Page 72 - Bankruptcy Volume 1

Most prepetition claims are reported initially as LSTC for several reasons. For example, at the time the
balance sheet is prepared, collateral supporting the secured status of a loan may not have been appraised.
Accordingly, there may not be a clear determination that the related loan is fully secured and not subject
to compromise. Also, it might be determined as the case progresses that estimated cash flows to be gen-
erated from the property are less than anticipated. All security interests may not have been fully perfect-
ed. Due to these and other factors, it is not unusual for claims with an assertion of full security to be ini-
tially classified as subject to compromise and those that were presumed fully secured at the commence-
ment of a case to be compromised during the proceeding.

The debtor should reclassify liabilities from those subject to compromise to those that are not subject to
compromise or vice versa as such reclassifications are determined. FASB ASC 852-10-45-7 indicates
that circumstances arising during the reorganization may require a change in the classification of liabili-
ties between those subject to compromise and those not subject to compromise.

Principal categories (priority claims, trade debt, debentures, institutional claims, and so on) of claims
subject to compromise as well as claims not subject to reasonable estimation based on FASB ASC 450-
20 should be separately disclosed in the notes to the financial statements. Note that in the financial re-
porting it is imperative to provide information about the nature of the claims, rather than whether the
claims are current or noncurrent.

Liability accruals resulting from requirements such as those arising from the recognition of rent expense
on a straight-line basis in accordance with FASB ASC 840-20-25-1 should be classified as LSTC until
such time as the related agreement is assumed or rejected by the debtor. Similarly, liabilities related to
capital leases should also be classified as LSTC until the underlying lease is assumed or rejected. If the
lease is assumed, the related balance(s) should be evaluated for any changes required by the circum-
stances and any other transaction-specific accounting requirements as part of the reclassification out of
LSTC. If the lease is not assumed, the balance(s) should be adjusted to reflect the estimated lease termi-
nation liability. In the case of either assumption or rejection, any adjustment to the liability balance
would be recognized as a reorganization item.

Liabilities that are not subject to compromise consist of postpetition liabilities and prepetition liabilities
not expected to be impaired under the plan. One example of a loan that the debtor may leave unimpaired
is a loan which the parties determine is fully secured by the underlying collateral with a less-than-current
market interest rate. These liabilities are reported in the normal manner and are segregated into current
and noncurrent categories if a classified balance sheet is presented.

The liability section of the balance sheet would be presented in the following manner:

Liabilities and Shareholder’s Equity (Deficit)

Liabilities Not Subject to Compromise
Current Liabilities
Short-term borrowings $ 250,000
Accounts payable — trade 1,650,000

Liability under warranty contracts 90,000
Other current liabilities 35,000

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