Page 3 - More Bankruptcies, More Opportunities and Challenges for CPAs

Companies that have violated a cove- The amount is based on that por- Accounting and Financial
nant but obtained a waiver at period-end tion of the tax asset for which it is Reporting During Bankruptcy
should consider whether they will continue more likely than not that a tax ben- According to PricewaterhouseCoopers’
to meet the covenant in future periods. If efit will not be realized (Valuation comprehensive Bankruptcies and
a future violation is probable, the debt Allowance for Deferred Tax Assets, Liquidations guide (https://pwc.to/
would be classified as a current obligation. PricewaterhouseCoopers, https://pwc. 3jCQvnU), once a reporting entity has
If compliance is probable for the next to/33DqXS0). Given what typically filed a petition for bankruptcy under
12 months, the debt obligation should precedes a bankruptcy filing, including Chapter 11 of the Bankruptcy Code,
continue to be classified as noncurrent. operational losses and deteriorating its accounting and financial reporting
Companies should be mindful of the dis- credit conditions, it may be that the fall under the scope of Accounting
closure requirements associated with debt tax benefits from deferred tax assets Standards Codification (ASC) 852-
covenant violations and waivers. will not be realized and that a valuation 10. The most significant impact of
Debt extinguishments and modifica- allowance should be recorded. The ASC 852-10 on the financial report-
tions. Companies may consider a variety reporting entity’s history of operating ing of balance sheet items involves
of potential transactions to enhance the liabilities of a reporting entity in
liquidity. When debt instruments are reorganization, as discussed below.
either exchanged or modified, the debt- Liabilities subject to compromise.
or must first determine whether the Liquidation may be The balance sheet of an entity in Chapter
exchange or modification meets certain 11 must distinguish prepetition liabilities
criteria to be considered a “troubled debt a voluntary decision subject to compromise from those that
restructuring.” These criteria include based on economic are not (such as fully secured liabilities
assessing whether the debtor is experi- that are expected not to be compro-
encing financial difficulty and whether conditions, a mised) as well as postpetition liabilities.
the creditor has granted a concession. Liabilities subject to compromise are
If the criteria are met, a gain is rec- defined event for prepetition obligations that are not fully
ognized, but only to the extent that the a limited life entity, secured and that have at least a possibil-
gross cash flows of a new or modified ity of not being repaid at the full claim
debt instrument are less than the carrying or an involuntary amount. These liabilities can include any
amount of the old instrument. If the gross type of obligation, such as trade payables,
cash flows exceed the carrying amount of act brought about by contract obligations, or unsecured debt.
the old debt, no gain is recorded and a an entity’s creditors, The determination of which liabilities are
new effective interest rate is established, subject to compromise is made at the date
based on the carrying amount of the debt the bankruptcy court, of the bankruptcy filing, based on wheth-
and the revised cash flows. er the liability is adequately secured.
If an exchange or modification of an or other parties. If unsecured, or if there is doubt as to the
instrument is not a troubled debt restruc- adequacy of the value of security related to
turing, the debtor must still determine a given liability, the entire liability should
whether the transaction meets the criteria losses and the impact that a bankruptcy be included in liabilities subject to com-
to be considered an extinguishment. If filing could have on the reporting enti- promise. Liabilities subject to compromise
the modified or new debt instrument has ty’s ability to utilize deferred tax assets are presented as a group on one line in the
substantially different terms from the old in the future are relevant to any analysis balance sheet and are classified outside of
debt instrument, an extinguishment is regarding a valuation allowance. current liabilities. The principal categories
recognized. If the exchange is considered The assumptions (such as earn- and amounts of liabilities subject to com-
a modification, the effects are generally ings projections) used in assessing promise should be disclosed in the notes
reported prospectively utilizing a new whether deferred tax assets will be to the financial statements.
effective interest rate determined based realized should be consistent with Under bankruptcy accounting, lia-
on the carrying amount of the original the assumptions used in impair- bilities subject to compromise are pre-
debt and the revised cash flows. Interest ment testing and consideration of the sented at the expected amount of the
expense is recognized using the new reporting entity’s ability to continue total allowed claim. As a result, in most
effective interest rate. as a going concern. This assessment cases liabilities are initially presented at
Valuation allowance. A valuation will often lead to a conclusion that a amounts higher than the expected settle-
allowance is a reserve that is used to valuation allowance is required prior ment amount. Only later, as the claims
offset the amount of a deferred tax asset. to a bankruptcy filing. are addressed by the court or the reor-

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