Bankruptcy reorganization is a process that allows a business that is insolvent, or unable to meet its financial obligations, to stay alive by restructuring its debts and assets. This process is chosen over liquidation, or the sale of the company's assets, if the value of the reorganized company is expected to be greater than the value of its assets sold individually.
In a bankruptcy reorganization, a committee of unsecured creditors is appointed by the court to negotiate with the company's management on the terms of the reorganization. This may include
- reducing interest rates,
- lengthening the term of maturity, or
- exchanging some debts for equity.
The goal of restructuring is to make the company's cash flows more manageable by reducing its financial burden.
The court may also appoint a trustee or an examiner to oversee the reorganization. The trustee is responsible for preparing a list of creditors and stockholders, investigating the company's operations, and reporting any instances of fraud or mismanagement to the bankruptcy judge. The examiner investigates possible fraud or mismanagement by the company's current owners or managers.
The company's management or trustee must also submit a plan of reorganization to the bankruptcy court for confirmation. This plan must be accepted by a majority of the creditors, who must represent at least two thirds of the company's total liabilities, and by stockholders who own at least two thirds of the outstanding capital stock of each class. If the plan is accepted, it becomes binding on the company, its creditors and owners, and any other companies issuing securities or acquiring property under the plan.
Accounting for bankruptcy reorganization involves making adjustments to the carrying amounts of assets, reducing the par or stated value of capital stock, extending due dates and revising interest rates of notes payable, exchanging debt securities for equity securities, and eliminating a retained earnings deficit. The reorganized company is treated as a new enterprise, with assets and liabilities valued at current fair values and shareholders' equity consisting only of paid-in capital.
Disclosure of bankruptcy reorganization in financial statements is important to provide information on the complex issues involved in the process. This may include the nature and status of the reorganization, the effect on financial statements, and the company's ability to continue as a going concern.