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LIQUIDATION
INSOLVENCY
Ø A life cycle exists for businesses as for
individuals. The business press often
carries stories of companies in financial
difficulty.
Ø A basic assumption of accounting theory
is that a business is a going concern.
Ø Occasionally, a business becomes
insolvent
Ø A corporation is deemed insolvent if the
sum of all its debts is greater than all of
its assets at fair valuation (RA 10142)
Ø A corporation remains solvent as long as
the fair value of its assets exceed its
liabilities, even if it cannot meet its
current obligations due to insufficiency of
liquid resources
REASONS FOR FINANCIAL DIFFICULTY
Are the
Who gets creditors
the protected
assets? ?
How is the
If the assets
business
are sold,
failure
who gets
reported?
the money?
ALTERNATIVE COURSES OF ACTION
Ò The debtor company has a number of alternative courses open
to it:
É Reach an agreement with its creditors to postpone required
payments. (Debt restructuring)
É Turn its assets over to its creditors to liquidate.
Debt
Liquidation Restructuring
Prepares
Financial
May continue Statements
operations if it is in related to the
the interest of an Liquidation
orderly liquidation
FINANCIAL REPORTS
Ø Statement of Affairs
Ø Statement of Cash Receipt
and Disbursements
Ø Statement of Estate Deficit
Ø Statement of Realization and
Liquidation
STATEMENT OF FINANCIAL AFFAIRS
ü Current and non-current classifications become
meaningless as the company has ceased to exist or will
cease to exist
ü Statement is designed to separate secured and
unsecured balances
ü Historical cost becomes meaningless; estimated
realizable values or current fair values become
important
ü Prepared at the start of the liquidation process
ü Statement of financial position from a “quitting
concern” point of view
ü Provides information about the current financial
position of the debtor
ü Net realizable value of debtor’s assets
ü How are these assets applied to specific liabilities
STATEMENT OF FINANCIAL AFFAIRS
Unsecured
CLASSIFICATION OF LIABILITIES
Fully
Secured Creditor has a lien
on specific assets
whose estimated
realizable value ≥
liability amount
CLASSIFICATION OF LIABILITIES
Unsecured
EXPECTED RECOVERY PERCENTAGE
Used to determine
payments to unsecured
liabilities (including the
unsecured amount of
partially secured liabilities)
KEY POINTS
q Accrued interest are added to the
principal amounts. In case of assets
which earn interest, both the asset and
any interest are considered security
when an asset is pledged.
q Assets may require additional cost to
complete them before they are offered
for sale. The cost to complete the asset
is deducted from the estimated value
after completion.
q When corporate assets include
subscriptions receivable and these
contracts will be enforced, the amounts
estimated to be recoverable is reported
as free assets.
KEY POINTS
q When a company has branches, assets and
liabilities of the branches are combined with the
home office in view of the single legal entity
represented by such units. When a company has
controlling interest in the stocks of a subsidiary,
the investment is appropriately shown under the
asset heading.
q Prepaid expenses may be included in the asset
section at amounts estimated to be recoverable
but exceptions are made when it is possible that
certain prepaid expense will expire or be
consumed before liquidation is completed.
TRUSTEE AND RECEIVERSHIP
ACCOUNTING
Ø Trustee normally opens a new set of
accounting records or books
Ø Assets and liabilities are recorded at book
values rather than net realizable values
Ø Contra asset accounts are omitted as they
are not necessary in liquidation
Ø After assumption of the estate, the trustee
records gains, losses and liquidation
expenses directly to the estate equity
account
Ø All assets acquired and liabilities incurred
after the trustee takes charge of the estate is
identified as new
TRUSTEE ACCOUNTING
Ø Accounting Entries
Ø Statement of Cash Receipts and Cash
Disbursements
Ø Statement of Estate Deficit
Ø Balance Sheet
Ø Statement of Realization and Liquidation -
complete record of the transactions of the receiver
for a period of time
Ò See Problem 1.
Statement of Realization and Liquidation
Ò BreakThrough Company…
THE END