Fair Value Nuances in Fresh-Start Accounting

The complexities of bankruptcy-emergence accounting require coordination among management, valuation professionals, external auditors and tax experts.

Richard Law

Richard Law

Organizations filing for protection under Chapter 11 of the U.S. Bankruptcy Code are subject to Accounting Standards Codification (ASC), Reorganizations (ASC 852). Under this guidance, certain companies emerging from bankruptcy are required to adopt “fresh-start” accounting, which calls for measuring the fair value of assets and liabilities for the post-emergence entity. Doing that can be complex and requires a thorough understanding of the business, its assets and liabilities, industry and economic conditions, and the latest best practices in valuation.

While many of the accounting and valuation concepts contained within ASC 852 are similar to those used under the acquisition method for a business combination under ASC 805, Business Combinations, certain aspects of fresh-start accounting may require specific consideration. Such nuances require close coordination among management, independent valuation professionals, external auditors and tax professionals.

When Is Fresh-Start Accounting Applied?

The following criteria must be met for fresh-start accounting to be applied to a company emerging from Chapter 11 bankruptcy (per ASC 852-10-45-19):

• The reorganization value of the assets of the emerging entity immediately before the date of confirmation is less than the total of all post-petition liabilities and allowed claims — i.e., the company is balance-sheet insolvent.

• Holders of voting shares immediately before confirmation receive less than 50 percent of the voting shares of the emerging entity.

If both criteria are met, fresh-start reporting is applied when the bankruptcy court has confirmed a company’s reorganization plan, or as of a later date when all material conditions precedent to the plan becoming binding have been resolved. Companies may adopt fresh-start reporting on a period-end date near the confirmation date to avoid the need to perform financial reporting requirements twice within the same month, as long as the selected date does not have a material effect on the financial statements.

What Standard of Value Is Used for Fresh-Start Accounting?
Fresh-start accounting guidance in ASC 852 references ASC 805. In a business combination, ASC 805 requires the acquirer to record the assets acquired and liabilities assumed at fair value as of the acquisition date. Fair value is defined in ASC 820, Fair Value Measurement, as 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.

Differences between Fresh-Start Accounting and Business Combinations

Reorganization Value: One of the major differences between accounting for a business combination and fresh-start accounting is the starting point for the analysis. A business combination considers the purchase price as negotiated between unrelated third parties, while fresh-start accounting relies on the concept of reorganization value. ASC 852 defines reorganization value as the value of the entity before considering liabilities [that] approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring. In other words, the total value of the assets on the post-emergence opening balance sheet will equal a company’s reorganization value — usually determined as a range of values rather than a single-point estimate. However, the company must conclude on a single-point estimate for fresh-start reporting.

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