What is meant by a “partially secured liability”?

Answer: A liability that is collateralized by an asset whose net realizable value is less than the liability. 

Learning Objective: 13-04 

Topic: Classification of creditors

Difficulty: 1 Easy

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal

AICPA: BB Resource Management

AICPA FN: Risk Analysis

[QUESTION]

41.  What is meant by a “fully secured liability”?

Answer: A liability that is collateralized by an asset whose net realizable value equals or exceeds the liability.   

Learning Objective: 13-04

Topic: Classification of creditors

Difficulty: 1 Easy

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal

AICPA:BB Resource Management

AICPA FN: Risk Analysis

[QUESTION]

42.  What is the difference between a liquidation and a reorganization?

Answer: In a liquidation, all assets are liquidated (sold) and liabilities paid up to the amount received for the assets, in order of priority and subject to collateral agreements.  In a reorganization, the company attempts to continue business. 

Learning Objective: 13-05 

Topic: Liquidation versus Reorganization

Difficulty: 1 Easy

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal

AICPA FN: Risk Analysis

[QUESTION]

43.  What are the three categories of assets in a Statement of Financial Affairs?

Answer: (1) Pledged with fully secured creditors, (2) pledged with partially secured creditors, and (3) free assets.   

Learning Objective: 13-06

Topic: Statement of Financial Affairs

Difficulty: 2 Medium

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal

AICPA: FN Measurement

 

[QUESTION]

44.  What are the four categories of debts in a Statement of Financial Affairs?

Answer: (1) Liabilities with priority, (2) fully secured creditors, (3) partially secured creditors, and (4) unsecured creditors.

Learning Objective: 13-06   

Topic: Statement of Financial Affairs

Difficulty: 2 Medium

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal

AICPA: FN Measurement

  

[QUESTION]

45.  What is the purpose of Chapter 7 of the Bankruptcy Reform Act?

Answer: The purpose of Chapter 7 of the Bankruptcy Reform Act is to regulate the process of liquidation by providing an orderly and equitable structure for the selling of assets and settling debts.  

Learning Objective: 13-07

Topic: Bankruptcy laws

Difficulty: 1 Easy

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal 

[QUESTION]

46.  What is the meaning of the phrase debtor in possession?

Answer: When there is a debtor in possession during a reorganization, the owners retain possession of the assets, continue to operate the business, and have the primary responsibility to develop an acceptable plan of reorganization.   

Learning Objective: 13-08

Topic: Reorganization plan

Difficulty: 2 Medium

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal

AICPA: BB Resource Management

 

[QUESTION]

47.  What are possible plans that management of a troubled business might create to mitigate substantial doubt that the entity will fail to make its debt payments within one year from the issuance of financial statements?

Answer: Many possibilities exist. Some examples are: (1) Develop plans to dispose of assets in order to raise cash and reduce costs (2) Plan to borrow money (3) Plan to restructure the entity’s debt. (4) Plan to reduce expenditures (5) Plan to increase outside ownership.   

Learning Objective: 13-02

Topic: Conditions that signal troubled business

Difficulty: 2 Medium

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Resource Management 

AICPA FN: Risk Analysis  

[QUESTION]

48.  What is an order for relief?

Answer: An order for relief is a court order issued after a bankruptcy petition has been filed, to halt creditors’ actions against the debtor while the debtor prepares to liquidate or reorganize.

Learning Objective: 13-03  

Topic: Distinguish voluntary and involuntary

Difficulty: 1 Easy

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal

  

[QUESTION]

49.  What occurs in the accounting records for fresh start accounting when a bank agrees to accept less than the debtor’s book value of a note payable?

Answer: A Gain on Debt Discharge is recorded when the liability is written down and the Gain on Debt Discharge is closed to Retained Earnings, reducing the retained earnings deficit. 

Learning Objective: 13-10

Topic: Reorganized entity―Fresh start―GAAP

Difficulty: 2 Medium

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal

AICPA: FN Measurement

 

[QUESTION]

50.  What term is used for a bankruptcy forced upon a debtor by its creditors?

Answer: The appropriate term is involuntary bankruptcy.

Learning Objective: 13-03  

Topic: Distinguish voluntary and involuntary

Difficulty: 1 Easy  

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal

[QUESTION]

51.  To what does the term Chapter 7 bankruptcy refer?

Answer: A Chapter 7 bankruptcy is the liquidation of the debtor and is referred to as such because the laws applicable to liquidation are found in Chapter 7 of the Bankruptcy Reform Act. 

Learning Objective: 13-05 

Topic: Liquidation versus Reorganization

Difficulty: 1 Easy

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal 

[QUESTION]

52.  To what does the term Chapter 11 bankruptcy refer?

Answer: A Chapter 11 bankruptcy occurs when the debtor tries to reorganize rather than liquidate. The laws applicable to reorganization are found in Chapter 11 of the Bankruptcy Reform Act   

Learning Objective: 13-05

Topic: Liquidation versus Reorganization

Difficulty: 1 Easy

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal 

[QUESTION]

53. What is the role of the trustee in the liquidation of a company? 

Answer: The trustee must recover all properties belonging to the insolvent company and preserve the estate from further deterioration.  The trustee liquidates noncash assets and makes distributions to proper claimants.  The trustee may continue operating the company to complete all business activities that were in progress when the order for relief was entered.  The trustee is required to make proper recording of all activities and report them to the court and interested parties.

Learning Objective: 13-07

Topic: Trustee duties

Difficulty: 2 Medium

Blooms: Understand

AACSB: Reflective Thinking

AICPA BB: Legal

[QUESTION]

54. What information is included on the statement of realization and liquidation?

Answer: The statement of realization and liquidation reports the account balances of the company at the date the order of relief was filed. The report will specify the cash receipts generated by the sale of the debtors’ property, cash disbursements by the trustee to wind up the affairs of the business and to pay secured creditors, and other items that need book adjustments such as asset write-offs and recognition of unrecorded liabilities. Any cash that remains is paid to unsecured creditors.

Learning Objective: 13-07

Topic: Statement of Realization and Liquidation

Difficulty: 2 Medium

Blooms: Understand

AACSB: Reflective Thinking

AICPA BB: Legal

AICPA: FN Measurement

[QUESTION]

55. What are some of the common elements that can be included in a reorganization proposal? 

Answer: The common elements in a reorganization proposal are plans for proposing changes in the company’s operations, plans for generating additional monetary resources, plans for changes in management of the company, and plans to settle debts that existed when the order of relief was filed.

Learning Objective: 13-08

Topic: Reorganization plan

Difficulty: 2 Medium

Blooms: Understand

AACSB: Reflective Thinking

AICPA BB: Legal

 

[QUESTION]

56. Who must accept and confirm the Reorganization plan?

Answer: The Bankruptcy Reform Act specifies the plan must be voted on by the company’s creditors and stockholders before being confirmed by the court.

Learning Objective: 13-08

Topic: Reorganization plan

Difficulty: 1 Easy

Blooms: Remember

AACSB: Reflective Thinking

AICPA BB: Legal 

AICPA FN: Research  

[QUESTION]

57. How is the presentation of an income statement during a reorganization different from a normal income statement?

Answer: GAAP requires that all revenues, gains, losses, and expenses resulting from the reorganization should be reported separately. Such items are placed on the income statement before any income tax expense or benefit.

Learning Objective: 13-09

Topic: Financial Reporting During Reorganization

Difficulty:  2 Medium

Blooms: Understand

AACSB: Reflective Thinking

AICPA BB: Legal

AICPA: FN Measurement

[QUESTION]

58. How is the presentation of a balance sheet during a reorganization different from a normal balance sheet?  

Answer: GAAP requires that assets on the balance sheet will continue to be reported at their book values; however, liabilities that are subject to compromise should be reported at expected amounts to settle claims.  Additionally, assets and liabilities are not classified as current/noncurrent.

Learning Objective: 13-09

Topic: Reorganization reporting―GAAP

Difficulty: 2 Medium

Blooms: Understand

AACSB: Reflective Thinking

AICPA BB: Legal

AICPA: FN Measurement

Problems:

Use the following to answer questions 59 – 63:

REFERENCE: 13-04

A company that was to be liquidated had the following liabilities:

Income taxes

$

  10,400
Notes payable (secured by land)

156,000
Accounts payable

$

107,900
Salaries payable to employees ($15,000 for John Jay and
$2,800 for Ann Still)

 
  17,800
Bonds payable

  81,000
Administrative expenses for liquidation

  26,000

The company had the following assets:

Book

Fair

Value

Value

Current assets

$

104,000

$

  42,900
Land

 130,000

117,000
Buildings & equipment

130,000

143,000

[QUESTION]

REFER TO: 13-04

59.  Prepare a schedule to show the amount of total assets available to pay liabilities with priority and unsecured creditors.

Answer:

Learning Objective: 13-06  

Topic: Statement of Financial Affairs

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA BB: Legal

AICPA: FN Measurement

[QUESTION]

REFER TO: 13-04

60.  Prepare a schedule to show the amount of total liabilities with priority.

Answer:

Learning Objective: 13-06  

Topic: Statement of Financial Affairs

Difficulty: 2 Medium

Blooms: Apply

AACSB: Knowledge Application

AICPA BB: Legal

AICPA: FN Measurement

[QUESTION]

REFER TO: 13-04

61. Prepare a schedule to show the amount of assets available for unsecured creditors after payment of liabilities with priority.

Answer:

Assets available after payment of liabilities with priority:

Total available to pay priority liabilities with priority and unsecured creditors*
$185,900
   Total liabilities with priority
  (52,050)
   Total available for unsecured creditors after liabilities with        
$133,850
        priority
 

Learning Objective: 13-06  

Topic: Statement of Financial Affairs

Difficulty: 2 Medium

Blooms:  Apply

AACSB: Knowledge Application

AICPA BB: Legal

AICPA: FN Measurement

[QUESTION]

REFER TO: 13-04

62.  Prepare a schedule to show the amount of total unsecured non-priority liabilities.

Answer:

Learning Objective: 13-06  

Topic: Statement of Financial Affairs

Difficulty: 2 Medium   

Blooms: Apply

AACSB: Knowledge Application

AICPA BB: Legal

AICPA: FN Measurement

[QUESTION]

REFER TO: 13-04