CORPORATE

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

Ø Continued losses from

operations
Ø Overextended credit to customers
Ø Poor management of working
capital (i.e excessive investments
in inventories or PPE)
Ø Failure to react to changes in
economic conditions
Ø Inadequate financing
 20-4

LIQUIDITY PROBLEMS—A VICIOUS CYCLE

Ø Failing to make a sufficient level
of sales, a company cannot
obtain adequate financing, then
begins to miss debt payments,
and the vicious cycle of financial
difficulty is under way.
Ø At this point, outside creditors
may decide to exercise their
claims and demand payment of
their receivables.
WHAT HAPPENS TO A BUSINESS WHEN IT
FAILS?

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.

É Take the legal remedy of bankruptcy.

 INSOLVENCY OPTIONS
Reorganization

Debt
Liquidation Restructuring

The major difference between a reorganization and a

liquidation is that the debtor continues as a business
after a reorganization, whereas the business does not
survive a liquidation.
 CORPORATE LIQUIDATION

Ø May be initiated by filing a

voluntary petition with the
Securities and Exchange
Commission (SEC)
Ø The corporation is given three
years from the date of approval
to wind up its affairs
Ø The SEC may appoint a receiver
or trustee following the filing of
a petition for liquidation or
bankruptcy
 ROLE OF THE TRUSTEE

Appointed by the Realization of

SEC Assets and
Payment of
Liabilities

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

Information necessary before constructing a

statement of affairs:
ü Statement of Financial Position
ü Supplementary Information such as:
ü Estimates and appraisals from reliable sources of
amounts that will be realized upon each asset
ü Pledges of assets that have been made on specific
obligations
ü Obligations that are expected to emerge in the course of
liquidation but are not reflected in the balance sheet
 VALUATION AND CLASSIFICATION OF
ASSETS
Ø Valuated at estimated
realizable value or current
fair values
Classified as:
Ø Pledged to fully secured
creditors
Ø Pledged to partially
secured creditors
Ø Free Assets
 CLASSIFICATION OF ASSETS

Ø Pledged to fully ü Pledged as a security for a

secured creditors particular liability and
estimated realizable value ≥
liability amount
ü Excess of realizable value
over liability amount may be
used to cover unsecured
liabilities
 CLASSIFICATION OF ASSETS

Ø Pledged to partially ü Pledged as a security

secured creditors for a particular liability
and estimated
realizable value <
liability amount
ü Nothing would be left
for unsecured
liabilities
 CLASSIFICATION OF ASSETS

Ø Free Assets ü Not pledged as a security

for any particular liability
ü Available to meet the
claims of priority liabilities
and unsecured creditors
ü May also include the
excess of assets over
liability pledged to fully
secured creditors
 CLASSIFICATION OF LIABILITIES
Fully
Top Common and
Secured
Priority preferred
stockholders get
Partially what’s left over,
if any.
Secured
Unsecured With
Priority

Unsecured
CLASSIFICATION OF LIABILITIES

Fully
Secured Creditor has a lien
on specific assets
whose estimated
realizable value ≥
liability amount
CLASSIFICATION OF LIABILITIES

Creditor has a lien

on specific assets
whose estimated
Partially
realizable value <
Secured
liability amount
CLASSIFICATION OF LIABILITIES
No lien on any specific assets
but it ranks ahead of other
unsecured liabilities in the
order of payment:
• Unpaid employee’s salaries
and wages, and benefit
plans (Sec 133 RA 10142)
Unsecured • Legal and administrative
expenses of the receiver,
with Priority when properly authorized
and approved by the court
• Taxes
• Customer advance
payments (i.e. deferred
revenue)
CLASSIFICATION OF LIABILITIES

Creditors with no lien

on any specific assets

Unsecured
EXPECTED RECOVERY PERCENTAGE

Net Free Assets

Unsecured Claims

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

The court expects to receive periodic reports summarizing

the realization and distribution activities of the trustee.
The report, realization and liquidation account, has three
main sections—assets, liabilities, and revenues and expenses.
The asset section consists of four parts, illustrated as
follows:
Assets

Assets to be realized Assets realized

Assets acquired Assets not realized
Statement of Realization and Liquidation

The court expects to receive periodic reports summarizing

the realization and distribution activities of the trustee.
The report, realization and liquidation account, has three
main sections—assets, liabilities, and revenues and expenses.
The liabilities section consists of four parts, illustrated as
follows:
Liabilities

Liabilities liquidated Liabilities to be liquidated

Liabilities not liquidated Liabilities incurred
Statement of Realization and Liquidation

The report, realization and liquidation account, has three

main sections—assets, liabilities, and revenues and expenses.
The revenues and expenses section consists of:

Revenues and Expense

Supplementary Charges Supplementary Credits

E.g. Liquidation expenses e.g. income earned
SAMPLE PROBLEM

Ò BreakThrough Company…
THE END