Page 4 - More Bankruptcies, More Opportunities and Challenges for CPAs

COLUMNS I The Financial Advisor

ganization plan is confirmed, are they tures directly relating to the Chapter 11 statements of comprehensive income
adjusted to their settlement amounts. proceeding do not result in assets or and cash flows to a statement of net
Fully secured liabilities that may liabilities. It is not appropriate to defer assets in liquidation and a statement
become impaired in the reorganization professional fees and similar types of of changes in net assets in liquidation.
plan should be included as liabilities expenditures until the plan is confirmed Under the liquidation basis of account-
subject to compromise. For example, and then reduce gain from debt discharge ing, the emphasis shifts from reporting
if the asset that is securing a liability to the extent of the previously deferred about the entity’s economic performance
diminishes in value such that the liabil- expenses. Nor is it appropriate to accrue and position to reporting about the
ity is no longer fully secured, it may be professional fees and similar expenditures amount of cash or other consideration
appropriate to reclassify it as a liability upon the filing of the Chapter 11 petition. that an investor might reasonably expect
subject to compromise. Professional fees that become pay- to receive upon liquidation—that is, after
Some claims may be finalized early able upon emergence from bankruptcy, all of the entity’s assets have been liq-
in the bankruptcy process and should often referred to as “contingent fees” uidated and liabilities have been settled.
be reclassified from liabilities subject to or “success fees,” should be expensed The recognition and measurement
compromise. The court often approves upon emergence and recorded within principle for an entity that has adopted
some level of payment for prepetition reorganization costs. Professional fees, the liquidation basis of accounting may
claims for critical vendors of the debtor with perhaps the exception of certain include items which the entity did not
early in the proceedings so that the debt- debt issue costs as mentioned above, previously recognize on its going-con-
or can continue to operate its business. should not be capitalized for a report- cern balance sheet, such as internally
When the character of a claim changes ing entity in bankruptcy. developed intangible assets. If such
such that some or all of the claim will be assets are expected to generate sales pro-
paid, it may be appropriate to reclassify Liquidation Basis of Accounting ceeds, the assets should be recognized
the portion of the claim approved for The above discussion focuses pri- upon adoption of the liquidation basis.
payment out of liabilities subject to com- marily on bankruptcy as a mechanism Prior to adopting the liquidation basis
promise because, by definition, the claim to allow a business with financial dif- of accounting, an entity should consider
is no longer subject to compromise. ficulties to reorganize so that it can be whether any adjustments to its assets and
Debt. The treatment of debt and debt viable as a going concern. However, a liabilities are necessary while preparing
issue costs depends upon whether the business can reach a point where the going-concern financial statements. In
related debt is secured or unsecured (or best result for its stakeholders is for the the periods prior to the adoption of the
undersecured). A debt discount or pre- entity to cease operations, liquidate its liquidation basis of accounting, assets,
mium, as well as debt issuance costs, assets, and settle its obligations, with any including goodwill, intangible assets, and
should be reported as an adjustment remaining resources distributed to its long-lived assets, should be evaluated for
to the carrying amount of the related owners. Liquidation may be a voluntary impairment under the applicable stan-
debt. However, costs associated with decision based on economic conditions, dards. Financial statements after the adop-
entering into a revolving line of credit a defined event for a limited life entity, tion of the liquidation basis of accounting
or revolving debt arrangement meet or an involuntary act brought about by generally do not reflect goodwill because
the definition of an asset and should be an entity’s creditors, the bankruptcy it usually does not have any realizable
recorded as such on the balance sheet. court, or other parties. value in a liquidation. ■
Tax issues may arise when debt is Regardless of the reason, the
cancelled. In general, cancellation of need for relevant financial reporting Sidney Kess, JD, LLM, CPA, is of coun-
debt under a bankruptcy proceeding remains critical even when a busi- sel to Kostelanetz & Fink and a senior
does not result in taxable income, as ness is liquidating. According to consultant to Citrin Cooperman & Co.,
it might if the same debts were can- PricewaterhouseCoopers’ comprehen- LLP. He is a member of the NYSSCPA
celled without the bankruptcy filing. sive Bankruptcies and Liquidations Hall of Fame and was awarded the
Cancellation of debt (COD) for business guide (https://pwc.to/3jCQvnU), the Society’s Outstanding CPA in Education
entities can be complicated and require a users of the financial statements of a Award in May 2015. He is also a member
knowledgeable professional to assist in business facing liquidation have dif- of The CPA Journal Editorial Advisory
navigating the rules. ferent needs than investors in a going Board. Alan Gassman, JD, LLM, is a
Professional fees. Professional fees concern. When an entity has adopted partner of Gassman, Crotty & Denicolo,
must be expensed as incurred and report- the liquidation basis of accounting, P.A., Clearwater Fla. Aaron Slavutin,
ed as reorganization items because these its financial statement requirements JD, is an associate at Lenox Advisors,
amounts and similar types of expendi- change from a balance sheet and New York, N.Y.

82 OCTOBER/NOVEMBER 2020 | THE CPA JOURNAL

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