan? a. b. c. d.

LO1 3.

organization’s management. assigned trustee. entity’s stockholders. court and the creditors.

When the accounting equation of a corporation computes a negative ownership position, because liabilities are greater than assets, the firm is a. b. c. d.

LO1 4.

The The The The

a distressed corporation. a bankrupt corporation. insolvent in the equity sense. insolvent in the bankruptcy sense.

A bankruptcy petition filed by a firm’s creditors is a. b. c. d.

a Chapter 7 petition. a petition for liquidation. an involuntary petition. a voluntary petition.

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LO1 5.

The duties of a debtor in possession in a Chapter 11 bankruptcy case do not include a. filing a list of creditors and schedules of assets and liabilities with the bankruptcy court. b. operating the business during the reorganization period. c. filing a reorganization plan. d. surrendering all property to the trustee.

LO1 6.

Liabilities incurred after entering Chapter 11 a. can only occur after secured creditors are paid. b. must be approved by creditors’ committees in liquidation cases. c. must be approved by trustees. d. must be preapproved by the bankruptcy court.

LO1 7.

In a troubled debt restructuring involving a modification of terms, the debtor’s gain on restructuring a. b. c. d.

LO1 8.

will equal will equal may or may may or may

the the not not

creditor’s gain on restructuring. creditor’s loss on restructuring. equal the creditor’s gain on restructuring. equal the creditor’s loss on restructuring.

A single creditor a. can never file a petition for bankruptcy. b. with a $10,000 or more secured claim may file a petition for bankruptcy. c. with a $10,000 or more unsecured claim may file a petition for bankruptcy, if there are fewer than 12 unsecured creditors. d. with a $10,000 or more unsecured claim may file a petition for bankruptcy if there are more than 12 unsecured creditors.

LO1 9.

A case against a corporate debtor a. can be filed only under Chapter 7. b. can be filed only under Chapter 11. c. * can be filed either under Chapter 7 or Chapter 11. d. will be determined by the trustee whether is shall be Chapter 7 or Chapter 11.

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LO1 10.

A primary difference between bankruptcy petitions is that

voluntary

and

involuntary

a. creditors file the petition in an involuntary filing. b. trustees are not used in an voluntary filing. c. voluntary petitions are not subject to review by the bankruptcy court. d. the debtor corporation files the petition in an involuntary filing. LO1 11.

Creditor committees are elected a. in all bankruptcy cases. b. in Chapter 7 cases. c. only in bankruptcy cases petitions. d. in Chapter 11 cases.

LO2 12.

arising

from

involuntary

The first-to-last ranking order of priority of the following: I.stockholder claims II.unsecured priority claims III.secured claims II.unsecured nonpriority claims in a Chapter 7 bankruptcy case is a. b. c. d.

LO2 13.

I,II,IV, and III. III,II,IV and I. III,I,IV, and II. II,IV,III,and I.

In typical trustee accounting a. gains and losses on the sale of assets are charged to the estate equity account. b. unrecorded liabilities discovered by the trustee are credited to the estate equity account and credited to the liability account. c. liquidation expenses are charged to the estate equity account. d. all of the above procedures are typical for trustee accounting.

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LO2 14.

Trustees in a bankruptcy cases have the duty to a. b. c. d.

LO3 15.

If a debtor has material gains on its debt restructurings, these gains will be reported as a. b. c. d.

LO3 16.

lower of cost or market value of the note receivable. book value of the transferred assets. fair market value of the note receivable. fair market value of the transferred assets.

A judge would permit a debtor-in-possession in a a. b. c. d.

LO4 18.

operating gains of the debtor. other non-operating gains of the debtor. extraordinary gains of the debtor. discontinued operations.

A creditor will record assets transferred in full settlement of a note receivable at the a. b. c. d.

LO3 17.

nullify affiliate transactions. relegate tax payments to an unsecured status. call creditor meetings on liquidation proceedings. provide payments to creditors and customers.

case with only secured creditors. Chapter 7 case. Chapter 11 case. voluntary case.

Under the AICPA’s SOP 90-7, a reorganized company must meet a “reorganization value test” as one of the two conditions necessary for fresh start accounting. Reorganization value approximates the a. b. c. d.

fair fair book None

value of the value of the value of the of the above

entity’s total assets. entity’s net assets. entity’s net assets. choices are correct.

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LO4 19.

Under the AICPA’s SOP 90-7, “prepetition liabilities subject to compromise” are liabilities incurred before the Chapter 11 filing and are classified as a. b. c. d.

LO4 20.

residual claims. contingent claims. current operating claims. unsecured and undersecured claims.

Which of the following statements is correct concerning companies emerging from reorganization under Chapter 11 when they do not qualify for fresh start accounting? a. The forgiveness of debt is reported as an operating gain. b. Quasi-reorganization accounting is used. c. The forgiveness of debt is reported as an extraordinary item. d. The forgiveness of debt is reported as an increase in contributed capital.

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LO2 Exercise 1 Archery Corporation is liquidating under Chapter 7 of the Bankruptcy Act. The accounts of Archery at the time of filing are summarized as follows:

Cash Accounts receivable-net Inventory Equipment-net Land Building-net Goodwill

$

$ Accounts payable Wages and salaries Contributions due to pension plan Taxes payable Accrued interest payable (includes $10,000 from the mortgage payable and $2,000 from the note payable) Note payable Mortgage payable Capital stock Deficit

$

( $

Book Value 10,000 $ 60,000 110,000 70,000 20,000 200,000 42,000 512,000

Estimated Realizable Value 10,000 50,000 70,000 70,000 40,000 150,000

120,000 30,000 20,000 80,000 12,000

100,000 100,000 70,000 20,000 ) 512,000

The land and building are pledged as security for the mortgage payable as well as any accrued interest on the mortgage. The note payable is secured with the equipment, but the interest on the note is unsecured. Wages and salaries were accrued within the last 90 days and pension plan contributions were accrued within the last 6 months; neither exceeds $4,000 per employee. Liquidation expenses are expected to be $50,000.

Required: 1. Prepare a schedule showing the creditors and the expected payouts.

priority

rankings

of

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the

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2. Banyo Corporation was a supplier to Archery Corporation and at the time of Archery’s bankruptcy filing, Banyo’s account receivable from Archery was $40,000. On the basis of the estimates, how much can Banyo expect to receive? LO2 Exercise 2 Hinsch Company is in bankruptcy and is being liquidated under the provisions of Chapter 7 of the bankruptcy code. The trustee has converted all assets into $120,000 cash and has prepared the following list of approved claims: Customer deposits ($1,000 from each of two customers that ordered products that were never delivered)

$

Property taxes payable

2,000 4,000

Accounts payable, unsecured

30,000

Trustee’s fees and other costs of liquidation

16,000

Mortgage payable, secured by property that was sold for $80,000

60,000

Note payable to bank, secured by all accounts receivable of which $30,000 were collected and $10,000 were written off as uncollectible

30,000

Required How much will the bank receive on the note payable?

LO2 Exercise 3 Ingham Corporation is being liquidated under Chapter 7 of the Bankruptcy Act. The trustee has determined that the unsecured claims will receive $.30 on the dollar. Platinum Corporation holds a $35,000 mortgage note receivable from Ingham that is secured by equipment with a $17,500 book value and a $7,000 fair value. Required: How much of the mortgage receivable will be recovered by Platinum?

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LO2*& Exercise 4 Buckley Corporation incurred major losses in 2005 and entered into voluntary Chapter 7 bankruptcy in the early part of 2006. By July 1, all assets were converted into cash, the secured creditors were paid, and $74,000 in cash was left to pay the remaining claims as follows: Accounts payable Claims prior to the trustee’s appointment Property taxes payable Wages payable (all under $4,000 per employee) Unsecured note payable Accrued interest on the note payable Administrative expenses of the trustee Total

$

$

22,000 4,000 7,500 21,000 28,000 3,000 15,000 100,500

Required: Classify the claims by their Chapter 7 priority ranking, and analyze which amounts will be paid and which amounts will be written off. LO2 Exercise 5 Jones Corporation is being liquidated under Chapter 7 of the Bankruptcy Act. The trustee has determined that the unsecured claims will receive $.50 on the dollar. Kevin Corporation holds a $200,000 mortgage note receivable from Jones that is secured by marketable securities with a $150,000 book value and a $164,000 fair value. Required: How much of the mortgage receivable will Kevin recover?

LO2 Exercise 6 Kresta Corporation is being liquidated under Chapter 7 of the Bankruptcy Act. The trustee has determined that the unsecured claims will receive $.25 on the dollar. Loanstar Corporation holds an $80,000 mortgage note receivable from Kresta that is secured by marketable securities with an $88,000 book value and a $60,000 fair value. Required: How much of the mortgage receivable will Loanstar recover? ©2009 Pearson Education, Inc. publishing as Prentice Hall 17-8

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LO3 Exercise 7 On December 31, 2005, Goldcoast bank agreed to restructure an $800,000, 10% loan receivable from Fielding Corporation because of Fielding’s financial problems. The loan was issued at par and at December 31, there was $40,000 of accrued interest for a six-month period. Terms of the restructuring agreement are as follows: ** Reduce the loan from $800,000 to $600,000; ** Extend the maturity date by 2 years from December 31, 2005 to December 31, 2007; and, ** Reduce the interest rate on the loan from 10% to 6%. Present value assumptions: Present Present Present Present

value value value value

of of of of

$1 $1 an an

for 2 years at 6% for 2 years at 10% annuity of $1 for 2 years at 6% annuity of $1 for 2 years at 10%

= = = =

0.8900 0.8264 1.8334 1.7355

Required: 1. What amount of gain or loss from restructuring the loan will Fielding report for 2005? 2. Compute the gain or loss that will be reported by Goldcoast Bank. Assume that the bank has not recognized an impairment before the restructuring. LO3 Exercise 8 Logan Corporation owes Mango Finance Company $825,000 plus $53,750 of accrued interest. Logan has a cash flow shortage and arranges for an equity settlement of the loan with Mango by issuing 55,000 shares of its $1.00 par value common stock to Mango on April 1, 2006. Logan common stock has a market value of $13.75 per share on April 1. Required: Prepare Logan's restructuring.

journal

entry

to

record

the

troubled

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debt

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LO3 Exercise 9 Matrix Corporation owes Norman Finance Company $750,000 on a note payable plus $37,500 of accrued interest. Matrix has a cash flow shortage and negotiates a debt restructuring with Norman by issuing 60,000 shares of its $1.00 par value common stock to Norman on January 1, 2006. Matrix's common stock has a market value of $10.10 per share on January 1st. Required: Prepare Matrix's restructuring.

journal

entry

to

record

the

troubled

debt

LO3 Exercise 10 On December 31, 2006, Galvin Bank agreed to restructure a $900,000, 10% loan receivable from Hines Corporation because of Hines’ financial problems. The debt was issued at par and at December 31, there was accrued interest of $60,000 for six months. Terms of the restructuring agreement are as follows: ** Reduce the loan from $900,000 to $600,000; ** Extend the maturity date of the loan by 2 years from December 31, 2006 to December 31, 2008; and, ** Reduce the interest rate from 10% to 8%. Present value assumptions: Present Present Present Present

value value value value

of of of of

$1 $1 an an

for 2 years at 8% for 2 years at 10% annuity of $1 for 2 years at 8% annuity of $1 for 2 years at 10%

= = = =

0.8573 0.8264 1.7833 1.7355

Required: 1. What amount of gain or loss from restructuring the loan will Hines report for 2006? 2. Compute the gain or loss that will be reported by Galvin Bank. Assume that the bank has not recognized an impairment before the restructuring.

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SOLUTIONS Multiple Choice Questions 1.

a

2.

d

3.

d

4.

c

5.

d

6.

d

7.

d

8.

c

9.

c

10.

a

11.

b

12.

b

13.

d

14.

d

15.

c

16.

d

17.

b

18.

a

19.

d

20.

c

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Exercise 1 Requirement 1

Amount of Claim

Expected Payment

Estimated available cash Secured claims: Mortgage payable & interest

$

Partially secured claims: Note payable ($30,000 reclassified as unsecured) Unsecured priority claims: Estimated liquidation expenses Wages and salaries Pension fund liability Taxes payable Unsecured nonpriority claims: Accounts payable Unsecured portion of note payable Accrued interest on note payable

$

110,000 $

Estimated Remaining Cash $ 390,000

110,000 $

280,000

100,000

70,000

210,000

50,000 30,000 20,000 80,000

50,000 30,000 20,000 80,000

160,000 130,000 110,000 30,000

120,000 30,000 2,000

0

Expected return on the dollar for unsecured nonpriority claims: $30,000/$150,000 = $.20 on the dollar Requirement 2 Banyo’s estimated return: $40,000 claim x $.20 = $8,000

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Exercise 2 Cash Mortgage payable, paid in full

$ (

Note payable to bank, secured portion Priority claims ($16,000 of administrative costs + $2,000 of customer deposits + $4,000 property tax) Available for unsecured nonpriority claims

Unsecured, nonpriority claims: Unsecured portion of note payable to bank Accounts payable Total unsecured, nonpriority claims

(

( $

$

120,000 60,000 ) 60,000 30,000 ) 30,000 22,000 ) 8,000

$

10,000 30,000 40,000

Amount paid to bank: $30,000 for secured portion + ($10,000 x .20) for unsecured portion = $

32,000

$8,000 cash/$40,000 claims = $.20 on the dollar

Exercise 3 Mortgage note receivable Less: Portion secured by equipment Unsecured portion

$

Estimated recovery on secured portion Estimated recovery on unsecured portion ($28,000 x $.30) = Recovery on mortgage note receivable

$

7,000

$

8,400 15,400

( $

35,000 7,000 ) 28,000

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Exercise 4 Requirement 1 Unsecured priority claims:

Administrative expenses

$

Claims prior to the trustee’s appointment Wages payable Property taxes payable

Unsecured Nonpriority Claims:

Accounts payable Unsecured note Accrued interest on the note

Claim Amount 15,000 $

$

Cash Left 59,000

4,000

4,000

55,000

21,000

21,000

34,000

7,500

7,500

26,500

Claim Amount $

To be Paid 15,000

To be Paid

Written Off

22,000 $

11,660 *$

10,340

28,000

14,840 **

13,160

3,000

0

3,000

(

$26,500/($22,000 + $28,000) = 53% * $22,000 x 53% = $11,660 **$28,000 x 53% = $14,840

Exercise 5 Mortgage note receivable Less: Portion secured by marketable securities Unsecured portion

$ $

200,000 164,000 ) 36,000

Estimated recovery on secured portion Estimated recovery on unsecured portion ($36,000 x $.50) = Recovery on mortgage note receivable

$

164,000

$

18,000 182,000

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Exercise 6 Mortgage note receivable Less: Portion secured by marketable securities Unsecured portion

$ $

80,000 60,000 ) 20,000

Estimated recovery on secured portion Estimated recovery on unsecured portion (20,000 x $.25) = Recovery on mortgage note receivable

$

60,000

$

5,000 65,000

(

Exercise 7 Requirement 1 Fielding’s gain on restructuring: Carrying value of the debt ($800,000 + $40,000 accrued interest) Total future cash flows ($600,000 + $72,000 interest) Gain on restructuring

$

840,000 (

$

672,000 ) 168,000

Requirement 2 Goldcoast Bank’s loss on restructuring: Carrying value of the loan before restructuring $ Present value of $600,000 due in 2 years at 10% historical rate: $600,000 x .8264 = $495,840 Present value of $36,000 interest for 2 years at 10% historical rate = $36,000 x 1.7355 = 62,478 Carrying value of the loan $558,318 (

840,000

Loss on restructuring

281,682

$

558,318 )

Exercise 8 Note payable Accrued interest payable Common stock, $10 par Capital paid in excess of par Extraordinary gain on restructuring

825,000 53,750 55,000 756,250 67,500

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Exercise 9 Note payable Accrued interest payable Common stock, $1 par Capital paid in excess of par Extraordinary gain on restructuring

750,000 37,500 40,000 546,000 201,500

Exercise 10 Requirement 1 Hines’ gain on restructuring: Carrying value of the debt ($900,000 + $60,000 accrued interest) Total future cash flows ($600,000 + $96,000 interest) Gain on restructuring

$

960,000 (

$

696,000 ) 264,000

Requirement 2 Galvin’s loss on restructuring: Carrying value of the loan before restructuring $ Present value of $600,000 due in 2 years at 10% historical rate: $600,000 x .8264 = $495,840 Present value of $48,000 interest for 2 years at 10% historical rate = $48,000 x 1.7355 = 83,304 Carrying value of the loan $579,144 (

960,000

Loss on restructuring

380,856

$

579,144 )

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