CORPORATION IN FINANCIAL DIFFICULTY:

“REORGANIZATION AND
TROUBLED DEBT
RESTRUCTURING”
 Learning objectives

After studying this chapter you would be able to:

❏ Understand the nature and process of
reorganization and troubled debt restructuring.
❏ Know the accounting process for restructuring and
reorganizing debt for corporation experiencing
financial difficulties.
Introduction
A corporation experiencing financial difficulty has
number of alternatives aside from liquidating company’s
assets or declaring bankruptcy. Reorganization and debt
restructuring are arrangements with the creditors to fix the
company, reorganize and reconstruct to be able to return its
operation to its normal pace.
This chapter will present the procedures in accounting
for reorganization and troubled debt restructuring and
major actions used by corporations experiencing financial
problems.
REORGANIZATIO
N
 What is Reorganization?

Reorganization distinct from liquidation is that control

over the company is normally retained by the ownership
(referred as debtor in possession).
However the Securities and Exchange Commission (SEC)
may appoint a trustee because of fraud, gross
mismanagement by current owners or managers, or to
protect the interest of creditors or stockholders of the
company (Guerrero, 2017).
Plan for Reorganization

• The plan should be submitted by the management to

the company's creditors and stockholders and to the
SEC for approval.

• Must include provisions altering or modifying the

interests, and rightof the creditors and stockholders
of the company, as well as a number of additional
provisions.
• SEC will review the plan, but before the plan will be
confirmed, it must be first accepted by a majority of the
creditors and by stockholders owning at least two-thirds
(2/3) of the outstanding capital stock.
• Incase some of the stockholders and creditors will not
accept the plan, SEC may still confirm the plan for
reorganization if it is fair and equitable to the
nonacceptors.
• Confirmation of the plan by the SEC makes the plan
binding on the debtor, all creditors and stockholders.
 ACCOUNTING FOR REORGANIZATION

• The ownership of the common stock of such

company as a result of reorganization, it is no
longer controlled by its former stockholders.
• Asset and liabilities should be valued at
current fair values and the stock holders
equity consist only of paid in capital.
The accounting for reorganization usually requires the
following that results to a fresh start accounting,

a. Journal entries for adjustments of book values of

assets.
b. Reductions of par value or stated value of capital stock
(with recognition of resultant additional paid in capital
for the excess of par.
c. Extension of due dates and revision of
interest rates of notes payable

d. Exchanges of equity securities for debt

securities

e. Elimination of retained earnings deficit

TROUBLED DEBT
RESTRUCTURIN
G
What is Troubled Debt Restructuring?

Debt restructuring is a situation where

the creditor for economic or legal reasons
related to financial difficulties grants to the
debtor concession that would not otherwise
be granted in a normal business relation
(Valix, 2017).
Common form of troubled debt restructuring
A. Asset or Equity Swap
B. Modification of Terms - It may include:
1. Reduction of the stated interest rate for the
remainder of the original debt.
2. Extension of maturity date at a lower rate.
3. Reduction of the face amount of the
original debt.
4. Reduction in the accrued interest.
 - Debtor recognizes gain
Carrying Value of Debt
for the difference.
is Greater than the
- All cash payments are
Modified Future Cash
reductions in principal (no
Flows
interest).

Modification
of terms
- No gain/loss recognized.
- Compute new effective
Carrying Value of Debt
interest rate
is Less than the
- Record annual interest at
Modified Future Cash
new rate.
Flows
 Illustration 1
Cookie Corporation is financially distressed and is evaluating a
variety of restructuring alternatives.

1. On December 31, 2016, the company has an unsecured

current liability of P30,000 to the Creditor Company, on which
P3,000 interest has been accrued an unpaid.
2. Cookie Corporation has been negotiating with Creditor
Company to restructure the current debt of P33,000 including
accrued interest.
Alternative 1: Payment of Cash in Full Settlement of
Debt - The immediate transfer of P27,000 in full
settlement of the book value of the debt.

Notes Payable P30,000

Accrued Interest 3,000
Total Liability P33,000
Cash Payment 27,000
Gain on restructuring of debt P 6,000
Entry on December 31, 2016 for Cookie Corporation:

Notes Payable P30,000

Accrued Interest Payable 3,000
Cash P27,000 *Gain on
restructuring of debt 6,000

*Gain is reported as part of continuing operation.

Alternative 2: Payment of Non-cash Assets in Settlement of
Debt - Transfer inventory with a book value of 45,000 and fair
value of 26,000 in full settlement of the P33,000 debt.

A. Gain/Loss on disposal of asset

Fair Value of Inventory P26,000

Carrying Amount of Inventory (45,000)
Loss on Disposal P19,000
B. Gain/Loss on Restructuring

Notes Payable P30,000

Accrued Interest 3,000
Total Liability P33,000
Fair Value of Inventory 26,000
Gain on restructuring of debt P 7,000
Carrying Amount Carrying Amount
Fair Value of
of Debt of Asset
Asset

Gain/Loss on Gain/Loss on
restructuring of dispossal of assets
debt
C. Entry on December 31, 2016 for Cookie Corporation:

Notes Payable P 30,000

Accrued Interest Payable 3,000
Loss on disposal of inventory 19,000
Inventory P 45,000
Gain on restructuring of debt 7,000
Alternative 3: Modification of Terms
Case A: Carrying Value of Debt is Greater than the
Modified Future Cash Flows

Terms being modified in the contract:

a. Forgive accrued interest of P3,000.
b. Reduce the interest rate of 10% to 5%.
c. Extend the maturity for 1 additional year.
COMPUTATION
Notes Payable P30,000
Accrued interest 3,000
Carrying Value of Debt P33,000

Future Notes Payable P30,000

Future interest
(30,000×5%×1) 1,500
Total Future Cash Flows (31,500)
Gain on restructuring debt P 1,500
JOURNAL ENTRY

Entry on December 31, 2016 for Cookie Corporation:

Notes Payable - old P 30,000

Accrued Interest Payable 3,000
Notes Payable - new P 31,500
Gain on restructuring of debt 1,500
Case B: Carrying Value of Debt is Less than the Modified
Future Cash Flows

Terms being modified in the contract:

a. Forgive P500 of accrued interest.

b. Reduce interest from 10% to 5%.
c. Extend maturity for additional 1 year.
COMPUTATION
Notes Payable P30,000
Accrued interest 3,000
Carrying Value of Debt P33,000
Future Notes Payable P30,000
Remaining accrued interest
(3,000 - 500) 2,500
Future interest (30,000×5%×1) 1,500
Total Future Cash Flows (34,000)
Gain on restructuring debt P 1,000
JOURNAL ENTRY

Entry on December 31, 2016 for Cookie Corporation:

To record restructuring of debt:

Notes Payable - old P30,000

Accrued Interest Payable 3,000
Notes Payable - new P33,000
To record payment of debt:

Interest expense P1,000

Notes Payable - new 33,000
Cash P34,000
The restructured debt is stated at P33,000 and a
total of P1,000 of interest expense will be recognize
over the term to maturity of the restructured debt.
 ILLUSTRATION 2

On January 1, 2017, an entity showed the following:

Notes Payable - 14%

(due January 1, 2017) 5,000,000
Accrued Interest Payable 1,000,000
An entity is granted by the creditor the following
concession:

a. The accrued interest of P1,000,000 is forgiven.

b. The principal obligation is reduced to P4,000,000.
c. The new interest rate 10% payable every
December 31.
d. The new date of maturity is December 31, 2020.
SOLUTION:
Notes Payable P4,000,000
Future interest Payment
(4,000,000 × 10% × 4 years) 1,600,000
Total Restructured Liability P5,600,000

Carrying amount of old liability P6,000,000

Total restructured liability (5,600,000)
Gain on debt restructuring P 400,000
JOURNAL ENTRY
Note payable - old P5,000,000
Accrued interest payable 1,000,000
Notes Payable - restructured P5,600,000
Gain on debt restructuring 400,000

Gain/loss of debt restructing is simply the difference

between the carrying amount of old liability and
absolute amount of the restructured liability.