Fresh Start accounting: Emergence from bankruptcy can be complex

An airtight approach to accounting for a Chapter 11 reorganization

Chapter 11 continues to be an opportunity to reconstitute your business, extinguish old debts, and endeavor to make new fortunes. However, not all things stay the same. Kirk Blair, partner; Anthony Sasso, managing director; and Michael C. Sullivan, managing director—Deloitte Financial Advisory Services LLP, give their take on Fresh Start reporting as they explain the changes and challenges.

Once again, the US economy is churning under stormy skies: Supply chain issues persist, food and energy costs are spiking, labor costs are increasing, interest rates are rising, and the number of companies filing for bankruptcy is growing. Experts predict that during the next few years, there will be a significant uptick in the number of companies seeking to reorganize under Chapter 11, and they will face many challenges in the development, negotiation, and implementation of a plan of reorganization.

Organizations contemplating a Chapter 11 filing often have a narrow time frame to address financial reporting requirements upon emergence. These accounting requirements are a part of Accounting Standards Codification (ASC) 852 Reorganizations (ASC 852). A company that reorganizes under Chapter 11 bankruptcy protection is afforded an opportunity to reconstitute its business and extinguish pre-petition debt upon emergence. In addition, with Fresh Start reporting—a part of US GAAP reporting since 1990—it must remeasure its tangible and identifiable intangible assets and liabilities to their fair values. In substance, this results in the emerged entity having a “fresh start,” with the ability to become a new company in many ways from both a legal and financial reporting perspective.

Part 1: Jump start the revival journey

Acting fast and seeking support when needed

It is not uncommon for companies operating in foreign jurisdictions to file financial statements, whether US GAAP or non-US GAAP, for local and other statutory reporting purposes. Maintaining historical basis records while also determining and maintaining the new basis of accounting values resulting from the adoption of Fresh Start reporting for US GAAP reporting can create many new challenges.

Little or no time may be available to focus on planning for the successor entity’s financial reporting requirements during the pendency of the bankruptcy proceeding. Yet awareness of the challenges and upfront planning is just what a company in Chapter 11 needs to successfully navigate the many demanding hurdles in a timely manner. Often, executives seek help from experienced professionals to maneuver through the require¬ments and minimize distractions, thus enabling the company to truly start afresh as a better-prepared and more organized new entity.

Fresh Start reporting and ASC 852

ASC 852 provides financial reporting guidance for entities that have filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code and expect to reorganize as going concerns. This guidance covers financial reporting both for the period in bankruptcy and upon emergence from Chapter 11.

Upon emergence, the reporting entity needs to determine whether it must adopt Fresh Start reporting. As defined in ASC 852, a company (whether a parent or subsidiary) must adopt Fresh Start reporting if it meets two conditions:

  1. Immediately prior to confirmation of its plan of reorganization, it should be “balance sheet insolvent”—that is, the reorganization value of its assets is less than the sum of its post-petition liabilities and allowed claims.
  2. Holders of voting shares before the court confirms the bankruptcy plan receive less than 50% of the emerging company’s voting shares.

Managers of organizations in Chapter 11 have some complicated matters to orchestrate over a short time frame. Before dealing with accounting issues, they should develop, negotiate, and confirm a reorganization plan. They also need to be mindful of the fact that there are many key differences between ordinary acquisition accounting and Fresh Start accounting.

Making a fresh start and seven steps to get there

The following are a few steps that management must take when preparing for the emergence from Chapter 11 and applying the requirements of Fresh Start Reporting. We could have included many more, but for this article, we have boiled our approach down to seven key items, which typically need to be addressed concurrently.

Part 2: Explore mechanics of preparing for Fresh Start in detail
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