Chapter 20 - Corporations in Financial Difficulty

Chapter 20
Corporations in Financial Difficulty

Multiple Choice Questions

1. What is defined as a condition in which a company is unable to meet debts as the debts
mature?
A. Deficit
B. Liability
C. Insolvency
D. Credit squeeze

Answer: C
LO: 20-01
Topic: Nonjudicial Actions
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

2. Under a composition agreement,

A. creditors agree to accept less than the face amount of their claims.
B. debtors in financial difficulty transfer assets “without recourse.”
C. a creditors' committee is initiated with a plan of settlement proposed by the debtor.
D. the debtor petitions for relief in a bankruptcy court.

Answer: A
LO: 20-01
Topic: Nonjudicial Actions
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

3. In which of the following ways can debt be restructured?

I. Assets can be transferred to the creditor.
II. An equity interest can be granted to the creditor.
III. The terms of the debt can be modified.
A. I and II only
B. I and III only
C. II and III only
D. I, II, and III

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Chapter 20 - Corporations in Financial Difficulty

Answer: D
LO: 20-01
Topic: Nonjudicial Actions
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 2 Medium

4. Under which nonjudicial action do creditors agree to assist the debtor in managing the most
efficient payment of creditors' claims?
A. Debt restructuring arrangement
B. Creditors' committee management
C. Transfer of assets
D. Composition agreement

Answer: B
LO: 20-01
Topic: Nonjudicial Actions
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

5. A transfer of assets by a company in financial difficulty is considered a sale if:

I. the transfer includes a recourse provision allowing the buyer to return the asset.
II. the transferee obtains the right to pledge or exchange the transferred assets.
III. the transferred assets have been isolated from the transferor.
IV. the transferor does not maintain effective control over the transferred assets.
A. I, II, and IV
B. Both I and III
C. Both I and II
D. II, III, and IV

Answer: D
LO: 20-01
Topic: Nonjudicial Actions
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 2 Medium

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Chapter 20 - Corporations in Financial Difficulty

6. The Bankruptcy Reform Act contains chapters which deal with:

I. Individuals.
II. Corporations.
III. Municipal governments.
A. Only I and II
B. Only II and III
C. Only I and III
D. I, II, and III

Answer: D
LO: 20-01
Topic: Judicial Actions
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

7. A debtor may file which type of petition when seeking judicial protection under the
Bankruptcy Reform Act?
I. Voluntary
II. Involuntary
A. I only
B. II only
C. Either I or II.
D. Neither I nor II

Answer: A
LO: 20-01
Topic: Judicial Actions
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

8. Creditors may file which type of petition when seeking remedy under the Bankruptcy Code?
I. Voluntary
II. Involuntary
A. I only
B. II only
C. Either I or II
D. Neither I nor II

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Chapter 20 - Corporations in Financial Difficulty

Answer: B
LO: 20-01
Topic: Judicial Actions
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

9. Under the Bankruptcy Code, an insolvent corporation may be:

I. Reorganized.
II. Liquidated.
A. I
B. II
C. Either I or II
D. Neither I nor II

Answer: C
LO: 20-01
Topic: Judicial Actions
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

10. Which chapters of the Bankruptcy Code deal with corporations?

A. Chapters 1, 3, and 5
B. Chapter 9
C. Chapters 7 and 11
D. Chapters 12 and 13

Answer: C
LO: 20-01
Topic: Judicial Actions
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

11. Chapter 11 of the Bankruptcy Code provides for:

I. Reorganization.
II. Liquidation.
A. I only
B. II only
C. Both I and II
D. Neither I nor II

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Chapter 20 - Corporations in Financial Difficulty

Answer: A
LO: 20-02
Topic: Chapter 11 Reorganizations
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

12. Which of the following could be true of the proceedings under Chapter 11 of the Bankruptcy
Code?
A. Always administered by the bankruptcy courts.
B. The debtor's assets are sold and its liabilities extinguished.
C. The company does not operate during this period.
D. The debtor continues as a business after the reorganization.

Answer: D
LO: 20-02
Topic: Chapter 11 Reorganizations
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

13. Under Chapter 11 proceedings, what represents the fair value of the entity before considering
liabilities and approximates the amount a willing buyer would pay for the entity's assets?
A. Reorganization value
B. Fire sale value
C. Fresh start value
D. Excess value

Answer: A
LO: 20-02
Topic: Chapter 11 Reorganizations
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

14. A reorganization value in excess of amounts assignable to identifiable assets is:

A. not reported.
B. reported as an intangible asset called Reorganization Value in Excess of Amounts Allocable to
Identifiable Assets.
C. reported as Goodwill Associated with Exit or Disposal Activities.
D. passed on to prior shareholders of the company.

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Chapter 20 - Corporations in Financial Difficulty

Answer: B
LO: 20-02
Topic: Chapter 11 Reorganizations
Blooms: Understand
AACSB: Reflective Thinking
AICPA: FN Reporting
Difficulty: 2 Medium

15. Which of the following observations regarding the use of fresh start accounting is true?
A. It is always required under Chapter 11 bankruptcy proceedings.
B. Prior shareholders will have control of the emerging company.
C. It results in a new reporting entity.
D. It is used under Chapter 7 bankruptcy proceedings.

Answer: C
LO: 20-02
Topic: Fresh Start Accounting
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

16. A “debtor-in-possession” balance sheet is prepared for a company which:

A. is having its debts restructured.
B. is undergoing a liquidation under Chapter 7.
C. is undergoing a reorganization under Chapter 11.
D. is in bankruptcy reorganization but management still controls the company.

Answer: D
LO: 20-02
Topic: Chapter 11 Reorganizations
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

17. A debtor-in-possession balance sheet should report:

I. Liabilities not subject to compromise.
II. Liabilities subject to compromise.
A. I only
B. II only
C. Both I and II
D. Neither I nor II

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Chapter 20 - Corporations in Financial Difficulty

Answer: C
LO: 20-02
Topic: Chapter 11 Reorganizations
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 2 Medium

18. On a debtor-in-possession income statement, which of the following items should be reported
under the heading “Reorganization Items”?
A. Sales
B. Selling expenses
C. Income tax benefit
D. Loss on disposal of assets

Answer: D
LO: 20-02
Topic: Chapter 11 Reorganizations
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 2 Medium

19. Typically, the plan of reorganization must be approved by at least _____ of all creditors, who
must hold at least _____ of the dollar amount of the outstanding debt.
A. one-third; half
B. two-thirds; half
C. half; one-third
D. half; two-thirds

Answer: D
LO: 20-02
Topic: Plan of Reorganization
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 2 Medium

20. Chapter 7 of the Bankruptcy Code provides for:

I. Reorganization.
II. Liquidation.
A. I only
B. II only
C. Both I and II
D. Neither I nor II

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Chapter 20 - Corporations in Financial Difficulty

Answer: B
LO: 20-03
Topic: Chapter 7 Liquidations
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

21. _____ have liens, or security interests, on specific assets.

A. Secured creditors
B. Creditors with priority
C. Unsecured creditors
D. Assured creditors

Answer: A
LO: 20-03
Topic: Classes of Creditors
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

22. As defined by the Bankruptcy Code, creditors with priority:

I. have collateral claim against specific assets.
II. are unsecured creditors who have priority over other unsecured creditors.
III. are the first to be paid from any proceeds available to unsecured creditors.
A. I only
B. II only
C. I, II and II
D. Both II and III

Answer: D
LO: 20-03
Topic: Classes of Creditors
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 2 Medium

23. Which of the following observations concerning claims by general unsecured creditors is
NOT true?
A. They are paid only after secured creditors and unsecured creditors with priority are satisfied to
the extent of any legal limits.
B. They often receive less than the full amount of their claim.

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Chapter 20 - Corporations in Financial Difficulty

C. They are entitled to “preference payments” at the discretion of the debtor's management.
D. The amounts to be paid to them are usually stated as a percentage of the total claim.

Answer: C
LO: 20-03
Topic: Classes of Creditors
Blooms: Understand
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 2 Medium

24. The payment to general unsecured creditors is often termed:

A. a “preference payment.”
B. a “dividend.”
C. a “write-off.”
D. a “bonus.”

Answer: B
LO: 20-03
Topic: Classes of Creditors
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

25. “Preference payments” made by the debtor to one creditor to the detriment of all other
creditors within 90 days before the bankruptcy petition was filed:
A. is reduced from the monies available to the general unsecured creditors.
B. is usually written off.
C. may be recovered and returned to the cash available for all creditors.
D. are not recovered, as management assurances are binding.

Answer: C
LO: 20-03
Topic: Classes of Creditors
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

26. The accounting statement of affairs is prepared:

A. at the end of the reorganization process.
B. at the end of the liquidation process.
C. at the beginning of the reorganization process.
D. at the beginning of the liquidation process.

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Chapter 20 - Corporations in Financial Difficulty

Answer: D
LO: 20-03
Topic: Statement of Affairs
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

The following data applies to Questions 27 - 29:

Orville Company recently petitioned for bankruptcy and is now in the process of preparing a
statement of affairs. The carrying values and estimated fair values of the assets of Orville
Company are as follows:

Debts of Orville are as follows:

27. Based on the preceding information, what is the total amount of unsecured claims?
A. $113,000
B. $126,000
C. $93,000
D. $121,000

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Chapter 20 - Corporations in Financial Difficulty

Answer: D
LO: 20-03
Topic: Statement of Affairs
Blooms: Apply
AACSB: Analytic
AICPA: FN Measurement
Difficulty: 3 Hard

28. Based on the preceding information, what estimated amount will be available for general
unsecured creditors upon liquidation?
A. $28,000
B. $93,000
C. $113,000
D. $121,000

Answer: B
LO: 20-03
Topic: Statement of Affairs
Blooms: Apply
AACSB: Analytic
AICPA: FN Measurement
Difficulty: 3 Hard

29. Based on the preceding information, what is the estimated dividend percentage?
A. 23 percent
B. 93 percent
C. 77 percent
D. 68 percent

Answer: C
LO: 20-03
Topic: Statement of Affairs
Blooms: Apply
AACSB: Analytic
AICPA: FN Measurement
Difficulty: 3 Hard

The following data applies to Questions 30 – 32:

Wright Company recently petitioned for bankruptcy and is now in the process of preparing a
statement of affairs. The carrying values and estimated fair values of the assets of Wright
Company are as follows:

Carrying Value Fair Value

Cash $10,000 $10,000

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Chapter 20 - Corporations in Financial Difficulty

Accounts Receivable 60,000 20,000

Inventory 70,000 40,000
Land 90,000 75,000
Building (net) 200,000 150,000
Equipment (net) 80,000 25,000
Total $510,000 $320,000

Debts of Wright are as follows:

Accounts Payable $40,000
Wages Payable (all have priority) 6,000
Taxes Payable 12,000
Notes Payable (secured by receivables and inventory) 90,000
Interest on Notes Payable 5,000
Bonds Payable (secured by land and buildings) 200,000
Interest on Bonds Payable 8,000
Total $361,000

30. Based on the preceding information, what is the total amount of unsecured claims?
A. $52,000
B. $71,000
C. $75,000
D. $95,000

Answer: C
LO: 20-03
Topic: Statement of Affairs
Blooms: Apply
AACSB: Analytic
AICPA: FN Measurement
Difficulty: 3 Hard

31. Based on the preceding information, what estimated amount will be available for general
unsecured creditors upon liquidation?
A. $34,000
B. $52,000
C. $56,000
D. $75,000

Answer: A
LO: 20-03
Topic: Statement of Affairs
Blooms: Apply
AACSB: Analytic
AICPA: FN Measurement
Difficulty: 3 Hard

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Chapter 20 - Corporations in Financial Difficulty

32. Based on the preceding information, what is the estimated dividend percentage?
A. 45 percent
B. 55 percent
C. 61 percent
D. 69 percent

Answer: A
LO: 20-03
Topic: Statement of Affairs
Blooms: Apply
AACSB: Analytic
AICPA: FN Measurement
Difficulty: 3 Hard

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Chapter 20 - Corporations in Financial Difficulty

33. Eagle Company recently petitioned for bankruptcy and is now in the process of preparing a
statement of affairs. The following information has been assembled for this statement:

What amount will be paid to the fully secured creditors and the creditors with priority?

Answer: A
LO: 20-03
Topic: Statement of Affairs
Blooms: Apply
AACSB: Analytic
AICPA: FN Measurement
Difficulty: 3 Hard

34. Norton Company recently petitioned for bankruptcy and is now in the process of preparing a
statement of affairs. The following information has been assembled for this statement:

Assets Book Value Estimated Current Value

Cash $50,000 $50,000

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Chapter 20 - Corporations in Financial Difficulty

Other current assets 120,000 110,000

Building 300,000 400,000
Land 150,000 200,000

Liabilities
Liabilities with priority $90,000
Mortgage payable (secured by Building) 150,000
Notes Payable (secured by Land) 250,000
Unsecured liabilities 350,000

What amount will be paid to the fully secured creditors and the creditors with priority?
Fully Secured Creditors Creditors with Priority
A. $150,000 $50,000
B. $150,000 $90,000
C. $350,000 $50,000
D. $400,000 $90,000

Answer: B
LO: 20-03
Topic: Statement of Affairs
Blooms: Apply
AACSB: Analytic
AICPA: FN Measurement
Difficulty: 3 Hard

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Chapter 20 - Corporations in Financial Difficulty

35. What is the general form of the trustee's opening entry, accepting the assets of the debtor
company?

A) Assets XXX

Debtor Company—In Receivership XXX

B) Net Assets XXX

Debtor Company—In Receivership XXX

C) Retained Earnings XXX

Debtor Company—In Receivership XXX

D) Debtor Company—In Receivership XXX

Net Assets XXX

Answer: A
LO: 20-04
Topic: Trustee Accounting and Reporting
Blooms: Understand
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 2 Medium

36. Which monthly report shows the results of the trustee's fiduciary actions beginning at the
point the trustee accepts the debtor's assets?
A. Statement of affairs
B. Statement of realization and liquidation
C. Statement of financial position
D. Statement of activities

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Chapter 20 - Corporations in Financial Difficulty

Answer: B
LO: 20-04
Topic: Trustee Accounting and Reporting
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

37. The Statement of Realization and Liquidation contains sections for all the following items
except:
A. assets.
B. supplementary items.
C. liabilities.
D. stockholders equity.

Answer: D
LO: 20-04
Topic: Trustee Accounting and Reporting
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

38. In a statement of realization and liquidation, unusual revenue items are reported under:
A. assets.
B. extraordinary items.
C. supplementary items.
D. These are never reported.

Answer: C
LO: 20-04
Topic: Trustee Accounting and Reporting
Blooms: Remember
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 1 Easy

39. All of the following items are reported in a statement of realization and liquidation except:
A. Cash
B. Prepaid assets
C. Depreciable assets (net)
D. Receiver's expenses

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Chapter 20 - Corporations in Financial Difficulty

Answer: A
LO: 20-04
Topic: Trustee Accounting and Reporting
Blooms: Understand
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 2 Medium

40. Which of the following items are likely to be reported in the supplementary items section of a
statement of realization and liquidation?
A. Creditors' claims settled during the period.
B. Trustee's administration fees.
C. New obligations incurred by the trustee.
D. Assets subsequently acquired by the trustee.

Answer: B
LO: 20-04
Topic: Trustee Accounting and Reporting
Blooms: Understand
AACSB: Reflective Thinking
AICPA: FN Decision Making
Difficulty: 2 Medium

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Chapter 20 - Corporations in Financial Difficulty

Essay Questions

41. To obtain cash quickly, DebCo. sold $750,000 of its receivables to Finco., with recourse. As
the accountant for DebCo., what issues do you need to resolve in order to determine the
appropriate accounting treatment?

Answer:

Selling receivables “with recourse” means that the debtor must accept the return of any
uncollectible receivables that were transferred. ASC 860 specifies that a transfer of financial
assets is considered a sale only if the transferor has surrendered control over the transferred
assets. Selling the receivables with recourse does not remove ultimate control from the debtor.

LO: 20-01
Topic: Nonjudicial Actions
Blooms: Understand
AACSB: Communication
AICPA: BB Critical Thinking
Difficulty: 2 Medium

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Chapter 20 - Corporations in Financial Difficulty

42. What are the conditions necessary for using fresh start reporting in reorganization?

Answer:

The conditions are:

1. 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.
2. Holders of existing voting shares immediately before confirmation receive less than 50 percent
of the voting shares of the emerging entity. This implies that the prior shareholders have lost
control of the emerging company.

LO: 20-02
Topic: Fresh Start Accounting
Blooms: Understand
AACSB: Communication
AICPA: BB Critical Thinking
Difficulty: 2 Medium

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Chapter 20 - Corporations in Financial Difficulty

43. Wilbur Corporation is to be liquidated under Chapter 7 of the Bankruptcy Code. The balance
sheet on December 31, 20X8, is as follows:

The following additional information is available:

1. Marketable securities consist of 2,000 shares of Bristol Inc. common stock. The market value
per share of the stock is $8. The stock was pledged against a $20,000, 8 percent note payable that
has accrued interest of $800.
2. Accounts receivable of $40,000 are collateral for a $35,000, 10 percent note payable that has
accrued interest of $3,500.
3. Inventory with a book value of $35,000 and a current value of $32,000 is pledged against
accounts payable of $60,000. The appraised value of the remainder of the inventory is $50,000.
4. Only $1,000 will be recovered from prepaid insurance.
5. Land is appraised at $65,000 and plant and equipment at $160,000.
6. It is estimated that the franchises can be sold for $15,000.
7. All the wages payable qualify for priority.
8. The mortgages are on the land and on a building with a book value of $110,000 and an
appraised value of $100,000. The accrued interest on the mortgages is $7,500.
9. Estimated legal and accounting fees for the liquidation are $10,000.

Required
a. Prepare a statement of affairs as of December 31, 20X8.
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Chapter 20 - Corporations in Financial Difficulty

b. Compute the estimated percentage settlement to unsecured creditors.

Problem 43 (continued):
Answer:
Wilbur Corporation
Statement of Affairs
December 31, 20X8

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Chapter 20 - Corporations in Financial Difficulty

Problem 43 (continued):

b)

LO: 20-03
Topic: Statement of Affairs
Blooms: Apply
AACSB: Analytic
AICPA: FN Measurement

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Chapter 20 - Corporations in Financial Difficulty

Difficulty: 3 Hard

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Chapter 20 - Corporations in Financial Difficulty

44. Briefly explain the three classes of creditors specified in the Bankruptcy Code.

Answer:

The Bankruptcy Code specifies three classes of creditors whose claims have the following
priorities: (1) secured creditors, (2) creditors with priority, and (3) unsecured creditors.

Secured creditors have liens, or security interests, on specific assets, often called “collateral.”
A creditor with such a legal interest in a specific asset has the highest priority claim on that asset.
Creditors with priority are unsecured creditors having no collateral claim against specific assets,
who have priority over other unsecured creditors. Creditors with priority are the first to be paid
from any proceeds available to unsecured creditors. General unsecured creditors are paid only
after secured creditors and unsecured creditors with priority are satisfied to the extent of any
legal limits. Often the general unsecured creditors receive less than the full amount of their
claim.

LO: 20-03
Topic: Classes of Creditors
Blooms: Understand
AACSB: Communication
AICPA: BB Critical Thinking
Difficulty: 2 Medium

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Chapter 20 - Corporations in Financial Difficulty

45. A trustee has been appointed for Smith Company, which is being liquidated under Chapter 7
of the Bankruptcy Code. The following transactions occurred after the assets were transferred to
the trustee:

1. Credit sales by the trustee were $100,000. Cost of goods sold were $72,000, consisting of all
the inventory transferred from Smith.
2. The trustee sold all $20,000 worth of marketable securities for $15,000.
3. Receivables collected by the trustee:
Old: $28,000 of the $50,000 transferred
New: $65,000
4. Disbursements by the trustee:
Old current payables: $31,000 of the $65,000 transferred
Trustee's expenses: $6,000
5. Recorded $24,000 depreciation on the plant assets of $120,000 transferred from Smith.

Required:
Prepare a statement of realization and liquidation according to the traditional approach illustrated
in the chapter.

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Chapter 20 - Corporations in Financial Difficulty

Problem 45 (continued):
Answer:

LO: 20-04
Topic: Trustee Accounting and Reporting
Blooms: Apply
AACSB: Analytic
AICPA: FN Measurement
Difficulty: 3 Hard

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