CHAPTER 5

ACCOUNTING FOR FINANCIALLY

DISTRESSED CORPORATIONS

A financially distressed
company is one:
1. Whose ability to continue existence is
doubtful;
2. That is in the process of reorganization;
3. That is a reorganized company;
4. That contemplates or plans liquidation; or
5. That is under liquidation.

A financially distressed company

may undertake a:
1. Quasi-reorganization;
2. Troubled debt restructuring; or
3. Liquidation

QUASIREORGANIZATION
Quasi-reorganization is a
permissive but not mandatory
procedure under which a financially
distressed entity restates its
accounts and establishes a fresh
start in accounting sense.

ILLUSTRATION 1:

TROUBLED DEBT RESTRUCTURING

Troubled debt restructuring is an
arrangement in which a creditor, for
economic or legal reasons related to a
debtors financial difficulties, grants a
concession to the debtor that it could not
otherwise consider.
Concession is granted when there is a change
in the original terms of the obligation making
it easier for the debtor to comply with the
new terms.

A TROUBLED DEBT
RESTRUCTURING MAY BE IN
THE FORM OF:
(1)ASSET SWAP
If an asset swap, the debtor transfers a
noncash asset (real estate or other asset) to
the creditor in settlement of the liability.

ILLUSTRATION 2: CASE 1

(2) EQUITY SWAP

In an equity swap, the debtor issues its own shares of stock to the
creditor in settlement of its obligations. As mentioned earlier, the fair
value of the consideration given up is less than the carrying value of
obligation

CASE 2

(3) MODIFICATION OF TERMS

The modification of terms may involve the
interest, the maturity value, or both. Interest
concession may be in the form of reduction of
interest rate, partial or full condonation of
interest or a moratorium on payment of
interest for a specified period of time.
Concession on maturity value may include
partial condonation of principal or an
extension of the maturity date.

ILLUSTRATION 3

STATEMENT OF AFFAIRS
The statement of affairs is in effect a statement of
position from a quitting concern or a nongoing concern point of view. The assets are
reported at their estimated realizable value
instead of book value.
The assets are not classified as current or
noncurrent, but reported as either pledged with
certain creditors or free and thus available to
general creditors.

ILLUSTRATION 4 (EXAMPLE OF STATEMENT OF AFFAIRS)

FUNCTIONS SERVED BY THE

STATEMENT OF AFFAIRS
The statement of affairs will assist
creditors in determining just what policy
shall be adopted or what actions shall be
taken with respect to the insolvency.
Analysis of this stamen will help them to
decide whether an extension of time, a
composition agreement, or some other
form action is in their best interests.

DEFICIENCY STATEMENT
A deficiency statement is usually
prepared to accompany the statement of
affairs. It indicates the source of the
deficiency to unsecured creditors

ILLUSTRATION 5