Page 102 - Bankruptcy Volume 1

 Tax consequences of the proposed plan

Reorganization Value

The accountant often analyzes and includes in the disclosure statement the reorganization value of the
entity to emerge from bankruptcy. Usually, determining the reorganization value is critical to developing
a plan. Once the debtor, creditors, equity security holders, and other parties in interest agree on the reor-
ganization value of the entity emerging from bankruptcy, the value is then allocated among the creditors
and equity holders. Accordingly, before it can be determined what amount each party will receive under
a plan, reorganization value must be determined. In addition, FASB ASC 852, Reorganizations, pro-
vides that companies that expect to adopt fresh-start reporting should report information about the reor-
ganization value in the disclosure statement. Given its importance, interested parties often contest the
reorganization value.

A 1941 U.S. Supreme Court decision established the appropriate method for determining reorganization
value. See Consolidated Rock Co. v. DuBois 312 U.S. 510 (1941). In Consolidated Rock, the court de-
termined that the proper means to value an entity emerging from bankruptcy was to assess the entity’s
future earnings capacity (as opposed to valuations based on the book values of the entity’s assets or the
market value of its outstanding stocks and bonds). Although earlier courts based reorganization value on
the capitalization of earnings, since 1980 courts have focused more on discounted cash flows. It should,
however, be noted that reorganization value is often determined after considering the results of more
than one approach to determine the value.

Reorganization value based on the present value of future cash flows of an entity emerging from bank-
ruptcy consists of the following three components:

 The present value of the entity’s future cash flows (discounted by its cost of capital)

 The present value of the entity’s residual value (value beyond the forecast period)

 The value of any assets not required for operating the reorganized entity (that is, excess working
capital and assets liquidated as part of the plan)

To illustrate, the plan in the XYZ Company example assumes a reorganization value of $3.34 million,
allocated as follows:

New Debt

Senior secured debt holders $1,500,000
Subordinated debt holders 700,000
Trade creditors 140,000
Total debt 2,340,000

New Equity
Senior secured debt holders 1,000,000
Total $3,340,000

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