Page 74 - Bankruptcy Volume 1

extent necessary to report the debt at the allowed amount of the claim. If these adjustments are not
enough, the carrying value of the debt will be adjusted. As an example, the debtor determines that the
amount of an allowed claim including accrued interest as of the petition date on an unsecured $1,000
bond is $950, the debtor must adjust the discount and bond issuance cost to result in a net carrying value
of $950. If the balance of the discount is $60 and the balance of the unamortized issuance costs is $20,
the adjustment needed to report the claim at the allowed amount is $30. All of the unamortized issuance
costs and $10 of the discount results in a "loss from adjustments of liabilities to reflect allowed claims"
of $30 to be reported as a reorganized item.

Prepetition claims that become known after the petition is filed, such as a claim for damages arising
from the rejection of a lease, should reflect the expected amount of the allowed claim and not an esti-
mate of the settlement amount. These claims are reported at the allowed amount of the claim because
that is the amount of the liability the debtor has incurred until it is settled through the plan of reorganiza-
tion. The use of the allowed amount is consistent with other prepetition liabilities. The debtor should
record the claim for damages when the decision is made to reject the lease, or in case the debtor is una-
ble to estimate the damages, at such later date when the amount of the damages from the lease rejection
can be estimated.

If management estimates that the amount of the allowed claim for damages from the rejection of a lease
will be $50,000, the debtor should report the $50,000 as a liability subject to compromise. This proce-
dure is accurate, even though management expects the plan of reorganization to provide for the payment
of only 20% of unsecured prepetition claims.

Warranty claims also raise issues. The debtor should base the liability for warranties on an estimate of
the amount that will be allowed. To maintain customer goodwill, the court may issue an order allowing
the debtor to honor warranty claims from the sale of all goods including sales prior to the filing of the
petition. In this situation, it would appear that the debtor should reflect on the balance sheet the reserve
for warranty claims as a liability not subject to compromise. The amount of the reserve would continue
to be estimated in the normal manner based on the provisions of FASB ASC 450-20.

Estimated Claims

FASB ASC 450-20, which provides guidance in determining the expected amount of an allowed claim,
requires the recognition of a contingency in the financial statements if it is probable that the contingency
will become a liability and the amount of the probable liability is reasonably estimable. Claims that are
not subject to reasonable estimation are to be disclosed in the notes to the financial statements. A liabil-
ity for a claim should be recorded as soon as the two accrual provisions of FASB ASC 450-20 noted
previously are satisfied. FASB ASC 852-10-45-5 requires the recording of a liability once it is estimated
under the provisions of FASB ASC 450-20.

Under FASB ASC 450-20, recording a liability depends on the likelihood of loss from the expected fu-
ture outflow of an entity’s resources. When it is more likely than not that the entity has incurred a liabil-
ity, FASB Statement No. 141R, Business Combinations, required recognition of that liability at a value
based upon a weighting of probabilities as to the likelihood and amount of outflow of resources that the
entity could experience. A number of court cases have developed this same principal that contingent lia-

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