Page 77 - Bankruptcy Volume 1

vested in treasury securities. Assuming Company A continued to have the escrow arrangements with its
customers, once under Chapter 11 protection, Company A would continue to recognize the interest from
the escrows as interest income, but would recognize the interest the treasury securities paid on the ac-
cumulated operating cash as a reorganization item.

Interest Expense

FASB ASC 852-10-45-11 states that "Interest expense shall be reported only to the extent that it will be
paid during the proceeding or that it is probable that it will be an allowed priority, secured, or unsecured
claim." In a Chapter 11 case, interest on prepetition debt generally is allowed after the petition is filed
only (1) in the case of oversecured debt to the extent that the value of the collateral exceeds the amount
of the debt or, (2) in the case of unsecured debt, only in situations in which the debtor expects to pay un-
secured creditors at least 100% of their claim. Interest earned on both secured and unsecured debt prior
to the date that the Chapter 11 petition was filed is allowed and is considered part of the prepetition
claim on which interest accrued.

Interest related to capital lease obligations should be treated like interest on any other secured or partial-
ly secured obligations. If there is uncertainty as to whether the value of the leased property is greater
than the amount of the capital lease liability, no interest expense should be recognized as long as the un-
certainty exists. The full amount of the capital lease payment should be applied against the capital lease
liability in a manner similar to adequate protection payments for other secured or partially secured debt.

FASB ASC 852-10 requires disclosure of the extent to which reported interest differs from stated con-
tractual interest. The SEC staff prefers that SEC registrants disclose the contractual interest parentheti-
cally on the face of the statement of operations. ASC 852-10 specifies that interest expense is not con-
sidered a reorganization item. Some Chapter 11 debtors find it necessary to obtain a line of credit for
suppliers to ship inventory on account after the filing of the petition. Often, no or limited funds are actu-
ally advanced by the financial institution. Some practitioners have argued that the fees paid for the debt-
or-in-possession credit facility should be considered as a reorganization item. There is some basis for
this argument, provided the charges exceed what would be paid if the debtor were not in Chapter 11 and
the fees are not for interest.

Income from Debt Discharge

Gain from the forgiveness of debt, if any, is reported as an extinguishment of debt and classified in ac-
cordance with the requirements of FASB ASC 225-20 in the debtor’s statement of operations as of and
for the period immediately preceding the date determined in conformity with the guidance in FASB
ASC 852-10-45-17. Although not precluded from being so classified as provided in FASB ASC 470-50-
45-1, gain from the forgiveness of debt arising from a discharge under a confirmed plan of reorganiza-
tion is not extraordinary and is reported as a reorganization item (see chapter 16, "Financial Reporting
on Emergence From Chapter 11," for further discussion).

Statement of Cash Flows

As is the case with the statement of operations, reorganization items are disclosed separately within the
operating, investing, and financing categories of the statement of cash flows. Reorganization items relat-

© 2020 Association of International Certified Professional Accountants 75