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Accounting For Bankruptcies

This Handbook provides guidance on accounting and financial reporting for entities undergoing Chapter 11 bankruptcy, detailing the processes before, during, and after bankruptcy. It emphasizes the application of Subtopic 852-10, which outlines specific requirements for financial statements during bankruptcy proceedings. The document also discusses the implications of federal bankruptcy law and the importance of understanding various liabilities and reorganization items throughout the bankruptcy process.

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0% found this document useful (0 votes)

53 views193 pages

Accounting For Bankruptcies

Uploaded by

Ahmed hassan

We take content rights seriously. If you suspect this is your content, claim it here.

Available Formats

Download as PDF, TXT or read online on Scribd

You are on page 1/ 193

Accounting for

bankruptcies
Handbook

US GAAP

March 2024
______

frv.kpmg.us
Contents
Foreword ......................................................................................................... 1

About this publication ....................................................................................... 2

1. Executive summary ............................................................................. 4

2. Overview of bankruptcy....................................................................... 7

3. Before bankruptcy ..............................................................................24

4. During Chapter 11 bankruptcy ............................................................51

5. Emerging from Chapter 11 bankruptcy..............................................132

Subtopic 852-10 glossary ..............................................................................183

KPMG Financial Reporting View ....................................................................188

Acknowledgments ........................................................................................190

© 2024 KPMG LLP, a Delaware limited liability partnership and a member firm of the KPMG global organization of independent
member firms affiliated with KPMG International Limited, a private English company limited by guarantee. All rights reserved.
Accounting for bankruptcies 1
Foreword

A difficult time
Nobody enjoys going through Chapter 11 bankruptcy. The process of filing for
bankruptcy and successfully emerging from bankruptcy is time-consuming and
challenging. Bankruptcy takes a toll on resources as a business navigates the
interests of the Court, creditors, lawyers and advisors, and employees.
Subtopic 852-10 provides specific accounting and financial statement
presentation requirements for entities in Chapter 11 bankruptcy. These
requirements bring their own challenges, and in some cases it may be difficult
to understand how the guidance intersects with the broad US GAAP
requirements that continue to apply to entities in Chapter 11 bankruptcy.
This Handbook addresses some of the key accounting and presentation issues
facing companies moving through the various stages of Chapter 11 bankruptcy:
as they approach a bankruptcy filing, once they are in bankruptcy, and as they
emerge from bankruptcy.
We hope this Handbook will help take your mind off the accounting to focus on
what’s important – getting your business back on track.

Nick Burgmeier and Lisa Munro

Department of Professional Practice, KPMG LLP

About this publication

The purpose of this Handbook is to enhance your understanding of the
accounting and financial reporting considerations an entity may encounter as it
enters Chapter 11 bankruptcy, during the Chapter 11 bankruptcy, and as it
emerges from Chapter 11 bankruptcy. An entity in Chapter 11 bankruptcy is
subject to the guidance in Subtopic 852-10, Reorganizations.

Scope of this Handbook

Federal law governs bankruptcy in the United States and allows individuals and
businesses to eliminate or reorganize debt in a structured, orderly manner. Title
11 of the United States Code was enacted by the Bankruptcy Reform Act of
1978 (the Code) and provides the basis for the current federal bankruptcy
system.
This Handbook focuses on entities that are contemplating filing for bankruptcy,
operating during Chapter 11 bankruptcy and/or emerging from Chapter 11
bankruptcy. This Handbook considers the application of Subtopic 852-10,
Reorganizations, and the effects of the Code. Laws in other jurisdictions, which
are not considered in this Handbook, may have different accounting
consequences.
This Handbook does not address instances in which an entity is preparing
financial statements on a liquidation basis under Subtopic 205-30 or has
executed a quasi-reorganization under Subtopic 852-20.
In addition to Subtopic 852-10, other US GAAP will likely apply to an entity
during the aforementioned period. These other accounting and financial
reporting considerations are discussed throughout this Handbook. Where
applicable, links to other KPMG publications are included.

Organization of the text

Each chapter of this Handbook includes excerpts from the FASB’s Accounting
Standards Codification® and overviews of the relevant requirements. Our in-
depth guidance is explained through Q&As that reflect the questions we
encounter in practice. We include examples to explain key concepts.
Our commentary is referenced to the Codification and to other literature, where
applicable. The following are examples:
— 852-10-15-1 is paragraph 15-1 of ASC Subtopic 852-10
— FAS 141.44 is paragraph 44 of FASB Statement No. 141, Business
Combinations
— SAB Topic 5.P is paragraph P of SEC Accounting Bulletins Topic 5.P as
codified in ASC 420-10-S99
— 2002 AICPA Conf is the 2002 AICPA National Conference on Current SEC
Developments
— AAG-GDW 3.09 is paragraph 9 of chapter 3 of the AICPA’s Accounting and
Valuation Guide: Testing Goodwill for Impairment

— SEC SLB No. 2 is SEC Staff Legal Bulletin No. 2

— SEC FRM 9510.3 is section 9510.3 of the SEC Financial Reporting Manual
— PB 11.08 is paragraph 8 of AICPA Practice Bulletin No. 11
— REG S-K Item 303 is SEC Regulation S-K Item 303
— SOP 90-7.43 is paragraph 43 of AICPA Statement of Position of 90-7,
Financial Reporting by Entities in Reorganization Under the Bankruptcy
Code
— FSP SOP 90-7-1.6 is paragraph 6 of FASB Staff Position Statement of
Position 90-7-1, An Amendment of AICPA Statement of Position 90-7
— SEC Regs Comm 04/2004 is the April 2004 minutes of the SEC Regulations
Committee
— ASU 2017-07.BC25 is paragraph 25 of the basis for conclusions of ASU
2017-07, Compensation—Retirement Benefits (Topic 715): Improving the
Presentation of Net Periodic Pension Cost and Net Periodic Postretirement
Benefit Cost

Pending content
Unless otherwise stated, the discussion in this Handbook reflects the following
ASUs that are not yet effective for all entities in their annual financial
statements.
— 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement
of Credit Losses on Financial Instruments
— 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test
for Goodwill Impairment
— 2021-08, Business Combinations (Topic 805): Accounting for Contract
Assets and Contract Liabilities from Contracts with Customers

March 2024 edition

This edition of our Handbook has minor updates removing references to Topic
840, Leases.

Abbreviations
We use the following abbreviations in this Handbook:
AOCI Accumulated other comprehensive income
DIP Debtor-in-possession
VIE Variable interest entity

1. Executive summary
Scope
Federal law governs bankruptcy in the United States and allows individuals and
businesses to eliminate or reorganize debt in a structured, orderly manner. Title
11 of the United States Code was enacted by the Bankruptcy Reform Act of
1978 (the Code) and provides the basis for the current federal bankruptcy
system.
Chapter 11 is the focus of this Handbook. It is one of the most common types
of bankruptcy filing for businesses. It provides for a reorganization of an entity’s
financial affairs through a court-approved plan to modify, reduce or eliminate the
entity’s debt and other liabilities – all while continuing to conduct business
operations.
The following diagram depicts the accounting and financial reporting
considerations at the different stages of a Chapter 11 bankruptcy. Subtopic 852-
10 provides targeted guidance in certain areas to complement other guidance in
US GAAP but is not designed as a comprehensive framework for entities in
bankruptcy.
File petition for Emerge from
bankruptcy bankruptcy

— Apply US GAAP in the usual way — Apply US GAAP in the usual way — Apply fresh-start reporting (if applicable)
— Also apply Subtopic 852-10 — Then apply US GAAP in the usual way

Common considerations Common considerations

— Impairment, other asset- — Liabilities

related matters — Presentation
— Debt
— Derivatives, hedging
— Share-based payments
— Loss contingencies
— Consolidation
— Restructuring charges,
disposal or exit activities,
discontinued operations

Before bankruptcy
In the period preceding bankruptcy, there are no ‘special’ accounting
requirements, and an entity continues to apply US GAAP in the usual way.
However, the facts and circumstances causing the entity to contemplate
bankruptcy may trigger incremental accounting considerations given the entity’s
financial standing.
Examples of accounting issues that may take on increased importance ahead of
bankruptcy include the impairment of goodwill, long-lived assets, investments
and inventory; changes in the allowance for credit losses for contract assets,
accounts receivable and loans receivable; the classification of debt, troubled
debt restructurings, debt extinguishments and modifications; the criteria for
applying hedge accounting; and loss contingencies.
Read more: Chapter 3

During Chapter 11 bankruptcy

The financial statements of an entity reporting under Subtopic 852-10 are in
many ways similar to those the entity would ordinarily prepare. An entity
continues to follow US GAAP applicable to a going concern unless liquidation
becomes imminent.
However, during bankruptcy the needs of the financial statement users change.
Subtopic 852-10 attempts to meet those needs with incremental requirements
related to the classification and accounting for certain liabilities and the
presentation of the statement of operations.

Liabilities
The following diagram highlights how Subtopic 852-10 distinguishes between
different liabilities. Liabilities incurred by the entity before filing for bankruptcy
are prepetition liabilities, and those incurred after are postpetition liabilities.

Prepetition liabilities can be either subject to compromise or not subject to

compromise. A prepetition liability is subject to compromise if it is impaired
from the creditor’s perspective – i.e. the creditor might not recover the full
amount owed. This may be the case if, for example, a claim is unsecured or the
value of any security is less than the creditor’s claim. In contrast, postpetition
liabilities are not subject to compromise.

File petition for Emerge from

bankruptcy bankruptcy

Prepetition liabilities Postpetition liabilities

Subject to Not subject to

compromise compromise

Segregate into
Present
current and Follow applicable
separately on the
noncurrent if US GAAP
balance sheet
appropriate

When an entity files for bankruptcy, prepetition liabilities subject to compromise

are measured at the amount that is expected to be allowed for the claim.
Changes in that carrying amount are recognized separately in the statement of
operations – within ‘reorganization’ items.

Statement of operations
An entity in bankruptcy distinguishes transactions and events that are directly
associated with the bankruptcy proceedings from its ongoing, normal
operations. To accomplish this, expenses, gains and losses resulting from
bankruptcy proceedings are reported as reorganization items separately in the
statement of operations.

The following are examples of items that are typically considered reorganization
items:
— Changes to liabilities and related accounts resulting from the application of
Subtopic 852-10.
— Gains/losses from adjusting the carrying amount of debt to the amount of
the allowed claim.
— Losses from rejecting or modifying executory contracts.
— Other expenses directly related to bankruptcy proceedings.
Read more: Chapter 4

Emerging from Chapter 11 bankruptcy

An entity emerges from Chapter 11 bankruptcy when the Court has confirmed
the plan of reorganization and conditions precedent (if any) are met. Once
confirmed by the Court, the plan is binding on the entity (the debtor) and
creditors.
If an entity qualifies for fresh-start reporting under Subtopic 852-10, its
reorganization value (i.e. the aggregate value of the emerging entity’s assets
before considering liabilities) is assigned to its assets, liabilities and equity.
Assigning value to its assets and liabilities is performed using the acquisition
method principles followed in a business combination. From an accounting and
financial reporting perspective, the emerging entity is considered a new
reporting entity separate from the pre-emergence (or predecessor entity).
The diagram highlights the criteria that need to be met for an entity to qualify
for fresh-start reporting.

Does the total of all

postpetition liabilities and
allowed claims exceed
No
reorganization value?
Yes

Do the holders of
Do not apply
existing voting shares
No fresh-start reporting
lose control?

Yes

Apply
fresh-start reporting

An entity that does not qualify for fresh-start reporting continues to apply other
US GAAP.
Read more: Chapter 5

2. Overview of bankruptcy
Detailed contents
2.1 Introduction

2.2 Types of bankruptcies

2.3 The Chapter 11 bankruptcy process

2.3.10 Overview
2.3.20 Filing for Chapter 11
2.3.30 Operations during bankruptcy proceedings
2.3.40 Plan development, acceptance and confirmation
2.3.50 Prearranged plans and prepackaged bankruptcies
2.3.60 Alternative endings for Chapter 11 cases

2.4 Chapter 7 bankruptcy

2.5 Chapter 9 bankruptcy

2.6 Chapter 15 bankruptcy

2.1 Introduction
Federal law governs bankruptcy in the United States and allows individuals and
businesses to eliminate or reorganize debt in a structured, orderly manner. Title
11 of the United States Bankruptcy Code was enacted by the Bankruptcy
Reform Act of 1978 (the Code) and provides the basis for the current federal
bankruptcy system.
This chapter provides an overview of the types of bankruptcies available to
businesses and the process followed during bankruptcy proceedings. Later
chapters explain:
— accounting and financial reporting considerations before filing for
bankruptcy (see chapter 3)
— accounting and financial reporting during Chapter 11 bankruptcy (see
chapter 4)
— accounting and financial reporting upon emergence from Chapter 11
bankruptcy (see chapter 5).
Chapter 11 is one of the most common types of bankruptcy filing for
businesses. It allows an entity to reorganize its financial affairs while continuing
to conduct business operations. This Handbook focuses on entities that are
contemplating filing for bankruptcy, operating during Chapter 11 bankruptcy
and/or emerging from Chapter 11.
The following diagram depicts the accounting and financial reporting
considerations at the different stages. Subtopic 852-10 provides targeted
guidance in certain areas to complement other guidance in US GAAP but is not
designed as a comprehensive framework for an entity in bankruptcy.

File petition for Emerge from

bankruptcy bankruptcy

— Apply US GAAP in the usual way — Apply US GAAP in the usual way — Apply fresh-start reporting (if applicable)
— Also apply Subtopic 852-10 — Then apply US GAAP in the usual way

Common considerations Common considerations

— Impairment, other asset- — Liabilities

This Handbook does not address instances in which an entity is preparing

financial statements on a liquidation basis under Subtopic 205-30 or has
executed a quasi-reorganization under Subtopic 852-20.
In this chapter, terms that are defined in the Subtopic 852-10 glossary are
highlighted.

2.2 Types of bankruptcies

The US Bankruptcy Court (the Court) is an adjunct of the US District Courts.
Under the jurisdiction of the District Court, the Bankruptcy Court is generally
responsible for cases filed under the Code.
There are six types of bankruptcies under the Code. They are identified by the
chapters within the Code that describe them. The following table provides a
description of each type of bankruptcy, as well as the types of entities
permitted to use them.

Type Applicability Description

Chapter 7 Individuals and Provides for the appointment of a panel trustee
businesses for orderly liquidation of the assets of the entity to
satisfy some or all of its liabilities to its creditors.
See section 2.4.
Chapter 9 Municipalities Allows reorganization similar to Chapter 11 for an
entity that meets the Code’s definition of a
municipality. See section 2.5.
Chapter 11 Individuals and Provides for a reorganization of an entity’s
businesses financial affairs through a court-approved plan to
modify, reduce or eliminate the entity’s debt and
other liabilities; allows business operations to
continue during proceedings. See section 2.3.
Chapter 12 Farmers Provides debt relief to family farmers with regular
annual income.
Chapter 13 Individuals and Provides debt relief to individuals with regular
qualifying annual income and qualifying small businesses.
businesses
Chapter 15 Ancillary and Provides mechanisms for dealing with cross-
other cross- border insolvency cases. See section 2.6.
border cases

Chapter 7, Chapter 11 and Chapter 13 are the most common types of

bankruptcies. Chapter 11 is the focus of this Handbook. Subtopic 852-10
discusses the accounting and financial reporting for this type of bankruptcy. A
unique aspect of this guidance is the requirement to use ‘fresh-start’ reporting
on emerging from bankruptcy if certain conditions are met.

2.3 The Chapter 11 bankruptcy process

2.3.10 Overview

Excerpt from ASC 852-10

05-2 This Subtopic addresses the accounting and financial statement

disclosure for entities that have filed petitions with the Bankruptcy Court and
expect to reorganize as going concerns under Chapter 11 of the Bankruptcy

Code. This Subtopic necessarily contains many references to provisions of the

Bankruptcy Code; however, the material in this Subtopic should not be relied
upon as definitive interpretations of the law for any purposes. The accounting
and reporting guidance in this Subtopic is incremental to guidance that
otherwise applies to an entity.
05-3 An entity enters reorganization under Chapter 11 by filing a petition with
the Bankruptcy Court, an adjunct of the United States District Courts. The filing
of the petition starts the reorganization proceeding. The goal of the
proceeding is to maximize recovery by creditors and shareholders by
preserving it as a viable entity with a going concern value. For that purpose, the
entity prepares a plan of reorganization intended to be confirmed by the
court. The plan provides for treatment of all the assets and liabilities of the
debtor, which might result in forgiveness of indebtedness. For the plan to be
confirmed and the reorganization proceedings thereby concluded, the
consideration to be received by parties in interest under the plan must exceed
the consideration they would otherwise receive on liquidation of the entity
under Chapter 7 of the Bankruptcy Code. The court may confirm a plan even if
some classes of creditors or some of the stockholders have not accepted it,
provided that it meets standards of fairness required by Chapter 11 to the
dissenting class of creditors or the dissenting stockholders.
05-4 The plan is the heart of every Chapter 11 reorganization. The provisions of
the plan specify the treatment of all creditors and equity holders upon its
approval by the Bankruptcy Court. Moreover, the plan shapes the financial
structure of the entity that emerges.
05-5 Chapter 11 provides that, unless a trustee is appointed, the debtor has
the exclusive right to file a plan for the first 120 days of the case, or such
longer or shorter time as the Bankruptcy Court decrees, for cause. If a plan is
filed within the exclusive period, additional time is provided to allow the debtor
to obtain plan acceptance. The appointment of the trustee immediately
terminates the debtor's exclusive right to file a plan, and any party in interest
may then do so.
05-6 Except to the extent that specific debts are determined by the Bankruptcy
Court not to be discharged by the plan, the provisions of a confirmed plan
bind the debtor, any entity issuing securities under the plan, any entity
acquiring assets under the plan, and any creditor, equity security holder, or
general partner in the debtor, regardless of whether the claim is impaired
under the plan and whether such creditor, equity security holder, or general
partner has accepted the plan. A claim is impaired if, subject to certain rights to
cure defaults, its legal rights are affected adversely by the plan.
05-7 In general, except as provided in the plan or in the order confirming the
plan, confirmation of the plan discharges the debtor from all preconfirmation
claims and terminates all rights and interest of equity security holders or
general partners as provided for in the plan.
05-8 The Bankruptcy Court confirms a plan if it finds all of the following:
a. The plan and the plan proponent have complied with various technical
requirements of the Bankruptcy Code.
b. Disclosures made in soliciting acceptance of the plan have been adequate.

c. Dissenting members of consenting classes of impaired claims would

receive under the plan at least the amount they would have received under
a Chapter 7 proceeding.
d. Claims entitled to priority under the Bankruptcy Code will be paid in cash.
e. Confirmation of the plan is not likely to be followed by liquidation or further
reorganization.
f. At least one class of impaired claims, apart from insiders, has accepted the
plan.
g. The plan proponent has obtained the consent of all impaired classes of
claims or equity securities, or the plan proponent can comply with the
cram-down provisions of the Bankruptcy Code. Under the cram-down
provisions, the court may confirm a plan even if one or more classes of
holders of impaired claims or equity securities do not accept it, as long as
the court finds the plan does not discriminate unfairly and is fair and
equitable to each nonconsenting class impaired by the plan.
05-9 In general, a secured claim is deemed to be treated fairly and equitably if
it remains adequately collateralized and will receive a stream of payments
whose discounted value equals the amount of the secured claim on the
effective date of the plan. In general, an unsecured claim is deemed to be
treated fairly and equitably if it receives assets whose discounted value equals
the allowed amount of the claim, or if the holder of any claim or equity security
interest that is junior to the dissenting class will not receive or retain any
assets under the plan. Similarly, an equity security interest is deemed fairly and
equitably treated if that interest receives assets whose discounted value
equals the greatest of any fixed liquidation preference, any fixed redemption
price, or the value of such interest, or if no junior equity security interest will
receive any assets under the plan.
> Reorganization Value
05-10 An important part of the process of developing a plan is the
determination of the reorganization value of the entity that emerges from
bankruptcy. Reorganization value generally approximates fair value of the entity
before considering liabilities and approximates the amount a willing buyer
would pay for the assets of the entity immediately after the restructuring. The
reorganization value of an entity is the amount of resources available and to
become available for the satisfaction of postpetition liabilities and allowed
claims and interest, as negotiated or litigated between the debtor-in-
possession or trustee, the creditors, and the holders of equity interests.
Reorganization value includes the sum of the value attributed to the
reconstituted entity and other assets of the debtor that will not be included in
the reconstituted entity. Reorganization value and the terms of the plan are
determined only after extensive arm's-length negotiations or litigation between
the interested parties. Before the negotiations, the debtor-in-possession,
creditors, and equity holders develop their own ideas on the reorganization
value of the entity that will emerge from Chapter 11. Several methods are used
to determine the reorganization value; however, generally it is determined by
discounting future cash flows for the reconstituted business that will emerge
from Chapter 11 and from expected proceeds or collections from assets not
required in the reconstituted business, at rates reflecting the business and
financial risks involved.

> The Disclosure Statement

05-11 A disclosure statement approved by the court is transmitted to all
parties entitled to vote on the plan at or before the time their acceptance of the
plan is solicited. The disclosure statement provides information that enables
them to make informed judgments about the plan.
05-12 No postpetition solicitation of acceptance of a plan may be made unless
by the time of the solicitation a disclosure statement previously approved by
the Bankruptcy Court has been sent to those whose acceptance is required.
The disclosure statement must contain adequate information, which is defined
in the Bankruptcy Code as information that would enable a hypothetical
reasonable investor typical of holders of claims or interests of the relevant
class to make an informed judgment about the plan, as far as it is reasonably
practicable to provide in light of the nature and history of the emerging entity
and the condition of the emerging entity's records. Examples of the kinds of
items that may be included in disclosure statements to provide such
information include a summary of the reorganization plan, historical and
prospective financial information, and a pro forma balance sheet reporting the
reorganization value and the capital structure of the emerging entity.
05-13 What constitutes adequate information depends on the circumstances
of the entity in Chapter 11, the nature of the plan, and the sophistication of the
various classes whose acceptance is required. Although a valuation is not
required for a Bankruptcy Court's approval of a disclosure statement, the
instances in which valuations are not made are generally restricted to those in
which the reorganization value of the emerging entity is greater than the
liabilities or in which holders of existing voting shares retain more than 50
percent of the emerging entity's voting shares when the entity emerges from
reorganization.
05-14 After reorganization proceedings have started, acceptances of a plan
may not be solicited by any person without a disclosure statement approved by
the court, but acceptances obtained before the proceedings started may be
counted if they were solicited in compliance with applicable nonbankruptcy law
governing the adequacy of disclosure or there is not any applicable
nonbankruptcy law but there was in fact adequate information provided at the
time of the prebankruptcy solicitation of acceptances of the plan.
05-15 While the court determines the adequacy of the disclosure statement,
entities that expect to adopt fresh-start reporting (see Section 852-10-45 for
guidance on what is referred to as fresh-start reporting) should report
information about the reorganization value in the disclosure statement, so that
creditors and stockholders can make an informed judgment about the plan. The
most likely place to report the reorganization value is in the pro forma balance
sheet that is commonly part of the disclosure statement. Because
reorganization value may not have been allocated to individual assets
concurrently with the preparation of the pro forma balance sheet included in
the disclosure statement in some cases, it may be necessary to include in the
pro forma balance sheet a separate line item to reflect the difference of the
total reorganization value of the emerging entity over recorded amounts. When
possible, reorganization value should be segregated into major categories.

> The Financial Reporting Consequences of the Absolute Priority Doctrine

05-16 Under the absolute priority doctrine of the Bankruptcy Code, if the
amount of postpetition liabilities and allowed claims exceeds the reorganization
value of the emerging entity, existing shareholders lose their legal right to any
economic interest without the consent of creditors. Therefore, any equity
interest in the emerging entity ultimately held by existing shareholders is given
to them by the creditors. Among the reasons the creditors might give such
shareholders equity interests in the emerging entity are to avoid the expensive
and time-consuming legal proceedings necessary to implement the cram-down
provisions of the Bankruptcy Code or to preserve continuity of management.
Consequently, in this situation, if all of the conditions stated in paragraph 852-
10-45-19 are met, then upon an entity's emergence from Chapter 11, this
Subtopic requires the entity to adopt fresh-start reporting.
05-17 The following terms are widely used when addressing reorganizations,
yet are not included in the text of the standards:
a. Administrative expenses
b. Obligations subject to compromise
c. Undersecured claim.

A Chapter 11 bankruptcy under the Code is often called a reorganization

proceeding. An entity that files for bankruptcy under Chapter 11 seeks to
continue its business and restructure its debt. There is no limit on the amount
of debt that can be restructured.
The Chapter 11 bankruptcy process is iterative. Once an entity files for
bankruptcy, it works with the Bankruptcy Court and its advisors to manage
and administer claims, while continuing to manage the operations of the
business. The first step to initiating a bankruptcy proceeding is to file a
bankruptcy petition with the Court.

2.3.20 Filing for Chapter 11

An entity can voluntarily file for bankruptcy by filing a petition with the Court, or
its creditors can initiate involuntary bankruptcy proceedings under Chapter 11 if
certain criteria are met. A bankruptcy petition is filed by each legal entity
seeking bankruptcy protection. For example, a consolidated group that includes
ten subsidiaries, a holding company and the parent entity must file a petition for
each of these 12 entities to obtain bankruptcy protection for each entity.
An entity that is seeking or has been forced into reorganization under Chapter
11 is also referred to as a debtor.
The Court accepts the bankruptcy petition and rules on the proceedings. As the
bankruptcy progresses, the Court either confirms the plan of reorganization or
approves alternative actions to close the proceedings. The Court must also
approve all attorneys, accountants and other professionals engaged by the
debtor to assist with the proceedings.
Reorganization proceedings begin once a petition has been filed with the
Court. The debtor is also required to file the following:

— a list of creditors;
— the following documents (unless the Court orders them not to be filed):
— a schedule of assets and liabilities;
— a schedule of current income and expenses;
— a schedule of executory contracts and unexpired leases; and
— a statement of financial affairs.
Upon filing a voluntary petition, the debtor becomes a debtor-in-possession.
This means its board of directors and managers – as opposed to an
independent trustee – continue to manage the business and bankruptcy
proceedings.
In some cases, the Court may assign an independent trustee to serve in the
management role. The trustee monitors the debtor’s compliance with the
applicable reporting requirements, bankruptcy laws and procedures. The Code
only assigns a trustee in limited circumstances, the most common being when
there is alleged fraud or mismanagement at an entity that files for bankruptcy.
An examiner may also be appointed by the Court to investigate a certain issue
associated with the bankruptcy, or to assist in other aspects when
management continues to run the business as debtor-in-possession. An
examiner is generally not appointed if a trustee has been assigned.
Involuntary bankruptcy
Involuntary bankruptcy is rare. Unlike a voluntary petition, a debtor is not
immediately placed in bankruptcy by the Court when creditors file an
involuntary petition for bankruptcy. The Court serves the debtor with the
involuntary petition and a summons. The debtor must respond to the summons
within a specified period, typically by proposing to either:
— pay or otherwise resolve its outstanding debts with the creditor(s) that filed
the petition and have the petition dismissed; or
— convert the petition from an involuntary case to a voluntary one.
Once the debtor responds to the summons, the Court schedules a hearing and
determines whether the bankruptcy should proceed. If the Court rules in favor
of the debtor, the case is dismissed. If the debtor fails to respond to the
summons within the time allowed, or if the Court rules in favor of the creditors,
the debtor is placed into involuntary bankruptcy.
Debtor protections
When a debtor files a petition for bankruptcy, it is immediately provided some
important protections, most notably under the automatic stay provisions. These
provisions prohibit enforcement actions against the debtor, including acts to
control property of the debtor and its estate; efforts to collect, assess or
recover claims; initiation or continuation of lawsuits; creation or enforcement of
liens; or perfecting a lien so it can remain effective in the event the debtor
defaults. These provisions also protect the creditors as a group by prohibiting
actions by individual creditors to have their claims satisfied at the expense of
other creditors.

First-day motions
These statutory protections come with restrictions limiting a debtor’s discretion
to operate without Court approval. Because of this, debtor’s counsel (or
independent trustee if one has been appointed) typically files a number of ‘first-
day motions’ at the beginning of the bankruptcy proceedings.
For example, the Code generally prohibits a debtor from paying any obligations
that arose before the bankruptcy filing. However, a debtor may file a motion
seeking permission to pay prepetition employee wages or claims of critical
trade vendors – i.e. obligations that need to be satisfied to continue normal
business operations.
Avoidance powers
The purpose of avoidance powers is to recover unfair payments of prepetition
liabilities at the expense of other creditors because the payments returned to
the debtor can then be used to pay creditors in accordance with the priority
rules of the Code. During bankruptcy proceedings, the debtor may exercise
avoidance powers to cancel transactions that occurred up to 90 days before the
bankruptcy, or up to one year if the creditor is an insider of the debtor.
The Code defines an insider as:
— a director of the debtor (or a relative of a director);
— an officer of the debtor (or a relative of an officer);
— a person in control of the debtor (or a relative of a person in control);
— a partnership in which the debtor is a general partner; or
— a general partner of the debtor (or a relative of a general partner).
When a debtor exercises its avoidance powers to cancel a transaction and force
repayment, it is referred to as an avoidable transfer and the amount the
counterparty is forced to return to the debtor is referred to as a preferential
payment. The counterparty is entitled to file an unsecured claim for the amount
that it was forced to return to the debtor.
Adversary proceedings
An adversary proceeding is a lawsuit filed separately within a bankruptcy case
by filing a complaint with the Court. A debtor may initiate an adversary
proceeding to recover money or property from an avoidable transfer. An
adversary proceeding may also be initiated by creditors.
Creditor involvement
There are generally four classes of creditors, as follows (in priority order).

Type claim Description

Secured creditor A creditor is secured if it has a claim that is secured by
collateral. A fully secured claim is when the value of the
collateral is equal to or greater than the claim, and an
undersecured claim is when the value of the collateral is
less than the claim. For example, if a revolving line of credit
is fully collateralized by an asset, the creditor is secured.

Type claim Description

Administrative An administrative creditor holds an administrative claim. An
creditor administrative claim is a debt incurred postpetition, which
represents the actual, necessary costs and expenses to
continue to run the business in the debtor’s ordinary course.
These claims generally include salaries, certain taxes (e.g.
income taxes) and compensation for certain professional
services received.
Priority unsecured A priority unsecured creditor has an unsecured claim that is
creditor entitled to be paid ahead of other general unsecured claims,
pursuant to the Code. For example, employees that have
filed claims are usually priority unsecured creditors.
Unsecured creditor A general unsecured creditor has a claim for any other
unsecured prepetition debt owed to a creditor. These include
(among other things) counterparties to trade payables and
other accruals and contingency claims.

The absolute priority doctrine stipulates that no payments are made to

subordinate classes unless the prior classes have been paid in full or settled in
an equitable manner as determined by the Court. The debtor’s equity holders at
the time of the bankruptcy filing are entitled to any remaining residual interest in
the debtor. The equity holders’ interest may be reduced or eliminated during
the bankruptcy proceedings.
The regional US Trustee will generally appoint a creditors’ committee shortly
after the bankruptcy filing. The creditors’ committee comprises representatives
from a range of unsecured creditors, including some unsecured creditors that
are owed larger amounts by the debtor. Sometimes other committees are also
appointed if necessary, to represent the interests of creditors and/or other
stakeholders.
Obtaining cash to operate
Some debtors may not need additional cash to operate during bankruptcy
because they have enough unencumbered cash. Other debtors may need to
rely on cash collateral that is subject to a lender’s security interest. To use this
cash collateral, the secured party must agree to its use, or the Court may be
required to authorize its use.
If the debtor cannot continue to operate even with the use of cash collateral, it
may need to obtain a line of credit or another form of postpetition financing. The
Code permits a debtor to borrow funds referred to as debtor-in-possession (DIP)
financing and offers protections and priorities to induce lenders to make these
loans. Section 4.4.20 discusses accounting considerations related to DIP
financing.

2.3.30 Operations during bankruptcy proceedings

A few weeks after a bankruptcy filing, Chapter 11 activities may slow down,
and operations return to ‘business as usual’. However, in addition to running its

business, the debtor must continue to comply with the various obligations and
deadlines imposed by the Code. This can include, but is not limited to:
— filing monthly operating reports;
— paying quarterly fees to the US Trustee;
— filing tax returns by the IRS deadlines; and
— continuing to comply with SEC filing requirements, as applicable.
During this time, the debtor has a chance to evaluate its business and legal
strategies. From a business perspective, the debtor may evaluate issues such
as whether to sell or shut down certain locations or business lines, whether to
reduce workforce and how to reduce expenses. From a legal perspective, it
may evaluate issues such as whether to assume, assign or reject certain
executory contracts, as well as exercise its avoidance powers. There may also
be ongoing negotiations or litigation involving various stakeholders and other
parties to the proceedings.
Claims administration
The administration of bankruptcy claims is an important process during
bankruptcy proceedings. The Code defines a claim as either a right to payment
or a right to an equitable remedy for breach of performance if the breach results
in a right to payment.
A claim can be impaired or unimpaired. An impaired claim is a claim where the
creditor’s rights are expected to be altered as a result of bankruptcy. In
contrast, an unimpaired claim is one that is expected to be settled in full,
without any alterations.
In addition to being either impaired or unimpaired, there are four broad classes
of claims, which correlate to the creditors classes discussed under Creditor
involvement:
— secured claims;
— administrative expense claims;
— priority unsecured claims; and
— general unsecured claims.
A claims agent generally collects claims filed by creditors and maintains the list
of claims. Once the deadline for filing a timely filed claim (the ‘bar date’) has
passed and there is a complete list of all possible claims, the debtor has the
opportunity to analyze and object to claims.
Claims administration also involves ensuring that claims are classified
appropriately. This is important as voting on a plan of reorganization is done on a
plan class basis (see section 2.3.40).
Executory contracts during bankruptcy proceedings
An executory contract is a contract under which performance remains due,
either by the debtor or by the creditor (e.g. a lease). The Code allows a debtor
the following options on each executory contract, subject to the Court’s
approval.
— Assume the contract and continue performing without modification. If a
contract is assumed, it must be assumed in its entirety. Its terms cannot be
modified, nor can only part of the contract be assumed.

Additionally, there are some limits to a debtor’s ability to assume a contract.

For example, if a contract is in default, the debtor can only assume it if
certain requirements of the Code are met. Such stipulations include the
debtor’s requirement to cure pre- and postpetition defaults, reimburse the
counterparty for reasonable amounts resulting from the debtor’s defaults
(which may be in the form of legal fees) and provide adequate assurance
that the debtor will fulfill the contract’s future obligations.
— Modify the contract’s terms and conditions.
— Assign the contract to a third party. A contract may be assigned if there is
adequate assurance that the assignee will continue to perform under the
contract.
— Reject the contract, relieving all parties from further obligations. If a debtor
rejects a contract, it is protected from the counterparty seeking remedies
by the automatic stay provisions (see section 2.3.20). Instead, when a
debtor rejects a contract, the counterparty will generally file a claim for
breach of contract. Similar to assumed contracts, the debtor must reject a
contract in its entirety. It cannot reject only part of the contract and assume,
modify or assign the rest.
The debtor is allowed a reasonable amount of time (as determined by the
Court based on circumstances) to decide what action it will take on each
executory contract. The Code allows a debtor to assume or reject an
executory contract (other than a lease for nonresidential real property) any
time before confirmation. However, if the counterparty to the contract asks
the Court to require an earlier decision on the part of the debtor, the Court
has the authority to do so.
Additionally, the Code limits the amount of time a debtor has to assume or
reject a nonresidential real property lease. If the debtor does not assume or
reject such a lease by the earlier of either confirmation of its plan of
reorganization or 120 days after filing for bankruptcy, the contract is
deemed to be rejected and the debtor must surrender the property to the
lessor immediately.

2.3.40 Plan development, acceptance and confirmation

During bankruptcy proceedings, the debtor prepares a plan of reorganization,
which must be approved by the Court for the debtor to emerge from Chapter
11 bankruptcy. The goal of the plan is to treat the debtor’s assets and liabilities
in a manner that maximizes the recovery of the debtor’s creditors and
shareholders. This frequently results in the reduction, modification or
elimination of the debtor’s debt.
The debtor has an exclusive right to file a plan of reorganization for a 120-day
period after filing the petition, which may be extended or reduced by the Court.
The Court may grant an extension of the exclusive period for up to 18 months
after the petition date. After this exclusivity period ends, a creditor or the
independent trustee, if there is one, may file a plan. This process can extend
bankruptcy proceedings, possibly for many years.

Disclosure statement
A written disclosure statement must be filed with and approved by the Court
before the plan of reorganization can be voted on. The disclosure statement is a
document that provides sufficient detail so that creditors can make an informed
judgment about the plan. The document is written in plain English and generally
provides the following information (not exhaustive):
— background of the case;
— history of the entity;
— treatment of claims;
— expected recovery of claims;
— valuation and liquidation analyses; and
— prospective financial information.
Information provided to creditors
Once the disclosure statement is approved, the debtor must provide all
creditors and equity security holders with the following (among other things
when necessary):
— the plan of reorganization, or a court-approved summary of the plan;
— the court-approved disclosure statement;
— notice of the period within which acceptances and rejections of the plan
may be filed;
— notice of time period for filing objections;
— notice of the date and time of the confirmation hearing; and
— a ballot to accept or reject the plan.
Creditor voting
The debtor has 180 days after the petition date to obtain acceptances of its
plan. Similar to the timeline for filing the plan of reorganization, this period may
be extended for cause.
The following diagram summarizes the requirements, by class of creditor, to
consider the plan of confirmation to be accepted.

If a class of
Then it is deemed to have accepted the plan of confirmation:
creditor is:

Unimpaired
(i.e. fully Automatically
secured)

Creditors that represent at

Impaired (i.e. If ≥ 50% of the creditors in least 2/3 of the debt amount
undersecured
or unsecured) the class approve the plan included in that class of
creditors approve the plan

Impaired creditors are generally separated into multiple classes that share
similar claims or interests. Voting to approve the plan of reorganization is
performed separately for each class of impaired creditors. To obtain approval,
each class of impaired creditor must receive approval from at least 50% of the

creditors in the class and those creditors must represent at least 2/3 of the debt
amount in that class.
The plan is approved if each class of impaired creditors vote to approve the
plan. If at least one, but not all, of the classes of impaired creditors votes to
accept the plan (consenting classes), then the debtor may seek to apply the
cram-down provisions on the classes that rejected the plan (nonconsenting
class). Under the cram-down provisions, the plan can be confirmed despite
rejection of an impaired class if the Court determines that the plan’s treatment
of the rejecting (or dissenting) class is fair and equitable.
Plan confirmation
Once the debtor has received the necessary plan acceptances, it requests that
the Court confirm the plan at the confirmation hearing. The Code requires the
Court to make a number of specific findings to have a confirmed plan and
make it binding on all parties. These include determining that the plan complies
with all applicable law, that it has been proposed in good faith and that it is
feasible. If applicable, the Court must determine whether the cram-down
provisions are appropriate and whether the plan passes the ‘best interest of
creditors’ test. The best interest of creditors test requires that each claim holder
must either accept the plan or receive at least what it would receive in a
Chapter 7 liquidation, including interest on any payment stream.
Post-confirmation
Confirmation of a plan of reorganization does not mean the bankruptcy case is
over. Instead, it signifies that the requirements have been met and the Court
approves the terms of the plan. Generally, a number of required actions remain
in the post-confirmation period, including settling claims, raising capital,
divesting certain assets and executing other agreed upon transactions, and
litigating adversary proceedings. The Court issues a final decree once it
determines that the plan has been fully consummated.

2.3.50 Prearranged plans and prepackaged bankruptcies

A debtor may execute some of the requirements of a Chapter 11 bankruptcy
before filing a bankruptcy petition, which has a number of advantages. For
example, if the debtor spends less time in bankruptcy it will generally incur
lower professional fees. In addition, a debtor is exposed to less negative
publicity associated with bankruptcy if it can do as much of the work as
possible before formally entering into bankruptcy proceedings.
Depending on the extent of preparation before filing a petition, these types of
bankruptcies are referred to as either prearranged or prepackaged. The legal
requirements of prearranged and prepackaged bankruptcy filings are no
different from a standard bankruptcy filing. Therefore, these transactions are in
the scope of Subtopic 852-10.
Prearranged plan
A prearranged plan is simply one in which at least some of the work has been
done before filing a petition with the Court. Usually, the petition is filed after a
restructuring has been negotiated with at least one class of creditors that is

expected to be impaired. The key terms of the restructuring are approved by

representatives of these creditors. Only after the petition has been filed and the
Court approves the disclosure statement does the debtor formally solicit
creditor approval of the plan.
Prepackaged bankruptcy
In a prepackaged plan, not only have the terms of the reorganization been
negotiated, but the debtor has developed its disclosure statement and plan of
reorganization and has obtained the required approval of the plan from its major
stakeholders. Once sufficient votes are received to confirm the plan, the debtor
files a bankruptcy petition, along with the disclosure statement, plan of
reorganization and voting ballots. Ideally, all that is left once a petition is filed is
to obtain approval of the disclosure statement and confirmation of the plan from
the Court.

2.3.60 Alternative endings for Chapter 11 cases

Chapter 11 cases do not always end in a reorganization of the entity. Such
cases sometimes end with the debtor’s liquidation or a sale of the debtor’s
assets. Sometimes, a debtor’s plan of reorganization may require that another
party acquire the debtor.
Liquidation
Although Chapter 11 is used to reorganize an entity, debtors sometimes use
Chapter 11 as a forum for an orderly liquidation. Unlike a Chapter 7 liquidation, a
liquidating plan under Chapter 11 allows management to remain in place during
the bankruptcy process. Also, once the assets of a business are substantially
liquidated, typically the debtor, or the debtor jointly with the creditors’
committee, proposes a plan to make distributions to creditors. This permits the
creditors to take a more active role in arranging for the liquidation of assets and
the distribution of the proceeds than in a Chapter 7 case.
Other times, Chapter 11 cases begin as intended reorganizations, but ultimately
become going-out-of-business liquidations. This can occur if a debtor is
unsuccessful in obtaining DIP financing or does not have the liquidity to fulfill
the shortened terms, high fees and high interest rates that these instruments
sometimes carry. Also, in a lengthy Chapter 11 bankruptcy case, a debtor incurs
high administrative expenses that must be satisfied before distributing a
return to general unsecured creditors.
A Chapter 11 reorganization may be converted to a Chapter 7 liquidation to
avoid these high expenses, particularly if the debtor is under pressure from
creditors for a quick resolution. Further, a conversion into Chapter 7 liquidation
can occur if the debtor does not have sufficient funds to pay administrative
priority creditors in full and is therefore ‘administratively insolvent’. The Code
prohibits a Chapter 11 liquidation plan from being confirmed when the debtor is
administratively insolvent. In those situations, the case is typically converted to
a Chapter 7 liquidation plan.

Section 363 sale

Section 363 of the Code allows a debtor to sell substantially all of its assets free
and clear of liens and encumbrances. The liens are instead attached to
proceeds of the sale, and the proceeds are later paid to the appropriate parties.
Sometimes a debtor will elect a Section 363 sale to quickly realize maximum
value for its assets – avoiding the erosion of asset values due to continued
operating losses.
A Section 363 sale may be initiated by a debtor entering into an agreement with
a third party ‘stalking horse’ before an auction of the debtor’s assets. The
stalking horse is often a financial- or private equity-based purchaser.
The stalking horse’s bid represents the opening bid for the auction. The
agreement between the stalking horse and debtor generally provides the
stalking horse with compensation (e.g. breakup fee and reimbursement of
related expenses) in the event another entity wins the auction.
Although the entity may have sold all or a portion of its assets, it remains under
bankruptcy protection and Subtopic 852-10 continues to apply until the Court
has approved the plan of reorganization or an alternative option.
Merger or stock acquisition
Sometimes a debtor is acquired in a business combination while it is in
bankruptcy. In such a transaction, many of the debtor’s creditors and equity
holders typically receive equity interests in the acquirer (or in the new entity
that results from the merger). Among other things, an advantage of acquiring an
entity in bankruptcy is the relative ease with which the acquirer can bind
dissatisfied creditors to the plan of reorganization without approval. This is
because the cram-down provisions of the Code allow for the plan of
reorganization (which may include the acquisition of the debtor) to be forced on
any disapproving creditors, as long as it is approved by the other creditors and
the Court (see section 2.3.40).
An unsecured creditor can also sell its claim to another entity (a purchaser). This
will sometimes result in the purchaser gaining control of the bankrupt entity by
obtaining sufficient unsecured claims in the debtor that are expected to be
converted to a controlling financial interest in the reorganized entity.

2.4 Chapter 7 bankruptcy

Chapter 7 bankruptcy is also known as liquidation. In a Chapter 7 bankruptcy
case, a panel trustee is appointed at the beginning of the case. The trustee
may, with Court approval, continue to operate the business of the debtor, but it
typically closes the business as quickly as possible to avoid any unnecessary
administrative expenses. The role of the trustee is to liquidate the assets of the
entity as efficiently as possible and distribute the proceeds to creditors in
accordance with the Code.
A company liquidating under Chapter 7 applies the guidance in Subtopic 205-30
(liquidation basis accounting).

2.5 Chapter 9 bankruptcy

Chapter 9 of the Code allows a financially distressed municipality protection
from creditors while it negotiates a plan to reorganize its debt. The Code
broadly defines a municipality as a ’political subdivision or public agency or
instrumentality of a State’.
Unlike other forms of bankruptcy, Chapter 9 limits the Court’s involvement in a
case due to provisions of the Tenth Amendment to the Constitution, which
limits the Federal government’s ability to interfere with states’ rights. Because
of this, there is no provision in Chapter 9 for liquidating the assets of the
municipality and distributing the proceeds to creditors. However, for practical
reasons a municipality may agree to give the Court jurisdiction over many of the
traditional areas of judicial oversight in a bankruptcy case, to obtain the
protection of court orders and expedite the proceedings.
An entity that meets the Code’s definition of a municipality and is filing for
reorganization under Chapter 9 applies the guidance in GASB Codification
Section Bn5, Bankruptcies.

2.6 Chapter 15 bankruptcy

Chapter 15 of the Code provides mechanisms for dealing with cross-border
bankruptcy proceedings. When a debtor files a bankruptcy proceeding in
another country, it often files an ancillary proceeding in the United States under
Chapter 15. However, it could also file a Chapter 7 or Chapter 11 case in the
United States if it wants its US assets and liabilities to be liquidated or
reorganized under US bankruptcy law.
To begin an ancillary proceeding, a foreign representative files a petition under
Chapter 15, along with documents proving existence of the foreign proceeding.
The Court then issues an order recognizing the foreign proceeding as either a
foreign main proceeding (a proceeding pending in a country where the debtor’s
center of main interests is located) or a foreign non-main proceeding (a
proceeding pending in a country where the debtor has an establishment, but
not its center of main interests). Immediately upon the recognition of a foreign
main proceeding, certain provisions under the Code take effect in the United
States.
The accounting treatment of a Chapter 15 bankruptcy depends on whether an
entity is filing for a reorganization or a liquidation in a foreign country and is
outside the scope of this Handbook.

3. Before bankruptcy
Detailed contents
3.1 How the standards work

3.2 Professional fees in advance of bankruptcy filing

3.3 Impairment and other assets

3.3.10 Goodwill and indefinite-lived intangible assets
3.3.20 Long-lived assets
3.3.30 Inventories
3.3.40 Investments
3.3.50 Accounts receivable
Questions
3.3.10 Can an entity contemplating bankruptcy elect to apply Step 0
in an impairment analysis?
3.3.20 How can restructuring done to avoid bankruptcy affect the
allocation of goodwill to reporting units for impairment
testing?
3.3.25 In assessing the recoverability of long-lived assets, how are
future cash flows estimated if the entity is contemplating a
bankruptcy filing?
3.3.30 Could an entity contemplating bankruptcy conclude that its
long-lived assets classified as held-and-used are not
impaired?
3.3.40 Does an entity increase its per-unit allocation of overhead
costs to inventory in times of abnormally low production?
3.3.50 Does an entity discontinue applying the equity method if it
sells enough of its investment to decrease its ownership
percentage below 20%?
3.3.60 What is the effect on an entity’s customer accounts
receivable when it is experiencing financial difficulty?

3.4 Debt
3.4.10 Debt covenants and subjective acceleration clauses
3.4.20 Troubled debt restructurings, debt extinguishments and
modifications

3.5 Hedge accounting

3.6 Share-based payments

3.7 Retirement and nonretirement postemployment benefits

3.8 Loss contingencies

3.9 Income taxes

3.10 Consolidation
3.10.10 Decrease in ownership interest while retaining control
3.10.20 Loss of control

3.11 Discontinued operations and exit or disposal activities

3.11.10 Discontinued operations
3.11.20 Exit or disposal activities
3.11.30 Leases (as lessee)

3.12 Disclosures
3.12.10 Overview
3.12.20 Risks and uncertainties
3.12.30 Going concern
3.12.40 Additional disclosures for SEC registrants
Questions
3.12.10 How might financial difficulties affect an entity’s disclosures
about the nature of its operations?
3.12.20 How might financial difficulties affect an entity’s disclosures
about significant estimates?
3.12.30 How might financial difficulties affect an entity’s disclosures
about concentrations?
3.12.40 Does filing a bankruptcy petition automatically raise
substantial doubt about an entity’s ability to continue as a
going concern?
3.13 Bankruptcy as a subsequent event
Question
3.13.10 Is the filing of a petition for Chapter 11 bankruptcy after the
reporting date a recognized subsequent event?

3.1 How the standards work

This chapter discusses the potential accounting consequences to financial
statements prepared under US GAAP in the period before entering bankruptcy.

File petition for Emerge from

bankruptcy bankruptcy

— Apply US GAAP in the usual way — Apply US GAAP in the usual way — Apply fresh-start reporting (if applicable)
— Also apply Subtopic 852-10 — Then apply US GAAP in the usual way

Common considerations Common considerations

— Impairment, other asset- — Liabilities

In the period preceding bankruptcy, an entity continues to follow applicable US

GAAP when preparing its financial statements. However, the facts and
circumstances causing the entity to contemplate bankruptcy may trigger
incremental accounting considerations given its financial standing (e.g. asset
impairments).
Some of the common causes of bankruptcy that also trigger pre-bankruptcy
accounting consequences include:
— deteriorating conditions in an entity’s industry or overall economy;
— prolonged or increasing operating losses and negative cash flow; and
— significant unforeseen events requiring immediate cash outflows.

3.2 Professional fees in advance of bankruptcy filing

An entity typically incurs professional fees in advance of filing for bankruptcy.
These fees are not in the scope of Subtopic 852-10 because that Subtopic
applies to bankruptcy-related fees incurred only after an entity has filed a
petition with the Court. Instead, the entity accounts for and presents these pre-
filing expenses in accordance with other applicable US GAAP, which generally
requires these costs to be expensed as incurred.
Professional fees incurred after the filing related to bankruptcy are presented as
reorganization items in the statement of operations (see section 4.9.10).

3.3 Impairment and other assets

Events and circumstances leading to bankruptcy can also lead to the
impairment of, and other accounting impacts on, an entity’s assets. This section
discusses common accounting considerations for an entity having financial
difficulties. However, any asset held by an entity may be adversely affected by
events and circumstances that can lead to bankruptcy.

Asset Accounting considerations Section

Goodwill and indefinite-lived
Impairment 3.3.10
intangible assets
Impairment, held-for-sale
Long-lived assets 3.3.20
designation
Inventories Recoverability 3.3.30
Investments Impairment, classification 3.3.40
Accounts receivable Credit losses 3.3.50

3.3.10 Goodwill and indefinite-lived intangible assets

Topic 350 requires that goodwill and indefinite-lived intangible assets be tested
for impairment. Although important differences exist between the two
impairment tests, the general premise is that the asset is tested for impairment
at least annually, but more frequently if a triggering event is identified that
indicates it is more likely than not (i.e. greater than 50%) that the fair value of
the reporting unit or indefinite-lived intangible asset is less than its carrying
amount. [350-20-35-28, 35-30, 350-30-35-18]
The events and circumstances leading up to a bankruptcy often constitute
triggering events, and interim impairment tests are often necessary in the
period shortly before an entity files for bankruptcy.
If an entity has elected the Private Company Council (PCC) alternative for the
subsequent accounting for goodwill, it tests goodwill for impairment only on a
triggering event. The PCC alternative test does not change the requirement to
test indefinite-lived intangible assets for impairment at least annually. [350-20-05-
5, 350-30-35-18]

Goodwill
Topic 350 provides examples (not exhaustive) of events or circumstances that
suggest a possible impairment of goodwill. [350-20-35-3C]

Deterioration in general economic conditions; limitations on

Macroeconomic
accessing capital; fluctuations in foreign exchange rates; other
conditions
developments in equity and credit markets.
Deterioration in the environment in which an entity operates; an
Industry and increased competitive environment; a decline in market-
market dependent multiples or metrics (absolute terms and/or relative
considerations to peers); a change in the market for an entity’s products or
services; a regulatory or political development.
Increases in raw materials, labor or other costs that have a
Cost factors
negative effect on earnings and cash flows.
Negative or declining cash flows or a decline in actual or
Financial
planned revenue or earnings compared with actual and
performance
projected results of relevant prior periods.
Entity-specific Changes in management, key personnel, strategy or
events customers; contemplation of bankruptcy; litigation.
Changes in the composition or carrying amount of its net
assets; a more-likely-than-not expectation of selling or
Events affecting a disposing of all, or a portion, of a reporting unit; the testing for
reporting unit recoverability of a significant asset group within a reporting
unit; recognition of a goodwill impairment loss in the financial
statements of a component subsidiary.
A sustained decrease in share price (absolute terms and/or
Share price
relative to peers).

Goodwill is tested for impairment at a level of reporting referred to as a

reporting unit. A reporting unit is an operating segment or one level below an
operating segment (also known as a component). Entities that have elected the
PCC alternative to goodwill impairment testing are permitted to elect to test
goodwill for impairment at the entity level, rather than at the reporting unit level.
[350-20-35-1, 350-20 Glossary, 350-20-35-65]

Before testing goodwill for impairment, an entity needs to evaluate whether any
indefinite-lived intangible assets or other long-lived assets in the same reporting
unit have been impaired. The carrying amounts of such assets are decreased
for any impairment losses, with a corresponding adjustment to the carrying
amount of the reporting unit in which those assets reside. Goodwill impairment
testing is then performed based on the adjusted carrying amount of the
reporting unit. [350-20-35-31]
The required sequencing is:
— other assets (e.g. accounts receivable, inventory) and indefinite-lived
assets.
— long-lived assets (asset group).
— goodwill.
For entities that have adopted ASU 2017-04, Simplifying the Test for Goodwill
Impairment, goodwill impairment is measured by calculating the difference

between the carrying amount and the fair value of the reporting unit. For
entities that have not yet adopted ASU 2017-14, an entity performs a two-step
impairment test to determine the extent that the goodwill carrying amount is
greater than its implied fair value.
For a discussion of testing goodwill for impairment, see KPMG Handbook,
Impairment of nonfinancial assets.

Question 3.3.10
Can an entity contemplating bankruptcy elect to
apply Step 0 in an impairment analysis?

Background: An entity has the option of performing a qualitative evaluation of

whether it is more likely than not that a reporting unit’s fair value is less than its
carrying amount (Step 0 evaluation). If it is more likely than not that the goodwill
is impaired, the entity must move on to the quantitative test. If it is not, the
entity need not perform the quantitative test. [350-20-35-3A – 35-3B]
Interpretive response: Theoretically yes, but we believe it would be unusual.
Because an entity contemplating bankruptcy is likely already experiencing many
of the indicators that a reporting unit’s fair value may be less than its carrying
amount, we generally believe that an entity in this situation should not invest
time performing a qualitative analysis and instead should move directly to a
quantitative test.

Question 3.3.20
How can restructuring done to avoid bankruptcy
affect the allocation of goodwill to reporting units
for impairment testing?
Background: Goodwill is allocated to an entity’s reporting units based on the
extent to which the reporting unit will benefit from the synergies realized as a
result of a business combination. A reporting unit may be an operating segment
(as defined by Topic 280). However, a component of an operating segment (i.e.
a level below the operating segment level) is considered a reporting unit if: [350-
20-35-34]

— the component constitutes a business for which discrete financial

information is available; and
— segment management regularly reviews the operating results of the
component.
Further, an entity aggregates two or more components of an operating
segment into a single reporting unit if the components have similar economic
characteristics. [350-20-35-34 – 35-35]
A key factor in determining an entity’s reporting units is the approach that
management takes to organize the business for making operating decisions and
assessing performance.

Interpretive response: An entity restructuring its operations may need to

reevaluate its operating segments, reporting units or both. If an entity
concludes that the composition of its reporting units has changed, goodwill is
reassigned to the affected reporting units on a relative fair value basis.
For example, an entity experiencing financial distress might eliminate an
unsuccessful operating segment by reallocating all of its operations to other
operating segments; or an entity might change its structure from being
organized primarily geographically to being organized primarily by product line.
As a result, its reporting units change and goodwill must be reallocated.

Question 3.3.25
In assessing the recoverability of long-lived assets,
how are future cash flows estimated if the entity is
contemplating a bankruptcy filing?
Interpretive response: In the period preceding bankruptcy, an entity continues
to follow applicable US GAAP when preparing its financial statements.
Therefore, Topic 360 is applied in the usual way and the forecast period is not
limited to the potential timing of a bankruptcy filing.
The general requirement in Topic 360 is for the entity to consider all available
evidence, and for the underlying assumptions to be consistent with those used
for other estimates. Further, the likelihood of the different outcomes needs to
be considered if: [360-10-35-30]
— the entity is considering alternative courses of action for the operation or
disposition of the asset group; and/or
— there is a range of possible future cash flows.
The estimated future cash flows should take into account the factors that have
led to the potential bankruptcy filing, including the possible scenarios that might
arise following the filing. While an entity could use either a single best estimate
or probability-weighted cash flows, the relevance of using probability-weighted
cash flows will be heightened when the entity is considering alternative courses
of action for an asset group.
For an in-depth discussion of the relevant accounting considerations when
estimating cash flows used for a Topic 360 impairment test before bankruptcy,
see KPMG Handbook, Impairment of nonfinancial assets.

Indefinite-lived intangible assets

Subtopic 350-30 includes subsequent measurement guidance for indefinite-
lived intangible assets. Indefinite-lived intangible assets are periodically
evaluated to determine: [350-30-35-18, 35-16]
— if the assets have been impaired; and
— if the assets still have indefinite useful lives.
For reasons similar to goodwill, indefinite-lived intangible assets of an entity in
financial distress should be carefully analyzed to determine whether they have

been impaired. Additionally, contemplation of restructuring or otherwise

significantly changing the entity’s operations to alleviate financial distress can
potentially affect the conclusion that an intangible asset has an indefinite life or
that it is not impaired. For further discussion, see KPMG Handbook, Impairment
of nonfinancial assets.

3.3.20 Long-lived assets

When an entity experiences financial difficulties, its long-lived tangible and
intangible assets may become impaired. Also, the entity may sell both tangible
and intangible long-lived assets to increase liquidity.
Long-lived asset impairments
The guidance for an impairment test of long-lived assets (both tangible and
intangible) subject to depreciation or amortization is under Subtopic 360-10.
Long-lived assets intended to be held and used are tested for impairment
whenever a triggering event is identified. The likelihood that a triggering event
has occurred, and an asset is impaired increases in the period preceding a
bankruptcy. [350-30-35-14, 360-10-35-21]
The triggering events for long-lived assets are similar to those identified for
goodwill (see section 3.3.10), focusing on the effect of events on the significant
inputs used to determine the fair values of such assets. The following are
indicators of when a long-lived asset (asset group) should be tested for
impairment (not exhaustive). [360-10-35-21]

Market price A significant decrease in the market price of a long-lived asset

(asset group).
Changes in asset A significant adverse change in the extent or manner in which a
use long-lived asset (asset group) is being used or in its physical
condition.
Changes in legal A significant adverse change in legal factors or in the business
factors/ business climate that could affect the value of a long-lived asset (asset
climate group), including an adverse action or assessment by a
regulator.
Cost factors An accumulation of costs significantly in excess of the amount
originally expected for the acquisition or construction of a long-
lived asset (asset group).
Financial A current-period operating or cash flow loss combined with a
performance history of operating or cash flow losses or a projection or
forecast that demonstrates continuing losses associated with
the use of a long-lived asset (asset group).
Events affecting A current expectation that, more likely than not, a long-lived
an asset’s use asset (asset group) will be sold or otherwise disposed of
significantly before the end of its previously estimated useful
life.

The Topic 360 impairment test for held-and-used assets is performed at the
asset group level, which is the lowest level for which identifiable cash flows are

largely independent of the cash flows of other groups of assets and liabilities.
[360-10 Glossary, 360-10-35-17]

When performing this impairment test, an entity first compares the carrying
amount of the asset (or asset group) to the sum of the estimated undiscounted
future cash flows from its use and eventual disposal. If the estimated
undiscounted future cash flows are less than the carrying amount, the entity
determines the fair value (e.g. discounted cash flows) of the asset (or asset
group) and recognizes an impairment charge to the extent the carrying amount
exceeds fair value. [360-10-35-17]
When a long-lived asset (or asset group) is tested for impairment, it is likely
necessary to review the useful life and salvage value estimates. In such cases,
an entity recognizes an impairment loss before revising depreciation estimates.
An entity cannot avoid an impairment charge by prospectively adjusting an
asset’s useful life or salvage value. [250-10-45-17, 360-10-35-22]

Question 3.3.30
Could an entity contemplating bankruptcy conclude
that its long-lived assets classified as held-and-used
are not impaired?
Interpretive response: Yes, because the first step of the impairment test for
assets that are held-and-used involves comparing the carrying amount of the
asset (or asset group) to its entity-specific undiscounted future cash flows
(recoverability test). Even if an entity is contemplating bankruptcy, it may be
able to conclude that the carrying amount of specific assets (or asset groups) is
recoverable through future cash flows and therefore no impairment charge is
required. [360-10-35-17, 35-29 – 35-35]

Long-lived assets held-for-sale

Long-lived assets classified as held-for-sale are measured at the lower of
carrying amount or fair value less cost to sell. [360-10-45-14]
Often, an entity intends to dispose of assets that are held-for-sale (and any
liabilities directly associated with those assets) as a group, referred to as a
disposal group. For example, the assets and liabilities associated with
operations of an entity that are being disposed of may be included in a single
disposal group. [360-10 Glossary]
The assets and liabilities of a disposal group are presented separately in the
asset and liability sections of the balance sheet. Different presentation guidance
applies if the disposal group qualifies as a discontinued operation (see section
3.11.10). [360-10-45-14]
To classify an asset (or disposal group) as held-for-sale, all of the following
criteria must be met: [360-10-45-9]
— management, having the authority to approve the action, commits to a plan
to sell the asset;

— the asset is available for immediate sale in its present condition, subject
only to terms that are usual and customary for sales of such assets;
— an active program to locate a buyer and other actions required to complete
the plan to sell the asset have been initiated;
— the sale of the asset is probable, and transfer of the asset is expected to
qualify for recognition as a completed sale within one year (with exceptions
for certain events beyond the entity’s control);
— the asset is being actively marketed for sale at a price that is reasonable in
relation to its current fair value; and
— actions required to complete the plan indicate that it is unlikely that
significant changes to the plan will be made, or that the plan will be
withdrawn.
If an entity intends to dispose of an asset (disposal group) by means other than
sale (e.g. abandonment), it continues to classify it as held-and-used until it is
disposed of. The guidance on assets held-and-used (such as evaluating the
salvage value, useful life and recoverability) continues to apply until the asset is
disposed of. [360-10-45-15]
For further discussion about the accounting for discontinued operations, see
KPMG Handbook, Discontinued operations and held-for-sale disposal groups.

3.3.30 Inventories
Generally, an entity writes down its inventory when the inventory’s cost (as
reflected in the carrying amount) is greater than the inventory’s net realizable
value. This could be due, for example, to physical deterioration or obsolescence
of the inventory, excess inventory or changes in price levels. Circumstances
that may cause an entity to file for bankruptcy could also indicate inventory
impairment. [330-10-35-1B]
The following are examples.
— Sales incentives. An entity experiencing financial difficulties may attempt
to increase its sales volumes by providing sales incentives or discounted
pricing to its customers to generate cash. This would affect the
assessment of estimated sales prices for inventory on hand, which could
result in an impairment of inventory.
— Cost increases. An entity may experience financial difficulties because of
increasing inventory costs. If the entity cannot raise its prices to adequately
recover those costs, it may need to write down its inventory.
An entity may also need to recognize a loss on firm purchase commitments if it
does not expect to recover the cost to purchase the inventory upon sale of the
finished product. A net loss on a purchase commitment is measured in the
same manner as an inventory impairment. [330-10-35-17 – 35-18]

Question 3.3.40
Does an entity increase its per-unit allocation of
overhead costs to inventory in times of abnormally
low production?
Background: Abnormally low inventory production may occur in entities
experiencing financial difficulty. This in itself could be part of the cause of an
entity’s financial difficulties (e.g. plant shutdowns or worker strikes). In addition,
technological obsolescence or shifts in market demand of an entity’s products
may cause financial difficulty and also result in abnormally low inventory
production.
Interpretive response: No. Fixed overhead costs related to production are
allocated to inventory based on the normal capacity of the production facilities.
When production is abnormally low, an entity expenses the under-absorbed
overhead costs as incurred; it does not allocate more overhead to each unit of
inventory. [330-10-30-6, 30-7]

3.3.40 Investments
Investments in debt securities
An entity contemplating bankruptcy may need to evaluate its investments in
debt securities from two perspectives:
— whether those investments are impaired; and
— whether any held-to-maturity investments need to be reclassified.
Impairment of investments
Often an entity is contemplating bankruptcy due to macroeconomic conditions
affecting the general economy or industry in which it operates. If the factors
affecting the entity are also negatively affecting entities in which it holds debt
securities, the entity needs to consider if its held-to-maturity and available-for-
sale debt securities are impaired. After adoption of ASU 2016-13, Measurement
of Credit Losses on Financial Instruments, entities need to consider whether
adequate credit losses have been recognized under Topic 326. For a discussion
of Topic 326, see KPMG Handbook, Credit impairment.
Before adoption of ASU 2016-13, an entity needs to consider the sufficiency of
other-than-temporary impairment losses for debt securities under Topic 320.
[320-10-35]

Reclassification of held-to-maturity investments

Topic 320 requires an entity to reassess the appropriateness of the
classification of its debt securities at each reporting date. This reassessment
usually focuses on the entity’s ability to continue to hold a security to maturity.
In a period preceding a bankruptcy filing, an entity may no longer have this
ability if it is experiencing cash flow challenges and its need for liquidity requires
selling investments. If an entity no longer has the ability to hold an investment
to maturity, reclassification to available-for-sale or trading is required. [320-10-35-5
– 35-7]

A sale or transfer of a held-to-maturity security usually contradicts an entity’s

assertion that it has the intent and ability to hold the securities to maturity.
Consequently, the entity reclassifies the remaining held-to-maturity securities to
available-for-sale. Exceptions to this would be rare. [320-10-25-6, 25-9, 25-14, 320-10-
35-8 – 35-9]

Investments in equity securities

The method used to measure equity securities depends on whether the
security has a readily determinable fair value. [321-10-35-1 – 35-2]

Equity security with a Equity security without a readily

readily determinable fair value determinable fair value

Both initially and subsequently, Both initially and subsequently,

measure at fair value with changes in measure at fair value with changes in
fair value recognized in net income. fair value recognized in net income.

Or apply the measurement alternative:

Measure at cost (adjusted for fair

value changes when there are
observable prices) less impairment.

If an entity that is contemplating bankruptcy has elected the measurement

alternative to measure its equity securities without readily determinable fair
values, there may be a heightened risk of impairment of those securities. This is
particularly if the entity is contemplating bankruptcy because of macroeconomic
conditions affecting the general economy or industry in which the investee
operates.
See KPMG Handbook, Investments for more information about performing an
impairment analysis of equity securities.
Equity method investments
Topic 323 requires an entity to account for an investment using the equity
method if it can exercise significant influence over the investee. There is a
rebuttable presumption that significant influence can be exercised if the
investor owns 20% or more of the voting stock of a corporate investee. In
addition, an investor considers other indicators, including: [323-10-15-6, 15-8]
— representation on the board of directors;
— participation in policy-making processes;
— material intra-entity transactions;
— interchange of managerial personnel between investor and investee;
— technological dependency; and
— extent of ownership by an investor in relation to the concentration to the
other shareholdings.
If an entity in financial distress is making changes to its legal structure, or it
restructures its operations due to a shift in strategy, it should carefully consider
these indicators to determine whether it can still exercise significant influence
over each of its equity method investees.

In addition, Topic 323 requires an entity to evaluate equity method investments

for impairments that are other than temporary. [323-10-35]

Question 3.3.50
Does an entity discontinue applying the equity
method if it sells enough of its investment to
decrease its ownership percentage below 20%?
Interpretive response: Generally, yes. An entity may dispose of a portion of its
equity method investment to increase liquidity, resulting in owning less than
20% of the investee’s voting stock. In this case, there is a rebuttable
presumption that the entity no longer has significant influence over the
investee. However, the equity method remains appropriate if the facts and
circumstances indicate that the entity has retained significant influence. [323-10-
15-8]

See section 2.4 of KPMG Handbook, Equity method of accounting for more
information about the determination of significant influence and equity method
investments.

3.3.50 Accounts receivable

Accounts receivable (as well as contract assets and loans receivable) are in the
scope of Subtopic 326-20, which requires an entity to estimate credit losses on
initial recognition and at each reporting date. See KPMG Handbook, Credit
impairment, for guidance on measuring the allowance for credit losses.

Question 3.3.60
What is the effect on an entity’s customer accounts
receivable when it is experiencing financial
difficulty?
Interpretive response: When an entity suffers financial difficulties, it should
consider the effect on its allowance for credit losses. For example, as
customers become aware of the entity’s financial difficulties, it may experience
late or nonpayment from customers. This may happen when customers
become concerned about the entity’s ability to meet its obligations (e.g. future
product or service delivery) or as customers in the same industry experience
similar financial difficulties.

3.4 Debt
3.4.10 Debt covenants and subjective acceleration clauses
An entity facing financial difficulty may be in violation of debt covenants or in
danger of creditors exercising subjective acceleration clauses on its long-term
debt. In this case, the entity may have to reclassify the debt to current liabilities.
Violations of debt covenants
Debt agreements generally require debt covenant compliance to be evaluated
quarterly or semiannually. Debt covenants are often based on the financial
health of an entity, so those contemplating bankruptcy due to financial distress
should carefully consider whether they are in violation of any of their debt
covenants.
Subjective acceleration clauses
Some debt agreements include subjective acceleration clauses that allow the
creditor to accelerate the scheduled maturities of the loan under conditions that
are not objectively determinable. Circumstances such as recurring losses or
liquidity problems could cause creditors to exercise their acceleration rights. If it
is reasonably possible that the creditor will invoke the acceleration clause, an
entity should evaluate the relevant facts to determine the proper classification
(current or long-term) and appropriate disclosures. If it is probable that the
creditor will invoke the acceleration clause, an entity should reclassify debt that
otherwise is long-term to current. [470-10-45-2]
For an in-depth discussion of the relevant accounting considerations on debt
classification, see section 3.6 of KPMG Handbook, Debt and equity financing.

3.4.20 Troubled debt restructurings, debt extinguishments

and modifications
An entity in financial distress may attempt to negotiate the terms of its debt to
decrease the interest rate, increase the term, or modify contractual terms in
other ways to improve its cash flow. The following table presents the three
possible accounting treatments when a debt instrument is modified before a
bankruptcy filing.

Characterization Attributes Accounting consequences

Troubled debt The debtor is If the entity transfers assets or
restructuring experiencing financial issues equity instruments in partial
difficulty and the creditor or full settlement of the debt, it first
grants a concession reduces the carrying amount of the
because of the debtor’s debt by the fair value of the assets
financial difficulty. or equity instruments transferred.
[470-60-35-2 – 35-3, 35-8]
If the debt is thereby fully settled,
the entity recognizes a gain equal to
the remaining carrying amount of
the debt. [470-60-35-3]

Characterization Attributes Accounting consequences

If the debt is not fully settled, the
entity recognizes a gain only to the
extent that the undiscounted cash
flows (including contingent
payments) of new or modified debt
are less than the remaining carrying
amount of the old debt. [470-60-35-7]
If undiscounted cash flows equal or
exceed the remaining carrying
amount of old debt, no gain is
recognized and a new effective
interest rate is established
prospectively. [470-60-35-5]
Extinguishment The renegotiated debt is The old debt is derecognized and
of original debt – substantially different new debt is recognized at fair value.
does not qualify from the original debt – [470-50-40-13]
as a troubled i.e. the present value of The extinguishment gain or loss is
debt cash flows under the measured by comparing the fair
restructuring renegotiated debt differs value of the new debt to the
by least 10% from the carrying amount of the old debt.
present value of the [470-50-40-13]
remaining cash flows A new effective interest rate is
under the original debt. established based on the new debt.
[470-50-40-10 – 40-11] [470-50-40-13]

Modification of The renegotiated debt is No gain or loss is recognized.

debt – does not not substantially different [470-50-40-8]
qualify as a from the original debt. A new effective interest rate is
troubled debt established prospectively based on
restructuring the carrying amount of the debt and
revised cash flows. [470-50-40-14]

3.5 Hedge accounting

Subtopic 815-20 describes the criteria that must be met for an instrument to
qualify for hedge accounting. These criteria are discussed in KPMG Handbook,
Derivatives and hedging.
Financial difficulties experienced by an entity or its counterparty to a hedging
instrument can call into question whether it continues to qualify for hedge
accounting. For example, hedge accounting is permitted only if the hedging
relationship is expected to be (and actually is) highly effective. Among other
things, the creditworthiness of the counterparty and the entity’s own
nonperformance risk affect whether a hedging relationship is highly effective.
An entity’s own nonperformance risk may increase if it is experiencing financial
difficulties. Similarly, if an entity is experiencing financial difficulties due to
macroeconomic factors and the counterparty to the forecasted transaction is
subject to those same factors, the counterparty’s creditworthiness may decline.
[815-20-35-14 – 35-18, 25-122]

For a discussion of assessing counterparty creditworthiness or the entity’s own

nonperformance risk when evaluating the effectiveness of a hedging
relationship, see section 13.2.60 of KPMG Handbook, Derivatives and hedging.
Additionally, in a cash flow hedge, the hedged forecasted transaction must be
probable of occurring to be eligible for hedge accounting. If an entity is
experiencing financial difficulties, it may no longer be able to assert that a
transaction is probable of occurring. The probability of a forecasted transaction
occurring can also be affected by the counterparty’s creditworthiness. [815-20-25-
15]

For further discussion about assessing the probability of forecasted

transactions, see section 9.3.40 of KPMG Handbook, Derivatives and hedging.

3.6 Share-based payments

An entity facing financial difficulties applies the same guidance on share-based
payments as it otherwise would. Topic 718 provides guidance on accounting for
share-based payment transactions.
An entity may modify or cancel share-based payment awards if it is
experiencing financial distress. For example, if an entity is anticipating filing for
bankruptcy, it may modify the terms of share-based payments to incentivize key
employees to stay with the company through the bankruptcy proceedings. In
these cases, careful consideration should be given to the modification or
cancellation guidance in Topic 718. Additionally, changes to a share-based
payment award may cause its classification to change from equity to liability, or
vice versa.
Modifications to share-based payment awards often involve complex valuation
models and techniques. Because of this, entities modifying awards should
consider involving a valuation specialist.
For further discussion, see KPMG Handbook, Share-based payment.

3.7 Retirement and nonretirement postemployment

benefits
An entity in financial distress may freeze its pension plan. Topic 715 contains
specific guidance requiring gain or loss recognition when a pension plan
curtailment occurs.
Additionally, an entity contemplating bankruptcy may undergo restructuring
activities to improve its financial position (see section 3.11). Those activities
may include reducing headcount (e.g. by closing a location or a line of business).
Sometimes an entity offers benefits that may be triggered as a result of
restructuring activities. Topic 712, Topic 715 and Topic 420 contain guidance on
accounting for termination benefits. Termination benefits may take various
forms, including lump-sum payments and/or periodic future payments. They
may be paid directly from an employer’s assets, an existing pension plan, a new
employee benefit plan or a combination of those means.

For further discussion about the accounting for retirement and nonretirement
postemployment benefits, see KPMG Handbook, Employee benefits.
The following are examples.

Special termination benefits A liability is recognized for a special termination

may be offered in exchange for benefit once the employee accepts the offer
an employee’s voluntary irrevocably and the amount due to the employee
termination of service. can be reasonably estimated. [712-10-25-1, 715-30-
25-10]

Contractual termination
benefits may be due to A liability is recognized when it is probable that the
employees upon their employee will be owed the benefit, and the
termination as a result of a amount due to the employee can be reasonably
certain event (e.g. a plant estimated. [712-10-25-2, 715-30-25-10, 715-60-25-10]
closure).
Other involuntary If the benefits vest or accumulate, a liability is
termination benefits may be recognized as the employees provide the services.
provided through an ongoing Otherwise, they are recognized when it is probable
plan, which may be written or the employee will be owed the benefit, and the
achieved through consistent amount can be reasonably estimated. [712-10-25-4 –
past practices. 25-5]

One-time termination A liability is measured at fair value on the

benefits may be provided on communication date and recognized ratably over
their own or in addition to base the future service period if the employee is
contractual benefits or benefits required to render services beyond a minimum
provided through an ongoing retention period – which cannot exceed the legal
plan. notification period or, in its absence, 60 days.
Otherwise, the liability is recognized at fair value on
the communication date. [420-10-25-6 – 25-9]

3.8 Loss contingencies

Sometimes an entity may contemplate bankruptcy because an event has
occurred that could potentially result in a material financial outlay. This could be
due to a catastrophic event, pending litigation or regulatory actions, among
other things. Certain events might result in a single or multiple levels of financial
loss and exposure.
For example, if an entity experienced an explosion at a manufacturing plant, the
negative financial effects may include the costs to repair the plant (payments
made beyond any insured limits), economic losses because the plant cannot
operate, litigation claims from harmed employees or third-party property
damages and regulatory actions for environmental damages or operational
misconduct. In this scenario, the costs to write off or impair the carrying
amount of the assets are recognized in the period of the event, the costs to
repair the plant are expensed or capitalized as incurred depending on the facts
and circumstances, economic losses are recognized as incurred, and the
possible losses from litigation claims and regulatory actions are accounted for
as loss contingencies.

When to recognize and disclose a loss contingency is summarized in the

following diagram. [450-20-25-2, 50-3 – 50-5]

Is it probable that an asset

has been impaired or a Can the amount of loss be Accrual required2 and
liability has been incurred at Yes reasonably estimated? Yes disclosure may be required
the reporting date?

No No

Disclose nature of
Is it reasonably possible
contingency and estimate
that a loss may have been
Yes of possible
incurred?
loss (if applicable)1

Neither accrual nor

disclosure required

Notes:
1. The disclosure requirements apply to both unrecognized losses and possible additional
losses in excess of a recognized loss. [450-20-50-3]
2. If a loss contingency relates to a guarantee, the accrual is initially measured at the
greater of the fair value of the guarantee (determined under Topic 460 (guarantees)) or
the amount to be recognized for the loss contingency (determined under Subtopic 450-
20). [460-10-30-3]

As the diagram indicates, if it is reasonably possible (but not probable) that a

loss has been incurred or if it is probable that a loss has been incurred but the
amount of the loss cannot be reasonably estimated, an entity does not
recognize the loss contingency. Instead, the entity discloses both the nature of
the contingency and an estimate of the possible loss or range of loss. If the
amount of loss cannot be reasonably estimated, the disclosure must state that
fact. [450-20-50-3 – 50-4]
In addition, special consideration should be given to unasserted claims that
occur before the entity files for bankruptcy; if an entity is contemplating
bankruptcy, the likelihood that they will be asserted may increase. An entity is
required to disclose the existence of unasserted claims or assessments if: [450-
20-50-6]

— it is probable that a claim will be asserted; and

— there is at least a reasonable possibility that the outcome will be
unfavorable.

3.9 Income taxes

The realizability of deferred tax assets may be affected if an entity is
experiencing financial difficulties. Section 4 of KPMG Handbook, Accounting for
income taxes, provides guidance on the valuation of deferred tax assets.
In addition, a multinational entity contemplating bankruptcy because of financial
difficulties may reevaluate its global cash needs and revise its plans for

repatriating or reinvesting foreign earnings. See section 7 of KPMG Handbook,

Accounting for income taxes, for information about the tax consequences of
changes in an entity’s repatriation plans.

3.10 Consolidation
A reporting entity (parent) consolidates another entity (subsidiary) if it has a
controlling financial interest in the other entity. This is usually achieved by
either: [810-10-05-08 – 08A]
— having the power to direct the activities that most significantly affect the
other entity’s economic performance, if that entity is a variable interest
entity; or
— owning a majority of the other entity’s voting interests, if that entity is a
voting interest entity.
A parent in financial distress may attempt to increase its liquidity by selling part
of its interests in a subsidiary. Alternatively, it may cause a subsidiary to issue
shares to third parties, thereby diluting its ownership of the subsidiary’s equity.
A parent may also make other changes to the subsidiary or its governing
structure that could result in changes to its consolidation conclusion.
— For a discussion of factors to consider when reassessing the primary
beneficiary of a variable interest entity, see chapter 6 of KPMG Handbook,
Consolidation.
— For a discussion of the accounting for the derecognition of, and changes in
a parent’s ownership interest in, a subsidiary, see chapter 7 of KPMG
Handbook, Consolidation.

3.10.10 Decrease in ownership interest while retaining

control
A reduction in ownership of a subsidiary’s voting interests without losing
control can result in either:
— the recognition of a noncontrolling interest, if the parent previously owned
100% of the voting interests; or
— an increase to a previously recognized noncontrolling interest, if the parent
previously owned less than 100%.
When a noncontrolling interest in a subsidiary exists, it is generally reported in
the balance sheet within equity in the consolidated financial statements but is
presented separately from the parent’s equity. [810-10-45-16]
Changes in the parent’s ownership interest that do not result in loss of control
are accounted for by the parent as equity transactions. The parent adjusts the
carrying amount of the noncontrolling interest and recognizes the difference
between the change in the noncontrolling interest and the fair value of
consideration received in additional paid-in capital attributable to the parent. [810-
10-45-23]

For a discussion of the accounting for changes in a parent's ownership that do

not result in a loss of control, see chapter 7 of KPMG Handbook, Consolidation.

3.10.20 Loss of control

If a parent sells enough of its interest such that it no longer has a controlling
financial interest in a subsidiary that is a business or not-for-profit activity, the
parent deconsolidates the subsidiary’s assets and liabilities, eliminates the
equity components related to that subsidiary (e.g. existing noncontrolling
interest, cumulative translation adjustment) and recognizes a gain or loss in net
income. [810-10-40-4 – 40-4A]
If the subsidiary is a business or not-for-profit activity, an entity accounts for the
loss of control in accordance with Subtopic 810-10. The gain or loss generally is
computed as the difference between the fair value of the consideration
received and amounts removed from the parent’s consolidated balance sheet. If
the parent retains a noncontrolling interest in the entity, it records the interest
as an investment at fair value and includes the fair value of that interest in the
calculation of the gain or loss. [810-10-40-5]
If the subsidiary is not a business or not-for-profit activity, the guidance applied
to decreases in ownership depends on the nature of the assets transferred. For
example, an entity applies other guidance such as Subtopic 610-20 for
nonfinancial assets (including in-substance nonfinancial assets) or Topic 860 for
the transfer of financial assets.
For further discussion about accounting for changes in a parent's ownership
that result in a loss of control, see chapter 7 of KPMG Handbook, Consolidation.

3.11 Discontinued operations and exit or disposal

activities
An entity in financial distress may decide to take actions such as exiting or
restructuring a business, reductions in workforce, and restructuring leases and
facilities.

3.11.10 Discontinued operations

An entity contemplating bankruptcy may discontinue certain of its operations to
increase liquidity, decrease costs or increase efficiencies. A disposal (or planned
disposal) of a component (or group of components) of an entity is reported in
discontinued operations if the disposal represents a strategic shift that has or
will have a major effect on the entity’s operations and financial results. [205-20-45-
1B]

A component of an entity comprises operations and cash flows that can be

clearly distinguished from the rest of the entity (both operationally and for
financial reporting purposes). It may be a reportable segment, an operating
segment, a reporting unit, a subsidiary or an asset group. [205-20 Glossary]
A disposal occurs in this context when a component is either disposed of
(through sale or other means) or qualifies to be classified as held-for-sale. The

criteria that must be met for a component to be classified as held-for-sale are

the same as those listed in section 3.3.20. [205-20-45-1A – 45-1B, 45-1G]
The results of discontinued operations are presented as a separate component
of income in the statement of operations. Similarly, the cash flows of
discontinued operations are presented separately from those of continuing
operations in the statement of cash flows. See Question 20.2.10 of KPMG
Handbook, Statement of cash flows, for guidance on three acceptable methods
of presenting the cash flows from discontinued operations. [205-20-45-3A]
If the discontinued operations meet the held-for-sale criteria (see section 3.3.20)
before being disposed of, the assets and liabilities of the discontinued
operations are presented separately from other assets and liabilities in the
balance sheet. This presentation is required in the period(s) that a discontinued
operation is classified as held-for-sale and all comparative periods presented.
However, an entity accounts for those assets as held-for-sale (i.e. ceases
depreciating them and carries them at the lower of their carrying amounts or
fair value less cost to sell) only from the date they qualify as held-for-sale, even
if they are retrospectively presented as a disposal group in earlier periods.
If the assets and liabilities of the discontinued operations are disposed of before
meeting the criteria to be classified as held-for-sale, the assets and liabilities
disposed of are still required to be presented separately in the balance sheet for
the period(s) presented before the period of disposal. [205-20-45-10]
For further discussion about the accounting for discontinued operations, see
KPMG Handbook, Discontinued operations and held-for-sale disposal groups.

3.11.20 Exit or disposal activities

An entity facing financial difficulties often restructures its operations by exiting a
line of business or disposing of some of its assets to improve its financial
position. Topic 420 includes guidance on accounting for: [420-10-15-3]
— one-time employee termination benefits;
— costs to terminate a contract that is not a lease;
— costs to consolidate facilities or relocate employees;
— costs associated with disposing of discontinued operations; and
— costs associated with an exit activity.
Topic 420 provides details about the above transactions and activities to help an
entity determine whether a cost is associated with an exit or disposal activity
and therefore is in the scope of the guidance. It generally requires that a liability
for a cost associated with an exit or disposal activity be recognized in the period
in which the liability is incurred, measured initially at fair value. [420-10-25-1, 420-10-
30]

If involuntary termination benefits are provided to an employee under a one-

time termination arrangement, those benefits are accounted for under Topic
420. However, other termination benefits (e.g. those provided under an ongoing
benefit arrangement) are accounted for under other guidance. See section 3.7
for a discussion of various types of termination benefits and the appropriate
accounting treatment. [420-10-15-6 – 15-8]

For further discussion about the accounting for termination benefits, see
chapter 4 of KPMG Handbook, Employee benefits.
Lease terminations are accounted for under Topic 842 (see section 3.11.30).

3.11.30 Leases (as lessee)

If an entity restructures operations as a result of financial difficulties, it may
modify or terminate leases.
Lease modifications and terminations
When evaluating a lease modification under Topic 842, the first step is to
determine whether the modification represents a separate contract. For an
entity in financial distress, this is usually not the case, because a modification is
accounted for as a separate contract only when the entity obtains additional
rights of use and the payments increase commensurate with the standalone
price of the additional rights of use. [842-10-25-8]
If the modified agreement is not considered a separate contract, the lease
classification is reassessed as of the effective date of the modification.
Generally, the lease liability is remeasured on the date the modification is
approved and the right-of-use asset is adjusted by the amount of the change in
the liability. However, if the lease modification reduces the lessee’s right of
use, the right-of-use asset is reduced proportionally, and the lessee recognizes
a gain or loss for the difference between the reduction of the lease liability and
the proportional reduction of the right-of-use asset. [842-10-25-9 – 25-13]
For further discussion about the accounting for lease modifications by lessees,
see section 6.7 of KPMG Handbook, Leases.

3.12 Disclosures
3.12.10 Overview
When an entity is contemplating bankruptcy, disclosures may be required that
the entity may not have previously considered. The following are examples.
— Topics 350 and 360 require an entity to make certain disclosures in a period
in which it recognizes an impairment. [350-20-50-2, 350-30-50-3, 360-10-50-2]
— Topic 330 requires disclosures about losses from the subsequent
measurement of inventory, and when an entity incurs losses on firm
purchase commitments. [330-10-50-2, 50-5]
— Topic 320 requires incremental disclosures when a debt security has been
impaired. [320-10-50-6 – 50-8B]
— Topic 420 requires an entity to include disclosures about exit or disposal
activities. [420-10-50-1]
— Topic 470 requires disclosure about subjective acceleration clauses in some
circumstances. [470-10-45-2, 50-3]

Management of an entity contemplating bankruptcy should carefully consider

disclosure requirements and ensure that disclosures are sufficiently detailed to
provide a reader with transparency about the financial health of the entity. In
this section, we discuss some disclosure requirements particularly relevant for
entities experiencing financial difficulties.

3.12.20 Risks and uncertainties

An entity experiencing financial difficulties needs to carefully consider its
disclosures under Topic 275, which provides disclosure guidance about: [275-10-
50-1]

— the nature of the entity’s operations;

— the use of estimates in preparing the financial statements;
— certain significant estimates; and
— current vulnerability because of certain concentrations.

Question 3.12.10
How might financial difficulties affect an entity’s
disclosures about the nature of its operations?

Interpretive response: For an entity experiencing financial difficulties and

contemplating bankruptcy, it becomes increasingly important to provide
comprehensive, transparent disclosures about the risks and uncertainties it is
facing.
For example, if an entity is experiencing challenges because demand for its
product is decreasing (e.g. due to obsolescence), or it operates in a
geographical area that is experiencing a recession, its disclosures about the
nature of its operations need to be clear enough that a user can fully understand
the associated risks and uncertainties.

Question 3.12.20
How might financial difficulties affect an entity’s
disclosures about significant estimates?

Interpretive response: An entity experiencing financial difficulties may have a

number of significant estimates because of increased sensitivity or volatility of
assumptions. Topic 275 requires disclosure if it is at least reasonably possible
that an estimate could change in the near term and the effect of that change
would be material. [275-10-50-6]
For example, an entity that historically has not disclosed the fair value of its
reporting units as a significant estimate may need to reevaluate that practice if
it is experiencing financial difficulties that make goodwill impairments more
likely.

Question 3.12.30
How might financial difficulties affect an entity’s
disclosures about concentrations?

Interpretive response: Concentrations may become increasingly important in

assessing the future financial performance of an entity if the financial
challenges it faces are pervasive across the industry or economy in which it
operates.
The following are examples of circumstances that could affect an entity’s
disclosures concerning concentrations:
— a small number of large customers who are experiencing financial
difficulties;
— revenue is concentrated in one product that is rapidly becoming obsolete;
— heavy reliance on a consistent supply of a material that is increasing in cost
(e.g. steel); or
— transactions primarily in a geographical location that is experiencing a
recession.

3.12.30 Going concern

Unless an entity’s liquidation is imminent (as defined by Subtopic 205-30,
liquidation basis of accounting), its financial statements are prepared under the
assumption that it will continue as a going concern. While liquidation may not
be imminent for an entity experiencing financial difficulties, the assumption that
it will continue as a going concern becomes challenged as its financial
difficulties persist. [205-40-05-1]
Subtopic 205-40 (going concern) requires an entity’s management to evaluate
whether there are conditions or events, considered in the aggregate, that raise
substantial doubt about the entity’s ability to continue as a going concern. It
also provides guidance on how management should consider its plans when it
identifies such conditions or events and whether those plans mitigate doubt
about an entity’s ability to continue as a going concern. [205-40-50-1, 50-6]
If, as a result of its analysis, management concludes that substantial doubt
exists about the entity’s ability to continue as a going concern, the disclosure
requirements depend on whether that doubt is alleviated by management’s
plans. [205-40-50-12 – 50-13]

Disclosures when substantial Disclosures when substantial

doubt is alleviated doubt is not alleviated
— Principal events or — Principal events or
conditions that initially raised conditions that initially raised
the substantial doubt. the substantial doubt.

Disclosures when substantial Disclosures when substantial

doubt is alleviated doubt is not alleviated
— Management’s evaluation of — Management’s evaluation of
the significance of those the significance of those
events or conditions in events or conditions in
relation to the entity’s ability relation to the entity’s ability
to meet its obligations. to meet its obligations.
— Management’s plans that — Management’s plans that
alleviated the substantial were intended to alleviate
doubt. the substantial doubt.
— A statement indicating that
there is substantial doubt
about the entity’s ability to
continue as a going concern.

Question 3.12.40
Does filing a bankruptcy petition automatically
raise substantial doubt about an entity’s ability to
continue as a going concern?
Interpretive response: Generally, yes. While facts and circumstances differ for
every entity, we believe an entity contemplating bankruptcy will likely conclude
that substantial doubt about its ability to continue as a going concern exists. In
that case, the disclosure requirements of Subtopic 205-40 apply.

3.12.40 Additional disclosures for SEC registrants

This section highlights some of the more significant SEC disclosure
requirements that a registrant should consider if it is experiencing financial
difficulties. In addition, a registrant should consider updating the description of
business (e.g. if the registrant has shifted business activities to try to avoid
bankruptcy) and risk factors (e.g. because of unprofitable operations in recent
periods) sections of its periodic filings.
Asset impairments
In addition to the disclosure requirements of Topics 350 and 360 in the period
of an asset impairment, the SEC staff has suggested that SEC registrants
consider discussing circumstances that could result in an impairment charge in
periods leading up to the impairment, so the charge does not take investors by
surprise in the period in which it is recognized. [2002 AICPA Conf]
The SEC staff expects registrants to provide the following information for
reporting units that are at risk of failing the quantitative goodwill impairment
test (Step 1 if the entity has not adopted ASU 2017-04): [SEC FRM 9510.3]
— the percentage by which the fair value of the reporting unit exceeds the
carrying amount;

— the amount of goodwill allocated to the reporting unit;

— a description of the method(s) used to determine the reporting unit’s fair
value;
— for each key assumption used in the model:
— a description of the key assumption;
— an explanation of how it was determined;
— the degree of uncertainty associated with the assumption; and
— a description of the potential events and/or changes in circumstances
that could be reasonably expected to negatively affect the assumption.
See Question 4.15.50 for related Form 8-K filing requirements.
Liquidity and capital resources
Regulation S-K requires disclosures in a registrant’s MD&A about liquidity and
capital resources. A key objective of these disclosures it to provide a clear
picture of the registrant’s ability to generate cash and to meet known or
reasonably likely future cash requirements. [Reg S-K Item 303]
A registrant facing financial difficulties is likely experiencing or anticipating
problems maintaining its liquidity. Regulation S-K requires disclosure of any
known trends, demands, commitments, events or uncertainties that have or
may result in a registrant’s liquidity decreasing materially, as well as a
discussion of the steps taken to remedy the liquidity deficiency. [Reg S-K Item 303]
Other items that a registrant experiencing financial difficulties should discuss in
MD&A include: [Reg S-K Item 303]
— material commitments and how they will be funded – required for all
registrants regardless of their financial condition; and
— any risk of breaching a debt covenant.
Exit or disposal costs
In addition to the disclosure requirements of Topic 420, the SEC staff has
requested that registrants include a separate description in MD&A of the nature
and amounts of the different types of exit costs that have been incurred. If
multiple exit plans are being executed, the related costs should be
disaggregated by the exit or disposal activities to which they relate. [420-10-50,
SAB Topic 5.P]

Because the events or conditions that cause an entity to consider executing an

exit plan often occur over a period of time, certain disclosures are sometimes
required for MD&A before the related costs or liabilities are recognized under
US GAAP. The entity should describe in its MD&A the reason the exit activity
has been (or will be) executed and the expected effect it will have on the
registrant’s financial position, including the anticipated timing of the cash
outlays and the sources of their funding. [SAB Topic 5.P]
See Question 4.15.50 for related Form 8-K filing requirements.

3.13 Bankruptcy as a subsequent event

A subsequent event is an event or a transaction that occurs after an entity’s
reporting date, but before its financial statements are issued (available for
issuance). [855-10 Glossary]
If a subsequent event provides additional evidence about conditions that
existed at the reporting date, it is considered a recognized subsequent event,
meaning that the effects of the subsequent event are recognized in the financial
statements. A subsequent event is nonrecognized if it provides evidence about
conditions that did not arise until after the reporting date. However, if the
nonrecognized subsequent event is of such a nature that it must be disclosed
to keep the financial statements from being misleading, an entity discloses the
nature of the event and an estimate of its financial effect. [855-10-25-1, 25-3, 50-2]

Question 3.13.10
Is the filing of a petition for Chapter 11 bankruptcy
after the reporting date a recognized subsequent
event?
Interpretive response: No. We believe the Chapter 11 bankruptcy petition
filing after year-end but before issuance of the entity’s financial statements is a
nonrecognized subsequent event. This means that an entity does not apply
Subtopic 852-10 until the filing occurs. However, the entity should disclose the
subsequent event to keep the financial statements from being misleading. The
disclosure should include a description of the nature of the event and an
estimate of its financial effect, or a statement that an estimate cannot be made.
[855-10-50-2]

Additionally, filing a petition after the period-end may provide evidence about
conditions that existed at the reporting date that need to be considered. For
example, a bankruptcy filing may affect an entity’s asset impairment
evaluations.
See Question 4.11.60 for a discussion of when a parent losses control of a
subsidiary due to the subsidiary filing bankruptcy after the consolidated
reporting date.

4. During Chapter 11
bankruptcy
Detailed contents
4.1 How the standard works

4.2 Scope of Subtopic 852-10

Questions
4.2.10 Does Subtopic 852-10 apply to an entity that is reorganizing
under foreign bankruptcy laws?
4.2.20 Does Subtopic 852-10 apply to not-for-profit organizations?
4.2.30 Does Subtopic 852-10 apply when an entity undergoes a
reorganization without filing a bankruptcy petition?
4.2.40 Does Subtopic 852-10 apply to a prearranged or
prepackaged bankruptcy?

4.3 Liabilities under Subtopic 852-10

4.3.10 Overview
4.3.20 Prepetition liabilities
4.3.30 Liabilities not subject to compromise
Questions
4.3.10 When are prepetition liabilities subject to compromise?
4.3.20 How are prepetition liabilities classified when there is
uncertainty about whether a secured claim is undersecured?
4.3.30 How is a prepetition liability classified if an entity learns
about it after the petition date?
4.3.40 Where are liabilities subject to compromise presented on
the balance sheet?
4.3.50 When is a prepetition claim probable and reasonably
estimable?
4.3.60 In what period should a claim be recognized if the entity
learns about it after the reporting date?
4.3.70 How are liabilities not subject to compromise accounted for?
Example
4.3.10 Lifecycle of a liability subject to compromise

4.4 Debt
4.4.10 Prepetition debt
4.4.20 Debtor-in-possession financing
Questions
4.4.10 When is debt that is subject to compromise adjusted to the
amount of the allowed claim?
4.4.20 Are premiums, discounts and debt issue costs written off
during bankruptcy proceedings if the debt is not subject to
compromise?
4.4.30 Can debt extinguishment gains or losses resulting from
bankruptcy proceedings be presented in discontinued
operations?
4.4.40 Does the troubled debt restructurings guidance apply to an
entity in bankruptcy?
4.4.50 Upon filing for bankruptcy, how does an entity account for a
deferred gain associated with a liability subject to
compromise that resulted from a previous troubled debt
restructuring?
4.4.60 How are fees related to DIP financing accounted for in
bankruptcy proceedings?
4.4.70 How are cash flows related to DIP financing classified in the
statement of cash flows?
4.4.80 How is DIP financing classified on the balance sheet?
Example
4.4.10 Accounting for debt subject to compromise

4.5 Other considerations for liabilities

4.5.10 Contingent liabilities
Questions
4.5.10 Does an entity reclassify an accrual related to ongoing
litigation to liabilities subject to compromise at the time it
files for bankruptcy?
4.5.20 How are environmental remediation liabilities accounted for
while an entity is in bankruptcy?
4.5.30 How are asset retirement obligations accounted for in
bankruptcy?
Example
4.5.10 Accounting for a litigation-related accrual during bankruptcy

4.6 Executory contracts

Questions
4.6.10 How are executory contracts with vendors accounted for in
bankruptcy?
4.6.20 How is deferred revenue (or a contract liability) related to an
existing sales contract accounted for in bankruptcy?

4.7 Lessee’s accounting for leases

The items in this section have been renumbered to reflect the removal of
content about Topic 840.
4.7.10 Overview
4.7.20 Topic 842
Questions
4.7.10 Does filing for bankruptcy by a lessee trigger a
reassessment of the lease term or a lessee purchase
option?
4.7.20 How does an entity account for a lease that is assumed
without modification?
4.7.30 How does an entity account for a lease that is amended in
bankruptcy?
4.7.40 How does an entity account for a lease that is rejected in
bankruptcy?
4.7.50 How does an entity account for a lessor’s claim when a
lease is rejected?
Example
4.7.10 Rejection of an operating lease

4.8 Preferential payments

Question
4.8.10 How are preferential payments accounted for in bankruptcy?

4.9 Statement of operations under Subtopic 852-10

4.9.10 Reorganization items
4.9.20 Interest
4.9.30 Other fees
Questions
4.9.10 What types of transactions are presented as reorganization
items in the statement of operations?
4.9.20 Is interest expense on debt obligations recognized during
bankruptcy?

4.9.30 How is a contingent fee incurred when an entity emerges

from bankruptcy accounted for?
Example
4.9.10 Accounting for interest income while in bankruptcy

4.10 Other accounting considerations

4.10.10 Overview
4.10.20 Goodwill and indefinite-lived intangible assets
4.10.30 Long-lived assets
4.10.40 Derivatives and hedge accounting
4.10.50 Share-based payments
4.10.60 Retirement and nonretirement postemployment benefits
4.10.70 Equity and convertible debt
4.10.80 Foreign currency denominated liabilities
4.10.90 Cash and cash equivalents
4.10.100 Income taxes
Questions
4.10.10 How does filing for bankruptcy affect the Topic 350
impairment tests?
4.10.20 How does filing for bankruptcy affect the Topic 360
recoverability test?
4.10.30 Can assets that were held-and-used before bankruptcy meet
the held-for-sale criteria after the filing but before the Court
approves their sale?
4.10.40 How does filing for bankruptcy affect the accounting for a
derivative?
4.10.50 How are amounts in AOCI from cash flow hedges
accounted for upon hedge termination?
4.10.60 How are adjustments to the carrying amount of a hedged
item in a fair value hedge accounted for when the hedging
relationship is terminated?
4.10.70 Does the probable cancellation of stock under a plan of
reorganization affect an assumed forfeiture rate used to
determine compensation cost?
4.10.75 How are pre-petition employee termination benefits
accounted for in bankruptcy?
4.10.80 When is a modification to, or a termination of, pension and
postretirement benefits recognized?
4.10.90 Is the interest cost component of net periodic benefit cost
recognized while in bankruptcy?

4.10.100 Does an entity in bankruptcy continue to recognize

cumulative dividends on preferred stock?
4.10.110 At what amount is a foreign currency denominated
prepetition liability recognized during bankruptcy?
4.10.120 How are cash and cash equivalents classified during
bankruptcy?
4.10.130 How are liabilities for uncertain tax positions accounted for
during bankruptcy?
4.10.140 How are deferred tax liabilities classified during bankruptcy?

4.11 Financial statement presentation

4.11.10 Segment reporting
4.11.20 Consolidation
4.11.30 Discontinued operations
Questions
4.11.10 Does filing for bankruptcy cause an entity to immediately
reassess its operating and reporting segments?
4.11.20 Does a parent that files for bankruptcy continue to
consolidate a subsidiary that has not?
4.11.30 Does Subtopic 852-10 apply to a subsidiary’s stand-alone
financial statements if the subsidiary is not included in the
parent’s bankruptcy petition?
4.11.40 Does a parent continue to consolidate a majority-owned
subsidiary that is a voting interest entity after the subsidiary
files for bankruptcy?
4.11.50 Is filing for bankruptcy a reconsideration event when
assessing whether an entity is a VIE?
4.11.60 Is a parent’s loss of control due to a subsidiary’s bankruptcy
filing after year-end a recognized subsequent event?
4.11.70 How does a parent calculate the gain or loss resulting from
deconsolidating a subsidiary?
4.11.80 Is an investment in a deconsolidated subsidiary accounted
for under the equity method?
4.11.90 How does a parent account for a guarantee issued on behalf
a deconsolidated subsidiary?
4.11.100 How does a parent account for obligations of a
deconsolidated subsidiary for which it is liable?
4.11.110 When does a parent begin to consolidate a bankrupt entity it
acquires?
4.11.120 Does a parent continue to consolidate a subsidiary after both
have filed for bankruptcy?

4.11.130 Is incremental reporting required if consolidated financial

statements include both entities that are in bankruptcy and
entities that are not?
4.11.140 How are intercompany balances accounted for when a party
to the balances is in bankruptcy?
4.11.150 How are liabilities subject to compromise presented when
they are part of a discontinued operation?
4.11.160 Where does an entity in bankruptcy present a loss from
remeasuring an asset held-for-sale that is part of a
discontinued operation?

4.12 Section 363 sales

Questions
4.12.10 How does an entity in bankruptcy account for a Section 363
sale?
4.12.20 How is a ‘break-up fee’ accounted for in bankruptcy?

4.13 Example financial statements while in bankruptcy

4.13.10 Overview
4.13.20 Balance sheet presentation
4.13.30 Statement of operations presentation
4.13.40 Statement of cash flows presentation
Examples
4.13.10 Balance sheet under Subtopic 852-10
4.13.20 Statement of operations under Subtopic 852-10
4.13.30 Statement of cash flows (prepared under the direct method)
under Subtopic 852-10

4.14 Disclosures
Question
4.14.10 What are additional items that an entity in bankruptcy should
consider disclosing?

4.15 SEC registrants

4.15.10 SEC reporting requirements
4.15.20 Disclosures
4.15.30 Other considerations
Questions
4.15.10 Are SEC registrants operating in bankruptcy relieved from
their SEC reporting requirements?

4.15.20 What information does an SEC registrant in bankruptcy

include in its request for a no-action position?
4.15.30 What modified reports will the SEC accept if an SEC
registrant in bankruptcy has been approved for a no-action
position?
4.15.40 Do SEC registrants operating in bankruptcy need to assess
the effectiveness of internal control over financial reporting?
4.15.50 When is an SEC registrant in bankruptcy required to file a
Form 8-K?
4.15.60 Is preferred stock in temporary equity reclassified to
stockholders' equity if it likely will be converted to common
stock upon bankruptcy emergence?

4.1 How the standard works

As illustrated in the diagram, the financial statements of an entity reporting
under Subtopic 852-10 are in many ways similar to those the entity would
ordinarily prepare. While an entity is in Chapter 11 bankruptcy, it continues to
follow US GAAP applicable to a going concern unless liquidation becomes
imminent. However, during bankruptcy, the needs of the financial statement
users change.

File petition for Emerge from

bankruptcy bankruptcy

— Apply US GAAP in the usual way — Apply US GAAP in the usual way — Apply fresh-start reporting (if applicable)
— Also apply Subtopic 852-10 — Then apply US GAAP in the usual way

Common considerations Common considerations

— Impairment, other asset- — Liabilities

Subtopic 852-10 attempts to meet those needs by requiring a bankrupt entity

to: [205-30-25-1, 852-10-45-2, 45-4]
— distinguish transactions and events that are directly associated with the
bankruptcy proceedings from the entity’s ongoing, normal operations; and
— measure certain liabilities based on amounts expected to be approved for
payment by the Court.
Additionally, each financial statement includes debtor-in-possession in its title
until the entity emerges from bankruptcy.
The requirements in Subtopic 852-10 are incremental, meaning they are applied
in addition to (rather than instead of) other US GAAP. Additionally, the
bankruptcy process may affect how an entity applies other US GAAP.
This chapter discusses the incremental requirements of Subtopic 852-10 and
common instances in which the bankruptcy process can affect how an entity
applies other US GAAP.

4.2 Scope of Subtopic 852-10

Excerpt from ASC 852-10

10-1 Presenting an entity’s financial evolution in its financial statements during

a Chapter 11 reorganization proceeding is an objective of the guidance in
this Subtopic.
> Financial Reporting during Reorganization Proceedings
45-1 Entering a reorganization proceeding, although a significant event, does
not ordinarily affect or change the application of generally accepted accounting
principles (GAAP) followed by the entity in the preparation of its financial
statements. However, the needs of financial statement users change, and thus
changes in the reporting practices previously followed by the entity are
necessary.
45-2 For the purpose of presenting an entity's financial evolution during a
Chapter 11 reorganization (see paragraph 852-10-10-1), the financial
statements for periods including and after filing the Chapter 11 petition shall
distinguish transactions and events that are directly associated with the
reorganization from the ongoing operations of the business.
45-3 Example 1 (see paragraph 852-10-55-2) provides an illustration of financial
statements and notes thereto for an entity operating under Chapter 11.
> Entities
15-1 This Subtopic provides guidance on financial reporting by entities that
have filed petitions with the Bankruptcy Court and expect to reorganize as
going concerns under Chapter 11 of title 11 of the United States Code. The
guidance in this Subtopic applies to all entities except governmental
organizations.
> Transactions
15-2 The guidance in this Subtopic applies to the following transactions and
activities:
a. Reorganizations by entities that expect to reorganize as a going concern
under Chapter 11
b. Reorganizations by entities upon emergence from Chapter 11 under
confirmed plans.
15-3 The guidance in this Subtopic does not apply to the following transactions
and activities:
a. Debt restructurings outside of Chapter 11
b. Reorganization activities consisting of liquidation or adoption of plans of
liquidation under the Bankruptcy Code.

The accounting and financial reporting requirements of Subtopic 852-10 apply

once an entity files a petition with the Court for Chapter 11 bankruptcy
assuming it expects to reorganize as a going concern. This guidance does not
apply to an entity that has filed a petition for Chapter 7 bankruptcy (i.e.

liquidation). The guidance for liquidation basis of accounting is in Subtopic 205-

30, which is outside the scope of this publication. [852-10-15-1, 15-2(a), 15-3(b)]

Question 4.2.10
Does Subtopic 852-10 apply to an entity that is
reorganizing under foreign bankruptcy laws?

Interpretive response: It depends. We believe an entity should consider the

bankruptcy laws in the foreign jurisdiction to determine whether Subtopic 852-
10 should be applied.
Specifically, an entity should consider the laws governing the foreign petition
filing and how those laws compare to those of the Code, including but not
limited to:
— the level of legal/court involvement;
— the existence of any automatic stay provisions; and
— whether the foreign jurisdiction directs segregation of the creditors into
different classes.
A foreign entity will have to exercise judgment – and should consider whether
to seek legal advice as to how closely the foreign laws compare to those of the
Code – to determine whether to apply Subtopic 852-10.

Question 4.2.20
Does Subtopic 852-10 apply to not-for-profit
organizations?

Interpretive response: Yes. The guidance in Subtopic 852-10 applies to all

entities except governmental organizations. Therefore, we believe Subtopic
852-10 applies to a not-for-profit organization that has filed for bankruptcy and
expects to reorganize under Chapter 11 as a going concern. [852-10-15-1]
However, if the entity applies GASB GAAP because it is owned by a
government unit, the guidance does not apply. If an entity in bankruptcy is a
government or a government-sponsored entity, it applies the guidance in GASB
Codification Section Bn5, Bankruptcies. [852-10-15-1]

Question 4.2.30
Does Subtopic 852-10 apply when an entity
undergoes a reorganization without filing a
bankruptcy petition?
Interpretive response: No. The requirements of Subtopic 852-10 do not apply
until a petition is filed. Therefore, if a reorganization is achieved entirely ‘out of
court’, we believe Subtopic 852-10 does not apply. [852-10-15-1]

However, Subtopic 852-20 (quasi-reorganizations) may apply if certain criteria

are met. Subtopic 852-20 is outside the scope of this publication.

Question 4.2.40
Does Subtopic 852-10 apply to a prearranged or
prepackaged bankruptcy?

Interpretive response: Yes, after the entity has filed for bankruptcy. Subtopic
852-10 applies to an entity that is operating while in bankruptcy, regardless of
whether the bankruptcy is prearranged or prepackaged, or is expected to be
executed through the standard process with the Court. [852-10-15-1]
For a discussion of prearranged and prepackaged bankruptcies, see section
2.3.50.

4.3 Liabilities under Subtopic 852-10

4.3.10 Overview

Excerpt from ASC 852-10

• > Balance Sheet

45-4 The balance sheet of an entity in Chapter 11 shall distinguish prepetition
liabilities subject to compromise from those that are not (such as fully secured
liabilities that are expected not to be compromised) and postpetition
liabilities. Liabilities that may be affected by the plan shall be reported at the
amounts expected to be allowed, even if they may be settled for lesser
amounts. If there is uncertainty about whether a secured claim is
undersecured, or will be impaired under the plan of reorganization, the entire
amount of the claim shall be included with prepetition claims subject to
compromise; such a claim shall not be reclassified unless it is subsequently
determined that the claim is not subject to compromise.
45-5 Prepetition liabilities, including claims that become known after a petition
is filed, shall be reported on the basis of the expected amount of the allowed
claims in accordance with Subtopic 450-20, as opposed to the amounts for
which those allowed claims may be settled. Once these claims satisfy the
accrual provisions of that Subtopic, they shall be recorded in the accounts in
accordance with this paragraph. Paragraph 852-10-50-2 notes that claims not
subject to reasonable estimation are required to be disclosed in the notes to
financial statements.
45-7 Paragraph 852-10-45-4 addresses the separation of liabilities subject to
compromise from those that are not. Circumstances arising during
reorganization proceedings may require a change in the classification of
liabilities between those subject to compromise and those not subject to

compromise. Liabilities not subject to compromise shall be further segregated

into current and noncurrent classifications if the entity presents a classified
balance sheet.
45-8 Section 470-10-45 requires current liabilities classification in a classified
balance sheet for long-term liabilities that, by their terms, are due on demand
or will be due on demand within one year, or the operating cycle, if longer. This
classification requirement also applies to long-term liabilities that are or will be
callable by the creditor because of a violation of a provision of the debt
agreement. The automatic stay provisions of Chapter 11 make it
unnecessary to reclassify prepetition long-term liabilities even though
prepetition creditors might demand payment or there is a violation of a
covenant in the debt agreement.

Subtopic 852-10 significantly affects the classification and presentation of

liabilities. Liabilities incurred by the entity before filing for bankruptcy are
prepetition liabilities, and those incurred after are postpetition liabilities.
Prepetition liabilities can be either subject to compromise or not subject to
compromise. In contrast, postpetition liabilities are not subject to compromise.
The bankrupt entity needs to distinguish prepetition liabilities subject to
compromise from other liabilities. [852-10-45-4, 45-7]
The following diagram illustrates the distinction between the different liabilities.
File petition for Emerge from
bankruptcy bankruptcy

Prepetition liabilities Postpetition liabilities

Subject to Not subject to

compromise compromise

Segregate into
Present
current and Follow applicable
separately on the
noncurrent if US GAAP
balance sheet
appropriate

4.3.20 Prepetition liabilities

Classifying and presenting prepetition liabilities subject to
compromise
Prepetition liabilities are those that are incurred by the entity before it files for
bankruptcy. This includes liabilities considered by the Court to be prepetition
claims, such as a rejection of a lease (see section 4.7). Prepetition liabilities can
include claims that become known after the petition is filed, but that were
incurred before the petition filing. [852-10 Glossary, 852-10-45-5]

The following diagram illustrates the life cycle of a prepetition liability subject to
compromise – from the date of filing for bankruptcy to the date of emerging
from bankruptcy (the ‘bankruptcy proceeding period’).

Prepetition liability subject to compromise

File petition for Emerge from

bankruptcy bankruptcy

Bankruptcy proceeding period

— Adjust expected amount of allowed claim

as it changes due to new facts and
circumstances.
— Recognize changes in carrying amount as
‘reorganization items’.

Record at
expected
amount of
allowed claims

Prepetition liabilities subject to compromise are presented separately on the

balance sheet from liabilities not subject to compromise (see Example 4.13.10).
[852-10-45-4]

Question 4.3.10
When are prepetition liabilities subject to
compromise?

Interpretive response: A prepetition liability is subject to compromise if it is

impaired from the creditor’s perspective under the plan of reorganization. This
may be the case if, for example, a claim is unsecured or undersecured – i.e. the
value of the security interest is less than the amount of the claim. In contrast, a
prepetition liability is not subject to compromise if it is fully secured and
therefore not expected to be impaired as a result of bankruptcy proceedings.
[852-10-45-4]

Is the liability fully secured?

No Yes

Classify as
Classify as
liability not
liability subject to
subject to
compromise
compromise

Priority claims are generally not impaired because the Code requires that all
priority claims be satisfied in full for the entity’s plan of reorganization to be
confirmed. Consequently, liabilities recognized for priority claims are presented
as not subject to compromise.

Throughout bankruptcy proceedings, a prepetition liability may be reclassified

from liabilities subject to compromise to liabilities not subject to compromise or
vice versa as new or better information becomes available (see Question
4.3.20). [852-10-45-4]

Question 4.3.20
How are prepetition liabilities classified when there
is uncertainty about whether a secured claim is
undersecured?
Interpretive response: If an entity is uncertain about whether a secured claim
is undersecured, it initially classifies the claim as a liability subject to
compromise in its entirety. [852-10-45-4]
This uncertainty may exist for a number of reasons. For example, the appraised
value of collateral may not be known at the time the balance sheet is prepared,
or cash flow expectations may be uncertain because the effect of the
bankruptcy on those cash flows cannot be reasonably determined. For these
reasons and others, many prepetition claims are initially reported as liabilities
subject to compromise, even if they are secured.
As the bankruptcy proceedings evolve, a liability classified as subject to
compromise is reclassified if:
— the Court approves payment of the claim; or
— new information affects the evaluation of whether the claim is fully
secured.
Court approval of payment of claim
It may be appropriate to reclassify a liability initially subject to compromise to
liabilities not subject to compromise when the Court approves payment of a
claim. For example, the Court often approves certain claims early in the
bankruptcy process (e.g. payments to critical vendors or employees) so the
entity can continue its operations. Once approved for payment by the Court, a
liability is by definition no longer subject to compromise and reclassification is
appropriate.
New information about claim’s secured status
An entity may identify information that indicates a prepetition liability is fully
secured and should be reclassified to liabilities not subject to compromise. For
example, revised projections may indicate that the estimated cash flows from
the collateral securing a claim are greater than initially anticipated. In this case,
the liability is reclassified in its entirety to liabilities not subject to compromise
because it is now deemed fully secured. [852-10-45-7]
Similarly, new information may be obtained about a prepetition liability initially
classified as not subject to compromise. For example, an entity may determine
that all security interests are either unsecured or undersecured and will likely
not be repaid in full. It is not unusual to discover that claims that appeared to be
fully secured at the onset of bankruptcy proceedings are in fact undersecured.

Because of this, an entity continues to assess the classification of its

prepetition liabilities at each reporting date during the bankruptcy proceedings.

Question 4.3.30
How is a prepetition liability classified if an entity
learns about it after the petition date?

Background: As a result of the schedule of claims filing process, an entity

could become aware of additional obligations after it files a petition for
bankruptcy that were incurred before filing (e.g. a legal or environmental claim).
Interpretive response: Because prepetition liabilities include claims that
become known after a petition is filed, a claim identified after the petition date
for which the obligating event occurred before the petition date is classified
consistent with other prepetition claims. [852-10-45-5]

Question 4.3.40
Where are liabilities subject to compromise
presented on the balance sheet?

Interpretive response: Liabilities subject to compromise are presented as a

single financial statement caption on the balance sheet, either before or after
noncurrent liabilities. Details about the caption are disclosed in the notes to the
financial statements (see section 4.14).
Prepetition claims are generally prohibited from being paid until after the entity
emerges from bankruptcy. The basis for conclusions in Statement of Position
90-7 stated that, because the timing of emergence is usually unknown, and
bankruptcy proceedings often take greater than one year from petition filing to
emergence, liabilities subject to compromise should be presented separately
from current liabilities. [SOP 90-7.43-48]
Further, the automatic stay provisions of the Code prohibit creditors from
attempting to collect, assess or recover claims on the entity in bankruptcy.
Because of this, it is unnecessary for an entity to recharacterize long-term
liabilities subject to compromise as short-term, even though the creditor may
demand payment because of a violation of the agreement. [852-10-45-8]
See Example 4.13.10 for an example of the balance sheet presentation of
liabilities subject to compromise during bankruptcy proceedings.

Recognizing and measuring prepetition liabilities subject to

compromise
Prepetition liabilities subject to compromise are recognized when they meet the
recognition criteria in Subtopic 450-20 (loss contingencies). That Subtopic

requires a loss contingency to be recognized if it is probable and reasonably

estimable. [852-10-45-5, 450-20-25-2]
Although liabilities subject to compromise are usually settled for less than the
allowed claim amount, they are measured at the amount that is expected to be
allowed by the Court. If that amount cannot be reasonably estimated, the
existence of the liability is disclosed in the notes to the financial statements
(see section 4.14). [852-10-45-4, 45-5, 50-2]

Question 4.3.50
When is a prepetition claim probable and
reasonably estimable?

Background: A prepetition claim, including a claim that becomes known after a

petition is filed, is recognized as a liability when it is probable and reasonably
estimable. The liability is measured at the amount of the expected allowed
claim as opposed to the amounts for which those allowed claims may be
settled. [450-20-25-2, 852-10-45-5,]
A claim is allowed or expected to be allowed if:
— it is included on the debtor’s schedule of assets and liabilities filed with the
Court by the debtor – and not marked on the schedule as contingent,
unliquidated or disputed by the vendor;
— it is submitted by a creditor and not objected to by the debtor; or
— it has been approved by the Court.
Interpretive response: For some claims (e.g. prepetition debt and accounts
payable), determining that the claim is probable and reasonably estimable is
relatively easy because the debtor includes them on the schedule filed with the
Court and there are contractual amounts owed. For these claims, the liability is
reclassified to liabilities subject to compromise when appropriate and measured
at the amount of the expected allowed claim.
For other claims, determining whether the Court is expected to allow a claim
may be more difficult and may require the assistance of legal counsel. For
example, a vendor may file a claim for breach of contract, but there is a dispute
about whether the contract has been breached or about the amount of
damages. In these cases, the probable and/or reasonably estimable threshold
may not be met, and it would be appropriate to wait until the Court approves
the claim from the vendor to recognize a liability subject to compromise. See
Questions 4.5.10 and 4.5.20 for a discussion of measuring prepetition
contingent liabilities.
Liabilities subject to compromise are estimates of the amount that is expected
to be allowed by the Court. As bankruptcy progresses and new or better
information about a claim becomes available, an entity’s estimate of an allowed
claim may change. Any changes to liabilities subject to compromise as a result
of changes to the expected allowed claim are recognized as reorganization
items in the statement of operations (see section 4.9.10).

The amount recorded for a claim is not changed to reflect the settlement
amount until emergence. These settlement adjustments are generally
recognized as reorganization items (see section 4.9.10).

Example 4.3.10
Lifecycle of a liability subject to compromise
ABC Corp. filed a petition for bankruptcy on July 1, Year 1. At the time of the
petition filing, ABC owed Lender $500 for an unsecured loan.
The claim was allowed by the Court and, at the time of preparing its September
30 financial statements, ABC estimated the allowed claim to be $500. ABC
reclassified the $500 payable to Lender from loans payable to liabilities subject
to compromise on its September 30 balance sheet.
As the bankruptcy proceedings progress, ABC believes that the claim with
Lender will ultimately be settled for $450. However, $500 is still the best
estimate of the allowed claim. Therefore, the liability is not adjusted for the
amount at which ABC expects it to settle.
On November 1, ABC is notified that the Court has revised the allowed claim to
$475 because a late payment fee has been disallowed. As a result, ABC
reduces the carrying amount of liabilities subject to compromise by $25. The
adjustment is recognized as a reorganization item in ABC’s statement of
operations. ABC records the following journal entry.

Debit Credit
Liabilities subject to compromise 25
Reorganization items 25
To adjust liabilities subject to compromise to
amount of allowed claim.

See Example 5.3.30 for the treatment of the claim payable to Vendor upon
ABC’s emergence from bankruptcy.

Question 4.3.60
In what period should a claim be recognized if the
entity learns about it after the reporting date?

Background: As discussed in section 3.13, if a subsequent event provides

additional evidence about conditions that existed at the reporting date, it is
recognized in the financial statements. In contrast, if an event provides
evidence about conditions that did not arise until after the reporting date, it is a
nonrecognized subsequent event that may need to be disclosed.
Interpretive response: The filing of a claim (and the allowance or expected
allowance by the Court) after the reporting date, but before the entity’s financial

statements are issued (or available to be issued), is a recognized subsequent

event and the entity recognizes a liability if:
— the condition existed at the reporting date; and
— the claim meets the requirements to be recognized and measured as a
prepetition liability subject to compromise (see Question 4.3.50).

4.3.30 Liabilities not subject to compromise

Liabilities not subject to compromise include prepetition liabilities that are not
expected to be impaired under the plan of reorganization (including fully secured
liabilities) and postpetition liabilities. In addition to being presented separately
from liabilities subject to compromise, liabilities not subject to compromise
should be segregated into current and noncurrent if the entity presents a
classified balance sheet. [852-10-45-4, 45-7]

Question 4.3.70
How are liabilities not subject to compromise
accounted for?

Interpretive response: During bankruptcy proceedings, liabilities not subject to

compromise are accounted for under other applicable US GAAP – i.e. in the
same manner as if the entity were not in bankruptcy.
As discussed in Question 4.3.20, the classification of prepetition liabilities can
change as the bankruptcy proceedings evolve and the entity obtains new or
better information. If the entity determines that a liability that was initially
classified as not subject to compromise becomes subject to compromise, the
liability is reclassified and the requirements of Subtopic 852-10 apply (see
section 4.3.20).
See Example 4.13.10 for an example balance sheet presentation during
bankruptcy proceedings.

4.4 Debt
4.4.10 Prepetition debt

Excerpt from ASC 852-10

• > Balance Sheet

45-6 Debt discounts or premiums as well as debt issue costs shall be viewed
as valuations of the related debt. When the debt has become an allowed claim
and the allowed claim differs from the net carrying amount of the debt, the
recorded amount shall be adjusted to the amount of the allowed claim (thereby

adjusting existing discounts or premiums, and deferred issue costs to the

extent necessary to report the debt at this allowed amount). The gain or loss
resulting from the entries to record the adjustment shall be classified as
reorganization items, as discussed in paragraph 852-10-45-9. Premiums and
discounts as well as debt issuance cost on debts that are not subject to
compromise, such as fully secured claims, shall not be adjusted.

The Court typically allows a claim for unsecured or undersecured debt in an

amount totaling the principal balance plus accrued interest as of the petition
date. When adjusting the carrying amount to the amount of the allowed claim,
the adjustment includes a write off of unamortized debt issuance costs and
debt premiums or discounts; see Question 4.4.10 for a discussion of when this
adjustment is made. Consistent with the treatment of other prepetition
liabilities, this gain or loss is classified as a reorganization item (see section
4.9.10). [852-10-45-4, 45-6]
If debt is fully secured and therefore not subject to compromise, no adjustment
is made to the net carrying amount of the debt (including unamortized debt
issuance costs and debt premiums or discounts) and it continues to be
accounted for under Topic 470 (debt) and Topic 835 (interest). [852-10-45-6]

Question 4.4.10
When is debt that is subject to compromise
adjusted to the amount of the allowed claim?

Background: Generally, prepetition liabilities subject to compromise are

measured at the amount that is expected to be allowed by the Court. For
unsecured or undersecured debt, which would be considered subject to
compromise upon filing, the expected allowed claim is typically the total
principal balance plus any accrued interest. [852-10-45-4]
Subtopic 852-10 also indicates that the carrying amount of debt is adjusted to
the allowed amount when it has become an allowed claim. When the
adjustment is made to the allowed amount, premiums, discounts and debt
issuance costs are written off to reorganization items. Subtopic 852-10 is silent
on the treatment of debt before it becomes an allowed claim. [852-10-45-4, 45-6]
Because of the nature of bankruptcy proceedings, the debt may not be formally
allowed by the Court when the petition is filed. Therefore, it is unclear whether
debt should be adjusted when it is expected that it will become an allowed
claim (when considered subject to compromise) or when the Court explicitly
allows the claim.
Interpretive response: We believe two approaches commonly used in practice
are acceptable. An entity should apply a consistent approach to each debt that
is subject to compromise.
Approach 1: Expectation
Under this approach, the debt is adjusted to the expected allowed claim when it
is probable that the Court will allow the claim and the amount of the claim is

reasonably estimable. Generally, this would be at the petition date for the
following reasons.
— Probable. Because prepetition debt is a claim the entity is aware of when it
files for bankruptcy, it is included on the schedule of claims, and therefore it
is expected to be an allowed claim at that time.
— Reasonably estimable. Because the Court customarily allows a claim for
unsecured or undersecured debt at an amount totaling the principal balance
plus accrued interest as of the petition date, the entity can reasonably
estimate the amount.
Approach 2: Allowed by the Court
Under this approach, the entity measures the debt and related discount or
premium and debt issue costs under other relevant US GAAP until the debt has
formally become an allowed claim. At the time the claim is allowed, the
adjustment to the amount of the allowed claim is recognized as a reorganization
item. However, the debt would be classified as a liability subject to compromise
before becoming an allowed claim.

Example 4.4.10
Accounting for debt subject to compromise
ABC Corp. files a petition for bankruptcy on July 1, Year 1. As of that date, ABC
has an unsecured loan outstanding with Bank. No principal payments are due
on the loan until January 1, Year 4.
The debt was not callable before the filing, and therefore ABC’s balances
related to the debt as of July 1, Year 1 are:
— Principal balance: $1,000
— Unamortized discount: $100
— Unamortized debt issue costs: $20
— Accrued interest payable: $30
Because the debt was included on the schedule filed with the Court when ABC
filed for bankruptcy (see Question 4.4.10), at the petition date ABC expects the
Court to allow the claim in the amount of $1,030 (principal of $1,000 plus
accrued interest of $30).
ABC follows Approach 1 in Question 4.4.10 and adjusts the balance of the debt
to the expected allowed claim on July 1, Year 1 because the expected allowed
claim is probable and reasonably estimable. ABC records the following journal
entries.

Debit Credit
Reorganization items 120
Debt discount 100
Debt issue costs 20
To write off debt discount and debt issue costs to
reorganization items.

Debit Credit
Long-term debt 1,000
Accrued liabilities 30
Liabilities subject to compromise 1,030
To present amount of allowed claim as liabilities
subject to compromise.

If ABC followed Approach 2 in Question 4.4.10, it would classify the debt as

subject to compromise but otherwise continue to account for the debt under
other applicable GAAP until the debt became an allowed claim. At that time, it
would record an entry similar to the one above to write off the debt discount
and debt issue costs.

Question 4.4.20
Are premiums, discounts and debt issue costs
written off during bankruptcy proceedings if the
debt is not subject to compromise?
Interpretive response: No. If debt is fully secured and therefore not subject to
compromise, no adjustment is made to the balance of the debt or its related
premiums or discounts and debt issue costs. These amounts continue to be
accounted for under Topic 470 (debt) and Topic 835 (interest). Therefore, an
adjustment to the effective yield or the unamortized amount of premiums,
discounts or debt issue costs is made only if required by Topic 470 or Topic
835. [852-10-45-6]

Question 4.4.30
Can debt extinguishment gains or losses resulting
from bankruptcy proceedings be presented in
discontinued operations?
Interpretive response: Yes. We believe such presentation is acceptable if the
debt is clearly associated with the discontinued operation and the gain or loss is
disclosed either in the statement of operations or in the notes to the financial
statements (see section 4.14). [852-10-45-9]

Question 4.4.40
Does the troubled debt restructurings guidance
apply to an entity in bankruptcy?

Interpretive response: Potentially, yes. The scope of Subtopic 470-60 includes

all troubled debt restructurings, including those consummated under

reorganization, arrangement, other provisions of the Federal Bankruptcy Act or

related federal statutes.
However, Subtopic 470-60 does not apply if, under provisions of those federal
statutes or in a quasi-reorganization or corporate readjustment with which a
troubled debt restructuring coincides, the debtor restates its liabilities generally.
This means that if such restructurings or modifications accomplished under the
oversight of the Court encompass most of the amount of the debtor's liabilities,
they are not in the scope of Subtopic 470-60. [470-60-15-5, 15-10]
While Subtopic 470-60 will generally not apply in bankruptcy, entities should
consider the facts and circumstances of their bankruptcy proceedings when
concluding whether they are restructuring the majority of their liabilities. For
example, if an entity is executing a prepackaged or prearranged bankruptcy (see
section 2.3.50) with the objective of restructuring only a specific debt
agreement, without affecting its other liabilities, it may conclude that the
restructuring is a troubled debt restructuring.

Question 4.4.50
Upon filing for bankruptcy, how does an entity
account for a deferred gain associated with a
liability subject to compromise that resulted from a
previous troubled debt restructuring?
Background: Before filing for bankruptcy, an entity may seek financial relief by
negotiating a modification to a debt agreement. The modification may have
been accounted for as a troubled debt restructuring.
Interpretive response: We believe a deferred gain from a previous troubled
debt restructuring associated with a liability subject to compromise should
generally be written off to reorganization items at the time of the bankruptcy
filing. This is analogous to the accounting treatment for discounts, premiums
and debt issue costs. As discussed in section 4.4.10, the Court typically allows
a claim for unsecured or undersecured debt in an amount totaling the principal
balance plus accrued interest as of the petition date. Therefore, any discounts,
premiums and debt issue costs are generally written off to report the debt at
the amount of the allowed claim. See Question 4.4.10 for a discussion of when
this adjustment is made. [852-10-45-6]
Similar to discounts, premiums and debt issue costs, a deferred gain is not an
amount due to the creditor, but a measurement balance resulting from the
required accounting treatment. Therefore, we believe the deferred gain should
be adjusted similarly to other measurement type accounts recognized and
presented within the net carrying amount of the debt.

4.4.20 Debtor-in-possession financing

DIP financing is provided to an entity in bankruptcy to finance the ongoing
operations of the entity while it reorganizes.

Question 4.4.60
How are fees related to DIP financing accounted for
in bankruptcy proceedings?

Background: When entering into a debtor-in-possession (DIP) financing

arrangement, an entity incurs fees payable to the DIP lender and third parties,
including attorneys and rating agencies.
For an entity not in bankruptcy, debt issue costs are typically recognized as a
reduction of the carrying amount of the debt and amortized using the effective
interest method over the term of the debt as a component of interest expense.
However, US GAAP prohibits deferring professional fees and similar
expenditures during bankruptcy. It is unclear whether this prohibition is meant
to apply to fees for DIP financing. [835-30-35-2, 45-1A, 852-10-45-10]
Interpretive response: We are aware of two approaches to the accounting for
these fees, which are explained below. We believe either of these methods is
acceptable provided that the fees related to DIP financing are clearly disclosed
in the notes to the financial statements (see section 4.14).
Approach 1: Defer fees
Under this approach, all fees related to the DIP financing are deferred and
amortized over the term of the arrangement. This approach is based on the
statement in Subtopic 852-10 that interest expense is not a reorganization item.
Under this approach, fees related to DIP financing are treated as an additional
cost of borrowing while the entity is operating in bankruptcy, similar to the
treatment of financing costs for debt obligations incurred outside of bankruptcy.
[852-10-45-11]

An entity amortizes these fees into interest expense over the expected term of
the DIP financing arrangement. Because the time period over which the entity
will operate in bankruptcy is uncertain, the term of the DIP financing
arrangement is estimated at the origination of the financing and is updated at
each reporting date until emergence.
If the DIP financing is extinguished upon emergence from bankruptcy (which is
usually the case as it is replaced with post-emergence debt), any fees related to
DIP financing remaining on the balance sheet are expensed. These fees are
presented outside of reorganization items. [852-10-45-11]
Approach 2: Expense fees
Under this approach, all fees related to the DIP financing are expensed as
incurred and recognized as reorganization items in the statement of operations.
This approach is based on AICPA Consulting Services Practice Aid 98-1
(nonauthoritative). The Practice Aid indicates that there is some basis for this
provided the charges exceed what would be paid if the entity were not in
bankruptcy, and the fees do not represent interest. [AICPA CSPA 98-1 9.29]
Additionally, supporters of this approach believe that all fees related to DIP
financing would not otherwise be incurred, and therefore they should be
expensed as incurred under Subtopic 852-10 (see section 4.9.30); this is
consistent with other professional fees directly related to the bankruptcy
proceeding.

In our experience, many entities that expect to replace the DIP financing when
they emerge from bankruptcy follow this approach.

Question 4.4.70
How are cash flows related to DIP financing
classified in the statement of cash flows?

Interpretive response: We believe that cash flows related to DIP financing

(including fees) should be classified consistent with the treatment of similar
financing arrangements required by Topic 230. For guidance on presenting debt
financing transactions in the statement of cash flows, see chapter 12 of KPMG
Handbook, Statement of cash flows.
See Example 4.13.30 for an example statement of cash flows for an entity in
bankruptcy, which includes DIP financing.

Question 4.4.80
How is DIP financing classified on the balance
sheet?

Background: DIP financing can be structured in a variety of ways, depending

on the facts and circumstances surrounding the debtor’s bankruptcy
proceedings. Usually, DIP financing is structured as a term loan, but some
debtors may obtain a revolving credit facility. DIP financing must be approved
by the Court.
Interpretive response: DIP financing is entered into postpetition and therefore
it is not subject to compromise (see section 4.3.30). Consistent with other
liabilities not subject to compromise, if an entity prepares a classified balance
sheet, DIP financing is classified as a current and/or noncurrent liability based
on its terms and the related analysis under Subtopic 470-10.

4.5 Other considerations for liabilities

There are many considerations when accounting for liabilities while in
bankruptcy. This section discusses some of the more common considerations.
However, an entity should consider facts and circumstances specific to its
liabilities to determine the appropriate accounting treatment while in
bankruptcy.

4.5.10 Contingent liabilities

A contingency is an existing condition, situation or set of circumstances
involving uncertainty as to possible gain or loss to an entity that will ultimately

be resolved when one or more future events occur or fail to occur. [450-10
Glossary]

As discussed in section 4.3.20, Subtopic 450-20 provides overall guidance on

accounting for loss contingencies. However, additional guidance exists for
certain types of loss contingencies, as illustrated in the following table (not
exhaustive). [450-20-60]

Type of loss
Guidance contingency Description
Subtopic 410-20 Asset retirement Contingencies associated with the
obligations retirement of a long-lived asset that
result from the acquisition,
construction, development or normal
operation of a long-lived asset. [450-20-
60-7]

Subtopic 410-30 Environmental Contingencies related to

remediation liabilities environmental remediation liabilities
that arise from the improper operation
of a long-lived asset. [450-20-60-8]
Subtopic 460-10 Product warranties and Contingencies related to the
product defects performance of nonfinancial assets
that are owned by the guaranteed
party. [460-10 Glossary]
Topic 460 Guarantees Contingent obligations that do not
meet the definition of a derivative that
can require the guarantor to make
payments to the guaranteed party for
a number of reasons: [460-10-15-4]
— based on changes in an
underlying;
— based on another entity’s failure
to perform under an obligating
agreement; or
— based on indirect guarantees of
the indebtedness of others.

Subtopic 954-450 Malpractice claims Contingent obligations against a

medical professional for malpractice.
[450-20-60-21]

Regardless of the type of contingency, once an entity files for bankruptcy, it

must consider whether each obligation is expected to be an allowed claim. If
the obligation is an allowed claim, it is accounted for under Subtopic 852-10
when it meets the requirements to be recognized and measured as a
prepetition liability subject to compromise (see Question 4.3.50).

Question 4.5.10
Does an entity reclassify an accrual related to
ongoing litigation to liabilities subject to
compromise at the time it files for bankruptcy?
Background: Before bankruptcy, an entity may or may not have accrued
liabilities related to ongoing litigation. For some types of litigation, an entity may
conclude that a loss is both probable and reasonably estimable, and therefore
recognize an accrual. However, for other litigation matters, an entity may not
recognize an accrual, concluding either that a loss is not probable or that the
amount is not reasonably estimable. [450-20-25-2]
For an entity not in bankruptcy, the amount accrued for a contingency such as a
loss from litigation is based on an estimate of the amount at which the entity
expects the related lawsuit to settle; or the minimum amount within a range of
loss when no amount within the range is a better estimate than any other. This
amount may differ from a settlement in bankruptcy.
Interpretive response: Generally, yes. Claims related to ongoing lawsuits
underlying a prepetition contingent liability initially fall under the automatic stay
provisions when the entity files a petition for bankruptcy; legal cases
outstanding at that time become part of the bankruptcy proceedings. Therefore,
contingencies for litigation accrued before bankruptcy are usually classified as
liabilities subject to compromise.
The entity adjusts the contingent liability subject to compromise to the amount
of the allowed claim (see Question 4.3.50). Absent any other changes or
information from the bankruptcy proceedings about the amount of the allowed
claim, we believe the contingent liability should continue to be recorded at the
same amount as it was prior to the filing. When additional information is known
about the amount of the allowed claim, the liability should be adjusted.
However, there may be situations in which the entity has enough certainty as of
the filing date to conclude that the claim will not be subject to compromise. For
example, when the plaintiff petitions the Court to exclude the litigation from the
bankruptcy case and the entity expects the claim to be excluded based on
available information. This is often the case with environmental remediation
liabilities, particularly if the US government is a party to the matter (see
Question 4.5.20).
During bankruptcy proceedings, the Court assesses each case and decides
whether to dispose of it (through outright dismissal or determining a judgment),
or to permit the continuance of the litigation post-emergence. The entity should
monitor the Court’s progress to determine whether the liability should be
reclassified into or out of liabilities subject to compromise based on these
proceedings.
Disposal through judgment (including settlement)
If a case is disposed of through a judgment by the Court or settlement by the
parties before emergence, the judgment or settlement amount becomes an
allowed claim that is part of the unsecured class of claims; the liability is
classified as subject to compromise if not already and is adjusted to the amount
of the allowed claim.

As discussed in Question 4.3.50, liabilities subject to compromise are measured

at the amount that is allowed or expected to be allowed by the Court.
Therefore, the liability for the case is not reduced below the amount of the
allowed claim even if it becomes apparent that the claim will be settled, as part
of the plan of reorganization, for an amount less than the allowed claim.
Instead, upon emergence from bankruptcy when the entity settles the
obligation, the difference between the liability recognized and the settlement
amount is presented as a reorganization item in the predecessor financial
statements.
Disposal through outright dismissal
If the Court dismisses a case without judgment being awarded to the plaintiff,
the entity derecognizes the liability through reorganization items in the
statement of operations only when all corresponding appeals to the Court have
been exhausted. This generally occurs when the plan of reorganization is
confirmed by the Court and the entity emerges from bankruptcy.

Example 4.5.10
Accounting for a litigation-related accrual during
bankruptcy
ABC Corp. is a construction company that had recognized a $1 billion contingent
liability for asbestos-related litigation. In an effort to manage its asbestos
liability, ABC files a petition for bankruptcy on March 1, Year 1, to use the Court-
supervised reorganization process to resolve all of its present and future
asbestos claims.
As a consequence of ABC filing for bankruptcy, holders of asbestos claims are
stayed from continuing to prosecute pending litigation and from filing new
lawsuits against ABC. In addition, ABC is prohibited from paying any prepetition
claims unless they are authorized by the Court.
Significant differences exist in the way ABC’s asbestos-related claims may be
addressed in the bankruptcy process as opposed to if it were not in bankruptcy.
At the filing date, ABC does not have information about the amount the Court
expects to allow. Therefore, ABC continues to measure its asbestos liability at
the prepetition amount until the Court acts on the claims. ABC classifies the
liability as subject to compromise.

Question 4.5.20
How are environmental remediation liabilities
accounted for while an entity is in bankruptcy?

Background: Subtopic 410-30 requires a liability for an environmental

remediation obligation to be recognized if the criteria in Subtopic 450-20 are
met – i.e. it is probable that a liability has been incurred and the loss can be
reasonably estimated. [410-30-25-4]

To conclude that it is probable that an environmental remediation liability has

been incurred, both of the following criteria must be met: [410-30-25-4]
— litigation has commenced or a claim or assessment has been asserted or is
probable; and
— it is probable that the outcome of this litigation, claim or assessment will be
unfavorable.
Interpretive response: Environmental remediation liabilities are accounted for
during bankruptcy consistent with other contingent liabilities; however, they are
not generally classified as liabilities subject to compromise (see Question
4.5.10). This is because environmental obligations existing at the date the entity
files a petition for bankruptcy typically are not dismissed in the bankruptcy
proceedings and instead remain an obligation of the entity after emerging from
bankruptcy, particularly if the US government is a party to the matter.

Question 4.5.30
How are asset retirement obligations accounted for
in bankruptcy?

Background: Unlike an environmental remediation liability that arises from

improper operations (see Question 4.5.20), AROs are obligations associated
with the retirement of a long-lived asset that result from the acquisition,
construction or development and/or the normal operation of a long-lived asset;
this includes environmental remediation liabilities that arise from the normal
operation of a long-lived asset that are associated with the retirement of that
asset. [410-20 Glossary]
Interpretive response: Usually an ARO continues to be accounted for under
Subtopic 410-20 during bankruptcy. Although an ARO represents a legal
obligation, it generally does not represent an amount owed to another party,
and therefore there is no counterparty to file a claim against the entity.
In limited circumstances, an ARO may be reclassified to liabilities subject to
compromise. For example, an entity may rent space and have a contractual
obligation to remove leasehold improvements. If the entity rejects the lease and
fails to remove the leasehold improvements before returning the property to
the lessor, the lessor may file a claim to recover the cost of removing the
leasehold improvements. In this case, the ARO is reclassified to liabilities
subject to compromise when the criteria for doing so are met (see Question
4.3.20).

4.6 Executory contracts

An executory contract is generally understood to be a contract under which
performance remains due from any party to the contract. Executory contracts in
place at the time the petition is filed can be assumed with or without
modification or rejected during bankruptcy proceedings (see section 2.3.30)
subject to Court approval.

If an entity rejects a contract, it is protected from the counterparty seeking

remedies by the automatic stay provisions (see section 2.3.30) and the
counterparty will generally file a proof of claim for damages or losses incurred
as a result of the action.
The following summarizes the accounting treatment for executory contracts
depending on whether they are assumed or rejected.

If the contract is: Treat the contract:

As an unsecured claim, which generally means the following.

— Record a liability at the estimated allowed amount,
(including amounts due under the terms of the contract
Rejected
as well as penalties and other clauses).
— Classify as a liability subject to compromise, unless it
will be satisfied in full.

As it would be treated in the normal course of business.

— Remit all past amounts owed to the counterparty.
Assumed — Account for the contract through bankruptcy and upon
emergence in its current state.
— Do not classify as a liability subject to compromise.

There are many types of executory contracts, including but not limited to:
— operating lease agreements (discussed in section 4.7);
— revenue contracts; and
— supply contracts.
Generally, an executory contract has no financial reporting consequence until at
least one party (partially) performs – e.g. a contractor meets a building
milestone, a purchase is made or a service is rendered – or the contract is
terminated or modified.

Question 4.6.10
How are executory contracts with vendors
accounted for in bankruptcy?

Interpretive response: The accounting for executory contracts with vendors

(e.g. supply or service contracts) depends on whether the contract is assumed
or rejected by the entity.
— Contract assumed. If an executory contract is assumed without
modification during bankruptcy proceedings, it continues to be accounted
for under the US GAAP applicable to the contract with no changes.
— Contract rejected. If an executory contract is rejected, the counterparty
can file a proof of claim as a result of the rejection. The claim could relate to
amounts due at the filing date (e.g. accounts payable) and/or damages
resulting from the rejection. The claims are generally considered unsecured
claims subject to compromise and recognized if it is probable the Court will

allow the claim and the amount can be reasonably estimated (see Question
4.3.50). However, all facts and circumstances about a claim and whether it
is expected to be impaired under the plan should be considered in
determining whether it is subject to compromise.
We believe that amounts recognized because of the termination of an
executory contract should be presented as a reorganization item (see section
4.9.10).

Question 4.6.20
How is deferred revenue (or a contract liability)
related to an existing sales contract accounted for
in bankruptcy?
Interpretive response: It depends on whether the sales contract is assumed
without modification, rejected or modified.
Contracts with customers to provide goods or services are generally executory
contracts; therefore, the accounting for the related deferred revenue (or
contract liability) generally follows the model discussed in Question 4.6.10.
— If an executory contract is assumed without modification during bankruptcy
proceedings, it continues to be accounted for under applicable US GAAP
(e.g. Topic 606).
— If the sales contract is modified or amended by mutual agreement, the
modification is accounted for under applicable US GAAP (e.g. Topic 606).
For guidance on accounting for contract modifications under Topic 606 see
chapter 11 of KPMG Handbook, Revenue recognition.
— If an executory contract is rejected, the counterparty can file a proof of
claim as a result of the rejection. A customer’s claim could relate to
advanced deposits and/or damages for a breach of contract.
The claims are generally considered unsecured claims subject to
compromise and recognized at the amount expected to be allowed by the
Court if it is probable the Court will allow the claim and the amount can be
reasonably estimated (see Question 4.3.50). However, all facts and
circumstances about a claim and whether it is expected to be impaired
under the plan should be considered in determining whether it is subject to
compromise.
Any remaining recorded liabilities associated with the contract (i.e. deferred
revenue or contract liabilities), beyond the estimated claim amount, are
written off as a reorganization item.
If the sales contract is not an executory contract, it continues to be accounted
for as it ordinarily would under US GAAP.

4.7 Lessee’s accounting for leases

4.7.10 Overview
During bankruptcy proceedings, an unexpired lease agreement can be affirmed
(assumed without modification), amended (renegotiated or assumed as
modified) or rejected, subject to approval by the Court. When a lease is
rejected, the underlying asset is generally returned to the lessor; the lessee is
protected from the lessor seeking further remedies by the automatic stay
provisions (see section 2.3.20) and the lessor will generally file a proof of claim
for damages or losses incurred as a result of the action.
While leases are generally treated in bankruptcy consistent with the preceding
paragraph, it is important to understand the legal treatment because accounting
leases (those that meet the definition of a lease in Topic 842) may be treated
differently by the Court. For example, in some cases an accounting lease may
be treated like a secured borrowing by the Court, in which case the lessor
would be considered a creditor and the lease obligation a claim.
This section describes the accounting for leases that are assumed, modified or
rejected during bankruptcy. The entity accounts for arrangements considered
secured borrowings consistent with other debt (see section 4.4).

4.7.20 Topic 842

An entity records a lease liability and a right-of-use (ROU) asset on its balance
sheet, regardless of how the lease is classified, for all leases that are not short-
term leases (as defined).
For guidance on how to account for leases as a lessee, see chapter 6 of KPMG
Handbook, Leases.
Evaluate whether a lease reassessment is needed as of the petition date
Obligation is:

Assumed without
Rejected Amended
modification

Asset must be Asset not being

Continue Topic 842
returned returned
accounting
immediately immediately

Follow Topic 842 Follow Topic 842

lease termination lease modification
guidance guidance

Question 4.7.10
Does filing for bankruptcy by a lessee trigger a
reassessment of the lease term or a lessee purchase
option?
Background: Topic 842 requires a lessee to reassess the lease term or a
lessee option to purchase the underlying asset when one of the following
occurs; see section 6.6.1 of KPMG Handbook, Leases.
— An event written into the contract obliges the lessee to exercise (or not
exercise) an option.
— The lessee elects to exercise an option that it had previously determined it
was not reasonably certain to exercise.
— The lessee elects not to exercise an option that it had previously
determined it was reasonably certain to exercise.
— A ‘triggering event’ occurs – i.e. a significant event or significant change in
circumstances that (1) is within the lessee’s control, and (2) directly affects
the assessment of whether the lessee is reasonably certain to exercise the
extension or purchase option.
Interpretive response: It depends. We believe filing for bankruptcy is a
significant event within the lessee’s control – either it initiated the filing or
undertook actions that triggered its debtors’ to impose bankruptcy on the entity
– and therefore the filing meets the first criterion for a triggering event.
However, determining when a lessee’s bankruptcy directly affects whether it is
reasonably certain to exercise a lease extension (including by not exercising an
available termination option) or exercise a purchase option – i.e. meets the
second criterion for a triggering event -- will depend on the facts and
circumstances. A lessee may conclude that filing for bankruptcy, and the events
leading to the bankruptcy, are triggering events for all of its leases or for only
certain of its leases.
For example, if the lessee expects to emerge from bankruptcy with significant
changes to some parts of its operations and only insignificant (or no) changes to
other parts, it may conclude that:
— the bankruptcy does not meet the second triggering event criterion for
those leases used in the relatively unaffected parts of its operations; but
— meets the second triggering event criterion for those leases used in the
significantly affected parts of its operations.
If the effect of the bankruptcy is expected to be pervasive to the lessee’s
operations, or if the lessee may not emerge from bankruptcy, the entity may
conclude that the bankruptcy filing is a triggering event for most (or even all) of
its leases.
Even if the bankruptcy is not expected to significantly affect the lessee’s
operations, the filing may trigger a reassessment of ancillary or non-essential
leases (e.g. of a non-essential corporate aircraft or facility).

If the lessee determines that a reassessment is required as a result of the filing,

the reassessment is performed at the filing date. This is regardless of whether
the lessee intends to assume, amend or reject the lease in bankruptcy.
If the reassessment leads to a change in either the lease term or the
assessment of whether the lessee is reasonably certain to exercise a purchase
option, the lessee remeasures its lease liability and the ROU asset. In addition,
the measurement date of these items may be significantly affected by a change
in the discount rate for the lease, which is updated in the remeasurement. If the
lessee uses its incremental borrowing rate as the discount rate for the lease,
that rate may be significantly higher than it was before the bankruptcy filing;
this is because the lessee’s creditworthiness may have significantly
deteriorated since lease commencement.
For guidance about when and how a lessee reassesses its leases, see section
6.6 of KPMG Handbook, Leases.

Question 4.7.20
How does an entity account for a lease that is
assumed without modification?

Interpretive response: An entity continues to account for the lease under

Topic 842 in the usual way because, in assuming the lease, the parties to the
contract have reached an agreement to continue the contract without
modification. Therefore, liabilities associated with an assumed lease are not
subject to compromise.
A lease agreement is only considered to be assumed without modification if no
amendments are made to the agreement – e.g. no changes in total rent due,
timing of payments, term. Any amendments that change the scope or
consideration for the lease would result in the application of lease modification
accounting.
Appropriate disclosure about assumed leases and other executory contracts
should be made in the notes to the financial statements (see section 4.14).

Question 4.7.30
How does an entity account for a lease that is
amended in bankruptcy?

Interpretive response: When a lease agreement is amended as to the scope

of or consideration for the lease as part of bankruptcy proceedings, it is
accounted for under the lease modification guidance of Topic 842. This
guidance is applied on the date that the modification is approved by all relevant
parties. For an entity in bankruptcy, this includes approval by the Court.
For guidance on accounting for lease modifications as a lessee, see section 6.7
of KPMG Handbook, Leases.

Question 4.7.40
How does an entity account for a lease that is
rejected in bankruptcy?

Background: When a lease is rejected as part of a bankruptcy, the underlying

asset is generally returned to the lessor. However, the lessee may have a
period of time (e.g. six months) before it must return the underlying asset to the
lessor, including vacating leased premises.
Interpretive response: The entity’s accounting for the rejection depends on
the timing of returning the underlying asset.
— Underlying asset returned immediately. If the asset is returned as of the
effective date or is required to be returned immediately thereafter, the
rejection is accounted for as a lease termination; see section 6.8 of KPMG
Handbook, Leases.
— Underlying asset not returned immediately. If the lessee retains the
right to use the asset for a period of time after the rejection is approved,
the rejection is accounted for as a modification that reduces the lease term;
see section 6.7 of KPMG Handbook, Leases. In applying that guidance, the
lessee remeasures and reallocates the remaining consideration in the
contract and remeasures the lease liability using a discount rate determined
at the effective date of the modification.
As discussed in Question 4.7.30, the effective date of the modification is the
time at which it is approved by all relevant parties (including the Court). Before
the rejection is approved by the Court, the lessee does not adjust the amounts
recognized under Topic 842. Question 4.7.50 discusses evaluating a lessor’s
claims upon rejection.
When the lease is modified to reduce the lease term as described above, the
lessee also decreases the carrying amount of the ROU asset. If that amount
exceeds the pre-modification carrying amount of the ROU asset, the excess is
recognized as a gain.
We believe any gain recognized as a result of terminating or modifying the lease
should be presented as a reorganization item; this is because it results directly
from the bankruptcy proceedings (see section 4.9.10). However, if in
conjunction with the rejection the entity and lessor enter into a new lease for
the same (or a similar) asset, we believe the transaction (i.e. the rejection of the
original lease and entering into the new lease) is, in substance, a lease
modification and should be accounted for as such under the lease modification
guidance of Topic 842.

Question 4.7.50
How does an entity account for a lessor’s claim
when a lease is rejected?

Background: As discussed in Question 4.7.40, until a lease is rejected the

lessee does not adjust the amounts recognized under Topic 842. When the
rejection is approved, it is accounted for as a termination or modification. Upon
a rejection, the lessor generally files a claim for late payments due from the
lessee and damages resulting from rejecting the lease.
Interpretive response: Upon rejection, the accounting for the claim for
damages and/or payments due at the petition date depends on whether it is
subject to compromise.
A liability for past-due rent on a rejected lease is a claim that generally meets
the requirements to be classified as subject to compromise; this is because it is
unsecured and expected to be impaired. When the liability is considered subject
to compromise, it is adjusted to the amount expected to be allowed.
Any claim for damages resulting from the rejection is recognized as a liability
subject to compromise when it is probable and reasonably estimable (see
Question 4.3.50). However, all facts and circumstances about the claim and
whether it is expected to be impaired under the plan should be considered in
determining whether it is subject to compromise.

Example 4.7.10
Rejection of an operating lease
Lessee filed a petition for bankruptcy on October 15, Year 2. At the date of the
filing, Lessee was renting an aircraft from Lessor. The lease was classified as
an operating lease and is accounted for under Topic 842.
On October 15, Year 2, Lessee owed Lessor $1,500 for the last three months’
rent; this amount is included in Lessee’s lease liability. In addition, Lessee owed
Lessor $75 in late payment fees, which is recognized as a separate accrued
liability on Lessee’s balance sheet. Because the lease had not yet been rejected
or modified, Lessee does not adjust the amounts recognized under Topic 842 at
the petition date.
Lessee’s carrying amounts related to the lease on October 15, Year 2 are as
follows, which include any effect of Lessee’s remeasurement of the lease on
filing for bankruptcy (see Question 4.7.10).

Late payment fee liability $75

Lease liability (including $1,500 past-due rent payments) $11,293
Right-of-use asset $7,593

On October 18, Year 2, Lessee filed a motion with the Court to reject the
aircraft lease with Lessor; the motion was approved by the Court on October

21, Year 2. As a result of the lease rejection, Lessee must return the aircraft to
Lessor within six months. The lease is treated as an executory contract under
bankruptcy law.
On October 25, Year 2 Lessor filed a claim with the Court in the amount of
$2,575. This represented $1,500 of missed payments by Lessee, damages for
breach of contract of $1,000 and late payment fees of $75. At the time the
claim was filed, Lessee expected the Court to allow the entire claim. The claim
is allowed by the Court on October 30, Year 2 and is expected to be impaired by
the plan.
Because Lessee will continue to use the aircraft for six months, the rejection of
the lease is accounted for as a lease term modification. As a result, Lessee
remeasures the lease liability at the effective date of the modification (October
21, Year 2) based on a remaining lease term of six months, with monthly
payments of $500 and Lessee’s incremental borrowing rate at the effective
date of the modification of 15%. As a result, the post-modification carrying
amount of the lease liability is reduced to $2,909. Rejection of the lease after
the reporting date represents a nonrecognized subsequent event because it is a
condition that arose after the reporting date.
Because $1,500 of the pre-modification lease liability is part of the claim filed by
Lessor, it is reclassified to liabilities subject to compromise. The remaining
$6,884 reduction to the lease liability is a corresponding adjustment to the ROU
asset. The $1,000 claim for damages is recognized as a liability subject to
compromise and the related expense as a reorganization item.
Lessee records the following journal entries for the month of October Year 2.

Debit Credit
Lease liability 1,500
Accrued expenses 75
Liabilities subject to compromise 1,575
To reclassify portion of lease liability that
represents past-due rent, and accrued late
payment fees, to liabilities subject to compromise.
Lease liability1 6,884
ROU asset 6,884
To reduce carrying amount of lease liability before
modification to modified carrying amount.
Reorganization items 1,000
Liabilities subject to compromise 1,000
To recognize damages as liabilities subject to
compromise.
Note:
1. $11,293 - $1,500 reclassified to liabilities subject to compromise - $2,909 ending lease
liability = $6,884.

4.8 Preferential payments

As discussed in section 2.3.20, if an entity in bankruptcy exercises its avoidance
powers to cancel certain prepetition transactions, the counterparty may be
required to return payments received from the entity (referred to as preferential
payments). The counterparty is then permitted to submit a claim to the Court
for the obligation.

Question 4.8.10
How are preferential payments accounted for in
bankruptcy?

Interpretive response: When an entity in bankruptcy demands the return of

payments from a counterparty, we believe it should recognize a receivable for
the amount once the Court approves the request. The entity should also record
a liability subject to compromise for the claim expected to be filed by the
counterparty.

4.9 Statement of operations under Subtopic 852-10

4.9.10 Reorganization items

Excerpt from ASC 852-10

• > Statement of Operations

45-9 The statement of operations shall portray the results of operations of the
reporting entity while it is in Chapter 11. Revenues, expenses (including
professional fees), realized gains and losses, and provisions for losses resulting
from the reorganization and restructuring of the business shall be reported
separately as reorganization items, except for those required to be reported
as discontinued operations in conformity with Subtopic 205-20.

An entity in bankruptcy distinguishes transactions and events that are directly

associated with the bankruptcy proceedings from its ongoing, normal
operations. To accomplish this, expenses, gains and losses resulting from
bankruptcy proceedings are reported as reorganization items separately in the
statement of operations. [852-10-45-9]

Question 4.9.10
What types of transactions are presented as
reorganization items in the statement of
operations?
Interpretive response: The reorganization items caption in the statement of
operations consists only of amounts that are incremental and directly related to
bankruptcy proceedings. Segregation of these items from normal business
operations provides meaningful disclosure during a bankruptcy.
The following are items that typically are considered reorganization items
versus those that are not.

Present as reorganization items?

Yes No
— Changes to liabilities and related — Revenue
accounts resulting from the — Impairment charges
application of Subtopic 852-10
— Gains/losses from the sale of
(Question 4.3.50)
assets (see below)
— Gains/losses from adjusting the
— Restructuring costs resulting from
carrying amount of debt to the
normal operations
amount of the allowed claim
(Question 4.4.10) — Interest expense (section 4.9.20)
— Losses from rejecting or modifying — Interest income related to normal
executory contracts (Question invested capital (section 4.9.20)
4.6.10) — Reorganization activities associated
— Interest income related to invested with a discontinued operation
capital in excess of normal (section (Question 4.11.160)
4.9.20) — Tax effects of reorganization items
— Other expenses directly related to
bankruptcy proceedings (section
4.9.30)

When determining if a loss is a reorganization item, an important distinction to

make is whether it is incremental and directly related to the bankruptcy
proceedings. It is incremental if it would not have been incurred but for the
proceedings – e.g. losses incurred on an executory contract that is terminated
as part of the bankruptcy proceedings.
Although Subtopic 852-10 suggests that revenue can be a reorganization item,
we expect the treatment of revenue as such to be rare. Additionally,
impairment charges (even those incurred during bankruptcy proceedings) are
not reorganization items because the charge likely would have been incurred
even if the entity were not in bankruptcy. [852-10-45-9]
We believe that gains or losses associated with the sale of assets (and the
related selling costs) should typically not be reorganization items; this is
because they are incurred as part of the ongoing operations of the entity.
However, these amounts might be included in reorganization items if the entity
can show that the asset is being sold because of a requirement in a Court-
approved plan of reorganization, and would not have otherwise been disposed
of.

See Example 4.13.20 for an example statement of operations presentation

during bankruptcy proceedings.

4.9.20 Interest
Interest expense

Excerpt from ASC 852-10

• > Statement of Operations

45-11 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. Interest expense is not a reorganization item.

An entity in bankruptcy recognizes interest expense only to the extent that:

— the interest will be paid during the bankruptcy proceedings; or
— it is probable that the interest will be an allowed claim.
Interest expense is not presented as a reorganization item, because the entity
would continue to accrue interest on its outstanding debt even if it were not in
bankruptcy. [852-10-45-11]

Question 4.9.20
Is interest expense on debt obligations recognized
during bankruptcy?

Interpretive response: Subtopic 852-10 limits the amount of interest expense

to the amount that (1) will be paid during the proceeding, or (2) is probable of
being an allowed claim. The guidance also states that interest expense is not a
reorganization item. [852-10-45-11]
Postpetition interest expense on prepetition debt subject to compromise
usually does not accrue during proceedings, and therefore it does not meet the
criteria to be recognized. As discussed in Question 4.4.10, the Court typically
allows a claim for unsecured or undersecured debt in an amount totaling the
principal balance plus accrued interest as of the petition date – i.e. postpetition
interest is usually not included in the claim allowed by the Court.
However, interest on fully secured claims (i.e. not subject to compromise) may
accrue to the extent that the value of the underlying collateral exceeds the
principal amount of the claim, or the Court approves the payment of related
postpetition interest expense. [SOP 90-7.51]
Interest on DIP financing (see section 4.4.20) generally is recognized during
bankruptcy.

The extent to which reported interest expense differs from stated contractual
interest is disclosed in the notes to the financial statements (see section 4.14).
[852-10-45-11, 50-3]

While the above treatment of interest expense is typical during bankruptcy

proceedings, an entity evaluates the specific facts and circumstances of its debt
arrangements and the proceedings when determining the appropriate
accounting treatment.

Interest income

Excerpt from ASC 852-10

• > Statement of Operations

45-12 Interest income earned by an entity in Chapter 11 that it would not have
earned but for the proceeding, normally all interest income, shall be reported
as a reorganization item.

An entity may continue to earn interest income on its invested capital (e.g. cash
and/or investments) while it is in bankruptcy. However, because of the
automatic stay provisions of the Code (see section 2.3.20), the entity’s invested
capital may increase above normal levels because funds generally are not used
to pay prepetition liabilities while the entity is in bankruptcy. This results in an
increase in interest income earned by the entity, which likely will be used to pay
creditors upon bankruptcy emergence under the plan of reorganization. [SOP 90-
7.52]

Interest income earned by the entity on the excess invested capital

accumulated as a result of the proceeding is presented as a reorganization item.
Interest income applicable to normal invested capital should be reported as an
operating item (not a reorganization item) to the extent management is able to
reasonably estimate it. [852-10-45-12, SOP 90-7.52]

Example 4.9.10
Accounting for interest income while in bankruptcy
ABC Corp. filed a petition for bankruptcy on July 1, Year 1. Before filing for
bankruptcy, ABC earned approximately $300 a month of interest income –
based on its average invested capital balance of $100,000.
As a result of filing for bankruptcy and the application of the automatic stay
provisions of the Code, ABC’s average invested capital balance increases to
$150,000. As a result, from July 1 to September 30 ABC earns $1,350 of
interest income, rather than the $900 it would have earned had it not been in
bankruptcy.
In its quarter-to-date September 30, Year 1 statement of operations, ABC
presents the $450 of interest income earned on the incremental $50,000

average invested capital as a reorganization item. ABC recognizes the remaining

$900 earned on its normal average invested capital as interest income.

4.9.30 Other fees

Excerpt from ASC 852-10

• > Statement of Operations

45-10 It is not appropriate to defer professional fees and similar types of
expenditures until the plan is confirmed and then reduce gain from debt
discharge to the extent of the previously deferred expenses. It is also not
appropriate to accrue professional fees and similar types of expenditures upon
the filing of the Chapter 11 petition. Rather, because professional fees and
similar types of expenditures directly relating to the Chapter 11 proceeding do
not result in assets or liabilities, they shall be expensed as incurred and
reported as reorganization items.

An entity in bankruptcy incurs various types of professional fees during the

bankruptcy proceedings. Because professional fees directly related to the
bankruptcy proceedings do not result in assets and liabilities, they are expensed
as incurred and reported as reorganization items. [852-10-45-10]

Question 4.9.30
How is a contingent fee incurred when an entity
emerges from bankruptcy accounted for?

Background: A contingent or success fee is payable to certain service

providers (such as investment bankers) only if the entity emerges from
bankruptcy. Subtopic 852-10 requires professional fees directly related to
bankruptcy proceedings to be expensed as incurred and presented as
reorganization items. [852-10-45-10]
Interpretive response: We believe contingent fees should be accounted for in
accordance with Subtopic 450-20 and recognized when probable and
reasonably estimable. However, the fee generally is not recognized as a
reorganization item until the entity emerges from bankruptcy because the fee is
not considered probable until that time. In this situation, if the entity applies
fresh-start reporting (see chapter 5), it recognizes the expense in the
predecessor period.

4.10 Other accounting considerations

4.10.10 Overview
Although there are incremental accounting and reporting requirements once an
entity files a petition for bankruptcy (as discussed in sections 4.3 to 4.9), filing a
petition does not generally affect the application of other relevant US GAAP.
Many of the requirements discussed in chapter 3 continue to apply while the
entity undergoes bankruptcy proceedings. This section discusses how an entity
should consider those issues while in bankruptcy and how they interact with
the requirements of Subtopic 852-10.

4.10.20 Goodwill and indefinite-lived intangible assets

The requirements of Topic 350 apply to an entity in bankruptcy. Therefore, an
entity continues to evaluate whether there are triggering events that require
goodwill and indefinite-lived intangible assets to be tested for impairment more
frequently than the annual testing (see section 3.3.10).

Question 4.10.10
How does filing for bankruptcy affect the Topic 350
impairment tests?

Interpretive response: As discussed in section 3.3.10, an entity often has a

triggering event before filing for bankruptcy. In addition, at the time of filing, an
entity evaluates whether a triggering event has occurred. In making this
determination, an entity should document the factors it considered, and
whether or not it has concluded that a trigger has occurred.
If an impairment charge is recognized, an entity should document why the
timing of the charge is appropriate. If an impairment charge is not recognized,
an entity should consider the need for expanded disclosures in the notes to the
financial statements (see section 4.14).
For additional guidance on goodwill impairment testing, see KPMG Handbook,
Impairment of Nonfinancial assets.

4.10.30 Long-lived assets

Topic 360 applies to an entity operating in bankruptcy. Two aspects in particular
under that Topic may apply to a bankrupt entity.
— The bankrupt entity continues to monitor for triggering events indicating
possible impairment of its long-lived assets (i.e. property, plant and
equipment and finite-lived intangible assets).

— If a bankrupt entity reorganizes its operations to dispose of certain assets or

operating segments during bankruptcy, those assets or operating segments
may qualify as held-for-sale.
See section 3.3.20 for a discussion of long-lived asset accounting
considerations before entering bankruptcy.

Question 4.10.20
How does filing for bankruptcy affect the Topic 360
recoverability test?

Interpretive response: The following two impairment indicators discussed in

Topic 360 are often prevalent when an entity files for bankruptcy: [360-10-35-21(c),
35-21(f)]

— a current expectation that, more likely than not, a long-lived asset (asset
group) will be sold or otherwise disposed of significantly before the end of
its useful life – due to plans to dispose of some operations to raise funds;
and
— there has been a significant adverse change in the business climate that
could affect the value of a long-lived asset.
If a triggering event is identified, the entity proceeds to the recoverability test.
The estimated, undiscounted future cash flows expected to result from the use
and eventual disposition of the asset (asset group) are compared to the carrying
amount of the asset (asset group). [360-10-35-17]
Estimates of future cash flows should be based on supportable assumptions,
and should be reasonable in relation to other information used by the entity.
Examples include budgets, forecasts, projections, accruals related to executive
compensation and information communicated to others. The estimated future
cash flows should take into account the possible scenarios that might arise
following the filing. While an entity could use either a single best estimate or
probability-weighted cash flows, the relevance of using probability-weighted
cash flows will be heightened when the entity is considering alternative courses
of action for an asset group.
The general requirements of the recoverability test are discussed in chapter 7 of
KPMG Handbook, Impairment of nonfinancial assets, and Question 7.2.30
discusses estimating cash flows based on using either a single best estimate or
probability-weighted approach.
The following discussion highlights two specific ways in which bankruptcy
proceedings can affect estimates of future cash flows.
Potential disposal of long-lived assets
Undiscounted future cash flows are estimated based on entity-specific
assumptions about the use and eventual disposal of the asset. Therefore, if the
entity’s plan of reorganization contemplates the disposal of certain long-lived
assets, the estimated future cash flows associated with those assets needs to
consider that. In developing its estimates, the entity should also consider that
assets may be sold by public auction, and the Court may approve the auction

price if the amount is believed to be comparable to or better than the amount

that would be received in liquidation.
Potential extinguishment of liabilities in the asset group
An asset group is the lowest level for which identifiable cash flows are largely
independent of the cash flows of other groups of assets and liabilities. An asset
group often includes operating liabilities associated with the assets, so the
undiscounted future cash flows used in the impairment analysis include
changes in working capital balances attributed to the asset group. [360-10
Glossary]

An entity should consider how an asset group’s expected cash flows are
affected if a liability included in the asset group is expected to be extinguished
for an amount different from its carrying amount as a prepetition liability if that
course of action is under consideration.

Question 4.10.30
Can assets that were held-and-used before
bankruptcy meet the held-for-sale criteria after the
filing but before the Court approves their sale?
Interpretive response: Generally, no. A long-lived asset (disposal group) to be
sold is classified as held-for-sale in the period in which all of the criteria in Topic
360 are met (see section 3.3.20).
In our experience, presentation of a disposal group as held-for-sale by an entity
in bankruptcy is usually delayed until Court approval has been obtained. For a
more in-depth discussion, see Question 4.2.60 in KPMG Handbook,
Discontinued operations and held-for-sale disposal groups.

4.10.40 Derivatives and hedge accounting

The accounting for a derivative instrument in bankruptcy largely depends on its
contractual terms. The effect on a discontinued hedging relationship depends
on whether that relationship was designated as a cash flow hedge or a fair
value hedge. For a discussion of derivatives and hedge accounting
considerations while an entity is experiencing financial difficulties, see
section 3.5.

Question 4.10.40
How does filing for bankruptcy affect the
accounting for a derivative?

Interpretive response: The effect of filing for bankruptcy on the accounting for
a derivative instrument depends primarily on whether the instrument continues
to meet the criteria to be accounted for as a derivative.

In the event of bankruptcy, the terms of many derivative contracts either (1)
give the counterparty the right to terminate the agreement or (2) automatically
cause the agreement to terminate. An entity with derivative contracts should
review their terms to understand whether each contract continues to meet the
definition of a derivative after the bankruptcy filing.
— If it does, the entity continues to apply Topic 815 to the contract.
— If it does not, the accounting treatment depends on whether the contract is
in an asset or a liability position, as shown in the diagram.
Position of a contract no longer
accounted for as a derivative:

Asset Liability
Contractual asset
Prepetition liability
(generally a receivable)

Certain derivative instruments are not subject to the automatic stay provisions
of the Code, in which case they are not subject to compromise. An entity filing
for bankruptcy may need to consult with legal counsel to determine the effect
of a bankruptcy filing on its derivative instruments.
If a derivative that was designated as a hedging instrument no longer meets the
definition of a derivative, hedge accounting is discontinued. If a derivative that
was designated as a hedging instrument continues to meet the definition of a
derivative, an entity should ascertain that the hedging relationship continues to
be highly effective before continuing to apply hedge accounting.
For additional guidance on hedge accounting, see KPMG Handbook, Derivatives
and hedging.

Question 4.10.50
How are amounts in AOCI from cash flow hedges
accounted for upon hedge termination?

Interpretive response: Net gains or losses related to discontinued cash flow

hedges are reported in AOCI and reclassified to earnings when the forecasted
transaction is reported in earnings, unless it is probable that the forecasted
transaction will not occur by the end of the originally specified time period (or
within an additional two-month period). For additional guidance on accounting
for terminated cash flow hedges, see section 10.5 of KPMG Handbook,
Derivatives and hedging. [815-30-40-4]
An entity should specifically consider the facts and circumstances related to its
bankruptcy proceedings when determining if it is probable that the forecasted
transaction will not occur by the end of the originally specified time period.
For example, we believe that in many cases an entity will conclude that
amounts remaining in AOCI related to interest rate swaps on debt subject to
compromise should be reclassified because the forecasted interest payments
are not probable of occurring as originally specified or within the additional two-

month period. This is because during the bankruptcy proceeding, the entity's
plan of reorganization will often result in a significant modification to existing
debt arrangements, the issuance of common stock to satisfy the existing debt
arrangements and/or payments (including interest payments) will be suspended
until the entity emerges from bankruptcy. As a result, the entity may not be
able to ascertain whether any future interest payments on the debt will be
made or if such future payments will be in cash or equity.
Entities need to evaluate the specific facts and circumstances for other types of
cash flow hedges.

Question 4.10.60
How are adjustments to the carrying amount of a
hedged item in a fair value hedge accounted for
when the hedging relationship is terminated?
Interpretive response: As shown in the following table, the answer depends
on the nature of the hedged item.

Nature of hedged item Accounting treatment

Firm commitment Derecognize the asset or liability recognized in fair value
hedge accounting with a corresponding gain or loss if
the hedged item no longer meets the definition of a firm
commitment. [815-25-40-5]

Asset or liability not Account for the adjustment to the carrying amount from
subject to compromise fair value hedge accounting in the same manner as the
underlying asset. [815-20-35-8]
Interest-bearing financial Amortize the adjustment to earnings beginning no later
asset or liability not than when fair value hedge accounting is discontinued,
subject to compromise over a period consistent with the amortization of other
related discounts or premiums. [815-20-35-9 – 35-9A]
Liability subject to Derecognize the adjustment when the carrying amount
compromise of the liability is adjusted to the expected amount of the
allowable claim. [852-10-45-6]

For additional guidance on accounting for terminated fair value hedges, see
section 8.5 of KPMG Handbook, Derivatives and hedging.

4.10.50 Share-based payments

The guidance in Topic 718 applies to an entity in bankruptcy. While in
bankruptcy an entity may need to evaluate the guidance on modifying or
canceling share-based payment awards and on classifying awards as equity or
liabilities, as changes to the awards or circumstances that arise from filing a
petition for bankruptcy may result in the need to apply that guidance.

Question 4.10.70
Does the probable cancellation of stock under a
plan of reorganization affect an assumed forfeiture
rate used to determine compensation cost?
Background: Under Topic 718, an entity may elect to estimate the number of
forfeitures expected to occur or recognize the effect of forfeitures in
compensation cost when they occur. [718-10-35-3]
Interpretive response: No. If an entity elects to estimate its forfeiture rate, we
believe the entity should not adjust its forfeiture assumptions as a result of
management's belief that some or all of the stock to be issued upon exercise of
options or vesting of restricted stock will be canceled under a plan of
reorganization.
Management should not reflect anticipated cancellations in the current
measurement of compensation expense because the outcome of the
bankruptcy proceedings (and therefore the implementation of the plan of
reorganization) is unknown. Therefore, the entity should continue to follow
Topic 718 to recognize share-based compensation expense while operating in
bankruptcy. When estimating forfeitures, the entity should consider all relevant
facts and circumstances including, but not limited to, historical forfeiture rates
and the effect of restructuring activities (e.g. a reduction in the workforce) as a
result of the bankruptcy process.
If a share-based compensation award is canceled or modified, the entity follows
the applicable guidance in Topic 718.
For guidance on accounting for share-based compensation arrangements, see
KPMG Handbook, Share-based payment.

4.10.60 Retirement and nonretirement postemployment

benefits
An entity in bankruptcy continues to apply the applicable GAAP (e.g. Topic 712,
Topic 715 or Topic 420) when accounting for retirement and nonretirement
postemployment benefits. If a plan of reorganization includes modifying or
terminating retirement benefits, the curtailment, negative plan amendment and
settlement provisions of Subtopic 715-30 or Subtopic 715-60 will likely be
triggered. For guidance on accounting for pensions and other postemployment
benefits, see KPMG Handbook, Employee benefits.
See discussion about possible accounting consequences related to retirement
and nonretirement postemployment benefits while an entity is experiencing
financial difficulties in section 3.7.

Question 4.10.75
How are pre-petition employee termination benefits
accounted for in bankruptcy?

Interpretive response: Employee termination benefits generally continue to be

accounted for at the amount required by the applicable GAAP (e.g. Topic 712,
Topic 715 or Topic 420) until settled or acted on by the Court. If the Court
approves these benefits as an allowed claim at an amount that is less than the
previously recognized liability, the adjustment to the liability is classified as a
reorganization item (see section 4.9.10).
For further discussion about the accounting for termination benefits, see
chapter 4 of KPMG Handbook, Employee benefits.
Classifying these liabilities as subject to compromise before the Court acts on
them depends on the facts and circumstances, which should be evaluated
consistent with the discussion in Question 4.3.10. The classification evaluation
could change as the bankruptcy proceedings evolve and the entity obtains new
or better information.

Question 4.10.80
When is a modification to, or a termination of,
pension and postretirement benefits recognized?

Interpretive response: If the plan of reorganization contemplates a

modification to existing pension or postretirement benefits, the timing of the
financial statement effect of the modification depends on whether the
modification is effective during bankruptcy, or not until after emergence.
Freezing a pension plan could result in a negative plan amendment or a
curtailment. If the Court approves the action during bankruptcy, the entity
should evaluate the guidance in Topic 715 to determine the appropriate
accounting at that time – i.e. while the entity is still in bankruptcy. [715-30-35-74 –
35-96, 55-54 – 55-55]

Alternatively, an entity’s plan of reorganization may include modification or

termination of a pension or postretirement benefit plan only upon emergence
from bankruptcy. If this is the case, we believe the modification or termination
should not be recognized until the modification or termination is effective; this
will usually be when the entity emerges from bankruptcy. For further discussion
about the accounting for modification or termination of a pension or
postretirement benefit plan, see KPMG Handbook, Employee benefits.
The net gain or loss resulting from the modification or termination is reported as
a reorganization item in the predecessor’s statement of operations (see
Question 4.9.10). This treatment is consistent with treatment of curtailment
losses that are triggered by the consummation of a business combination. [805-
20-55-51]

Question 4.10.90
Is the interest cost component of net periodic
benefit cost recognized while in bankruptcy?

Interpretive response: Yes. We believe an entity should continue to recognize

the interest cost component of net periodic benefit cost for defined benefit
pension and postretirement plans while in bankruptcy.
As discussed in Question 4.9.20, Subtopic 852-10 requires an entity to
recognize interest expense only up to the amount that will be paid during the
proceedings or the amount that is probable of being allowed as a priority,
secured or unsecured claim. We do not believe this guidance was intended to
apply to the interest cost component of net periodic benefit cost, which
represents the increase in the projected or accumulated postretirement benefit
obligation due to the passage of time. In addition, Topic 715 explicitly states
that the interest cost component of net periodic benefit cost should not be
considered interest for purposes of applying Topic 835. [715-30-35-9, 715-60-35-9]
This position is further supported by discussion in the basis for conclusions to
ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net
Periodic Postretirement Benefit Cost. Though not authoritative, the basis for
conclusions indicates that the FASB considered requiring the interest cost
component of net benefit cost to be capitalized in assets, but ultimately
rejected the idea because it does not represent a borrowing cost related to
expenditures for an asset. [ASU 2017-07.BC25]
For further discussion about the accounting for the interest cost component of
net periodic benefit cost, see chapter 7 of KPMG Handbook, Employee
benefits.

4.10.70 Equity and convertible debt

If an entity has issued a convertible debt instrument, any element of the
instrument that is classified as a liability (e.g. host instrument, bifurcated
embedded derivative) is subject to the guidance on liabilities subject to
compromise (see section 4.3). This means that the liability will likely be
classified as subject to compromise, and should be remeasured under Subtopic
852-10 (see Question 4.3.50).
Similarly, an entity may have an equity instrument, or portions of an instrument,
classified as a liability (e.g. mandatorily redeemable preferred stock). Any
prepetition liabilities of this nature are subject to the guidance on liabilities
subject to compromise (see section 4.3).
The terms of these instruments can be complex and should be carefully
evaluated to determine to what extent they are affected by the bankruptcy
proceedings.

Question 4.10.100
Does an entity in bankruptcy continue to recognize
cumulative dividends on preferred stock?

Interpretive response: Yes. We believe that an entity in bankruptcy should

continue to recognize dividends on cumulative preferred stock under applicable
US GAAP or SEC requirements, unless:
— the terms and conditions of the instrument explicitly provide for
discontinuing the payment of preferred stock dividends upon entering
bankruptcy; or
— the entity expects the Court to deny the claim for future dividends.
Section 502 of the Code explicitly states that it will not allow a claim for
‘unmatured interest’ if the claim is objected to by the entity in bankruptcy (or
another party). However, we do not believe it is appropriate to analogize this
provision in the Code to preferred stock dividends. Such an analogy to an
accounting treatment that is based on specific law would not be appropriate
when that specific law does not explicitly address the instrument being
accounted for.

4.10.80 Foreign currency denominated liabilities

Question 4.10.110
At what amount is a foreign currency denominated
prepetition liability recognized during bankruptcy?

Interpretive response: If the liability effectively converts to a US dollar

denominated claim during bankruptcy proceedings, we believe an entity should
fix the carrying amount of the liability in US dollars using the applicable foreign
currency translation rate as of the petition date. Any difference between the
final settlement amount of the liability and its carrying amount is a
reorganization item upon settlement.
If the liability does not effectively convert to a US dollar denominated obligation,
the entity continues to remeasure the liability at the current exchange rate each
reporting date in the usual way. [830-20-35-2]
Whether a liability denominated in a foreign currency effectively converts to a
US dollar denominated claim is a matter of law. Consultation with legal counsel
may be necessary.

4.10.90 Cash and cash equivalents

Question 4.10.120
How are cash and cash equivalents classified during
bankruptcy?

Background: Topic 210 provides guidance on classifying assets as current or

noncurrent. Among other things, it requires that current assets exclude cash
and claims to cash that are restricted as to withdrawal or use for other than
current operations. [210-10-45-4(a)]
Interpretive response: In our experience, an entity operating while in
bankruptcy generally does not show cash and cash equivalents related to
normal business operations as restricted, even though the Court is required to
approve expenditures. However, the authority of the Court on the operations of
the business and the implications to liquidity and uses of cash should be
disclosed (see section 4.14).
If restrictions on cash are triggered as a result of the bankruptcy petition, or
actions are taken that are not considered to be ‘in the normal course of
operations’, we believe an entity should classify cash as restricted; this is
because of the restrictions placed on such assets through the bankruptcy
proceedings. The entity should also disclose information about the nature of the
restriction. [230-10-50-7]
An example of this is an external financing obligation that is fully secured by a
fixed asset maintained by the entity. If the entity sells the related fixed asset
and the proceeds are not immediately applied to the outstanding debt that was
collateralized by the fixed asset, the entity should classify the cash proceeds as
restricted on the balance sheet with appropriate note disclosure.

4.10.100 Income taxes

When an entity is in bankruptcy, Topic 740 continues to apply. In particular, an
entity in bankruptcy should carefully evaluate the realizability of its deferred tax
assets. For guidance on accounting for income taxes, see KPMG Handbook,
Accounting for income taxes.

Question 4.10.130
How are liabilities for uncertain tax positions
accounted for during bankruptcy?

Background: The Code provides for certain tax claims to have a priority status
within the unsecured claims classification that is higher than that of several
other categories (see section 2.3.20).

Creditors can assert a priority and state the amount and basis therefor, which is
then considered by the Court during the reorganization process. Each claim in
each priority category must be paid in full before any claim in the next category
receives any distribution. For a plan of reorganization to be confirmed, all priority
claims must be satisfied in full. The Code establishes the order of priorities of
the categories of claims (see section 2.3.20).
Interpretive response: The accounting for uncertain tax positions while an
entity is in bankruptcy depends on whether the underlying obligation meets the
definition of a claim. Because uncertain tax positions may not result in cash
payments to the taxing authority even if detected (e.g. if the entity had a net
operating loss carryforward that would be used to satisfy the obligation), they
may not meet the definition of a claim at the petition filing date. However, an
obligation related to a tax position taken before the filing date could meet the
definition of a claim under the Code, if it represents a right to payment by the
taxing authorities as of the filing date.
If an uncertain tax position meets the definition of a claim, it should be
evaluated to determine if it is a liability subject to compromise (see Question
4.3.10). Uncertain tax positions that have a priority status generally are not
subject to compromise. Regardless of the classification of the liability, the entity
is still required to show all of the required disclosures of Topic 740 in its
financial statements. [852-10-50-1]
Accrued interest and penalties for actual pecuniary losses at the petition date
related to existing income tax uncertainties meeting the definition of a claim are
treated the same as the underlying tax claim, which may be a secured claim, a
priority claim or an unsecured claim.
Entities should consult their tax advisors and legal counsel to consider the
treatment of income tax uncertainties during the bankruptcy reorganization
process.

Question 4.10.140
How are deferred tax liabilities classified during
bankruptcy?

Interpretive response: We believe deferred tax liabilities do not meet the

definition of a claim under the Code. Instead, they are liabilities recognized for
the future tax consequences of temporary differences. Therefore, they are not
classified as liabilities subject to compromise.

4.11 Financial statement presentation

4.11.10 Segment reporting

Question 4.11.10
Does filing for bankruptcy cause an entity to
immediately reassess its operating and reporting
segments?
Background: A key concept in Topic 280 is the ‘management approach’, which
is how management assesses performance and allocates resources in its
business. In applying Topic 280, one of the criteria used to determine whether a
component is an operating segment is the requirement that operating results of
the component are regularly reviewed by the entity’s chief operating decision
maker (CODM). [280-10-50-1(b)]
During bankruptcy proceedings, an entity may change the manner in which it
assesses performance and makes resource allocation decisions. Quite often the
CODM will review financial information at levels different from those reviewed
before filing the bankruptcy petition. Specifically, an entity may compile data
and analyze operations at a lower level of detail as decisions about employee
terminations, lease assumption or rejection and other actions are considered.
Interpretive response: We believe the filing of a bankruptcy petition by itself
does not result in an immediate reassessment of the entity's operating and
reportable segments.
The threshold issue in these circumstances is whether actions during
bankruptcy proceedings are temporary, or whether they will result in a
fundamental change to the entity’s operations or management’s approach to
managing the business.
We believe a temporary review of the financial information of a component for
purposes of developing a plan of reorganization generally does not constitute a
‘regular’ review of that financial information. [280-10-50-1 – 50-4]
However, such changes are not always temporary. Instead, an entity in
bankruptcy could make changes to its internal reporting structure such that the
segment measures used by the CODM to assess performance and make
resource allocation decisions are different from those previously used. For
example, such changes may result from decisions to:
— revise the basis or types of amounts allocated from non-operating segment
activities (e.g. corporate activities) to operating segments; or
— revise the internal reporting (segment) accounting policies.
In addition, an entity in bankruptcy may restructure its operations such that the
identity of the CODM needs to be reassessed. A change in CODM can also be
an indicator of a change in operating and reporting segments.
If, after considering these changes, the entity determines that there has been a
change in the way in which the CODM assesses performance and allocates

resources, the entity should report its segment information using the new
segment measure retrospectively for all periods presented, beginning in the
period the change occurred.
An entity should also reexamine the aggregation criteria in Topic 280 to assess
whether aggregation continues to be appropriate for currently aggregated
operating segments. Topic 280 allows aggregation of operating segments if the
segments have similar economic characteristics, and if the segments are similar
in the following areas: [280-10-50-11]
— the nature of the products and services;
— the nature of the production processes;
— the type or class of customer for the products and services;
— the methods used to distribute the products or provide the services; and
— if applicable, the nature of the regulatory environment.
For additional guidance, see KPMG Handbook, Segment reporting.

4.11.20 Consolidation
Because the provisions of Subtopic 852-10 apply only to a legal entity that has
filed a petition for bankruptcy, it is important to understand which legal entities
in a consolidated group are included in a bankruptcy petition filing. [852-10-15-2]
The following chart summarizes consolidation scenarios when either the parent
or the subsidiary (or both) files a petition for bankruptcy. The guidance that
follows in this section elaborates on some of these common scenarios.

Which entity reflects

Subtopic 852-10 in its Should
stand-alone financial parent
statements? continue to
consolidate
Who is a party to the subsidiary?
Parent Subsidiary
bankruptcy petition?

Parent only Yes

Consolidated subsidiary
No
only

Parent and consolidated

It depends
subsidiary

Only parent files for bankruptcy

Question 4.11.20
Does a parent that files for bankruptcy continue to
consolidate a subsidiary that has not?

Interpretive response: Generally, yes. The parent generally retains control over
the subsidiary even if it has filed a petition for bankruptcy protection and is itself
controlled by the Court. This is because the subsidiary has not filed for
bankruptcy and therefore is not controlled by the Court.

Question 4.11.30
Does Subtopic 852-10 apply to a subsidiary’s stand-
alone financial statements if the subsidiary is not
included in the parent’s bankruptcy petition?
Interpretive response: No. If the subsidiary is not part of the parent’s
bankruptcy petition, it is not part of the bankruptcy proceedings and therefore is
not in the scope of Subtopic 852-10. Therefore, stand-alone financial
statements of the subsidiary do not reflect the provisions of that Subtopic.
However, we believe the subsidiary’s financial statements should disclose that
the parent is in bankruptcy (see section 4.14). The recovery of amounts
receivable from the parent, if any, should be carefully evaluated under these
circumstances.

Only consolidated subsidiary files for bankruptcy

Question 4.11.40
Does a parent continue to consolidate a majority-
owned subsidiary that is a voting interest entity
after the subsidiary files for bankruptcy?
Background: There are two primary models for determining whether a
reporting entity (parent) should consolidate another legal entity (subsidiary).
Both accounting models require the reporting entity to identify whether it has a
controlling financial interest in a legal entity. The first, addressed in this
question, is a voting interest entity model. The second is a variable interest
entity (VIE) model (see Question 4.11.50).
Under the voting interest entity model, a parent generally meets the
consolidation criteria if it owns a majority of the voting shares of a subsidiary.
[810-10-25-1]

Interpretive response: Generally, no. Topic 810 specifically prohibits

consolidation of a majority-owned subsidiary if control does not rest with the
majority owner due to, among other things, legal reorganization or bankruptcy

of the subsidiary. Topic 810 also indicates that a subsidiary should be

deconsolidated if, among other things, the subsidiary becomes subject to the
control of a government, Court, administrator or regulator. [810-10-15-10, 55-4A]
Operating while in bankruptcy usually indicates that control does not rest with
the majority owner because the Court must approve all significant actions. As a
result, deconsolidation of the subsidiary is appropriate in most cases.
Concluding that continued consolidation of a subsidiary in bankruptcy is
appropriate requires a fairly unique set of facts and is appropriate only in
infrequent and uncommon circumstances. A 2003 SEC staff speech highlighted
that while the staff believes that bankruptcy indicates that control does not rest
with the majority owner, there are circumstances in which the continued
consolidation of a subsidiary in bankruptcy is more meaningful. The staff
member described a specific example in which the staff did not object to the
parent’s conclusion to continue to consolidate its subsidiary during bankruptcy.
[2003 AICPA Conf]

In that fact pattern, the parent was the majority common shareholder, a priority
debt holder and the subsidiary’s single largest creditor. Because of its creditor
position, the parent was able to negotiate a prepackaged bankruptcy with the
subsidiary’s other creditors (see section 2.3.50). Under the terms of the
prepackaged bankruptcy, the parent expected to maintain majority voting
control after the bankruptcy and for the bankruptcy to be completed in less than
one year. [2003 AICPA Conf]
A conclusion to continue to consolidate and its basis should be adequately
disclosed, and the entity should reassess its facts and circumstances to confirm
the appropriateness of that conclusion at each reporting date (see section 4.14).

Question 4.11.50
Is filing for bankruptcy a reconsideration event
when assessing whether an entity is a VIE?

Background: There are two primary models for determining whether a

reporting entity (parent) should consolidate another legal entity (subsidiary).
Both accounting models require the reporting entity to identify whether it has a
controlling financial interest in a legal entity. The first is a voting interest entity
model (see Question 4.11.40).
The second, addressed in this question, is a variable interest entity (VIE) model.
Under this model, a parent generally meets the consolidation criteria if it has the
power to direct the activities that most significantly affect the other entity’s
economic performance, and the obligation to absorb losses of, or the right to
receive benefits from, the VIE that could potentially be significant to the VIE.
[810-10-05-8 – 8A]

Interpretive response: We believe an entity (parent) should reassess an

investee entity’s VIE status under Topic 810 if the investee files for bankruptcy;
this is because investors typically lose the power to direct the activities that
most significantly affect the entity’s economic performance. Topic 810 requires
reassessment of whether a legal entity is a VIE if, among other things, changes

in facts and circumstances cause the holders of the equity investment at risk to
lose the power to direct the activities of the entity that most significantly affect
its economic performance. [810-10-35-4]
An entity that has filed for bankruptcy may be a VIE because the equity
investment at risk is not sufficient or the equity investors may no longer have
power to direct the activities that most significantly affect the entity’s economic
performance (because the Court may control the entity). It is likely that a
previously consolidated entity will be required to be deconsolidated after the
bankruptcy filing because the parent lacks the power to direct the activities that
most significantly affect the entity’s economic performance.
For additional guidance on the consolidation, see KPMG Handbook,
Consolidation.

Question 4.11.60
Is a parent’s loss of control due to a subsidiary’s
bankruptcy filing after year-end a recognized
subsequent event?
Interpretive response: No. As discussed in Question 3.13.10, we believe that
a bankruptcy petition filing after year-end is a nonrecognized subsequent event.
A parent company deconsolidates a subsidiary as of the date it ceases to have a
controlling financial interest. As a result, the parent continues to consolidate the
subsidiary as of year-end. [810-10-40-4]
The parent should include appropriate disclosure of the subsequent event in the
year-end financial statements (see section 4.14).

Question 4.11.70
How does a parent calculate the gain or loss
resulting from deconsolidating a subsidiary?

Background: As discussed in Question 4.11.40, Topic 810 indicates that a

subsidiary should be deconsolidated if, among other things, the subsidiary
becomes subject to the control of a government, Court, administrator or
regulator. [810-10-15-10, 55-4A]
Interpretive response: To calculate a gain or loss on deconsolidation, the
parent: [810-10-40-4A, 40-5]
— derecognizes the assets, liabilities and equity components related to the
subsidiary; this includes any noncontrolling interest and amounts previously
recognized in AOCI (including any cumulative translation adjustments);
— recognizes any liabilities assumed or receivables due from the subsidiary;
and
— recognizes a gain or loss in net income (assuming the deconsolidated
subsidiary is a business as defined in Topic 805).

Applying this guidance when a subsidiary with negative equity petitions for
bankruptcy often results in an overall gain. However, the parent should also
consider whether there are any additional accounting consequences resulting
from deconsolidation of the subsidiary that may affect the gain or loss
recognized on deconsolidation.
The following are examples.
— Guarantee liabilities. Topic 460 does not apply to guarantees issued
between a parent and its subsidiary. However, if the parent previously
issued a guarantee on behalf of the subsidiary, it recognizes the guarantee
liability when the subsidiary is deconsolidated (see Question 4.11.90). [460-
10-25-1(g)]

— Joint and several liabilities. If the parent is jointly liable for obligations of
the now-deconsolidated subsidiary, it recognizes a liability if the total
amount of the obligation is fixed. The liability is measured as the sum of:
[405-40-15-1, 30-1]

— the amount the parent is directly responsible for under the joint and
several liability arrangement; and
— the amount the parent expects to pay on behalf of the deconsolidated
subsidiary.
— Other liabilities. If the parent is contractually responsible for certain of the
deconsolidated subsidiary’s liabilities (e.g. because the Court may hold it
liable) without having issued a guarantee in the scope of Topic 460, it
determines whether a liability should be recognized (see Question
4.11.100).
— Intercompany receivables and payables. If the parent entity previously
recognized intercompany receivables from or payables to the subsidiary
that were eliminated in consolidation, the receivables or payables are
recognized in the parent’s financial statements on deconsolidation, and the
receivables are assessed for recoverability (see Question 4.11.140).
For additional guidance on deconsolidation, see chapter 7 of the KPMG
Handbook, Consolidation. For guidance on deconsolidating foreign entities and
recognizing the cumulative translation adjustment, see section 4 of KPMG
Handbook, Foreign currency.

Question 4.11.80
Is an investment in a deconsolidated subsidiary
accounted for under the equity method?

Background: As discussed in Question 4.11.40, when a subsidiary files a

petition for bankruptcy, control of the subsidiary is usually with the Court. If the
parent no longer has a controlling financial interest, deconsolidation is
appropriate.
Interpretive response: We believe that an entity generally should not account
for a deconsolidated subsidiary using the equity method. Topic 323 provides
guidance on when and how to apply the equity method of accounting. The

same limitations under which a majority-owned subsidiary should not be

consolidated apply as limitations on the use of the equity method, including
when the investee is in legal reorganization or bankruptcy. [323-10-35-2]
When an entity deconsolidates a subsidiary and its remaining investment is not
accounted for under the equity method, its investment in the entity is generally
accounted for in one of two ways: [323-10-05-4, 321-10-35-1 – 35-2]
— at fair value, with unrealized holding gains and losses included in earnings;
or
— at cost minus impairment, adjusted to fair value if the entity identifies
observable price changes in orderly transactions for the same or a similar
investment in the same subsidiary.
See KPMG Handbook, Investments, for more information about accounting for
equity investments under Topic 321.

Question 4.11.90
How does a parent account for a guarantee issued
on behalf a deconsolidated subsidiary?

Background: As discussed in Question 4.11.40, if a subsidiary files for

bankruptcy but its parent does not, the parent is generally required to
deconsolidate the subsidiary because it has lost control of the subsidiary to the
Court. Before losing control of the subsidiary, the parent issued a guarantee
(that is in the scope of Subtopic 460-10) on behalf of the subsidiary that requires
the guarantor to make payments to the guaranteed party should the subsidiary
fail to perform under an obligating agreement.
A liability for a guarantee is not recognized if the guarantee is issued by a parent
to its consolidated subsidiary. However, once a parent deconsolidates a
subsidiary, the guarantee becomes subject to the recognition provisions of
Subtopic 460-10. [460-10-25-1(g)]
Interpretive response: Assuming the guarantee does not qualify for another
scope exception in Subtopic 460-10, we believe the parent should recognize the
guarantee when it deconsolidates the subsidiary; in that case, the parent
measures the guarantee as if it were newly issued on the date of
deconsolidation. Our view is based on an SEC staff speech that addressed
recognizing a pre-existing guarantee of a subsidiary’s performance when the
parent spins off the subsidiary. [2007 AICPA Conf]
A guarantee is initially measured at the higher of: [450-20-25-2, 460-10-30-3]
— its fair value; and
— the amount that would be recognized under the measurement guidance of
Subtopic 450-20 (loss contingencies), if a loss is both probable and
reasonable estimable.
A liability recognized for the guarantee reduces the gain (or increases the loss)
on deconsolidation (see Question 4.11.70).

Question 4.11.100
How does a parent account for obligations of a
deconsolidated subsidiary for which it is liable?

Background: A parent deconsolidates a subsidiary when the subsidiary files for

bankruptcy because it has lost control of the subsidiary. However, this question
addresses the situation where the parent is still contractually responsible for
certain of the subsidiary’s liabilities.
Interpretive response: If the parent is contractually responsible for the
subsidiary’s liabilities (e.g. because the Court may hold it liable), but it has not
issued a guarantee in the scope of Topic 460, it determines whether a loss
should be recognized for claims against it by the former subsidiary's creditors
under Subtopic 450-20 (loss contingencies). Any loss reduces the gain (or
increases the loss) on deconsolidation (see Question 4.11.70).
If a loss is not both probable and reasonably estimable, or if an exposure exists
beyond the amount accrued, the contingency is disclosed if a loss (or an
additional loss) is at least reasonably possible (see section 4.14). [450-20-50-3]

Question 4.11.110
When does a parent begin to consolidate a
bankrupt entity it acquires?

Interpretive response: The parent consolidates the newly acquired bankrupt

subsidiary once it has control of the subsidiary. As discussed in Question
4.11.40, the parent generally does not obtain control earlier than the date the
acquired subsidiary emerges from bankruptcy if it is under control of the Court
while it is bankruptcy. The parent should evaluate consolidation under the
voting interest entity or variable interest entity model, as appropriate. [810-10-15]
For additional guidance on consolidation, see KPMG Handbook, Consolidation.

Parent and/or consolidated subsidiary file for bankruptcy

Excerpt from ASC 852-10

• > Condensed Combined Financial Statements

45-14 Consolidated financial statements that include one or more entities in
reorganization proceedings and one or more entities not in reorganization
proceedings shall include condensed combined financial statements of the
entities in reorganization proceedings. The combined financial statements shall
be prepared on the same basis as the consolidated financial statements.

45-15 In addition to making the required paragraph 852-10-50-4 disclosures,

the propriety of the carrying amounts of intra-entity receivables from entities in
Chapter 11 shall be evaluated.

Question 4.11.120
Does a parent continue to consolidate a subsidiary
after both have filed for bankruptcy?

Interpretive response: It depends. As discussed in Questions 4.11.40 and

4.11.50, the parent should only continue to consolidate if it maintains control
over the subsidiary. When an entity files for bankruptcy, control usually rests
with the Court and not with the parent. When this is the case, deconsolidation
is appropriate.
In some cases, a consolidated entity files a single petition with the Court that
includes both the parent and the subsidiary. When there is a single petition in a
single jurisdiction, the Court generally views the consolidated entity as a single
group and the parent is generally able to demonstrate that it continues to
maintain control of a majority-owned subsidiary that is operating under the
same petition filing. In these situations, continued consolidation is appropriate.
However, if the parent and subsidiary execute separate petition filings or they
file petitions in separate jurisdictions (e.g. parent company files in the United
States and the subsidiary files in a foreign jurisdiction), then the parent likely has
lost control over the subsidiary (see Question 4.11.40). If control is lost, the
parent deconsolidates the subsidiary at the date that control is lost, which is
typically the date the subsidiary filed its bankruptcy petition. Due to the specific
legal considerations that may be involved in these situations, consultation with
legal counsel is likely necessary.

Question 4.11.130
Is incremental reporting required if consolidated
financial statements include both entities that are
in bankruptcy and entities that are not?
Interpretive response: Yes. When consolidated financial statements include
both entities that are in bankruptcy and entities that are not, the parent is
required to present condensed combined financial statements of the entities in
bankruptcy. The condensed combined financial statements should also disclose
details of the intercompany receivables and payables of entities in bankruptcy
(see section 4.14). [852-10-45-14, 50-4]
Question 4.11.140 discusses measuring intercompany receivables and payables
when an entity in the group is in bankruptcy.

Question 4.11.140
How are intercompany balances accounted for
when a party to the balances is in bankruptcy?

Background: Related entities often have intercompany amounts payable to and

receivable from each other. The measurement of those balances can be
affected if one or more of the related entities is in bankruptcy.
Interpretive response: We believe the treatment of intercompany payables
and receivables when a party to the balance is in bankruptcy depends on
whether the subsidiary is deconsolidated or continues to be consolidated.
Subsidiary is deconsolidated
As discussed in Question 4.11.40, if a subsidiary files for bankruptcy, we
generally expect the parent to deconsolidate the subsidiary due to loss of
control. In this situation, the subsidiary accounts for its intercompany payables
to its former parent or sister entities in the same manner as all prepetition
liabilities. The obligation is presented as a prepetition liability, and it is measured
at the amount of the claim expected to be allowed by the Court.
For the financial statements of the parent (that now exclude the subsidiary in
bankruptcy) or the stand-alone financial statements of the subsidiary, each
entity should assess the recoverability of receivables from the other entity
under Topic 310 (or Topic 326 if adopted). This includes the effect on that
recoverability as a result of the entity’s bankruptcy proceedings. Each entity
should adjust the carrying amount of the receivables as appropriate.
For guidance on assessing the recoverability of trade receivables under Topic
326, see chapter 18 of KPMG Handbook, Credit impairment.
Subsidiary remains consolidated
If the parent does not lose control of the subsidiary and continues to
consolidate, it continues to eliminate intercompany receivables and payables.
Further, as discussed in Question 4.11.130, the parent is required to present
condensed combined financial statements of the entities in bankruptcy,
including its subsidiaries. The condensed combined financial statements should
disclose details of the intercompany receivables and payables of entities in
bankruptcy. Additionally, the propriety of the carrying amounts of the
intercompany balances should be evaluated. [852-10-45-14 – 45-15, 50-4]

4.11.30 Discontinued operations

Subtopic 205-20 requires a component of an entity to be reported in
discontinued operations if the disposal represents a ‘strategic shift’ that has or
will have a major effect on the entity’s operations and financial results. A
disposal occurs in this context when a component is either disposed of or
qualifies to be classified as held-for-sale. [205-20-45-1A – 45-1B]
For additional guidance on accounting for discontinued operations while an
entity is experiencing financial difficulties, see section 3.11.10.

Question 4.11.150
How are liabilities subject to compromise presented
when they are part of a discontinued operation?

Interpretive response: If the buyer agrees to assume the liabilities, we believe

they should be classified as liabilities held-for-sale, assuming all other criteria for
held-for-sale classification are met.
Otherwise, when an entity is in bankruptcy, we believe liabilities subject to
compromise should be classified as such, rather than presented in discontinued
operations. If a liability subject to compromise that would otherwise be
presented with discontinued operations becomes not subject to compromise
(see Question 4.3.20), we believe it is appropriate to reclassify the liability to
discontinued operations.

Question 4.11.160
Where does an entity in bankruptcy present a loss
from remeasuring an asset held-for-sale that is part
of a discontinued operation?
Background: Before the petition filing date, an entity reports a component in
discontinued operations and recognizes and measures the long-lived assets of
the disposal group as held-for-sale. In accordance with Topic 360, the entity
measures the long-lived assets at the lower of their carrying amount or fair
value less cost to sell, and presents the resulting loss within discontinued
operations in its statement of operations. [205-20-45-3C, 360-10-35-43]
After the petition filing date, the entity revises its estimate of the held-for-sale
assets’ fair value less costs to sell. If the revision results in an additional loss,
that loss is recognized in the entity’s statement of operations.
Interpretive response: We believe an entity in bankruptcy should report
discontinued operations based on the criteria in Subtopic 205-20, just the same
as if it were not in bankruptcy. Therefore, if disposal costs and other amounts
related to the discontinued component (including adjustments to the fair value
less cost to sell the asset group) would normally be presented in discontinued
operations absent the bankruptcy filing, we believe those amounts should
continue to be classified as such – even if the entity is operating while in
bankruptcy. This is because Subtopic 852-10 explicitly prohibits amounts
required to be presented as discontinued operations from being presented as
reorganization items (see section 4.9.10). [852-10-45-9]
See Example 4.13.20 for an example statement of operations for an entity in
bankruptcy, which includes disposal costs and other amounts related to
discontinued operations.

4.12 Section 363 sales

As discussed in section 2.3.60, Section 363 of the Code allows an entity to sell
substantially all of its assets free and clear of liens and encumbrances. The
proceeds of the sale are then paid in priority order to the creditors with a
security interest in those assets.

Question 4.12.10
How does an entity in bankruptcy account for a
Section 363 sale?

Interpretive response: The answer depends on whether the group of assets

meets the definition of a business in Topic 805; see section 2 of KPMG
Handbook, Business combinations, for guidance on the definition of a business.
— If it does, the sale is in the scope of Topic 810 (consolidation).
— If it does not, the sale is usually in the scope of Subtopic 610-20 (gains and
losses from the derecognition of nonfinancial assets). [610-20-15-4]
In a typical Section 363 sale, the entity sells all (or substantially all) of its assets
such that what is being sold meets the definition of a business under Topic 805.
When a group of assets that is a business is sold, the entity recognizes a gain
or loss for the difference between the carrying amount of the group of assets
and the fair value of the consideration received in the sale. [810-10-40-5]
If the sale is in the scope of Subtopic 610-20, the accounting is similar to the
accounting for a sale of nonfinancial assets to a customer under Topic 606.

Question 4.12.20
How is a ‘break-up fee’ accounted for in
bankruptcy?

Background: As discussed in section 2.3.60, a Section 363 sale is often

initiated by the entity entering into an agreement with a ‘stalking horse’ entity
that agrees to purchase the entity’s assets and facilitate their sales to others
through a bidding process. The agreement with the stalking horse entity usually
includes a provision for a break-up fee, which is paid by the bankrupt entity to
the stalking horse entity if it is ultimately not the highest bidder in the auction
and another entity acquires the assets.
Interpretive response: If an entity in bankruptcy executes a Section 363 sale
and incurs a break-up fee, the liability is accounted for like any other
postpetition liability (see section 4.3.10) and presented as a reorganization item
in the entity’s statement of operations (see section 4.9.10).

4.13 Example financial statements while in bankruptcy

4.13.10 Overview

Excerpt from ASC 852-10

> Illustrations
• > Example 1: Illustrative Financial Statements and Notes to Financial
Statements for an Entity Operating Under Chapter 11
55-2 The following Example illustrates the guidance in paragraphs 852-10-45-1
through 45-13 and 852-10-50-2 through 50-3 relating to financial statement
reporting practices during the period that an entity is in reorganization.
Illustrative financial statements and accompanying notes follow.
55-3 XYZ Company is a manufacturing concern headquartered in Tennessee,
with a fiscal year ending on December 31. On January 10, 19X1, XYZ filed a
petition for relief under Chapter 11 of the federal bankruptcy laws. The
following financial statements (balance sheet and statements of operations and
cash flows) are presented as of and for the year ended December 31.
Illustrative Financial Statements and Notes to Financial Statements for an
Entity Operating Under Chapter 11
XYZ Company
(Debtor in Possession)
Balance Sheet
December 31, 19X1
Assets (000s)
Current assets
Cash $ 110
Accounts receivable, net 300
Inventory 250
Other current assets 30
Total current assets 690
Property, plant and equipment, net 430
Goodwill 210
Total Assets $ 1,330

Liabilities and Shareholders’ Deficit (000s)

Liabilities Not Subject to Compromise Current Liabilities:
Short-term borrowings` $ 25
Accounts payable—trade 200
Other liabilities 50
Total current liabilities 275
Liabilities Subject to Compromise 1,100 (a)

Total liabilities 1,375

Shareholders’ (deficit)
Preferred stock 325
Common stock 75
Retained earnings (deficit) (445)
(45)
Total liabilities & Shareholders’ (Deficit) $ 1,330

(a) Liabilities subject to compromise consist of the following:

Secured debt, 14%, secured by first mortgage on building $ 300,000 (b)
Priority tax claims 50,000
Senior subordinated secured notes, 15% 275,000
Trade and other miscellaneous claims 225,000
Subordinated debentures, 17% 250,000
$ 1,100,000

(b) The secured debt in this case should be considered, due to various factors, subject to
compromise.

The accompanying notes are an integral part of the financial statements.

XYC Company
(Debtor-in-Possession)
Statement of Operations
For the Year Ended December 31, 19X1
(000s)
19X1
Revenues:
Sales $ 2,400
Cost and expenses:
Cost of goods sold 1,800
Selling, operating and administrative 550
Interest (contractual interest $5) 3
2,353
Earnings before reorganization items and income tax benefit 47
Reorganization items:
Loss on disposal of facility (60)
Professional fees (50)
Provision for rejected executory contracts (10)
Interest earned on accumulated cash resulting from Chapter 11
proceeding 1
(119)
Loss before income tax benefit and discontinued operations (72)
Income tax benefit 10
Loss before discontinued operations (62)
Discontinued operations:
Loss from operations of discontinued procedures segment (56)
Net loss $ (118)
Loss per common share:
Loss before discontinued operations $ (0.62)
Discontinued operations (0.56)
Net loss $ (1.18)

The accompanying notes are an integral part of the financial statements.

XYZ Company
(Debtor-in-Possession)
Statement of Cash Flows
For the Year Ended December 31, 19X1
Increase in Cash and Cash Equivalents
(000s)
19X1
Cash flows from operating activities:
Cash received from customers $ 2,200
Cash paid to suppliers and employees (2,070)
Interest paid (3)
Net cash provided by operating activities before reorganization
items 147

Operating cash flows from reorganization items:

Interest received on cash accumulated because of the Chapter 11 1
proceeding
Professional fees paid for services rendered in connection with the
Chapter 11 proceeding (50)
Net cash used by reorganization items (49)
Net cash provided by operating activities 98
Cash flows from investing activities:
Capital expenditures (5)
Proceeds from sale of facility due to Chapter 11 proceeding 40
Net cash provided by investing activities 35
Cash flows used by financing activities:
Net borrowings under short-term credit facility (post petition) 25
Repayment of cash overdraft (45)
Principal payments on prepetition debt authorized by count (3)
Net cash provided by investing activities (23)
Net increase in cash and cash equivalents 110
Cash and cash equivalents at beginning of year -
Cash and cash equivalents at end of year $ 110

Reconciliation of net loss to net cash provided by operating activities

Net loss $ (118)
Adjustments to reconcile net loss to net cash provided by operating
activities
Depreciation 20
Loss on disposal of facility 60
Provision for rejected executory contracts 10
Loss on discontinued operations 56
Increase in postpetition payables and other liabilities 250
Increase in accounts receivable (180)
Net cash provided by operating activities $ 98

The accompanying notes are an integral part of the financial statements.

XYZ Company Notes to Financial Statements December 31, 19X1

Note X—Petition for Relief Under Chapter 11
On January 10, 19X1, XYZ Company (the Debtor) filed petitions for relief under
Chapter 11 of the federal bankruptcy laws in the United States Bankruptcy
Court for the Western District of Tennessee. Under Chapter 11, certain claims
against the Debtor in existence before the filing of the petitions for relief under
the federal bankruptcy laws are stayed while the Debtor continues business
operations as Debtor-in-possession. These claims are reflected in the
December 31, 19X1, balance sheet as liabilities subject to compromise.
Additional claims (liabilities subject to compromise) may arise after the filing
date resulting from rejection of executory contracts, including leases, and from
the determination by the court (or agreed to by parties in interest) of allowed
claims for contingencies and other disputed amounts. Claims secured against
the Debtor's assets (secured claims) also are stayed, although the holders of
such claims have the right to move the court for relief from the stay. Secured
claims are secured primarily by liens on the Debtor's property, plant, and
equipment.
The Debtor received approval from the Bankruptcy Court to pay or otherwise
honor certain of its prepetition obligations, including employee wages and
product warranties. The Debtor has determined that there is insufficient

collateral to cover the interest portion of scheduled payments on its prepetition

debt obligations. Contractual interest on those obligations amounts to $5,000,
which is $2,000 in excess of reported interest expense; therefore, the debtor
has discontinued accruing interest on these obligations. See Note X in Example
2 (paragraph 852-10-55-11) for a discussion of the credit arrangements entered
into after the Chapter 11 filings.

The financial statement presentation requirements for an entity in bankruptcy

are largely the same as the requirements for those that are not. The most
notable difference is that the financial statements of an entity in bankruptcy
must clearly distinguish transactions and events that are directly associated
with the bankruptcy proceedings from the ongoing, normal operations of the
entity. This is the primary objective of Subtopic 852-10.[852-10-45-10]
This section provides a comprehensive example of basic financial statements
prepared while an entity is in bankruptcy. This example illustrates the guidance
discussed throughout this chapter and highlights additional requirements of an
entity’s financial statement presentation while in bankruptcy.

4.13.20 Balance sheet presentation

To accomplish the objective of Subtopic 852-10 when presenting a balance
sheet, an entity presents liabilities as either subject to compromise or not, as
discussed in section 4.3.

Example 4.13.10
Balance sheet under Subtopic 852-10
ABC Corp. is a calendar year-end company that filed a petition for bankruptcy on
July 1, Year 1. ABC’s December 31, Year 1 balance sheet is as follows.

ABC Corporation
(Debtor-in-Possession)1
Balance Sheet
December 31, 20X1

Assets (000s)
Current assets
Cash $ 4,000
Short-term investments 500
Accounts receivable, net 1,000
Inventory 500
Other current assets 700
Total current assets 6,700
Property, plant and equipment, net 5,000
Intangible assets 1,000

Other assets 2,000

Total Assets $ 14,700

Liabilities and Shareholders’ Deficit

Current Liabilities:
Debtor-in-possession financing2 $ 1,000
Accounts payable 1,000
Other accrued liabilities 2,000
Total current liabilities 4,000
Long-term debt 4,000
Other liabilities 1,000
Total liabilities not subject to compromise 9,000
Liabilities subject to compromise3 9,000
Total liabilities 18,000
Shareholders’ (deficit):
Common stock 500
Additional paid-in capital 3,500
Accumulated deficit (7,300)
Total shareholders’ (deficit) (3,300)
Total liabilities and shareholders’ (deficit) $ 14,700

Because it is operating while in bankruptcy, ABC makes the following

adjustments to its balance sheet presentation.

1 Identifies itself as ‘Debtor-in-Possession’ in the title.

Classifies DIP financing as a current liability not subject to compromise, based
2
on the terms of the debt agreement.
Separately presents liabilities subject to compromise, either before noncurrent
3
liabilities or after (see Question 4.3.40).

4.13.30 Statement of operations presentation

To distinguish transactions and events that are directly associated with the
bankruptcy proceedings from the entity’s ongoing, normal operations, an entity
presents reorganization items as a separate caption in the statement of
operations. [852-10-45-9]

Example 4.13.20
Statement of operations under Subtopic 852-10
ABC Corp. is a calendar year-end company that filed a petition for bankruptcy on
July 1, Year 1. ABC’s December 31, Year 1 statement of operations is as
follows.

ABC Corporation
(Debtor-in-Possession)1
Statement of Operations
For the Year Ended December 31, 20X1
(000’s)

20X1
Net sales $ 20,000
Cost of goods sold 16,000
Gross margin 4,000

Operating expenses:
Selling, general and administrative expenses 5,500
Restructuring and impairment charges 1,000
Other expenses 500
Total operating expenses 7,000

Loss before interest, reorganization items, and income taxes (3,000)

Interest expense (contractual interest, $500)2 275
Reorganization items, net3 500

Loss before income tax benefit and discontinued operations (3,775)

Income tax benefit 600

Loss before discontinued operations (3,175)

Discontinued operations:
Loss from operations of a discontinued component (500)
Net loss $ (3,675)

Because it is operating while in bankruptcy, ABC makes the following

adjustments to its statement of operations presentation.

1 Identifies itself as ‘Debtor-in-Possession’ in the title.

As discussed in section 4.9.20, an entity in bankruptcy recognizes interest
expense only up to the amount that will be paid during the proceeding or the
amount that is probable of being an allowed claim. The extent to which reported
2
interest expense differs from stated contractual interest is required to be
disclosed. This requirement can be met by disclosing the amount parenthetically
on the face of the statement of operations. [852-10-50-3]
Separately presents reorganization items (see section 4.9.10). Details of
3 reorganization items are presented in the notes to the financial statements (see
section 4.14).

4.13.40 Statement of cash flows presentation

Excerpt from ASC 852-10

• > Statement of Cash Flows

45-13 Reorganization items shall be presented separately within the operating,
investing, and financing categories of the statement of cash flows. This
presentation can be better accomplished by the use of the direct method of
presenting the statement. Paragraph 230-10-45-25 lists the operating items
that shall be reported separately when the direct method is used. That
paragraph encourages further breakdown of those operating items if the entity
considers such a breakdown meaningful and feasible. Further identification of
cash flows from reorganization items should be provided to the extent feasible.
For example, interest received might be segregated between estimated
normal recurring interest received and interest received on cash accumulated
because of the reorganization. If the indirect method is used, details of
operating cash receipts and payments resulting from the reorganization shall
be disclosed in a supplementary schedule or in the notes to financial
statements. (See paragraph 852-10-50-6A.)

Similar to the statement of operations, reorganization items are presented

separately within the operating, investing and financing categories of the
statement of cash flows. It is easier to meet this requirement if the statement
of cash flows is presented under the direct method. If the indirect method is
used, the entity should disclose details of cash receipts and payments directly
resulting from bankruptcy proceedings, either in a supplementary schedule or in
the notes to the financial statements (see section 4.14). [852-10-45-13]
For guidance on changing the presentation method for the statement of cash
flows, see section 3.3.40 of KPMG Handbook, Statement of cash flows.

Example 4.13.30
Statement of cash flows (prepared under the direct
method) under Subtopic 852-10
ABC Corp. is a calendar year-end company that filed a petition for bankruptcy on
July 1, Year 1. ABC’s December 31, Year 1 statement of cash flows is as
follows.
ABC Corporation
(Debtor-in-Possession)1
Statement of Cash Flows
For the Year Ended December 31, 20X1
(000’s)

20X1
Cash flows from operating activities:
Cash received from customers 19,000

Cash payments to vendors and employees (21,500)

Interest paid (275)
Net cash used by operating activities before reorganization items (2,775)

Operating cash flows from reorganization items:

Interest received 50
Professional fees paid for services related to bankruptcy proceedings2 (150)
Net cash used for reorganization items (100)
Net cash used by operating activities (2,875)

Cash flows from investing activities:

Purchases of property, plant and equipment (50)
Proceeds from sale of equipment due to bankruptcy proceedings2 200
Net cash provided by investing activities 150

Cash flows from financing activities:

Receipt of DIP financing2 1,000
DIP financing costs2 (50)
Repayment of prepetition of debt (500)
Net cash provided by financing activities 450

Net decrease in cash and cash equivalents (2,275)

Cash and cash equivalents at beginning of year 4,275
Cash and cash equivalents at end of year 2,000

Reconciliation of net loss to net cash used by operating activities

Net loss (3,175)
Adjustments to reconcile net loss to net cash used by operating activities
Depreciation 275
Amortization of intangible assets 75
Loss on sale of equipment due to bankruptcy proceedings 50
Decrease in accounts receivable 225
Increase in accounts payable (150)
Increase in other accrued liabilities (175)

Net cash used by operating activities $ (2,875)

Because it is operating while in bankruptcy, ABC makes the following

adjustments to its statement of cash flows presentation.

1 Identifies itself as ‘Debtor-in-Possession’ in the title.

Clearly differentiates reorganization items within operating, investing and
2
financing activities.

Because ABC uses the direct method to prepare its statement of cash flows,
no additional disclosure about cash receipts and payments directly resulting
from bankruptcy proceedings is necessary.

4.14 Disclosures

Excerpt from ASC 852-10

• > EPS
45-16 Earnings per share (EPS) shall be reported, if required, in conformity with
Topic 260. If it is probable that the plan will require the issuance of common
stock or common stock equivalents, thereby diluting current equity interests,
that fact shall be disclosed.
General
50-1 This Section provides incremental disclosure guidance for entities with
transactions within the scope of this Subtopic. It is incremental to disclosure
guidance otherwise applicable to an entity under other generally accepted
accounting principles (GAAP).
> Financial Reporting during Reorganization Proceedings
50-2 The notes to financial statements of an entity in Chapter 11 shall disclose
both of the following:
a. Claims not subject to reasonable estimation based on the provisions of
Subtopic 450-20
b. The principal categories of the claims subject to compromise.
50-3 The extent to which reported interest expense differs from stated
contractual interest shall be disclosed. It may be appropriate to disclose this
parenthetically on the face of the statement of operations.
50-4 Intra-entity receivables and payables of entities in reorganization
proceedings shall be disclosed in the condensed combined financial
statements referred to in paragraph 852-10-45-14.
50-5 Paragraph 852-10-45-16 identifies a situation in which disclosure of a
probable issuance of common stock or common stock equivalents is required.
50-6 Example 1 (see paragraph 852-10-55-2) provides an illustration of financial
statements and notes thereto for an entity operating under Chapter 11.
50-6A If the indirect method is used to prepare the statement of cash flows,
details of operating cash receipts and payments resulting from the
reorganization shall be disclosed in a supplementary schedule or in the notes to
the financial statements. (See paragraph 852-10-45-13.)

An entity in bankruptcy is still required to follow the disclosure requirements of

other relevant US GAAP. The incremental disclosure requirements of Subtopic
852-10 are minimal. Perhaps more importantly, the disclosures required by
other relevant US GAAP may need to be elaborated on while an entity is in
bankruptcy to provide the users of those financial statements with adequate
transparency as to the entity’s financial health. [852-10-50-1]
Subtopic 852-10 requires the following disclosures when an entity is in
bankruptcy: [852-10-50-2 – 50-5, 45-13, 45-16]

— details of any claims that are probable but cannot be reasonably estimated;
— details about the principal categories of the liabilities subject to compromise
caption on the balance sheet;
— extent to which reported interest expense differs from stated contractual
interest;
— intra-entity receivables and payables of entities in bankruptcy proceedings
(if the entity is required to present condensed combined financial
statements);
— details of the operating cash receipts and payments directly resulting from
the bankruptcy proceedings (if the entity uses the indirect method to
prepare its statement of cash flows); and
— whether it is probable that the plan of reorganization will require the
issuance of common stock or equivalents that would dilute current equity
interests.

Question 4.14.10
What are additional items that an entity in
bankruptcy should consider disclosing?

Interpretive response: Each entity in bankruptcy has its own facts and
circumstances requiring different types or amounts of information to be
disclosed. While not an exhaustive list, we believe an entity in bankruptcy
should consider the following disclosures in the notes to its financial
statements – aimed at providing transparency about the bankruptcy
proceedings.
— Administrative details:
— the date of the petition filing;
— the jurisdiction in which the petition was filed;
— the entities in the consolidated group that are included in the petition (if
applicable).
— Other details:
— a description of the circumstances and events leading to bankruptcy;
— a summary of the expected timeline of the proceedings;
— an update on key bankruptcy related events that have occurred;
— implications of the Court’s authority over operations of the entity to
liquidity and uses of cash.
— Details about significant leases or other executory contracts that were
accepted or rejected as part of the proceedings.
— Details about any significant bankruptcy related subsequent events.
An entity in bankruptcy should disclose any other events or circumstances
resulting from the bankruptcy proceedings that significantly affect its financial
statements, in addition to the disclosure requirements in Topic 275 (risks and
uncertainties). Disclosure should also be made for situations when lack of
disclosure would render the financial statements misleading.

The following items identify common situations discussed in this chapter that
require disclosure.
— If the entity is presenting discontinued operations, it should disclose details
of the amounts included in discontinued operations – unless the details are
presented on the face of the statement of operations. [205-20-50-1]
— If the entity obtained DIP financing, it should disclose details about the
financing, including principal amount and related fees and terms of the
financing. [210-10-S99-1]
— If the bankruptcy affected other areas of the financial statements,
disclosure may be required under other applicable US GAAP, such as debt
covenant violations, impairment of intangible assets and long-lived assets,
income taxes, share-based compensation, foreign currency and others. [852-
10-50-1]

4.15 SEC registrants

4.15.10 SEC reporting requirements
SEC registrants in bankruptcy are not relieved of their current and periodic SEC
reporting obligations. Neither the Code nor the federal securities laws provide
an exemption from the Securities Exchange Act of 1934 (the Exchange Act)
periodic reporting requirements for registrants that have filed for bankruptcy.

Question 4.15.10
Are SEC registrants operating in bankruptcy
relieved from their SEC reporting requirements?

Interpretive response: No. However, the SEC will generally accept reports that
differ in form or content from reports required to be filed under the Exchange
Act when they are not deemed to be inconsistent with the protection of
investors. [SEC SLB No. 2]
A registrant operating in bankruptcy may request a ‘no-action’ position from the
Division of Corporation Finance that provides for acceptance of modified
Exchange Act reports from registrants subject to the jurisdiction of the
Bankruptcy Court. In providing a no-action position, the Division of Corporation
Finance determines whether modified reporting is consistent with the
protection of investors. [SEC SLB No. 2]

Question 4.15.20
What information does an SEC registrant in
bankruptcy include in its request for a no-action
position?
Interpretive response: The request for a no-action position includes the
following information regarding disclosure of financial condition and market for
the registrant’s securities. [SEC SLB No. 2]
— Whether the registrant complied with its Exchange Act reporting
obligations before it filed for bankruptcy. Because the registrant’s
efforts to inform the market of its financial condition are important, a
registrant submitting a request for a no-action position should have been
current in its Exchange Act reports for the 12 months before it filed for
bankruptcy.
— When the registrant filed its Form 8-K announcing its bankruptcy
filing, and whether it made any other efforts to advise the market of
its financial condition. There is no specific, objective test concerning the
timing of the Form 8-K filing; however, the registrant should state the date
the Form 8-K was due and filed. If the registrant filed the Form 8-K after the
due date, the reason should be explained. The registrant should also
discuss any other efforts it made to inform its security holders and the
market of its financial condition.
— Why the registrant is unable to continue Exchange Act reporting. The
registrant should discuss the following in its request:
— whether it has ceased its operations or the extent to which it has
curtailed operations;
— why filing periodic reports would present an undue hardship;
— why it cannot comply with the disclosure requirements; and
— why it believes granting the request is consistent with the protection of
investors.
Management of the registrant should also represent, if true, that:
— the filing of periodic reports would present an undue hardship; and
— the information contained in the monthly operating reports filed with
the Court pursuant to the Code is sufficient for the protection of
investors while the registrant is subject to the jurisdiction of the Court.
— Nature and extent of trading in the registrant’s securities. The
registrant should discuss in detail the market for its securities.
The Division of Corporation Finance will not approve a request for a no-
action position if the registrant’s securities trade on a national securities
exchange or the Nasdaq, because it indicates that there is an active market
for the registrant’s stock. Registrants that do not have securities traded on
a national securities exchange or the Nasdaq should quantify the effect of
the bankruptcy filing on the trading in their securities. This information
should demonstrate that there is minimal trading in the securities.
The registrant should state the number of market makers for its securities.
It also should provide detailed information regarding the number of shares

traded and the number of trades per month for each of the three months
before it filed for bankruptcy and each month after that filing. General
statements in the request that trading has been ‘minimal’ or ‘insignificant’
are not sufficient to enable the Division of Corporation Finance to reach a
conclusion on the request. An unequivocal statement that there is ‘no
trading’ in the registrant’s securities is sufficient.
A registrant should submit its request for no-action position promptly after it has
entered bankruptcy. A request is considered to be submitted ‘promptly’ if it is
filed before the date the registrant’s first periodic report is due following the
registrant’s filing for bankruptcy.

Question 4.15.30
What modified reports will the SEC accept if an SEC
registrant in bankruptcy has been approved for a
no-action position?
Interpretive response: If the registrant has successfully obtained a no-action
position from the Division of Corporation Finance, generally the SEC staff will
accept the monthly operating reports a registrant must file with the Bankruptcy
Court; this is instead of Form 10-K and Form 10-Q filings. The registrant must
file each monthly report with the SEC on a Form 8-K within 15 calendar days
after the monthly report is due to the Court. [SEC SLB No. 2]
The relief given applies only to filing Form 10-K and Form 10-Q. The registrant
must still satisfy all other provisions of the Exchange Act, including filing the
current reports required by Form 8-K and satisfying the proxy, issuer tender
offer and going-private provisions. [SEC SLB No. 2]

Question 4.15.40
Do SEC registrants operating in bankruptcy need to
assess the effectiveness of internal control over
financial reporting?
Interpretive response: Generally, yes. A registrant must provide a report of
management’s assessment of internal control over financial reporting with a
statement that the registered public accounting firm that audited the financial
statements included in the annual report has issued an attestation report on the
registrant’s internal control over financial reporting, or that the annual report
does not include an attestation report pursuant to the rules of the SEC, [Reg S-K
308]

As discussed in Question 4.15.10, registrants operating in bankruptcy are not

relieved of their periodic reporting obligations, unless a no-action position is
obtained from the Division of Corporation Finance that provides for acceptance
of modified Exchange Act reports from registrants subject to the jurisdiction of
the Bankruptcy Court.

We believe this same concept carries over to the registrant’s requirement to

assess the effectiveness of internal control over financial reporting. Neither the
Code nor the federal securities laws provide an exemption from Exchange Act
periodic reporting for registrants that have filed for bankruptcy. Therefore, the
requirement to assess the effectiveness of internal control over financial
reporting continues to apply during bankruptcy.

Question 4.15.50
When is an SEC registrant in bankruptcy required to
file a Form 8-K?

Background: An SEC registrant is required to file a Form 8-K after the

occurrence of any of the following events.
Registrant’s business and Corporate governance and
Securities trading and markets
operations management

Entry into or termination of a Notice of delisting or failure to Change in control of registrant

material definitive agreement satisfy continued listing rule or
standard Departure of directors or certain
Entry into bankruptcy or officers
receivership Transfer of listing
Election of directors or appointment
Mine safety – reporting of Unregistered sales of equity of certain officers
shutdowns and patterns of securities
violations Compensatory arrangements of
Material modifications to rights of certain officers
security holders
Financial information
Amendments to articles of
Matters related to accountants incorporation or bylaws
Completion of acquisition or and financial statements
disposition of assets Change in fiscal year
Changes in registrant’s certifying
Results of operations and financial accountant Temporary suspension of trading
condition under registrant’s employee benefit
Non-reliance on previously issued plans
Creation of, or triggering events financial statements or related
that accelerate or increase, direct audit report or completed interim Amendments to registrant’s code of
financial obligation or obligation review ethics
under off-balance sheet
arrangement Waiver of provision of registrant’s
code of ethics
Costs associated with exit or
disposal activities Change in shell company status

Material impairments Submission of matters to a vote of

security holders

Shareholder director nominations

Interpretive response: As discussed in Question 4.15.30, the relief provided to

registrants in bankruptcy for modified reporting applies only to filing Form 10-K
and Form 10-Q. Therefore, the registrant must continue to file Form 8-K in
accordance with the Exchange Act rules.
While not an exhaustive list, below is an explanation of some of the more
common events a registrant in bankruptcy may experience that require
reporting on Form 8-K. [Form 8-K General]
— Entry into bankruptcy or receivership. Registrants are required to file a
Form 8-K with the SEC when they enter into bankruptcy and when an order

confirming a plan of reorganization, arrangement or liquidation has been

entered by a court or governmental authority that has supervision over
substantially all of the assets or business of the registrant (or its parent).
— Disposition of assets. Registrants that dispose of a significant amount of
assets are required to file a Form 8-K disclosing the date of the transaction;
a description of the assets disposed of; the party to whom the assets were
sold; and the nature and amount of consideration received.
— Costs associated with exit or disposal activities. Registrants are
required to file a Form 8-K when they are committed to an exit or disposal
plan, or have incurred material charges as a result of disposing of a long-
lived asset or terminating employees under a plan of termination described
in Topic 420.
— Material impairments. Registrants are required to file a Form 8-K when
they recognize a material charge for impairment to one or more of their
assets.
Management of registrants in bankruptcy should be familiar with the rules
governing Form 8-K filings, as many developments throughout the bankruptcy
process may qualify as reportable events to be disclosed on Form 8-K.

4.15.20 Disclosures
SEC registrants that have not been approved to provide modified Exchange Act
reports (see Question 4.15.10) are required to continue filing periodic reports on
Form 10-K and Form 10-Q. The following table provides some example Form
10-K disclosure requirements that may be of elevated importance when the
registrant is in bankruptcy.
Item 5: Market for
registrant’s
common equity,
related stockholder
matters and issuer
Item 1A: Risk purchases of equity
Item 1: Business factors securities Item 7: MD&A

— Background — Risks relating to — Delisting of — Brief description

information bankruptcy, such common stock. of how business is
regarding as: operating while in
bankruptcy.
— Anticipated bankruptcy.
— Uncertainty inability to pay
— Strategy/program resulting from cash dividends in — Plans for
developed to the bankruptcy – the foreseeable bankruptcy
stabilize, improve e.g. actions and future due to reorganization,
and strengthen decisions of bankruptcy and including actions
the business and creditors, cash constraints. to be taken and
help ensure the obtaining Court challenges to be
entity emerges approval of the faced.
from plan, ability to
reorganization. avoid — Details of
burdensome reorganization
— Any DIP facility contracts, ability items, such as
and its planned to continue professional fees,
use. normal adjustments to
operations. prepetition
liabilities, and

Item 5: Market for

registrant’s
common equity,
related stockholder
matters and issuer
Item 1A: Risk purchases of equity
Item 1: Business factors securities Item 7: MD&A
— Recent — Adverse effects losses that are
developments of bankruptcy on probable and
related to ongoing reasonably
bankruptcy and operations. estimable.
resulting actions. — Adverse effects — Deconsolidation of
— Impairment of claims made certain entities
charges due to after bankruptcy due to loss of
constraints or claims not control resulting
resulting from discharged in from bankruptcy.
bankruptcy. bankruptcy.
— Details about
— Limitations on
— Suspension of registrant’s
liabilities subject
trading of to compromise,
ability to use net including nature
registrant’s stock. operating loss and amount,
carryforwards in whether they have
the future. been extinguished
— Adverse effects and contract
of bankruptcy on rejections.
the price of
registrant’s
— Assets written off
outstanding or impaired.
debt and equity — Liquidity and
securities. capital resources
— Limitations on affected by
secured bankruptcy.
creditors’ ability — Critical accounting
to realize value policies – financial
from their reporting under
collateral. bankruptcy.
— Potential inability
to emerge from
— If registrant
emerges from
bankruptcy.
bankruptcy
— Capital resources subsequent to
and liquidity reporting period-
considerations in end but before
relation to issuance of its
bankruptcy, such financial
as: statements,
— Liquidity needs include a
and challenges discussion of:
faced to — Financial
maintain reporting
adequate matters and
liquidity. comparability of
— Restrictions financial
imposed by DIP information.
facility that may — Applicability of
adversely affect fresh-start
liquidity. reporting.
— Potential inability — Fresh-start
to meet debt adjustments and
service their effect on
requirements. operating
results.

Item 5: Market for

registrant’s
common equity,
related stockholder
matters and issuer
Item 1A: Risk purchases of equity
Item 1: Business factors securities Item 7: MD&A
— Potential inability — Details of exit
to secure credit facility
additional upon
financing. emergence.
— Potential
restrictions on
operations due
to bankruptcy or
credit rating
downgrades.

4.15.30 Other considerations

Question 4.15.60
Is preferred stock in temporary equity reclassified
to stockholders' equity if it likely will be converted
to common stock upon bankruptcy emergence?
Interpretive response: No. A bankrupt registrant may recommend to the Court
that preferred stock be converted to common stock when the registrant
emerges from bankruptcy. However, this expectation is not sufficient to
reclassify preferred stock from temporary equity to stockholders’ equity. Any
actions that are to occur as a result of confirmation of a plan of reorganization
are not accounted for until the Court approves the plan.
If the effect of the plan is or will be significant to the financial statements, the
registrant should disclose the terms of the plan in the notes to its financial
statements and appropriate sections of Form 10-K, if applicable (see section
4.14).

5. Emerging from Chapter 11

bankruptcy
Detailed contents
5.1 How the standard works

5.2 Applicability of fresh-start reporting

5.2.10 Reorganization value
5.2.20 The reorganization value test
5.2.30 Loss of control test
Questions
5.2.10 Is reorganization value the same as fair value?
5.2.20 Is reorganization value equal to the value in an entity’s plan
of reorganization?
5.2.30 How does an entity reconcile enterprise value to
reorganization value?
5.2.40 How does an entity determine reorganization value if the
Court approves a valuation range rather than a point
estimate?
5.2.45 Can an entity use a value outside the Court-approved
valuation range to determine reorganization value?
5.2.50 Does a parent include its subsidiaries that did not file for
bankruptcy protection in its calculation of reorganization
value?
5.2.60 Are potentially dilutive instruments considered in the loss of
control test?
5.2.70 Is the loss of control criterion met if creditors have > 50% of
voting shares on emergence and previously controlled the
entity through a debt arrangement?
5.2.80 Is the loss of control criterion met if the majority shareholder
maintains majority ownership post-emergence because of
its debt position in the predecessor?
5.2.90 Is the loss of control criterion met if the majority shareholder
of the predecessor obtains a majority ownership upon
emergence through an additional investment?
5.2.100 Is mandatorily redeemable preferred stock considered
‘voting shares’ if holders are eligible to vote on all matters
submitted to the holders of common stock?

5.2.110 In assessing the loss of control criterion, does an entity

assume conversion of non-voting convertible preferred stock
issued upon emergence?
Examples
5.2.10 Using enterprise value to determine reorganization value
5.2.20 Performing the reorganization value test
5.2.30 Treatment of non-debtor subsidiary in the reorganization
value test

5.3 Applying fresh-start reporting

5.3.10 When to apply fresh-start reporting
5.3.20 How to apply fresh-start reporting
5.3.30 Financial statement presentation and disclosure
Questions
5.3.10 At what date is fresh-start reporting applied?
5.3.20 Can an entity use a convenience date for the accounting
cutoff in applying fresh-start reporting?
5.3.30 Can an entity apply fresh-start reporting before the
confirmation date?
5.3.40 Is confirmation of a plan of reorganization by the Court a
recognized subsequent event?
5.3.50 Do total assets of an entity that qualifies for fresh-start
reporting equal its reorganization value on emergence?
5.3.60 How does an entity account for reorganization value greater
than the fair value of identifiable assets of the emerging
entity?
5.3.70 How does an entity account for reorganization value less
than the fair value of identifiable assets of the emerging
entity?
5.3.80 Can an entity use a measurement period for fresh-start
reporting?
5.3.90 How are adjustments to pre-confirmation contingencies that
continue to exist on emergence accounted for?
5.3.100 Should debt issuance costs related to new debt issued on
emergence be written off in fresh start?
5.3.110 How is goodwill allocated to the emerging entity?
5.3.120 How does an entity account for share-based payment
awards on emergence?
5.3.130 How are postretirement benefit plans recognized when
applying fresh-start reporting?

5.3.140 How is the cancellation of the predecessor equity accounted

for?
5.3.150 How are amounts remaining in AOCI accounted for on
emergence?
5.3.160 How does an entity measure multiple classes of securities
issued in the reorganization?
5.3.165 How does an entity account for contingently issuable shares
upon emergence?
5.3.170 Does a successor entity that reports discontinued
operations recast the predecessor periods?
5.3.180 How are contract assets and liabilities accounted for?
5.3.190 Can an entity change its accounting policies on emerging
from bankruptcy?
5.3.200 In applying a retrospective change in accounting principle in
a period after fresh-start reporting, does an entity recast
predecessor periods?
5.3.210 Can an entity adopt a new Accounting Standards Update
that is not yet effective?
5.3.215 What disclosures are required when fresh-start reporting is
applied?
5.3.220 What additional disclosures should an entity consider?
5.3.230 Is disclosure required when an entity applies fresh-start
reporting after the reporting date but before the financial
statements are issued?
5.3.240 Is a private entity required to include the pre-emergence
stub period in its post-emergence financial statements?
Examples
5.3.10 Using a convenience date for fresh-start reporting
5.3.20 Allocating a deficit on a relative fair value basis
5.3.30 Lifecycle of a liability subject to compromise
5.3.40 Resolution of a pre-confirmation contingency
5.3.50 Discontinued operations in predecessor entity financial
statements
5.3.60 Financial statements on emerging from bankruptcy
5.3.70 Fresh-start reporting illustration

5.4 Entities not qualifying for fresh-start reporting

Questions
5.4.10 Does an entity not qualifying for fresh-start reporting apply
the guidance on troubled debt restructurings?

5.4.20 Can an entity not qualifying for fresh-start reporting offset its
accumulated deficit against paid-in capital?
5.4.30 At what amount does an entity not qualifying for fresh-start
reporting recognize a liability subject to compromise that
ultimately was not compromised?
5.4.40 Can an entity not qualifying for fresh-start reporting adopt a
new Accounting Standards Update that is not yet effective?
5.4.50 Can an entity not qualifying for fresh-start reporting change
its accounting policies on emergence?
5.4.60 What disclosures should an entity not qualifying for fresh-
start reporting consider?
Examples
5.4.10 General restructuring of liabilities in a bankruptcy
5.4.20 Claim reclassified from subject to compromise to not
subject to compromise

5.5 Considerations regardless of whether fresh-start reporting

applies
Questions
5.5.10 Can reorganization expenses be recorded in a period after
the entity emerges from bankruptcy?
5.5.20 Can an entity’s segment reporting change after emerging
from bankruptcy?

5.6 Accounting by group entities that did not file for bankruptcy
Questions
5.6.10 Can a subsidiary that was not in bankruptcy apply pushdown
accounting upon its parent’s emergence from bankruptcy?
5.6.20 How does a non-bankrupt parent account for a
deconsolidated bankrupt subsidiary when the subsidiary
emerges from bankruptcy?

5.7 Additional requirements for SEC registrants

Questions
5.7.10 Does a registrant evaluate whether fresh-start reporting will
apply before it emerges from bankruptcy?
5.7.20 Does pro forma financial information in connection with a
registration statement reflect the effect of fresh-start
reporting?

5.1 How the standard works

An entity emerges from Chapter 11 bankruptcy when the Court has confirmed
the plan of reorganization and conditions precedent (if any) are met. Once
confirmed by the Court, the plan is binding on the debtor and creditors.
Depending on the conditions set forth in the plan documents, an entity may
emerge at confirmation or at some milestone thereafter – at which point the
entity records the effects of the plan in its financial statements.
If the reporting entity qualifies for fresh-start reporting, the entity’s
reorganization value is assigned to its assets, its liabilities and equity. Assigning
value to its assets and liabilities is performed using the business combination
acquisition method principles in Subtopic 805-20. The post-emergence entity is
typically referred to as the emerging or successor entity. From an accounting
and financial reporting perspective, the emerging entity is considered a new
reporting entity separate from the pre-emergence (or predecessor entity).

File petition for Emerge from

bankruptcy bankruptcy

— Apply US GAAP in the usual way — Apply US GAAP in the usual way — Apply fresh-start reporting (if applicable)
— Also apply Subtopic 852-10 — Then apply US GAAP in the usual way

Common considerations Common considerations

— Impairment, other asset- — Liabilities

An entity that does not qualify for fresh-start reporting continues to apply other
US GAAP. Liabilities compromised by the confirmed bankruptcy plan are stated
at the present value of the amounts to be paid (see section 5.4).

5.2 Applicability of fresh-start reporting

Excerpt from ASC 852-10

> Financial Reporting When Entities Emerge from Chapter 11 Reorganization

45-17 Entities whose plans have been confirmed by the court and have
thereby emerged from Chapter 11 shall apply the reporting principles in
paragraphs 852-10-45-19 through 45-29 as of the confirmation date or as of a
later date, as discussed in the following paragraph, when all material conditions
precedent to the plan's becoming binding are resolved.
45-18 The effects of a plan should be included in the entity's financial
statements as of the date the plan is confirmed. However, inclusion shall be
delayed to a date not later than the effective date if there is a material
unsatisfied condition precedent to the plan's becoming binding on all the
parties in interest or if there is a stay pending appeal. That might occur, for
example, if obtaining financing for the plan or for the transfer of material assets
to the debtor by a third party is a condition to the plan's becoming effective.
Financial statements prepared as of the date after the parties in interest have
approved a plan through the voting process, and issued after the plan has been
confirmed by the court, shall report the effects of the plan if there are no
material unsatisfied conditions.
• > Fresh-Start Reporting
45-19 If the reorganization value of the assets of the emerging entity
immediately before the date of confirmation is less than the total of all
postpetition liabilities and allowed claims, and if holders of existing voting
shares immediately before confirmation receive less than 50 percent of the
voting shares of the emerging entity, the entity shall adopt fresh-start reporting
upon its emergence from Chapter 11. The loss of control contemplated by the
plan must be substantive and not temporary. That is, the new controlling
interest must not revert to the shareholders existing immediately before the
plan was filed or confirmed.

An entity applies fresh-start reporting under Subtopic 852-10 when it emerges

from Chapter 11 if: [852-10-45-19]
— the entity’s reorganization value immediately before the date of
confirmation is less than the total of all its postpetition liabilities and allowed
claims; and
— the holders of existing voting shares immediately before confirmation lose
control of the entity and the loss of control is not temporary; for this
purpose, losing control means those shareholders receive less than 50% of
the emerging entity’s voting shares.

Does the total of all

postpetition liabilities and
allowed claims exceed
No
reorganization value?
Yes

Do the holders of
Do not apply
existing voting shares
No fresh-start reporting
lose control?

Yes

Apply
fresh-start reporting

If either of these criteria is not met, the emerging entity does not qualify for
fresh-start reporting and continues to apply US GAAP (see section 5.4).

5.2.10 Reorganization value

Excerpt from ASC 852-10

20 Glossary
Reorganization Value
The value attributed to the reconstituted entity, as well as the expected net
realizable value of those assets that will be disposed of before reconstitution
occurs. Therefore, this value is viewed as the value of the entity before
considering liabilities and approximates the amount a willing buyer would pay
for the assets of the entity immediately after the restructuring.

The first criterion required to apply fresh-start reporting is that the

reorganization value of the emerging entity immediately before the date of
confirmation is less than the sum of all postpetition liabilities and allowed
claims. Reorganization value, which is a US GAAP term and not a term defined
in the Code, is the aggregate value of the emerging entity’s assets before
considering liabilities. [852-10 Glossary]

Question 5.2.10
Is reorganization value the same as fair value?

Interpretive response: No. Fair value is the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. Reorganization value is intended to

estimate the amount a willing buyer would pay for an entity’s assets
immediately after emerging from bankruptcy. [820-10 Glossary]
Reorganization value is usually based on a Court-determined value using
assumptions negotiated among the interested parties (see Question 5.2.20).
Differences between fair value and reorganization value include the following.

Category Fair value Reorganization value

Market participant assumptions Entity-specific assumptions
Underlying
(estimated by the reporting (negotiated among the
assumptions
entity) [820-10 Glossary] interested parties) [852-10-05-10]
Exit price: The price received to Entry price: The amount a
Price sell an asset willing buyer would pay for the
[820-10 Glossary, 820-10-30-2] assets [852-10 Glossary]
Generally each individual asset Emerging entity’s assets as a
Unit of
(or liability) group; excludes liabilities
valuation
[820-10 Glossary, 820-10-35-2E] [852-10 Glossary]

Question 5.2.20
Is reorganization value equal to the value in an
entity’s plan of reorganization?

Interpretive response: Generally, no. The plan of reorganization approved by

the Court usually includes a measure of the entity’s value on emerging from
bankruptcy using a going concern premise. In our experience, the most
common measure of an emerging entity’s Court-approved value is enterprise
value. This value is generally different from, and therefore needs to be
reconciled to, reorganization value (see Question 5.2.30).
Reorganization value is an asset value concept and is the value of the
reconstituted entity before considering liabilities. Enterprise value is generally
prepared by finance professionals engaged by the bankrupt entity using
assumptions negotiated among the interested parties, to provide an indication
of the value of the emerging entity regardless of how it is capitalized (e.g. debt
versus equity capitalization). Enterprise value therefore usually differs from
reorganization value.

Question 5.2.30
How does an entity reconcile enterprise value to
reorganization value?

Background: Under the most commonly used approach, enterprise value is

equal to the sum of the values of the entity’s post-emergence equity and
interest-bearing debt, less cash remaining in the entity after settling prepetition
liabilities. Reorganization value is an asset value concept and includes all assets
of the emerging entity immediately after the restructuring (see Question

5.2.20). The Court-approved enterprise value must first be reconciled to

reorganization value to determine whether fresh-start reporting applies.
Interpretive response: When enterprise value is calculated as described in the
background, an entity generally must add back cash and current and other non-
interest-bearing liabilities to arrive at reorganization value. Under this approach,
the total for the right side of the balance sheet (total liabilities and total equity) is
used as a proxy to determine the total for the left side of the balance sheet
(total assets or reorganization value).
Enterprise value Reconciling items Reorganization value

— Debt capital (interest- — Cash and cash — Current liabilities

bearing debt) equivalents — Debt capital (interest-
— Equity capital (successor — Current and other non- bearing debt)
capital stock) interest bearing liabilities — Equity capital (successor
— Less cash and cash capital stock)
equivalents

Performing this reconciliation requires identifying and understanding all

components of the calculation of an entity’s enterprise value (or other measure
of value approved by the Court); this is because enterprise value is not
calculated the same way in all instances.
Some items to consider include the following.
— In the calculation of enterprise value, cash is typically deducted and
therefore needs to be added back to arrive at reorganization value.
However, in some instances, some or all cash may be included in
enterprise value. Only the cash that has been excluded from enterprise
value is added back, and only to the extent the cash will remain in the
emerging entity. Cash that is paid out on emergence to settle prepetition
liabilities is not added back.
— Enterprise value typically excludes working capital liabilities, but in some
instances they may be included. Working capital liabilities included in
enterprise value are not added back (to avoid double-counting).
— Other liabilities excluded from enterprise value (e.g. pension liabilities, asset
retirement obligations) are added back to ensure that all liabilities are
included.
— A plan of reorganization may require the entity to sell specific assets that
will not be part of its continuing operations. If those assets are sold after
the entity emerges from bankruptcy, usually they will need to be added
back to enterprise value to arrive at reorganization value; this is because
enterprise value is usually based on the emerging entity’s post-emergence
continuing operations (i.e. excluding assets to be disposed of).

Question 5.2.40
How does an entity determine reorganization value
if the Court approves a valuation range rather than
a point estimate?
Background: In certain proceedings, the Court may approve a range for
enterprise value instead of a point estimate. Ranges may be more common in
industries that have a higher degree of variability due to market characteristics,
such as oil and gas. This may help give the stakeholders perspective on the
fluidity in value based on a range of acceptable assumptions at the time the
Court approved the range.
Interpretive response: If the Court approves a valuation range in the plan of
reorganization, management uses all available information to identify a point
estimate to serve as the starting point to determine reorganization value. The
SEC staff has requested that registrants disclose how they determined
reorganization value, including the methodology and assumptions used (see
section 5.3.30).

Question 5.2.45
Can an entity use a value outside the Court-
approved valuation range to determine
reorganization value?
Background: An entity’s reorganization value is usually based on a Court-
approved value using assumptions negotiated among the interested parties,
such as an enterprise value (see Questions 5.2.10 and 5.2.20). This value,
whether a point estimate or a range of estimates, is part of the entity’s plan of
reorganization and is approved by the Court on the confirmation date. As
discussed in Question 5.2.40, an entity uses a point estimate to serve as the
starting point to determine reorganization value.
Interpretive response: Generally, no. The terms precedent for an entity to
emerge from bankruptcy are specified in the plan of reorganization, which
includes the entity’s Court-approved value. Therefore, the fresh-start reporting
criteria should be based on a reorganization value derived from the value (or
range of values) in the plan of reorganization.
If the criteria are met and fresh-start reporting is applied, that same
reorganization value should be used to assign value to the emerging entity’s
assets and liabilities (as further discussed in section 5.3.20).
This interpretive response also applies if time has elapsed between the
confirmation date and the date the entity emerges from bankruptcy, and a
change in market conditions indicates that the current value is different from
the value approved by the Court.

Example 5.2.10
Using enterprise value to determine reorganization
value
ABC Corp. is in the oil and gas industry. The Court-approved enterprise value
was a range from $1,290 to $1,490.
Because of downward fluctuations in oil prices from the date the range of
enterprise value was finalized to the date of emerging from bankruptcy, ABC
concluded that it should use the low end of the range, $1,290, as the starting
point for determining reorganization value.
The components of ABC’s enterprise value calculation are as follows.

Post-emergence equity $1,000

Post-emergence debt 890
Less: Cash remaining after settling prepetition liabilities (600)
Enterprise value $1,290

ABC has current liabilities of $310, and reconciles enterprise value to

reorganization value as follows.

Enterprise value $1,290

Add back: Cash remaining after settling prepetition liabilities 600
Add: Current liabilities 310
Reorganization value $2,200

5.2.20 The reorganization value test

This first criterion for fresh-start reporting is that the sum of postpetition
liabilities and allowed claims must exceed reorganization value – the
reorganization value or solvency test.
Postpetition liabilities include all liabilities incurred after filing for Chapter 11
bankruptcy that remain outstanding immediately before the plan is confirmed by
the Court. Allowed claims are all claims allowed by the Court that are not
settled before the date of emergence; they are measured at the amounts
allowed by the Court (see section 4.3.20). [852-10-45-5, 45-19]

Example 5.2.20
Performing the reorganization value test
Continuing Example 5.2.10, ABC has the following postpetition liabilities and
allowed claims outstanding immediately before the date of confirmation.

Allowed claims $4,800

Postpetition liabilities (current) 310
Postpetition debt (noncurrent) 340
Total postpetition liabilities and allowed claims $5,450

Because the total of ABC’s postpetition liabilities and allowed claims

immediately before emergence ($5,450) exceeds ABC’s reorganization value
($2,200), the first criterion for fresh-start reporting is met.
ABC still needs to consider the second criterion before concluding that fresh-
start reporting applies (see section 5.2.30).

Question 5.2.50
Does a parent include its subsidiaries that did not
file for bankruptcy protection in its calculation of
reorganization value?
Background: Parent is in the process of emerging from Chapter 11 bankruptcy
protection. When Parent filed for bankruptcy, its subsidiaries continued normal
operations and did not file for bankruptcy.
Interpretive response: Yes. We believe that a parent’s non-debtor subsidiaries
should be included in the calculation of reorganization value. This is because
they are part of the consolidated entity and all of the entity’s assets and
liabilities should be considered in the reorganization value test. Those assets
represent resources that may be available to satisfy the parent’s postpetition
liabilities and allowed claims (e.g. through the sale of a subsidiary).
We believe that the parent may perform the reorganization value test on either
a consolidated or unconsolidated basis. Under either approach, it is important
that the test be performed on a like-for-like basis.
Approach 1: Consolidated basis
If the reorganization value test is performed on a consolidated basis, the parent
includes its non-debtor subsidiaries’ assets in calculating reorganization value.
The parent then compares its consolidated reorganization value to its
consolidated postpetition liabilities and allowed claims, which includes the
liabilities of consolidated subsidiaries.
Approach 2: Unconsolidated basis
Alternatively, if the reorganization value test is performed on an unconsolidated
basis, the parent’s investments in non-debtor subsidiaries are considered
assets available to satisfy the parent’s postpetition liabilities and allowed claims.
Under the unconsolidated approach, the sum of (1) the fair value of the parent’s
investment in each of those subsidiaries and (2) the reorganization value of the
parent’s other assets is compared to the parent’s postpetition liabilities and
allowed claims. The parent’s allowed claims and postpetition liabilities exclude
the non-debtor subsidiaries’ liabilities, because they are already considered in
valuing the parent’s investments in the subsidiaries. In this situation, the fair

value of each investment in (1) might include a liquidity adjustment; this is

discussed in section G of KPMG Handbook, Fair value measurement.

Example 5.2.30
Treatment of non-debtor subsidiary in the
reorganization value test
Parent is emerging from Chapter 11 bankruptcy. One of its wholly owned
subsidiaries continued normal operations and did not file for bankruptcy
protection.
Scenario 1: Reorganization value test performed on consolidated basis
The following information is relevant for purposes of performing the test
immediately before the date of confirmation:
— Enterprise value of Parent is $2,500, which excludes Subsidiary, non-
interest bearing working capital liabilities of $300 and cash of $50.
— Enterprise value of Subsidiary is $200, which excludes non-interest bearing
working capital liabilities of $30 and cash of $10.
— Total postpetition liabilities and allowed claims of Parent on a stand-alone
basis are $3,400. Subsidiary has total liabilities of $100.
On a consolidated basis, the reorganization value test is performed as follows.

Parent Parent
(excl. Sub) Subsidiary (consolidated)
Enterprise value $2,500 $200 $2,700
Add: Non-interest bearing
working capital liabilities 300 30 330
Add: Cash 50 10 60
Reorganization value $2,850 $240 $3,090
Less: Total of all postpetition
liabilities and allowed claims of
the consolidated Parent 3,400 100 3,500
Solvent/(insolvent) $ (410)

The reorganization value is less than the total of all postpetition liabilities and
allowed claims of the consolidated parent by $410. Therefore, Parent meets the
first criterion for fresh-start reporting. Parent still needs to perform the loss of
control test (see section 5.2.30) before concluding that fresh-start reporting
applies.
Scenario 2: Reorganization value test performed on unconsolidated basis
In addition to the information about Parent in Scenario 1, the fair value of
Parent’s investment in Subsidiary is assumed to be $140 (reorganization value
of $240 less liabilities of $100).

On an unconsolidated basis, the reorganization value test is performed as

follows, showing that the first criterion for fresh-start reporting is met.

Enterprise value of Parent $2,500

Add: Working capital and other liabilities 300
Add: Cash 50
Add: Investment in Subsidiary 140
Reorganization value $2,990
Postpetition liabilities and allowed claims of Parent 3,400
Solvent/(insolvent) $ (410)

5.2.30 Loss of control test

The second criterion necessary to apply fresh-start reporting is that there is a
loss of control. This criterion is met if the holders of voting shares immediately
before emergence from bankruptcy receive less than 50% of the voting shares
of the emerging entity. It is not necessary that a single entity has obtained
control, but rather that the entity’s voting shareholders before the confirmation
lost control of the emerging entity. The loss of control by the pre-emergence
shareholders must be substantive and not temporary. [852-10-45-19]

Question 5.2.60
Are potentially dilutive instruments considered in
the loss of control test?

Interpretive response: Generally, no. The potential dilutive effects resulting

from warrants and options, for example, are disregarded in assessing whether a
loss of control occurred upon emergence.

Question 5.2.70
Is the loss of control criterion met if creditors have
> 50% of voting shares on emergence and
previously controlled the entity through a debt
arrangement?
Background: Before emerging from Chapter 11, a group of debt holders had
control of an entity through their lending arrangement, which gave them rights
to elect a majority of the entity’s board of directors. However, those debt
holders had no voting shares.
Interpretive response: No. Although the legal form of subordinated debt is not
an equity position, the debt holders did have voting control of the entity through

their ability to elect a majority of the entity’s board of directors. Therefore, we

believe the loss of control criterion has not been met. In substance, the debt
holders had control before emergence and they continue to have control after
emergence. [852-10-45-19]

Question 5.2.80
Is the loss of control criterion met if the majority
shareholder maintains majority ownership post-
emergence because of its debt position in the
predecessor?
Background: Before emerging from Chapter 11, the majority shareholder of an
entity was also its largest creditor. When the entity emerged from Chapter 11,
that same shareholder obtained a majority of the voting shares in exchange for
its debt position in the predecessor entity.
Interpretive response: No. The majority shareholder before emergence did not
lose control of the entity; therefore, the loss of control criterion is not met.

Question 5.2.90
Is the loss of control criterion met if the majority
shareholder of the predecessor obtains a majority
ownership upon emergence through an additional
investment?
Interpretive response: No. The fact that the majority shareholder retains its
ownership interest in the emerging entity due to its additional investment does
result in the loss of control criterion being met. Accordingly, if the majority
shareholder retains 50% or more of the emerging entity through an additional
investment, the entity would not meet the loss of control criterion.

Question 5.2.100
Is mandatorily redeemable preferred stock
considered ‘voting shares’ if holders are eligible to
vote on all matters submitted to the holders of
common stock?
Background: Immediately before confirmation, an entity had mandatorily
redeemable preferred stock (MRPS) outstanding and each share provided the
holder the ability to vote on matters such as the election of the directors equal
to a common equivalent number of shares immediately before plan
confirmation.

Interpretive response: Yes. We believe the MRPS should be considered voting

shares because the MRPS holders have the right to vote on substantive
matters, such as the election of directors.

Question 5.2.110
In assessing the loss of control criterion, does an
entity assume conversion of non-voting convertible
preferred stock issued upon emergence?
Background: As part of an entity’s emergence from Chapter 11, the plan of
reorganization provides for the issuance of non-voting convertible preferred
stock on the date of confirmation. If converted, the preferred shareholders
would have a controlling voting interest.
Interpretive response: It depends. If conversion of the preferred shares after
the confirmation date results in the same group of owners regaining control of
the entity, the entity may not qualify for fresh-start reporting because the initial
loss of control was temporary and therefore was not substantive.
If the likelihood of conversion is not readily determinable at the date of
confirmation, we do not believe that conversion of the non-voting preferred
stock should be assumed. However, the entity must be able to demonstrate
that the original stockholders have lost control of the entity and that the loss of
control is substantive, not temporary. All relevant facts and circumstances
should be considered. [852-10-45-19]

5.3 Applying fresh-start reporting

Excerpt from ASC 852-10

• > Fresh-Start Reporting

45-20 Entities that adopt fresh-start reporting in conformity with the preceding
paragraph shall apply the following principles:
a. The reorganization value of the entity shall be assigned to the entity's
assets and liabilities in conformity with the procedures specified by
Subtopic 805-20. If any portion of the reorganization value cannot be
attributed to specific tangible or identified intangible assets of the
emerging entity, such amounts shall be reported as goodwill in accordance
with paragraph 350-20-25-2.
b. Subparagraph Not Used
c. Deferred taxes shall be determined under the requirements of paragraph
852-740-45-1.
d. Subparagraph Not Used
45-21 The financial statements of the entity as of and for the period
immediately preceding the date determined in conformity with the guidance in

paragraph 852-10-45-17 shall reflect all activity through that date in conformity
with the guidance in paragraphs 852-10-45-1 through 45-16. Additionally, the
effects of the adjustments on the reported amounts of individual assets and
liabilities resulting from the adoption of fresh-start reporting and the effects of
the forgiveness of debt shall be reflected in the predecessor entity's final
statement of operations. Forgiveness of debt, if any, shall be reported as an
extinguishment of debt and classified in accordance with Subtopic 220-20.
Adopting fresh-start reporting results in a new reporting entity with no
beginning retained earnings or deficit. When fresh-start reporting is adopted,
the notes to the initial fresh-start financial statements shall disclose the
additional information identified in paragraph 852-10-50-7.
• • > Comparative Financial Statements
45-26 Fresh-start financial statements prepared by entities emerging from
Chapter 11 will not be comparable with those prepared before their plans were
confirmed because they are, in effect, those of a new entity. Thus,
comparative financial statements that straddle a confirmation date shall not be
presented.
45-27 Regulatory agencies may require the presentation of predecessor
financial statements. However, such presentations shall not be viewed as a
continuum because the financial statements are those of a different reporting
entity and are prepared using a different basis of accounting, and, therefore,
are not comparable. Attempts to disclose and explain exceptions that affect
comparability would likely result in reporting that is so unwieldy it would not be
useful.
45-28 Example 2 (see paragraph 852-10-55-4) provides an illustration of fresh-
start reporting and the related illustrative notes to financial statements.

5.3.10 When to apply fresh-start reporting

Question 5.3.10
At what date is fresh-start reporting applied?

Interpretive response: Fresh-start reporting is applied as of the emergence

date, which is the later of: [852-10-45-17 – 45-18]
— Confirmation date, the date that the Court confirms the plan of
reorganization; and
— Effective date, the date that all material, unresolved conditions precedent
to the plan becoming binding have been resolved.
If the Court approves the entity’s plan of reorganization, but a material condition
precedent remains unresolved (e.g. obtaining exit financing), the entity does not
adopt fresh-start reporting until the financing is obtained. In the meantime, it
continues to follow the same accounting principles as before emerging from

bankruptcy (see chapter 4). Usually the Court issues a notice of effectiveness
when the conditions precedent are satisfied.

Question 5.3.20
Can an entity use a convenience date for the
accounting cutoff in applying fresh-start reporting?

Interpretive response: Yes, if the difference is not material to the predecessor

or successor financial statements. Although FASB Statement No. 141 permitted
using a convenience date when both parties to the transaction designate the
end of an accounting period between the dates that a business combination is
initiated and consummated, this specific provision was not carried forward into
Topic 805 (Statement 141(R)). [FAS 141.48]
However, the basis for conclusions to FASB Statement No. 141(R)
(nonauthoritative) highlights that although this concept was excluded from Topic
805, the financial statement effects of this change were rarely likely to be
material. Therefore, unless events between the convenience date and the
actual acquisition date result in material changes in the amounts recognized, the
entity’s practice would comply with Topic 805. [FAS 141R.B110]
If the emerging entity selects a reporting date that is different from the
confirmation date (or effective date), it needs to demonstrate that the
difference is not material to its financial reporting both:
— qualitatively, considering debt covenant implications and overall
presentation in the context of the entity’s normal reporting period-end
dates; and
— quantitatively, considering:
— the measurement differences between the emergence date and the
convenience date; and
— the impact of the results of operations on a prospective basis.
Although using a convenience date is permitted in certain circumstances, it
would not be appropriate when it crosses over an annual (or quarterly, for a
public company) reporting period-end. The effects of fresh-start adjustments
cannot be recognized in a reporting period before the entity actually emerges
from bankruptcy.

Example 5.3.10
Using a convenience date for fresh-start reporting
ABC Corp. is a calendar year-end public company that reports quarterly.
Scenario 1: Date of emergence is before period-end
ABC’s plan of reorganization was confirmed on September 27 with no material,
unresolved conditions precedent. ABC concludes that its operating results from

September 27 through September 30 are not material to either the predecessor

or successor periods.
In this scenario, ABC dates its financial statements as of and for the period
ended September 27, but decides to include the immaterial results of
operations for the three-day period between September 27 and 30 in its pre-
emergence reporting period.
Scenario 2: Date of emergence is after period-end
ABC’s plan of reorganization was confirmed on October 3 with no material,
unresolved conditions precedent. ABC concludes that its operating results from
September 30 through October 3 are not material to either the predecessor or
successor periods.
ABC cannot apply fresh-start reporting and recognize the related adjustments in
its September 30 interim financial statements. Although immaterial, the effects
of fresh-start adjustments must be recognized in the predecessor financial
statements in the period that includes the date of emergence from bankruptcy.
In this scenario, that will be the period ended December 31.

Question 5.3.30
Can an entity apply fresh-start reporting before the
confirmation date?

Background: If the entity emerging from Chapter 11 bankruptcy meets the

criteria to apply fresh-start reporting, fresh-start reporting is presented in the
financial statements as of the confirmation date or as of a later date when all
material conditions precedent to the plan becoming binding on all parties are
resolved (see Question 5.3.10). [852-10-45-17 – 45-18]
Interpretive response: No. We believe an entity may not apply fresh-start
reporting as of a date earlier than the date the Court approves the plan of
reorganization (confirmation date). This is the case even if the plan has been
approved by all of the entity’s creditors.
In our experience, Court confirmation of a plan of reorganization is not
perfunctory and therefore should not be assumed by the emerging entity.

Question 5.3.40
Is confirmation of a plan of reorganization by the
Court a recognized subsequent event?

Interpretive response: No. Subtopic 852-10 explicitly states that the effects of
an entity’s plan of reorganization are recognized as of the date the plan is
confirmed or as of a later date if there are material unsatisfied conditions
precedent to the plan becoming binding on all parties (see Question 5.3.10).
[852-10-45-17 – 45-18, 855-10-25-3]

Accordingly, Court confirmation of a plan of reorganization is a nonrecognized

subsequent event, because it does not confirm conditions that existed as of the
period-end date.

5.3.20 How to apply fresh-start reporting

If fresh-start reporting applies, the emerging entity is treated as a new entity for
financial reporting. When pre-emergence period financial statements are
presented (e.g. as required by the SEC), the pre- and post-emergence periods
are usually separated by a ‘black line’ in the financial statements because they
are not comparable. Reorganization costs, the effects of fresh-start adjustments
of assets and liabilities to fair value and gains from the extinguishment of
liabilities are recognized in the statement of operations of the predecessor
entity. Retained earnings (or deficit) of the emerging entity are reset to zero.
The period before emergence is generally referred to as the ‘predecessor’ and
the period after emergence as the ‘successor’. [852-10-45-21, 45-26]

File petition for Emerge from

bankruptcy bankruptcy1

Predecessor entity Successor entity

Note 1: Later of confirmation date and

effective date (see Question 5.3.10).

The reorganization value of the emerging entity is assigned to the entity’s

assets, and to its liabilities and equity. Assigning value to its assets and
liabilities is performed using the business acquisition method principles in
Subtopic 805-20. Further, this generally involves recording the assets and
liabilities at fair value under the measurement principles of Topic 820. For
guidance on recognizing and measuring assets and liabilities under Subtopic
805-20, see sections 7 and 17, respectively, of KPMG Handbook, Business
combinations. [852-10-45-20]
Applying Subtopic 805-20 in fresh-start reporting may result in recognizing
identifiable intangible assets not previously recognized. If part of the
reorganization value cannot be attributed to specific tangible or identifiable
intangible assets of the emerging entity, that amount is recognized as goodwill.
[852-10-45-20]

Adjustments to the carrying amounts of the entity’s assets and liabilities and
the effects of debt forgiveness are presented in the predecessor entity’s
financial statements as reorganization items. [852-10-45-21]
The effects of fresh-start reporting are illustrated in section 5.3.30, but are
generally presented in a table in the notes to the financial statements, showing:
[852-10-50-7]

— predecessor entity (balance sheet just before confirmation of the plan);

— plan effect adjustments;
— fresh-start adjustments; and
— successor entity (closing balance of predecessor entity).

Question 5.3.50
Do total assets of an entity that qualifies for fresh-
start reporting equal its reorganization value on
emergence?
Interpretive response: Generally, yes. Reorganization value is an estimate of
the value of an emerging entity’s gross assets, before considering liabilities. In
contrast, the consideration transferred in a business combination represents the
price paid for the net assets of the business, because when an acquirer obtains
control of a business, it acquires all of that business’s assets and assumes all of
its liabilities. [852-10 Glossary]
Accordingly, when fresh-start reporting is applied, both total assets and total
liabilities and equity generally equal reorganization value.
However, we believe it is acceptable for total assets recognized under Subtopic
805-20 to exceed reorganization value (see Question 5.3.70).

Question 5.3.60
How does an entity account for reorganization
value greater than the fair value of identifiable
assets of the emerging entity?
Interpretive response: If any portion of the reorganization value cannot be
attributed to specific tangible or identifiable intangible assets of the emerging
entity, the excess reorganization value is recognized as goodwill. [852-10-45-20]

Question 5.3.70
How does an entity account for reorganization
value less than the fair value of identifiable assets
of the emerging entity?
Interpretive response: An entity emerging from bankruptcy does not recognize
a bargain purchase gain. Instead, the entity first confirms that the fair values of
its assets and its reorganization value have been appropriately determined. [805-
30-25-4, 30-5]

If a difference remains, we believe there are two acceptable approaches to

accounting for the difference.
Approach 1: Recognize difference as a credit to opening additional paid-in
capital
This approach analogizes to the guidance on bargain purchase gains in
pushdown accounting. Under this approach, the emerging entity’s total assets
exceed its reorganization value, with the difference recognized as a credit to
additional paid-in capital. [805-50-30-11]

Approach 2: Allocate difference to certain nonfinancial assets on a relative

fair value basis
Under this approach, the emerging entity’s total assets equals its reorganization
value, and the difference is allocated to certain assets. We believe the allocation
should be done by analogy to the superseded cost allocation guidance for
bargain purchase amounts in FASB Statement No. 141.
Under that guidance, the difference is allocated on a pro rata basis to all assets
except for: [FAS 141.44]
— financial assets other than equity method investments;
— assets that are classified as held-for-sale. An asset that is acquired and that
will be sold (rather than held and used) is held-for-sale if the sale if probable
and expected to be completed within one year of the emergence date, and
all other held-for-sale criteria are probable of being met within a short period
following the emergence (usually within three months); [360-10-45-12]
— deferred tax assets;
— postretirement benefit plan assets; and
— other current assets, including inventory.
In addition, we also do not expect adjustments to be allocated to:
— contract assets recognized under Topic 606 (revenue); and
— indemnification assets.
We do not believe it is appropriate to use a residual method to allocate value to
nonfinancial assets, such as identifiable intangible assets or unproved oil and
gas properties.
The following diagram summarizes the process followed in applying fresh-start
reporting.
A Identify and measure
emerging entity’s assets
and liabilities in same way
as business combination

B
Compare reorganization Go back to A Go back to B
value to fair value assigned
to emerging entity’s assets Less than Reassess measurement Reassess measurement
of assets of reorganization value

Greater than
After reassessing
Excess recognized
as goodwill Deficit recognized as credit
to opening APIC
or
Deficit allocated to certain
nonfinancial assets based
on relative fair values

Example 5.3.20
Allocating a deficit on a relative fair value basis
On November 30, Year 1, ABC Corp. emerges from bankruptcy and applies
fresh-start reporting. ABC determines that its reorganization value is $150 and
the sum of the fair values of all of its identifiable assets is $158. ABC reviews
its determination of reorganization value and the fair values of its assets and
concludes that they were properly measured. ABC elects to allocate the $8
difference as a pro rata reduction of the carrying amount of its nonfinancial
assets as follows.

Fresh-
Fair Assets in % of Allocation start
Asset class value allocation Total of deficit amount
Cash $ 18 - - - $ 18
Other current assets 20 - - - 20
Building 70 70 58.3% $(4) 66
Equipment 40 40 33.3% (3) 37
Patent 10 10 8.4% (1) 9
Total $158 $120 100.0% $(8) $150

Alternatively, ABC could have elected to recognize the $8 difference as a credit

to additional paid-in capital.

Measurement period

Question 5.3.80
Can an entity use a measurement period for fresh-
start reporting?

Interpretive response: Generally, no. Although in a business combination the

acquirer may record provisional amounts for the assets acquired and liabilities
assumed and then adjust them during the measurement period, no such
concept exists in fresh-start reporting. All accounting for fresh-start reporting
must be completed by the next reporting date after emerging from bankruptcy.
In a business combination, management of the acquirer does not have access
to all the information needed to account for the business combination until the
acquisition takes place. In contrast, in fresh-start reporting, management has
full access to all information required to remeasure the entity’s assets and
liabilities, and in many cases the values of those assets and liabilities are
extensively discussed, debated and ultimately agreed on with advisors and
creditors.
A subsequent adjustment to an amount initially recognized is included in
income in the period in which the adjustment is determined, and is separately
disclosed.

Disposition of liabilities subject to compromise

When an entity emerges from bankruptcy, it settles its prepetition liabilities
usually with cash, new notes payable, new debt, new equity or some
combination thereof. An entity applying fresh-start reporting recognizes the gain
from the settlement of prepetition liabilities as a reorganization item in the
predecessor period. [852-10-45-21]

Example 5.3.30
Lifecycle of a liability subject to compromise
Continuing Example 4.3.10, ABC Corp. filed a petition for bankruptcy on July 1,
Year 1. At the time of the petition filing, ABC owed Lender $500 for an
unsecured loan.
The claim was allowed by the Court and, at the time of preparing its September
30 financial statements, ABC estimated the allowed claim to be $500. ABC
reclassified the $500 payable to Lender from loans payable to liability subject to
compromise on its September 30 balance sheet.
On November 1, ABC recognized a $25 reduction to the liabilities subject to
compromise after being informed by the Court that a $25 late payment fee was
disallowed. The $25 reduction was recognized as a reorganization item in ABC’s
December 31 statement of operations.
On January 30, Year 2, ABC emerges from bankruptcy and applies fresh-start
reporting. As part of the settlement with Lender, ABC provides the following
forms of consideration to satisfy Lender’s claim.
Note payable $200
Senior debt 75
Subordinated debt 100
Common stock 50
Cash paid 5
Total consideration $430

ABC records the following journal entry as part of its fresh-start reporting
(reorganization adjustment).

Debit Credit
Liabilities subject to compromise 475
Note payable 200
Senior debt 75
Subordinated debt 100
Common stock 50
Cash 5
Reorganization items (gain on debt discharge) 45
To record debt discharge upon reorganization.

Preconfirmation contingencies

Question 5.3.90
How are adjustments to pre-confirmation
contingencies that continue to exist on emergence
accounted for?
Interpretive response: We believe that an adjustment to a pre-confirmation
contingency as a result of a change in estimate or settlement of a contingent
asset or liability after fresh-start reporting should be recognized in the
statement of operations in the period following emergence.
Although superseded by Topic 805, we believe the guidance in AICPA Practice
Bulletin No. 11 remains informative when considering pre-confirmation
contingencies that continue to exist on an entity’s emergence from bankruptcy.
Under PB 11, the resolution of a pre-confirmation contingency after fresh-start
reporting is recognized in the statement of operations of the emerged entity,
rather than as an opening balance sheet adjustment. [PB 11.08]

Example 5.3.40
Resolution of a pre-confirmation contingency
ABC Corp. is a calendar year-end entity and its plan of reorganization was
confirmed on January 31, Year 1. At the time of the bankruptcy filing, ABC had
been engaged in negotiations with a state environmental agency to settle an
environmental matter. The agency filed a claim in the bankruptcy case that was
stayed by the Court in order to postpone legal proceedings. In fresh-start
reporting, ABC recognized a liability for the matter at its estimated fair value of
$120.
In July Year 1, ABC negotiates a final settlement with the state agency for its
obligation at the site of $100. ABC recognizes the $20 difference between the
estimated amount and the actual amount paid to settle the obligation in its
statement of operations in the post-emergence period.

Debt issuance costs

Question 5.3.100
Should debt issuance costs related to new debt
issued on emergence be written off in fresh start?

Interpretive response: No. We believe that direct costs associated with new
debt issued when an entity emerges from bankruptcy should not be expensed
or written off when applying fresh start. They should be accounted for as debt
issuance costs in accordance with Subtopic 835-30 and accounted for in the
post-emergence financial statements.

Our view is based on the perspective that the new debt is a new liability of the
successor company, as opposed to an assumed liability of an ‘acquired
company’.

Leases
Under fresh-start reporting, an emerging entity’s leases are treated the same as
in a business combination. For relevant guidance under Topic 842, see chapter
11 of KPMG Handbook, Leases.

Assigning goodwill to reporting units on emergence

Question 5.3.110
How is goodwill allocated to the emerging entity?

Interpretive response: Goodwill representing the excess reorganization value

over the fair values of the identified assets recognized should be allocated to
reporting units in the same manner as in a business combination. [350-20-35-41 –
35-44]

For guidance on accounting for goodwill in a business combination, see section

8 of KPMG Handbook, Business combinations.

Derivatives and hedge accounting

Under Subtopic 805-20, the emerging entity reassesses whether embedded
derivatives must be separated from their host instruments, and redesignates
derivative instruments as hedging instruments (e.g. as a cash flow hedge).
Redesignation is required for all derivative contracts. [805-20-25-7]
For additional guidance, see section 7 of KPMG Handbook, Business
combinations.

Share-based payments
When an entity emerges from bankruptcy, it may issue share-based payment
awards related to the emerged entity. This often happens on emergence and
the plan of reorganization requires awards issued by the predecessor entity to
be canceled. See Question 4.10.70 for a discussion on accounting for awards
during bankruptcy.

Question 5.3.120
How does an entity account for share-based
payment awards on emergence?

Background: When the plan of reorganization is confirmed by the Court, shares

of the entity existing at that time are typically canceled (and therefore rendered
valueless), which results in cancellation of the share-based payment awards as
well.
Interpretive response: The cancellation of an employee share-based payment
award by the Court as part of the plan of reorganization generally is treated as a
cancellation under Topic 718. In bankruptcy proceedings, canceling the award is
often not accompanied by the concurrent grant of a replacement award.
Share-based payment awards that the post-emergence entity awards are often
granted in amounts that are not proportionate to the previous awards. They are
also not generally made concurrently with the process of emerging from
bankruptcy. Therefore, the entity applies the guidance in Topic 718 for
cancellations and recognizes remaining unrecognized compensation cost in its
predecessor statement of operations within reorganization items.
The post-emergence entity typically treats new share-based payments as new
grants under Topic 718. However, in other more limited scenarios where the
awards have value, the Court may approve new awards that are granted on
emergence that are considered replacement awards. In this case, the
cancellation of an award and the concurrent grant of a replacement award is
accounted for as a modification. [718-20-35-8 – 35-9]

Pension and other postretirement benefits

Question 5.3.130
How are postretirement benefit plans recognized
when applying fresh-start reporting?

Interpretive response: Under Subtopic 805-20, the emerging entity recognizes

an asset or liability for the funded status of a single-employer defined benefit
pension or other postretirement benefit plan. The measurement of the benefit
obligation and plan assets are based on current assumptions (such as discount
rate(s) and mortality) at the emergence date. [805-20-30-15]
Defined benefit pension and other postretirement plans may be amended as
part of the plan of reorganization. The net gain or loss resulting from the
adjustment, settlement or curtailment of the benefit obligations under the plan
of reorganization is presented as a reorganization item in the predecessor’s
statement of operations. Planned or expected changes to benefit plans that are
not part of the plan of reorganization are accounted for on a prospective basis in
the usual way. [805-20-30-15, 852-10-45-21]
For further discussion on accounting and presentation for postretirement
benefit plans, see KPMG Handbook, Employee benefits.

Equity

Question 5.3.140
How is the cancellation of the predecessor equity
accounted for?

Interpretive response: We believe the cancellation of the predecessor’s equity

(including preferred stock) should be recognized directly in equity under fresh-
start reporting; this is consistent with Example 2 in Subtopic 852-10. The effect
should not be included in reorganization items because it does not result from
an adjustment to the reported amounts of assets or liabilities, or from the
forgiveness of debt. [852-10-45-21, 55-10]
See section 5.3.30 for an illustrative example of applying fresh-start reporting.

Question 5.3.150
How are amounts remaining in AOCI accounted for
on emergence?

Interpretive response: In applying fresh-start reporting on emergence from

bankruptcy, the balance in AOCI is reset to zero because the new reporting
entity at emergence has no beginning balance for AOCI. [852-10-45-21]
We are aware of diversity in practice with some entities recording the offset of
this adjustment as a reorganization item of the predecessor entity, while others
record the offset directly against retained earnings. We believe that either
approach is acceptable.

Question 5.3.160
How does an entity measure multiple classes of
securities issued in the reorganization?

Background: An entity may issue multiple classes of securities (e.g. preferred

stock and common stock) to settle its prepetition liabilities on emergence.
Interpretive response: In fresh-start reporting, we believe the initial value
ascribed to each series of new equity securities issued should be determined
consistent with the entity’s enterprise value. Usually an enterprise value
approved by the Court includes a value for each class of security issued.
Ordinarily, we believe it is acceptable to use that value in fresh-start reporting.
If there have been changes in the value of newly issued debt between the date
that enterprise value was calculated and the date the entity emerges from
bankruptcy (e.g. because fixed-rate debt was issued and interest rates
changed), a pro rata adjustment to the value of each class of equity security
would be necessary to ensure that the total for all liabilities and equity equals
the entity’s reorganization value (see Questions 5.3.50 and 5.3.70).

Question 5.3.165
How does an entity account for contingently
issuable shares upon emergence?

Background: An entity may emerge from bankruptcy, but be required under

the plan to hold back shares that will be issued to former creditors after certain
contingencies are resolved. For example, the court may need to resolve the
allocation of a certain number of shares among several classes of creditors.
Interpretive response: We believe these financial instruments should be
evaluated under Topic 480 and Subtopic 815-40 to determine if they are liability-
or equity-classified financial instruments. Depending on the classification, the
reorganization value is allocated to those items consistent with similar liabilities
or equity instruments.
If the instruments are liability-classified, the liability is adjusted to fair value each
period until settled, with changes in the fair value being recorded in earnings.
Equity-classified instruments are not remeasured and their subsequent
settlement is accounted for within equity.
For in-depth discussion on evaluating the classification and accounting for these
instruments, see KPMG Handbook, Debt and equity financing.

Income taxes

Excerpt from ASC 852-740

> Fresh-Start Reporting in a Chapter 11 Reorganization

45-1 For entities that meet the paragraph 852-10-45-19 requirements for fresh-
start reporting, deferred taxes shall be reported in conformity with generally
accepted accounting principles (GAAP). If not recognizable at the plan
confirmation date, initial recognition (that is, by elimination of the valuation
allowance) of tax benefits realized from preconfirmation net operating loss
carryforwards and deductible temporary differences shall be reported as a
reduction of income tax expense.

For guidance on accounting for income taxes in fresh-start reporting, see

section 10 of KPMG Handbook, Accounting for income taxes.

Discontinued operations on emergence

Question 5.3.170
Does a successor entity that reports discontinued
operations recast the predecessor periods?

Interpretive response: Yes. The SEC staff has indicated that the predecessor
financial statements of a registrant that has emerged from bankruptcy and

applies fresh-start reporting should be restated to reflect the impact of a

successor’s presentation of discontinued operations. [SEC FRM 13210.2, SEC Regs
Comm 04/2004]

We believe this approach should also be followed by non-SEC registrants. This

is because Subtopic 205-20 does not provide an exception to retrospectively
recasting prior periods for discontinued operations. [205-20-45-10]

Example 5.3.50
Discontinued operations in predecessor entity
financial statements
ABC Corp. is a calendar year-end company that has been operating under
Chapter 11 bankruptcy. In negotiating its plan of reorganization with its
creditors, ABC agreed to sell Component X to a third party.
ABC emerged from bankruptcy on August 14, Year 2 and met the requirements
to apply fresh-start reporting. On that date, Component X qualified to be
reported in discontinued operations. ABC presents its financial statements on a
comparative basis. As of December 31, Year 1, Component X did not meet the
criteria to be reported in discontinued operations.
In its December 31, Year 2 financial statements ABC recasts its predecessor
financial statements for the year ended December 31, Year 1 and the stub-
period through emergence on August 14, Year 2 to report the results and cash
flows of Component X in discontinued operations, and the assets and liabilities
of Component X as held-for-sale.

Contract assets and contract liabilities (deferred revenue)

Question 5.3.180
How are contract assets and liabilities accounted
for?

Interpretive response: An entity is required to assign its reorganization value to

its assets, liabilities and equity using the business combination acquisition
method principles in Subtopic 805-20. Therefore, an emerging entity applies the
same guidance to contract assets and liabilities in fresh start accounting as it
does in a business combination. [852-10-45-20]
In October 2021, the FASB issued ASU 2021-08, Accounting for Contract
Assets and Contract Liabilities from Contracts with Customers, which provides
an exception to the general fair value principle in Topic 805 for contract assets
and contract liabilities arising from acquired customer contracts in a business
combination. Section 17 of KPMG Handbook, Business combinations,
discusses the accounting for contract assets and contract liabilities before and
after the adoption of ASU 2021-08.
We believe this ASU also applies to the accounting for contract assets and
liabilities in fresh-start financial statements.

Before ASU 2021-08

The emerging entity recognizes a contract asset or contract liability at fair value.
An emerging entity only recognizes a contract liability if it represents a legal
obligation of the emerging entity.
Any changes in the contract assets or liabilities are presented as reorganization
items in the predecessor period. [852-10-45-21]
After ASU 2021-08
The emerging entity recognizes and measures contract assets and contract
liabilities using the principles in Topic 606 (revenue) as if the emerging entity
had originated the contract. That is, the emerging entity applies the accounting
policies of the emerging entity (see Question 5.3.190) to each contract (or
portfolio of contracts in certain cases) to determine the amount of a contract
asset or liability to record upon emergence.
Any changes in the contract assets or liabilities are presented as reorganization
items in the predecessor period – e.g. because of differences in accounting
policies between the predecessor and successor entities.

Accounting policies of the successor entity

Question 5.3.190
Can an entity change its accounting policies on
emerging from bankruptcy?

Interpretive response: Yes. The emerging entity is considered a new reporting

entity for financial reporting purposes, and therefore the financial statements for
periods after emerging from bankruptcy (successor periods) are not comparable
with the financial statements of the periods before emerging (predecessor
periods). Accordingly, the emerging entity’s accounting policies are not required
to be consistent with those of the predecessor entity.
We do not believe that the emerged entity needs to assess whether any new
accounting principle is preferable, and consequently a preferability letter is not
required for public entities. [250-10-45-2(b)]
The accounting policies of the predecessor and successor entities should be
clearly described in the notes to the financial statements. We do not believe it
is necessary to make the change in accounting policy disclosures required by
Topic 250 if the change occurs as part of applying fresh-start reporting.

Question 5.3.200
In applying a retrospective change in accounting
principle in a period after fresh-start reporting, does
an entity recast predecessor periods?
Interpretive response: No. Because the financial statements prepared by an
emerging entity are effectively those of a new entity, they are not comparable

with those of the predecessor periods. Therefore, we believe an entity is not

required to retrospectively apply a new accounting principle to the periods
before emerging from bankruptcy. [852-10-45-26]
However, we believe the financial statements of the predecessor periods
should be retrospectively recast for:
— discontinued operations (see Question 5.3.170); and
— segment disclosures to reflect a change in reportable segments (see
Question 5.5.20).

Question 5.3.210
Can an entity adopt a new Accounting Standards
Update that is not yet effective?

Interpretive response: Only if the new ASU permits early adoption. In fresh-
start reporting, an entity is permitted, but not required, to adopt new ASUs that
are not yet effective if they allow early adoption. An entity is not permitted to
early adopt an ASU in fresh-start reporting if early adoption is specifically
prohibited. [FSP SOP 90-7-1.6]

5.3.30 Financial statement presentation and disclosure

Excerpt from ASC 852-10

> Financial Reporting When Entities Emerge from Chapter 11 Reorganization

and Adopt Fresh-Start Reporting
50-7 Paragraph 852-10-45-21 requires additional information to be disclosed in
the notes to the initial fresh-start financial statements when fresh-start
reporting is adopted. That additional information consists of all of the following:
a. Adjustments to the historical amounts of individual assets and liabilities
b. The amount of debt forgiveness
c. Significant matters relating to the determination of reorganization value,
including all of the following:
1. The method or methods used to determine reorganization value and
factors such as discount rates, tax rates, the number of years for
which cash flows are projected, and the method of determining
terminal value
2. Sensitive assumptions—that is, assumptions about which there is a
reasonable possibility of the occurrence of a variation that would have
significantly affected measurement of reorganization value
3. Assumptions about anticipated conditions that are expected to be
different from current conditions, unless otherwise apparent.

> Illustrations
• > Example 2: Fresh-Start Reporting and Illustrative Notes to Financial
Statements
55-4 This Example illustrates the fresh-start-related guidance in paragraphs
852-10-45-19 through 45-27 and uses the same hypothetical XYZ Company as
in Example 1 (see paragraph 852-10-55-2). Illustrative accounting and
associated note disclosures follow.
55-5 The Bankruptcy Court confirmed XYZ's plan of reorganization as of June
30, 19X2. It was determined that XYZ's reorganization value computed
immediately before June 30, 19X2, the date of plan confirmation, was
$1,300,000, which consisted of the following.
Cash in excess of normal operating requirements
generated by operations $ 150,000
Net realizable value of asset dispositions 75,000
Present value of discounted cash flows of the
emerging entity 1,075,000
Reorganization value $ 1,300,000

55-6 XYZ Company adopted fresh-start reporting because holders of existing

voting shares immediately before filing and confirmation of the plan received
less than 50% of the voting shares of the emerging entity and its
reorganization value is less than its postpetition liabilities and allowed claims,
as shown in the following table.
Postpetition current liabilities $ 300,000
Liabilities deferred pursuant to Chapter 11 proceeding 1,100,000
Total postpetition liabilities and allowed claims 1,400,000
Reorganization value (1,300,000)
Excess of liabilities over reorganization value $ 100,000

55-7 The reorganization value of the XYZ Company was determined in

consideration of several factors and by reliance on various valuation methods,
including discounting cash flow and price/earnings and other applicable ratios.
The factors considered by XYZ Company included all of the following:
a. Forecasted operating and cash flow results that gave effect to the
estimated impact of both of the following:
1. Corporate restructuring and other operating program changes
2. Limitations on the use of available net operating loss carryovers and
other tax attributes resulting from the plan of reorganization and other
events.
b. The discounted residual value at the end of the forecast period based on
the capitalized cash flows for the last year of that period
c. Market share and position
d. Competition and general economic considerations
e. Projected sales growth
f. Potential profitability
g. Seasonality and working capital requirements.
55-8 After consideration of XYZ Company's debt capacity and other capital
structure considerations, such as industry norms, projected earnings to fixed

charges, earnings before interest and taxes to interest, free cash flow to
interest, and free cash flow to debt service and other applicable ratios, and
after extensive negotiations among parties in interest, it was agreed that XYZ's
reorganization capital structure should be as follows
Postpetition current liabilities 300,000
Internal Revenue Service (IRS) note 50,000
Senior debt 275,000 (a)
Subordinated debt 175,000
Common stock 350,000
Reorganization capital structure $ 1,150,000
(b)

(a) Due $50,000 per year for each of the next 4 years, at 12% interest, with
$75,000 due in the fifth year.
(b) See the table in paragraph 852-10-55-10 for the balance sheet adjustments
required to reflect XYZ Company’s reorganization value as of the date of
plan confirmation.
55-9 The following entries record the provisions of the plan and the adoption of
fresh-start reporting.
Entries to record debt discharge:

Liabilities subject to compromise $ 1,100,000

Senior debt–current $ 50,000
Senior debt–long-term 225,000
IRS note 50,000
Cash 150,000
Subordinated debt 175,000
Common stock (new) 86,000
Additional paid-in capital 215,000
Gain on debt discharge 149,000

Entries to record exchange of stock for stock:

Preferred stock 325,000
Common stock (old) 75,000
Common stock (new) 14,000
Additional paid-in capital 386,000

Entries to record the adoption of fresh-start

reporting and to eliminate the deficit:
Inventory 50,000
Property, plant and equipment 175,000
Reorganization value in excess of amounts allocable
to identifiable assets 175,000
Gain on debt discharge 149,000
Additional paid-in capital 351,000
Goodwill 200,000
Deficit 700,000

55-10 The effect of the plan of reorganization on XYZ Company's balance sheet, as of June 30, 19X2, is as follows.
XYZ
Company’s
Adjustments to Record Confirmation of Plan
Reorganized
Debt Exchange of Balance
Preconfirmation discharge stock Fresh start Sheet

Assets:
Current Assets
Cash $ 200,000 $ (150,000) $ 50,000
Receivables 250,000 250,000
Inventory 175,000 $ 50,000 225,000
Assets held for sale 25,000 25,000
Other current assets 25,000 25,000
675,000 (150,000) 50,000 575,000

Property, plant and equipment 175,000 175,000 350,000

Assets held for sale 50,000 50,000
Goodwill 200,000 (200,000)
Reorganization value in excess of amounts
allocable to identifiable assets 175,000 175,000
$ 1,100,000 $ (150,000) $ 200,000 $1,150,000
Liabilities and
Shareholders’ Deficit:
Liabilities Not Subject to Compromise
Current Liabilities
Short-term borrowings $ 25,000 $ 25,000
Current maturities of senior debt $ 50,000 50,000
Accounts payable trade 175,000 175,000
Other liabilities 100,000 100,000
300,000 50,000 350,000
Liabilities Subject to Compromise
Prepetition liabilities 1,100,000 (1,100,000)
IRS note 50,000 50,000
Senior debt, less current maturities 225,000 225,000
Subordinated debt 175,000 175,000
Shareholders’ deficit:
Preferred stock 325,000 $ (325,000)

© 2024 KPMG LLP, a Delaware limited liability partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by
guarantee. All rights reserved.
Accounting for bankruptcies 167
5. Emerging from Chapter 11 bankruptcy

Additional paid-in capital 215,000 386,000 $ (351,000) 250,000

Common stockold 75,000 (75,000)
Common stocknew 86,000 14,000 100,000
Retained earnings (deficit) (700,000) 149,000 700,000
(149,000)
(300,000) 450,000 – 200,000 350,000
$ 1,100,000 $ (150,000) $ – $ 200,000 $1,150,000

55-11 The following illustrative disclosure discusses the details of XYZ Company's confirmed plan of reorganization. In this illustration a
tabular presentation entitled Plan of Reorganization Recovery Analysis is incorporated in the note disclosure. The plan of reorganization
recovery analysis may alternatively be presented as supplementary information to the financial statements.
Note X - Plan of Reorganization
On June 30, 19X2, the Bankruptcy Court confirmed the Company's plan of reorganization. The Company accounted for the
reorganization using fresh-start reporting. Accordingly, all assets and liabilities are adjusted to fair value under accounting requirements
for business combinations under Topic 805. The excess of reorganization value over the fair value of tangible and intangible assets was
recorded as “reorganization value in excess of amounts allocable to identifiable assets.” The confirmed plan provided for the following:
Secured Debt—The Company’s $300,000 of secured debt (secured by a first mortgage lien on a building located in Nashville,
Tennessee) was exchanged for $150,000 in cash and a $150,000 secured note, payable in annual installments of $27,300
commencing on June 1, 19X3, through June 1, 19X6, with interest at 12% per annum, with the balance due on June 1, 19X7.
Priority Tax Claims—Payroll and withholding taxes of $50,000 are payable in equal annual installments commencing on July 1, 19X3,
through July 1, 19X8, with interest at 11% per annum.
Senior Debt—The holders of approximately $275,000 of senior subordinated secured notes received the following instruments in
exchange for their notes: $87,000 in new senior secured debt, payable in annual installments of $15,800 commencing March 1,
19X3, through March 1, 19X6, with interest at 12% per annum, secured by first liens on certain property, plants, and equipment,
with the balance due on March 1, 19X7; $123,000 of subordinated debt with interest at 14% per annum due in equal annual
installments commencing on October 1, 19X3, through October 1, 19X9, secured by second liens on certain property, plant, and
equipment; and 11.4% of the new issue of outstanding voting common stock of the Company.
Trade and Other Miscellaneous Claims—The holders of approximately $225,000 of trade and other miscellaneous claims received
the following for their claims: $38,000 in senior secured debt, payable in annual installments of $6,900 commencing March 1, 19X3,
through March 1, 19X6, with interest at 12% per annum, secured by first liens on certain property, plants, and equipment, with the
balance due on March 1, 19X7; $52,000 of subordinated debt, payable in equal annual installments commencing October 1, 19X3,
through October 1, 19X8, with interest at 14% per annum; and 25.7% of the new issue of outstanding voting common stock of the
Company.
Subordinated Debentures—The holders of approximately $250,000 of subordinated unsecured debt received, in exchange for the
debentures, 48.9% of the new issue outstanding voting common stock of the Company.

© 2024 KPMG LLP, a Delaware limited liability partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by
guarantee. All rights reserved.
Accounting for bankruptcies 168
5. Emerging from Chapter 11 bankruptcy

Preferred Stock—The holders of 3,250 shares of preferred stock received 12% of the outstanding voting common stock of the new
issue of the Company in exchange for their preferred stock.
Common Stock—The holders of approximately 75,000 outstanding shares of the Company's existing common stock received, in
exchange for their shares, 2% of the new outstanding voting common stock of the Company.
The following table (Plan of Reorganization Recovery Analysis) summarizes the adjustments required to record the reorganization and
the issuance of the various securities in connection with the implementation of the plan.
Recovery
Elimination
of Debt and Surviving Senior Subordinated Common Stock (a) Total Recovery
Equity Debt Cash IRS Note Debt Debt % Value $ %
Postpetition liabilities $ 300,000 $ 300,000 $ 300,000 100%
Claim or Interest
Secured debt 300,000 $ 150,000 $150,000 300,000 100
Priority tax claim 50,000 $50,000 50,000 100
Senior debt 275,000 $ (25,000) 87,000 $ 123,000 11.4% $ 40,000 250,000 91
Trade and other
miscellaneous claims 225,000 (45,000) 38,000 52,000 25.7 90,000 180,000 80
Subordinated debentures 250,000 (79,000) 48.9 171,000 171,000 68
1,100,000
Preferred stockholders 325,000 (283,000) 12.0 42,000 42,000
Common stockholders 75,000 (68,000) 2.0 7,000 7,000
Deficit (700,000) 700,000
Total $1,100,000 $ 200,000 $ 300,000 $ 150,000 $ 50,000 $275,000 $ 175,000 100.0% $350,000 $1,300,000

(a) The aggregate par value of the common stock issued under the plan is $100,000.

© 2024 KPMG LLP, a Delaware limited liability partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by
guarantee. All rights reserved.
Accounting for bankruptcies 169
5. Emerging from Chapter 11 bankruptcy

Question 5.3.215
What disclosures are required when fresh-start
reporting is applied?

Interpretive response: When fresh-start reporting is adopted, additional

disclosures are required, including: [852-10-50-7]
— adjustments to the historical amounts of individual assets and liabilities;
— the amount of debt forgiveness;
— significant matters relating to the determination of the reorganization value,
including all of the following:
– the method(s) used to determine the reorganization value, and factors
such as discount rates, tax rates, the number of years for which cash
flows are projected, and the method of determining terminal value;
– sensitive assumptions when there is a reasonable possibility of a
variation that would significantly affect the measurement of the
reorganization value; and
– assumptions about anticipated conditions that are expected to be
different from current conditions, unless otherwise apparent.

Question 5.3.220
What additional disclosures should an entity
consider?

Interpretive response: We believe an entity applying fresh-start reporting

should consider the following disclosures in addition to the specific
requirements of Subtopic 852-10.
— Labeling periods before emerging from bankruptcy and applying fresh-start
reporting as ‘Predecessor’ and those after emerging as ‘Successor’.
— A detailed discussion of emerging from bankruptcy, such as:
— how the entity will conduct its business;
— how the entity’s capital is structured on emergence;
— how many and what kind of equity securities were distributed to
creditors; and
— which businesses were ceased or subsidiaries were sold.
— The convenience date used to implement fresh-start reporting (if
applicable).
— The entity’s estimated reorganization value.
Additionally, fresh-start reporting may affect other areas of the financial
statements and disclosures may be required under other applicable US GAAP,
including updates to significant accounting policies, fair value of investments,
income taxes, commitments and contingencies, employee benefits, debt and
shareholders’ equity. [852-10-50-1]

Example 5.3.60
Financial statements on emerging from bankruptcy
ABC Corp. is a calendar year-end company that filed a petition for bankruptcy on
July 1, Year 1. ABC emerged from bankruptcy on January 30, Year 2. For
convenience, because the effect on both the predecessor and successor
periods was immaterial (see Question 5.3.20), ABC applied fresh-start reporting
on January 31, Year 2.
ABC presents financial statements for one comparative period. ABC’s
consolidated balance sheet and statement of operations are as follows as of
and for the years ended December 31, Year 2 and Year 1.
ABC Corporation
Consolidated Balance Sheets
(000s)
Successor Predecessor
December 31,
Year 2 Year 1
Assets
Cash $ 900 $ 1,650
Other current assets 225 200
Intangible assets 45 50
Property, plant and equipment, net 900 1,500
Goodwill 300 -
Total assets $ 2,370 $ 3,400
Liabilities and equity
Current liabilities 340 310
Long-term debt 320 340
Liabilities subject to compromise 0 4,800
Total liabilities $ 660 $ 5,450
Common stock – predecessor - 5
Additional paid-in capital – predecessor - 2,795
Common stock – successor 8 -
Additional paid-in capital – successor 1,102 -
Retained earnings (accumulated deficit) 600 (4,850)
Total shareholders’ equity (deficit) $ 1,710 $ (2,050)
Total liabilities and shareholders’ equity $ 2,370 $ 3,400

The successor and predecessor periods are clearly delineated both in the
column heading and also by separation via a black line.
ABC Corporation
Consolidated Statement of Operations
(000s)
Successor Predecessor
Period from Period from
February 1, January 1,
Year 2 Year 2
through through Year Ended
December 31, January 31, December 31,
Year 2 Year 2 Year 1
Net sales $ 25,500 $ 1,800 $ 21,000
Cost of goods sold (18,250) (1,350) (16,500)
Gross margin 7,250 450 4,500
Operating expenses
Selling, general and administrative expenses (4,400) (440) (5,000)
Restructuring and impairment charges (900) (80) (900)
Other expenses (600) (50) (600)
Total operating expenses (5,900) (570) (6,500)

Income (loss) before interest, reorganization

items, and income taxes 1,350 (120) (2,000)
Interest expense (425) (20) (275)
Reorganization items, net - 2,200 (850)
Income (loss) before income tax benefit and
discontinued operations 925 2,060 (3,125)
Income tax (expense) benefit (200) (700)
Income (loss) before discontinued operations 725 1,360 (3,125)
Discontinued operations:
Loss from operations of a discontinued
component - - (300)

Net income (loss) $ 725 $ 1,360 $ (3,425)

The results of operations of the predecessor entity are separately presented for
all periods before emergence. In addition, the successor and predecessor
periods are clearly delineated both in the column heading and by using a black
line.

Example 5.3.70
Fresh-start reporting illustration
ABC Corp. emerged from bankruptcy as of March 31 and qualified for fresh-
start reporting. ABC’s financial statement disclosures included the following
balance sheet reconciliation to present the reorganization adjustments and
fresh-start adjustments applied to the predecessor entity’s balance sheet as of
March 31.

Reorg. Fresh-start
Predecessor adjustments adjustments Successor
Assets
Cash $ 1,950 $ (1,770)a $ - $ 180
Other current assets 100 - 10c 110
Intangible assets 20 - 120c 140
PP&E net 1,170 - 20c 1,190
Goodwill - - 100c 100
Total assets $ 3,240 $ (1,770) $ 250 $ 1,720b
Liabilities and equity
Current liabilities $ 250 $ - $ - $ 250
Long-term debt 360 - - 360
Liabilities subject to
compromise 4,800 (4,800)a - -
Total liabilities 5,410 (4,800) - 610
Common stock - predecessor 15 (15) e - -
APIC – predecessor 2,785 (2,785) e - -
Common stock – successor - 8d - 8
APIC – successor - 1,102d - 1,102
Accumulated deficit (4,970) 4,720f 250g -
Total shareholders’ equity
(deficit) (2,170) 3,030 250 1,110
Total liabilities and
shareholders’ equity $ 3,240 $ (1,770) $ 250 $ 1,720

Notes:

The predecessor’s liabilities subject to compromise ($4,800) were settled with

A $1,770 in cash and 100% of the common stock of the emerging entity ($1,110).
See (f) for calculation of the gain on the settlement.

B ABC’s reorganization value (see section 5.2.10).

C To adjust the predecessor’s assets and liabilities to fair value.
New common stock and additional paid-in capital issued to creditors to settle
D
the predecessor’s liabilities.
E Cancellation of the predecessor common stock and associated paid-in capital.
Gain on the settlement of liabilities subject to compromise [$4,800 – ($1,770 +
F
$8 + $1,102 – $15 – $2,785)]
G Accumulated deficit resets to zero.

The first three columns of the table represent accounting by the predecessor
entity in the period just before emergence. The fourth column represents the
opening balance sheet for the successor entity after the adoption of fresh-start
reporting. As described in footnote (b), the total assets on the opening balance
sheet of $1,720 are equal to the reorganization value.

Question 5.3.230
Is disclosure required when an entity applies fresh-
start reporting after the reporting date but before
the financial statements are issued?
Interpretive response: Yes. An entity that applies fresh-start reporting after the
reporting date but before the financial statements are issued (or available to be
issued) is required to include appropriate disclosures of the nonrecognized
event in its financial statements. [855-10-50-3]
Further, Topic 855 indicates that sometimes a subsequent event is so
significant that the best way to convey information about the event may be by
providing pro forma financial data. Therefore, an entity may present a pro forma
balance sheet in the notes to the financial statements showing the effects of
fresh-start reporting on the period-end balances. [855-10-50-3]
In this circumstance, an emerging entity also makes the disclosures required by
Subtopic 852-10. [852-10-50-7]

Question 5.3.240
Is a private entity required to include the pre-
emergence stub period in its post-emergence
financial statements?
Interpretive response: No. A private entity is not required to include the pre-
emergence stub period in its post-emergence financial statements unless
required by banking or other agreements. Therefore, if a private entity with a
calendar year-end emerges from a Chapter 11 bankruptcy on June 30 and
applies fresh-start reporting, it is permitted to include only the post-emergence
six-month period in its first set of post-emergence financial statements. [205-10-
45-2]

5.4 Entities not qualifying for fresh-start reporting

Excerpt from ASC 852-10

• > Reporting by Entities Not Qualifying for Fresh-Start Reporting’ heading here
45-29 Entities emerging from Chapter 11 that do not meet the criteria in
paragraph 852-10-45-19 do not qualify for fresh-start reporting. Liabilities
compromised by confirmed plans shall be stated at present values of amounts
to be paid, determined at appropriate current interest rates. Forgiveness of
debt, if any, shall be reported as an extinguishment of debt and classified in
accordance with Subtopic 220-20.

An entity that does not meet both criteria for fresh-start reporting continues to
apply other US GAAP and discontinues applying Subtopic 852-10 on emergence
from bankruptcy. The pre- and post-emergence periods are treated as a
continuation of the same reporting entity. [852-10-45-29]

Question 5.4.10
Does an entity not qualifying for fresh-start
reporting apply the guidance on troubled debt
restructurings?
Interpretive response: Generally, no. The guidance on troubled debt
restructurings in Subtopic 470-60 does not apply when most of the amount of
an entity’s liabilities is restructured in a bankruptcy case and there is a general
restatement of the entity’s liabilities, which is usually the case when an entity
emerges from bankruptcy. [470-60-15-10]
However, if some but not most of the amount of an entity’s liabilities are
restructured on emergence, judgment may be required to determine whether
an entity should apply the guidance on troubled debt restructurings (see also
Questions 4.4.40 and 4.4.50).

Example 5.4.10
General restructuring of liabilities in a bankruptcy
ABC Corp. is a calendar year-end company. On November 15, 20X8, ABC filed a
prepackaged bankruptcy under Chapter 11.
Under the arrangement, which was confirmed by the Court, the parties agreed
that the existing shareholders would retain control of ABC and that ABC’s debt
would be restructured as follows.

Pre-bankruptcy Restructured
amount amount
Shareholder subordinated debt $65,430 $25,000
Revolving line of credit 3,540 2,832
Loan payable 1,350 1,080
Standby letter of credit 375 300
Senior notes payable 5,465 5,465
Total $76,160 $34,677

Because most of the amount of ABC’s liabilities is being restructured and the
restructuring is subject to Court approval, it is not a troubled debt restructuring
and Subtopic 470-60 does not apply. The compromised liabilities are
remeasured as of the emergence date at the present value of the amounts to
be paid.

Question 5.4.20
Can an entity not qualifying for fresh-start reporting
offset its accumulated deficit against paid-in
capital?
Interpretive response: No. Offsetting an accumulated deficit against paid-in
capital is appropriate only when an entity emerging from Chapter 11 qualifies
for fresh-start reporting (see Question 5.3.150). [852-10-45-29]

Question 5.4.30
At what amount does an entity not qualifying for
fresh-start reporting recognize a liability subject to
compromise that ultimately was not compromised?
Interpretive response: We believe that the liability should be recognized at an
amount equal to what the historical liability amount would have been on
emergence if it had never been classified as subject to compromise.
We believe this is consistent with the following requirements in Subtopic 852-
10. [852-10-45-6]
— premiums, discounts and debt issuance costs on liabilities that are not
subject to compromise are not adjusted (see Question 4.4.20); and
— liabilities subject to compromise are reclassified to not subject to
compromise if new or better information becomes available (see Question
4.3.20).
The effect of any adjustment is included in reorganization items.

Example 5.4.20
Claim reclassified from subject to compromise to not
subject to compromise
ABC Corp. has outstanding debt of $150 that was issued at a discount of $10.
ABC experienced financial difficulty and filed a petition for Chapter 11
bankruptcy.
Based on the estimated fair value of the collateral securing the debt, ABC
believed that the outstanding debt was undersecured and subject to
compromise. Therefore, in its financial reporting during the reorganization, ABC
recognized the outstanding debt at the expected amount of the allowed claim,
which was par value; there was no unpaid interest. ABC derecognized the $10
discount by recognizing an expense as part of reorganization items (see
Question 4.4.10).
Before ABC’s emergence from bankruptcy, ABC experienced a significant
increase in the demand for its products. As a result, the outstanding debt was
not compromised and remained as a post-emergence obligation at full contract
value. ABC did not qualify for fresh-start reporting.

In this example, the debt ultimately was not compromised. Therefore, on

emergence, ABC reclassifies the debt out of liabilities subject to compromise
and recognizes a debt discount of $8 ($10 less amortization of $2) equal to the
amount that would have been recognized on the date of emergence if the debt
had never been classified as a liability subject to compromise. The debt
discount is recorded as a reduction to the carrying value of the debt. The effect
of reinstating the debt discount is included in reorganization items.

Question 5.4.40
Can an entity not qualifying for fresh-start reporting
adopt a new Accounting Standards Update that is
not yet effective?
Interpretive response: Only if the new ASU permits early adoption. The
emerging entity should comply with the transition requirements of the new
accounting standard.

Question 5.4.50
Can an entity not qualifying for fresh-start reporting
change its accounting policies on emergence?

Interpretive response: Only if the new accounting policy is preferable. We

believe an entity emerging from bankruptcy that does not meet the criteria for
fresh-start reporting must follow the guidance in Topic 250 when changing an
accounting policy. This is because the emerging entity is not considered a new
reporting entity. [250-10-45-2]

Question 5.4.60
What disclosures should an entity not qualifying for
fresh-start reporting consider?

Interpretive response: Subtopic 852-10 contains no specific disclosure

requirements for an entity that does not qualify for fresh-start reporting. Other
US GAAP continues to apply. We believe an entity emerging from bankruptcy
should consider disclosing the following.
— A detailed discussion of emerging from bankruptcy, such as:
— how the entity will conduct its business;
— how the entity’s capital is structured on emergence;
— how many and what kind of equity securities were distributed to
creditors; and
— which businesses were ceased or subsidiaries were sold.
— An explicit statement that the criteria for applying fresh-start reporting on
emergence were not met.

— The amount of contractual interest not paid or accrued on prepetition

liabilities that were not allowed.
— Detail and explanation of reorganization items, such as:
— gain on discharge of prepetition liabilities;
— professional fees; and
— adjustments to the carrying amounts of allowed claims.

5.5 Considerations regardless of whether fresh-start

reporting applies

Question 5.5.10
Can reorganization expenses be recorded in a
period after the entity emerges from bankruptcy?

Interpretive response: Yes. Expenses that qualify as reorganization items are

presented as such in the accounting periods in which those expenses qualify
for recognition under US GAAP. We believe this is consistent with the
statement in Subtopic 852-10 that entering Chapter 11 bankruptcy does not
change the application of US GAAP. Therefore, if GAAP requires a
reorganization item to be expensed in a period after emergence, that timing
should not change the fact that it is a reorganization item. [852-10-45-1]
Additionally, certain reorganization expenses such as fees for attorneys and
other bankruptcy advisors are often incurred after the emergence date. [852-10-
45-9]

Question 5.5.20
Can an entity’s segment reporting change after
emerging from bankruptcy?

Interpretive response: Possibly. If an emerging entity’s organizational structure

changes, it should reconsider the criteria for determining its reportable
segments. The chief operating decision maker may change or may review new
or different information to allocate resources and assess performance after
emergence. Similar to presenting discontinued operations, we believe it is
appropriate to adjust the segment disclosures retrospectively in the financial
statements of the predecessor after applying fresh-start reporting. [280-10-50-34]

5.6 Accounting by group entities that did not file for

bankruptcy

Question 5.6.10
Can a subsidiary that was not in bankruptcy apply
pushdown accounting upon its parent’s emergence
from bankruptcy?
Background: Parent has a wholly owned subsidiary. Parent files for bankruptcy
and on emerging from bankruptcy applies fresh-start reporting. The subsidiary
did not file for bankruptcy. Parent continues to control the subsidiary post-
emergence, but no single entity, creditor or shareholder obtained control of
Parent on emerging from bankruptcy.
Interpretive response: Yes, we believe a subsidiary that did not file for
bankruptcy may elect to apply pushdown accounting provided the parent
company (or any intermediate parent company) meets the criteria for fresh-start
reporting. Under Subtopic 805-50, pushdown accounting is allowed, but not
required, when a change-in-control event occurs. [805-50-25-4 – 25-9]
See additional guidance on pushdown accounting in section 27 of KPMG
Handbook, Business combinations.

Question 5.6.20
How does a non-bankrupt parent account for a
deconsolidated bankrupt subsidiary when the
subsidiary emerges from bankruptcy?
Background: A parent entity usually deconsolidates a subsidiary that files for
bankruptcy; this is regardless of whether it had a controlling financial interest
through the voting interest entity model or variable interest entity model (see
Questions 4.11.40 and 4.11.50).
Interpretive response: If the parent previously deconsolidated the subsidiary
while in bankruptcy, the parent should first evaluate whether the emerging
entity is a VIE and, if so, whether the parent is the primary beneficiary. If the
emerging entity is not a VIE, the parent should evaluate whether it controls the
entity using the voting interest entity model. In either case, if the parent is
required to consolidate the emerged entity and that entity meets the definition
of a business, the parent should apply the acquisition method under Topic 805.
[805-10-25-1, 810-10-05]

5.7 Additional requirements for SEC registrants

The financial statement disclosure requirements are determined under Subtopic
852-10, but additional disclosure of certain information outside of the primary
annual and interim financial statements is required under Regulation S-K on
emerging from bankruptcy.
An entity is required to file an Item 1.03 Form 8-K within four business days of
the approval of its plan of reorganization or liquidation by a court or
governmental authority.
The Form 8-K should disclose: [Form 8-K Item 1.03]
— the identity of the Court or governmental authority;
— the date that the order confirming the plan was entered into by the Court or
governmental authority;
— a summary of the material features of the plan and a copy of the confirmed
plan (pursuant to Item 9.01);
— the number of shares or other units of the registrant or its parent issued
and outstanding, the number reserved for future issuance in respect of
claims and interests filed and allowed under the plan, and the aggregate
total of such numbers; and
— the assets and liabilities of the registrant or its parent as of the date that the
order confirming the plan was entered, or a date as close thereto as
practicable (i.e. an audited balance sheet).
Section 1141 of the Code states that a confirmed plan of reorganization is
binding on all parties at the confirmation date, defined as the date the Court
approves the plan of reorganization. The effective date is the date the plan of
reorganization goes into effect, usually within a short period of time after
confirmation of the plan when all conditions precedent are met. See discussion
in section 5.3.10.
Therefore, the date the Court confirms the plan of reorganization is generally
the date that should be used to apply the Form 8-K reporting requirements
because it is the date that the respective governmental authority having
jurisdiction in the matter has confirmed the plan of reorganization, thereby
making it binding on all parties.
A registrant is required to file a Form 8-K in connection with an amendment to a
material definitive agreement. A modification, exchange or extinguishment of
debt either before or on emergence from bankruptcy may trigger this
requirement.

Description of business
A registrant is required under Item 101 of Regulation S-K to include information
in the Form 10-K and most registration statements about the development of
the registrant’s business during the past five years, including any bankruptcy.
This information should include the effect a bankruptcy has had on the
registrant’s structure and capitalization. Other items for consideration in the
business discussion section in Form 10-K may include: [Reg S-K Item 101]

— background information regarding the bankruptcy with an emphasis on the

plan of reorganization;
— distributions provided for under the Plan of Reorganization confirmed by the
Court; and
— any other information, such as ceased operations and sold subsidiaries.

Results of operations
A registrant is required to analyze the periods covered by the financial
statements in its MD&A. This analysis should include a discussion of trends and
changes based on the financial statements included in the filing. If on
emergence from bankruptcy a registrant qualifies for fresh-start reporting, it
presents its financial statements for the predecessor and successor periods.
The registrant should not combine the predecessor and successor periods
within its MD&A. [Reg S-K Item 303]

Pro forma financial information

A registrant is required to provide investors with pro forma financial information
if events or transactions have occurred or are probable for which disclosure of
pro forma financial information would be material, such as applying fresh-start
reporting on emerging from bankruptcy. [SEC FRM 3160.1]
A registrant that emerged from bankruptcy may provide supplemental pro
forma results for the combined reporting period and discuss and analyze those
results by comparing them to the pro forma results for the immediately
preceding period. Generally, the SEC staff would not expect a registrant to
provide pro forma results for earlier periods, other than perhaps revenue and
cost of sales. If a registrant believes that additional details for prior periods are
necessary to understand the implications of fresh-start reporting, it is
encouraged to discuss the issue with the SEC staff before filing. [SEC FRM 9220.7
– 9220.8]

Pro forma adjustments

A registrant’s pro forma statement of operations should reflect adjustments to
eliminate nonrecurring costs directly related to the bankruptcy and not reflective
of continuing operations. These adjustments may include legal and professional
fees directly related to the bankruptcy, fees for claims administration, changes
to allowed claims compared to previously recognized amounts and debt
issuance costs related to debtor-in-possession financing. Although not included
in the pro forma statement of operations, these amounts should be reflected in
historical liabilities and retained earnings in the pro forma balance sheet. [SEC
FRM 3230.4]

The SEC staff believes the pro forma adjustments should exclude the reversal
of previously recognized impairment losses because they are unrelated to
resolution of the bankruptcy, even though after applying fresh-start reporting
those impairment charges likely would not have been necessary.

Question 5.7.10
Does a registrant evaluate whether fresh-start
reporting will apply before it emerges from
bankruptcy?
Interpretive response: Generally, yes. The sooner a registrant knows fresh-
start reporting will likely apply, the more time it will have to prepare pro forma
financial statements. Whether fresh-start reporting actually applies is not finally
determined until the emergence date, so an entity will need to project its
reorganization value, allowed claims and postpetition liabilities, and update
those projections as the bankruptcy case progresses and more information
becomes available.

Question 5.7.20
Does pro forma financial information in connection
with a registration statement reflect the effect of
fresh-start reporting?
Background: On July 15, Year 2, ABC emerged from bankruptcy. ABC met the
criteria to apply fresh-start reporting on emerging from bankruptcy. In
September Year 2, ABC filed a registration statement in connection with issuing
debt securities.
Interpretive response: Yes. Emerging from bankruptcy is generally an event
that would be material to investors that requires:
— a pro forma condensed balance sheet as of the end of the most recent
period for which a consolidated balance sheet is required; and
— pro forma condensed statements of operations for the most recent fiscal
year and for the period from the most recent fiscal year-end to the most
recent interim date.
Therefore, in the background example, ABC includes in its registration
statement:
— a pro forma condensed balance sheet as of June 30, Year 2; and
— pro forma condensed statements of operations for the year ended
December 31, Year 1 and for the six months ended June 30, Year 2.
The pro forma financial information is prepared by applying adjustments to
historical financial statements that give effect to the plan of reorganization and
fresh-start reporting, as if the emergence date had occurred on January 1, Year
1 for the pro forma statement of operations and on June 30, Year 2 for the pro
forma condensed balance sheet.
When preparing the pro forma condensed statement of operations for the year-
ended December 31, Year 1 and for the six-months ended June 30, Year 2,
ABC should include the effect of:
— issuing the debt securities; and
— the reorganization and fresh-start adjustments as if they had occurred on
January 1, Year 1 – i.e. on the first day of the period presented. Common

pro forma adjustments include removing reorganization adjustments related

to the plan of reorganization and revising historical interest expense for the
entity’s post-emergence debt position.
The pro forma condensed balance sheet as of June 30, Year 2 includes
reorganization and fresh-start adjustments, such as adjustments to reflect the
debt issued as part of the reorganization and to remove liabilities subject to
compromise that were settled as part of the reorganization.
While the effect of fresh-start reporting is not related (directly or indirectly) to
issuing debt securities, we believe the effect of the fresh-start adjustments is
so significant to the results of operations for Year 1 that it is appropriate to
include the pro forma effect of the fresh-start adjustments. Giving effect to the
fresh-start adjustments in the pro forma statement of operations provides
information on a consistent basis of accounting – as opposed to giving effect to
highly judgmental estimates of how historical management practices and
operating decisions may or may not have changed. We believe this presentation
provides more meaningful information to the reader of the pro forma financial
information than solely giving pro forma effect to issuing the debt securities.

Subtopic 852-10 glossary

Excerpt from ASC 852-10

Absolute Priority Doctrine

A doctrine that provides that if an impaired class does not vote in favor of a
plan, the court may nevertheless confirm the plan under the cram-down
provisions of the Bankruptcy Code. The absolute priority doctrine is triggered
when the cram-down provisions apply. The doctrine states that all members of
the senior class of creditors and equity interests must be satisfied in full before
the members of the second senior class of creditors can receive anything, and
the full satisfaction of that class must occur before the third senior class of
creditors may be satisfied, and so on.
Administrative Expenses
Claims that receive priority over all other unsecured claims in a bankruptcy
case. Administrative expenses (sometimes referred to as administrative
claims) include the actual, necessary costs and expenses of preserving the
estate, including wages, salaries, or commissions for services rendered after
the commencement of the case. Fees paid to professionals for services
rendered after the petition is filed are considered administrative expenses.
Allowed Claim
The amount allowed by the Bankruptcy Court as a claim against the estate.
This amount may differ from the actual settlement amount.
Automatic Stay Provisions
Provisions causing the filing of a petition under the Bankruptcy Code to
automatically stay virtually all actions of creditors to collect prepetition debts.
As a result of the stay, no party, with minor exceptions, having a security or
adverse interest in the debtor's property can take any action that will interfere
with the debtor or the debtor's property, regardless of where the property is
located or who has possession, until the stay is modified or removed.
Bankruptcy Code
A federal statute, enacted October 1, 1979, as title 11 of the United States
Code by the Bankruptcy Reform Act of 1978, that applies to all cases filed on
or after its enactment and that provides the basis for the current federal
bankruptcy system.
Bankruptcy Court
The United States Bankruptcy Court is an adjunct of the United States District
Courts. Under the jurisdiction of the District Court, the Bankruptcy Court is
generally responsible for cases filed under Chapters 7, 11, 12, and 13 of the
Bankruptcy Code.

Chapter 11
A reorganization action, either voluntarily or involuntarily initiated under the
provisions of the Bankruptcy Code, that provides for a reorganization of the
debt and equity structure of the business and allows the business to continue
operations. A debtor may also file a plan of liquidation under Chapter 11.
Chapter 7
A liquidation, voluntarily or involuntarily initiated under the provisions of the
Bankruptcy Code that provides for liquidation of the business or the debtor's
estate.
Claim
As defined by Section 101(4) of the Bankruptcy Code, a right to payment,
regardless of whether the right is reduced to judgment, liquidated,
unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed,
legal, secured, or unsecured, or a right to an equitable remedy for breach of
performance if such breach results in a right to payment, regardless of whether
the right is reduced to a fixed, contingent, matured, unmatured, disputed,
undisputed, secured, or unsecured right.
Confirmed Plan
An official approval by the court of a plan of reorganization under a Chapter 11
proceeding that makes the plan binding on the debtors and creditors. Before a
plan is confirmed, it must satisfy 11 requirements in section 1129(a) of the
Bankruptcy Code.
Consenting Classes
Classes of creditors or stockholders that approve the proposed plan.
Cram-Down Provisions
Provisions requiring that for a plan to be confirmed, a class of claims or
interests must either accept the plan or not be impaired. However, the
Bankruptcy Code allows the Bankruptcy Court under certain conditions to
confirm a plan even though an impaired class has not accepted the plan. To do
so, the plan must not discriminate unfairly and must be fair and equitable to
each class of claims or interests impaired under the plan that have not
accepted it. The Bankruptcy Code states examples of conditions for secured
claims, unsecured claims, and stockholder interests in the fair and equitable
requirement.
Debtor-in-Possession
Existing management continuing to operate an entity that has filed a petition
under Chapter 11. The debtor-in-possession is allowed to operate the business
in all Chapter 11 cases unless the court, for cause, authorizes the appointment
of a trustee.
Disclosure Statement
A written statement containing information approved as adequate by the court.
It is required to be presented by a party before soliciting the acceptance or
rejection of a plan of reorganization from creditors and stockholders affected by
the plan. Adequate information means information of a kind, and in sufficient

detail, as far as is reasonably practicable in light of the nature and history of the
debtor and the condition of the debtor's records, that would enable a
hypothetical reasonable investor typical of holders of claims or interests of the
relevant class to make an informed judgment about the plan.
Emerging Entity
An entity (sometimes referred to as the reorganized entity), that has had its
plan confirmed and begins to operate as a new entity.
Impaired Claim
In determining which class of creditors' claims or stockholders' interests must
approve the plan, it is first necessary to determine if the class is impaired. A
class of creditors' claims or stockholders' interests under a plan is not
impaired if the plan leaves unaltered the legal, equitable, and contractual right
of a class, cures defaults that lead to acceleration of debt or equity interest, or
pays in cash the full amount of the claim, or for equity interests, the greater of
the fixed liquidation preference or redemption price.
Liquidating Bank
A bank with a substantial amount of nonperforming assets may transfer some
or all of those assets to a newly created bank whose stock will be distributed
to existing shareholders or to new investors. The newly created bank will be a
liquidating bank; that is, it will manage the assets it receives and collect cash
from loan repayments or dispositions of assets. All cash remaining after paying
expenses and debt service, if any, will be distributed to the shareholders of the
liquidating bank. The liquidating bank will likely be in the process of liquidation
for several years.
Nonconsenting Class
A class of creditors or stockholders that does not approve the proposed plan.
Obligations Subject to Compromise
Includes all prepetition liabilities (claims) except those that will not be impaired
under the plan, such as claims in which the value of the security interest is
greater than the claim.
Petition
A document filed in a court of bankruptcy, initiating proceedings under the
Bankruptcy Code.
Plan of Reorganization
An agreement formulated in Chapter 11 proceedings under the supervision of
the Bankruptcy Court that enables the debtor to continue in business. The
plan, once confirmed, may affect the rights of undersecured creditors, secured
creditors, and stockholders as well as those of unsecured creditors. Before a
plan is confirmed by the Bankruptcy Court, it must comply with general
provisions of the Bankruptcy Code. Those provisions mandate, for example,
that the plan is feasible, the plan is in the best interest of the creditors, and, if
an impaired class does not accept the plan, the plan must be determined to be
fair and equitable before it can be confirmed.

Postpetition Liabilities
Liabilities incurred after the filing of a petition that are not associated with
prebankruptcy events. Thus, these liabilities are not considered prepetition
liabilities.
Prepetition Liabilities
Liabilities that were incurred by an entity before its filing of a petition for
protection under the Bankruptcy Code including those considered by the
Bankruptcy Court to be prepetition claims, such as a rejection of a lease for
real property.
Reorganization Items
Items of income, expense, gain, or loss that are realized or incurred by an
entity because it is in reorganization.
Reorganization Proceeding
A Chapter 11 case from the time at which the petition is filed until the plan is
confirmed.
Reorganization Value
The value attributed to the reconstituted entity, as well as the expected net
realizable value of those assets that will be disposed of before reconstitution
occurs. Therefore, this value is viewed as the value of the entity before
considering liabilities and approximates the amount a willing buyer would pay
for the assets of the entity immediately after the restructuring.
Secured Claim
A liability that is secured by collateral. A fully secured claim is one in which the
value of the collateral is greater than the amount of the claim.
Terminal Value
A component of reorganization value.
Reorganization value calculated based on the discounting of cash flows
normally consists of three parts; the discounted cash flows determined for the
forecast period, the residual value or terminal value, and the current value of
any excess working capital or other assets that are not needed in
reorganization. Terminal or residual value represents the present value of the
business attributable to the period beyond the forecast period.
Trustee
A person appointed by the Bankruptcy Court in certain situations based on
the facts of the case, not related to the size of the entity or the amount of
unsecured debt outstanding, at the request of a party in interest after a notice
and hearing.
Undersecured Claim
A secured claim whose collateral is worth less than the amount of the claim.
Sometimes referred to as an undersecured claim liability.

Unsecured Claim
A liability that is not secured by collateral. In the case of an undersecured
creditor, the excess of the secured claim over the value of the collateral is an
unsecured claim, unless the debtor elects in a Chapter 11 proceeding to have
the entire claim considered secured. The term is generally used in bankruptcy
to refer to unsecured claims that do not receive priority under the Bankruptcy
Code. Sometimes referred to as an unsecured claim liability.

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 Accounting changes and error  Impairment of nonfinancial assets

corrections
 Income taxes
 Asset acquisitions
 Internal control over financial
 Bankruptcies reporting

 Business combinations  Inventory

 Business combinations (SEC  Investments

reporting)
 Leases
 Climate risk in the financial
 Leases: Real estate lessors
statements
 Long-duration contracts
 Consolidation
 Reference rate reform
 Credit impairment
 Research and development
 Debt and equity financing
 Revenue recognition
 Derivatives and hedging

 Discontinued operations and held-  Revenue: Real estate

for-sale disposal groups  Revenue: Software and SaaS
 Earnings per share  Segment reporting
 Employee benefits  Service concession arrangements
 Equity method of accounting  Share-based payment
 Fair value measurement  Software and website costs
 Financial statement presentation  Statement of cash flows
 Foreign currency  Tax credits
 GHG emissions reporting  Transfers and servicing of financial
assets
 Going concern

 IFRS® compared to US GAAP

Acknowledgments
This Handbook has been produced by the Department of Professional Practice
(DPP) of KPMG LLP in the United States.

We would like to acknowledge the efforts of the main contributors to this

Handbook:
Nick Burgmeier
Justin Miller
Brian Stewart

We would also like to acknowledge the significant contributions of the following

current and former DPP members: Kimber Bascom, Richard Binderup, Valerie
Boissou, Tim Brown, Meredith Canady, Hershell Cavin, Regina Croucher,
Jeffrey Ford, Patrick Garguilo, Mike Hall, Kayreen Handley, Scott Muir, Mahesh
Narayanasami, Mark Northan, Tim Phelps, Joan Rood, Julie Santoro, Angie
Storm, Landon Westerlund.

Lastly, we would like to thank the following KPMG specialists on bankruptcy

matters who generously contributed their time for reviews of and input into this
Handbook: Tom Bibby, Cynthia Kielkucki, Joseph Yusz.

The FASB Accounting Standards Codification® material is copyrighted by the Financial Accounting Foundation, 801 Main Ave.,
Norwalk, CT 06851.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual
or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is
accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information
without appropriate professional advice after a thorough examination of the particular situation.

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