24 Fischer10e SM Ch21 Final

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CHAPTER 21
UNDERSTANDING THE ISSUES
1. Given a restructuring that is not under bank- er extent possible. Upon completion of the dis-
ruptcy law, the gain on restructuring is meas- tribution of assets, the business entity ceases
ured as the amount by which the book value of to exist.
the debt, including accrued interest, exceeds
3. If a creditor is fully secured, by definition no
the total of all restructured principal and interest
portion of their claim will become unsecured.
payments. If the total payments exceed the
However, if the value of the assets securing
book value, no gain is recognized. Note that the
their claim exceeds the amount of the claim,
present value of the payments received is not
such excess amounts will become available to
considered in the determination of the gain. For
unsecured creditors. The claims of partially se-
a restructuring that is under bankruptcy law, the
cured creditors exceed the value of the assets
gain is measured as the amount by which the
securing their claims. Therefore, the unsecured
book value of the debt, including accrued inter-
amounts are combined with the other existing
est, exceeds the fair value of the restructured
unsecured claims. Once the total of all unse-
consideration received. The value of the con-
cured claims is identified, those unsecured
sideration received is the net present value of
claims will proceed against the remaining as-
the restructured payments.
sets of the company in order of priority.
2. A corporate reorganization is a legal remedy
4. The statement of realization and liquidation
designed to restructure the debt and/or equity
serves several purposes. First, it provides a
of a troubled company so that the company
reporting of the activities of the trustee in liqui-
may continue to operate and ultimately become
dation and helps discharge the fiduciary
financially sound. The ultimate goal of a reor-
responsibility. The statement also documents
ganization is to provide a more attractive alter-
that available assets are being distributed
native than liquidation and allow the company
properly among the various creditors and in the
to continue its business purpose. A corporate
proper order of priority. A review of the state-
liquidation does not hold promise for a recovery
ment may also provide outstanding creditors
but rather is designed to facilitate a termination
with some sense of how much they may
of the business. Assets of the company are
receive in satisfaction of their claims.
converted into a distributable form and con-
veyed to creditors and shareholders to whatev-
819
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Ch. 21Exercises
EXERCISES
Note: Some calculations may vary due to rounding or method of calculation. Answers presented have
been determined using Excel.
EXERCISE 21-1
(1) Effect on Net Income

Alternative 1 Alternative 2
Gain on restructuring ...................................................................... $30,000a $ 0b
Interest expense ............................................................................. 0 (55,000)c
d
$30,000 $(55,000)
a
$620,000 ($350,000 + $120,000 + $120,000)
b
There is no gain because the sum of the payments (5 $135,000) exceeds the book value of the
debt ($620,000).
c
(5 $135,000) $620,000
d
If the gain on the disposition of the land were included, this alternative would have an even larger
effect on income. However, the land gain could also be realized under Alternative 2 if manage-
ment elected to dispose of the property.
(2) The economic cost of the two alternatives can best be assessed by comparing the net present
values associated with the consideration involved.
Net Present Values
Consideration Alternative 1 Alternative 2
Land................................................................................................ $350,000 $ 0
Payments........................................................................................ 208,264* 486,645**
$558,264 $486,645
*Net present value where: payment = $120,000, n = 2, i = 10%.
**Net present value where: payment = $135,000, n = 5, i = 12%.
Although Alternative 1 has the most positive effect on net income, the present value of the consid-
eration conveyed exceeds that of Alternative 2. This exercise illustrates that the most favorable ac-
counting alternative may not be the most favorable economic alternative. Which alternative best
enhances shareholder value?
820
Ch. 21Exercises
EXERCISE 21-2
Effect on Net Income

Item Increase (Decrease)
Exchange of preferred stock for debt ($5,100,000 of preferred stock, at
market value in exchange for $5,500,000 of debt) ....................................... $ 400,000
Exchange of land for debt ($3,000,000 of land at book value in exchange for
$4,500,000 of debt) ...................................................................................... 1,500,000
Restructuring of remaining debt of $10,875,000 with semiannual
payments of $818,016. The sum of the payments is $16,360,320
(20 $818,016). Since the sum of the payments exceeds the unpaid
balance, no gain is recognized on the restructuring. ................................... 0
Total effect on net income ................................................................................. $ 1,900,000
Retained earnings before restructuring.............................................................. (3,400,000)
Adjusted retained earnings ................................................................................ $(1,500,000)
In order to eliminate the deficit in retained earnings, the contributed capital in excess of par value would
be reduced to zero, and the par value of the common stock would have to be reduced by $500,000.
EXERCISE 21-3
(1) The impact on the ratios is directly related to how each of the actions taken by management im-
pacts the financial statements. The recognition of impairment losses will decrease long-lived as-
sets and decrease net income and corresponding shareholders equity. Future periods will base
depreciation/amortization on the long-lived assets on the lower impaired value, which will increase
future income. The restructuring of the long-term debt will result in a restructuring gain. However,
since the future cash payments are less than the carrying basis of the original debt, no interest ex-
pense will be recognized in future periods. The adjustment of the par value of common stock in or-
der to eliminate the deficit in retained earnings will have no impact on net income nor will it change
the total amount of shareholders equity. Given the above, it would appear that the current ratio
would be affected by the current portion of the restructured debt. Given the fact that the payments
are less than the carrying basis of the original debt, the current portion could very easily be less
and, therefore, the current ratio could increase. It is clear that the debt restructuring would leave
the company with less debt, which, absent any other information, would result in a decrease in the
debt-to-equity ratio. However, the net effect on income of the impairment loss and the gain on
restructuring will obviously have an impact on equity. Therefore, the debt-to-equity ratio must also
reflect any changes due to these transactions. The return on equity would be affected by the net
effect on income of the impairment loss and the restructuring gain. This net effect would obviously
impact net income and the balance in retained earnings. The adjustment of par would have no
effect on the return on equity because the total equity is not changed as a result of eliminating the
deficit.
(2) Net income in future periods would be affected by lower depreciation/amortization expense and no
interest expense on the new restructured debt.
821
Ch. 21Exercises
EXERCISE 21-4
Outstanding Debt
A B C D
Total amount due .............................. $ 84,000 $ 520,000 $328,000 $350,000
Less amounts applied against debt:
Value of assets transferred ......... (80,000) (120,000) (48,339)
Value of stock transferred ........... (380,000)
Remaining debt ................................. $ 4,000 $ 20,000 $328,000
$301,661
Total of periodic payments to be
applied against remaining debt ...... $ $ $300,000 $320,000
Regarding Debt A: A gain on restructuring of $4,000 would be recognized because no other considera-
tion is being conveyed to satisfy the remaining debt. There would be no interest expense.
Regarding Debt B: A gain on restructuring of $20,000 would be recognized because no other consider-
ation is being conveyed to satisfy the remaining debt. There would be no interest expense.
Regarding Debt C: Because the total of the periodic payments is less than the remaining debt, there
would be a gain of restructuring in the amount of $28,000. Furthermore, because the periodic pay-
ments are less than the remaining debt, no interest expense would be recognized. All periodic pay-
ments are considered to be a reduction of the revised principal amount due of $300,000.
Regarding Debt D: Because the total of the periodic payments exceeds the remaining debt, there is no
gain on restructuring. The periodic payments totaling $320,000 therefore represent a payment of the
remaining principal amount due of $301,661 and total interest in the amount of $18,339. The interest
rate is that rate which discounts the five semiannual payments so that their present value is $301,661.
This semiannual rate is 2%, and the interest for the first six months is $6,033 (2% $301,661).
822
Ch. 21Exercises
EXERCISE 21-5
(1) Debt Restructuring

Nonbankruptcy Bankruptcy
Approach Approach
Carrying basis of debt:
Principal ..................................................................................... $2,100,000
$2,100,000
Accrued interest ......................................................................... 72,737 72,737
$2,172,737
$2,172,737
Basis of consideration exchanged for debt (see Note A):
Sum of future payments ............................................................. $2,400,000
n/a
Present value of future payments .............................................. n/a $1,758,004
Total ........................................................................................... $2,400,000
$1,758,004
Gain on forgiveness of debt ............................................................. $ 200,000 $ 200,000
Gain on debt restructuring (see Note B) .......................................... 0 214,733
Total ........................................................................................... $ 200,000 $ 414,733
Future interest expense (see Note C) .............................................. $ 427,263 $ 641,996
Note A: The carrying value of the debt that is not forgiven is $1,972,737 ($2,100,000 $200,000 +
$72,737). If this debt is to be serviced over 60 months at an interest rate of 8%, the monthly pay-
ments are $40,000. The total of these payments is $2,400,000 ($40,000 60 months). The net
present value of these payments using a market rate of interest of 13% is $1,758,004.
Note B: Under the nonbankruptcy approach, a gain on restructuring results only if the sum of the
future payments is less than the carrying basis of the restructured debt. Under the bankruptcy ap-
proach, a gain is recognized to the extent that the fair value of the consideration received
($1,758,004) is less than the carrying basis of the restructured debt ($1,972,737).
Note C: Under the nonbankruptcy approach, the total interest expense is represented by the differ-
ence between the sum of the future payments ($2,400,000) and the carrying basis of the restruc-
tured debt ($1,972,737). In a bankruptcy approach, the total interest expense is represented by the
difference between the sum of the payments ($2,400,000) and the present value of the future pay-
ments using a market rate of interest ($1,758,004).
Nonbankruptcy Bankruptcy
(2) Approach Approach
Retained earnings deficit ................................................................. $ 500,000 $ 500,000
Gain on forgiveness and restructuring of debt ................................. (200,000) (414,733)*
Revised deficit.................................................................................. $ 300,000 $ 85,267
Present paid-in capital in excess of par value .................................. (80,000) (80,000)
Necessary reduction in par value of common stock ........................ $ 220,000 $ 5,267
*If the gain had been recorded directly as an increase in paid-in capital rather than as a component
of net income, the answer would remain the same.
823
Ch. 21Exercises
824
Ch. 21Exercises
EXERCISE 21-6
(1) Quarterly
Item Cash Outflows
Loan A restructuring:
$3,580,000 restructured at 10%, 8 years, and monthly
installments. The monthly payment is $50,000..................................... $150,000
Loan B restructuring:
No effect on cash outflows ................................................................... 0
Loan C restructuring:
Debt to be paid in installments is $1,787,500 ($2,000,000 +
$37,500 $250,000). Given n = 20 and i = 2.25%,
the payment is $111,973 ...................................................................... 111,973
Total quarterly cash outflows.. ..................................................................... $261,973
(2) Effect on Net Income If

Part of a Not Part of a
Item Formal Filing Formal Filing
Loan A restructuring:
Gain on forgiveness of debt .................................................... ... $500,000 $500,000
Gain on restructuring of remaining debt:
Total payments = $4,800,000 (96 $50,000). Net present
value of payments is $3,295,074 vs. carrying basis of
$3,580,000 ........................................................................... 284,926
Interest expense:
Based on stated rate of 10% .................................................... .. (81,812)
Based on imputed rate of 7.6644% (see note)......................... .. (68,075)
Loan B restructuring:
Gain on forgiveness of accrued interest..................................... 25,000 25,000
Gain on exchange of preferred stock ......................................... 100,000 100,000
Loan C restructuring:
Gain on transfer of land.............................................................. 50,000 50,000
Interest based on 9% ............................................................... .. (40,219) (40,219)
Total effect on net income for the first quarter ................................. $837,895 $566,706
Note: This is the interest rate given a periodic payment of $50,000, the 96 monthly periods, and a
present value of $3,580,000.
825
Ch. 21Exercises
EXERCISE 21-7
Liabilities
Unsecured
Fully Partially With Without
Secured Secured Priority Priority Total
Accounts payable .................................................... $130,000 $150,000 $ 280,000
Note payableA...................................................... $560,000 40,000 600,000
Note payableB...................................................... 300,000 200,000 500,000
Mortgage payable .................................................... 180,000 180,000
Accrued interest ....................................................... 12,000 12,000
Other liabilities ......................................................... $10,000 14,000 24,000
$322,000 $860,000 $10,000 $404,000 $1,596,000
Realizable
Value
Assets to be applied against
the liabilities:
Inventory ..................................... $ 150,000 $130,000 $ 20,000 $ 150,
Inventory ..................................... 200,000 $200,000 200,000
Receivables ................................ 360,000 360,000 360,000
Equipment .................................. 300,000 300,000 300,000
Equipment .................................. 60,000 60,000 60,000
Land............................................ 260,000 192,000 68,000 260,000
Cash ........................................... 60,000 $10,000 50,000 60,000
Other assets ............................... 45,000 45,000 45,0
$1,435,000 $322,000 $860,000 $10,000 $243
Dividend...................................... 100.0% 100.0% 100.0% 60.15%
Total consideration to be received by Note B:

Received toward partially secured portion ............................. $300,000
Received toward unsecured portion:
Unsecured portion............................................................ $200,000
Dividend ........................................................................... 60.15% 120,300
Total consideration received .................................................. $420,300
826
Ch. 21Exercises
EXERCISE 21-8
(1) Nonbankruptcy Approach Bankruptcy Approach

Alternative A Alternative B Alternative A Alternative B
Income Statement
Gain on sale of land:
Market value of land ............ $550,000 $550,000 $550,000 $550,000
Basis of land ........................ 400,000 400,000 400,000 400,000
Gain on sale of land ............. $150,000 $150,000 $150,000 $150,000
Land transaction costs ......... (35,000) (35,000) (35,000) (35,000)
Net gain on sale of land ....... $115,000 $115,000 $115,000 $115,000
Gain on restructuring
(see Schedule A) ............. 85,000 0 355,393 361,027
Income statement effect ............ $200,000 $115,000 $470,393 $476,027
Balance Sheet
Before restructuring:
Land ..................................... $ 400,000 $ 400,000 $ 400,000 $
400,000
Note payable ....................... 2,000,000 2,000,000 2,000,000
2,000,000
Retained earnings ............... 0 0 0 0
After restructuring:
Land ..................................... $ 0 $ 0 $ 0 $ 0
Note payable ....................... 1,400,000 1,700,000 1,129,607
1,338,973
Retained earnings ............... 200,000 115,000 470,393 476,027
Schedule A
Nonbankruptcy Approach Bankruptcy Approach
Alternative A Alternative B Alternative A Alternative B
Original basis of debt ................. $2,000,000 $2,000,000 $2,000,000
$2,000,000
Less net land proceeds ............. 515,000 300,000 515,000
300,000
Remaining balance .................... $1,485,000 $1,700,000 $1,485,000
$1,700,000
Remaining payments:
Absolute value ..................... 1,400,000 1,800,000
Net present value
discounted at 6% ............. 1,129,607
1,338,973
Gain on restructuring ................. $ 85,000 $ 0 $ 355,393 $
361,027
(2) Given a nonbankruptcy approach, Alternative B would be preferable since it involves giving up the
least net present value in satisfaction of the original debt. Furthermore, Alternative B retains some
of the cash that was realized from the sale of the land. It is possible that this cash can be put to a
more productive use rather than being invested in a nonoperating asset such as idle land. If inter-
827
Ch. 21Exercises
est rates were to rise over time, it might be advantageous to lock into an interest rate for a longer
period of time. Alternative B has a lower net present value of consideration given up in satisfaction
of the debt than does Alternative A as set forth below.
Alternative A Alternative B
Net present values:
Cash from sale of land ......... $ 515,000 $ 300,000
Remaining payments ........... 1,129,607 1,338,973
Total ..................................... $1,644,607 $1,638,973
828
Ch. 21Exercises
EXERCISE 21-9
Gyro Industries
Statement of Affairs
July 1, 20X5
Estimated
Estimated Amount Estimated
Net Available for Gain (or
Book Realizable Unsecured Loss) on
Value Assets Value Creditors Liquidation
Assets pledged with fully secured creditors:
$284,000 Property and equipment ............................ $ 330,000 $ 30,000 $ 46,000
Total .......................................................... $330,000
Assets pledged with partially secured creditors:
50,000 ................................................... Inventory $ 42,000
(8,000)
64,000 .................................. Accounts receivable 57,600
(6,400)
Total .......................................................... $ 99,600
Free assets:
2,000 .......................................................... Cash $ 2,000 $
2,000
94,000 .................................. Accounts receivable 68,800 68,800
(25,200)
24,000 ................................................... Inventory 18,600 18,600
(5,400)
16,000 .................................. Other current assets 12,000 12,000
(4,000)
136,000 ............................ Property and equipment 110,000 110,000
(26,000)
12,000 .............................................. Other assets
(12,000)
Total .......................................................... $211,400
Estimated amount available for unsecured
creditors with and without priority ................. $241,400
Less unsecured creditors with priority ............. (67,000)
Estimated amounts for unsecured creditors
without priority:
Net realizable amount available ................ $ 174,400
Deficiency .................................................. 30,000
$ 682,000 Grand totals ............................................... $641,000 $204,400 $(41,000)
829
Ch. 21Exercises
Exercise 21-9, Concluded
Estimated Estimated Unsecured

Book Secured With Without
Value Liabilities and Shareholders Equity Amount Priority Priority
Fully secured creditors:
$290,000 Mortgage payable ...................................... $290,000
10,000 ......................... Mortgage interest payable 10,000
Total .......................................................... $300,000
Partially secured creditors:
50,000 ...................................... Accounts payable $ 42,000
$ 8,000
64,000 ................... Accounts receivable assigned 57,600
6,400
Total .......................................................... $ 99,600 $ 14,400
Unsecured creditors with priority:
20,000 ........................................... Unpaid wages $20,000
14,000 .................................... Customer deposits 14,000
18,000 .......................................Real estate taxes 18,000
8,000 ........................ Unpaid state income taxes 8,000
7,000 ........... Estimated administrative expenses 7,000
Unsecured creditors without priority:
110,000 ...................................... Accounts payable
110,000
50,000 ............................... Other noncurrent debt
50,000
30,000 ...............................Other current liabilities
30,000
$671,000 Totals ......................................................... $399,600 $67,000
$204,400
11,000 Shareholders equity
$ 682,000 Total liabilities and shareholders equity
With Without
Priority Priority
Dividend to unsecured creditors:
Net proceeds available to creditors ................................. $67,000 $174,400
Total claims of creditors .................................................. 67,000 204,400
Dividend .......................................................................... 100.0% 85.3%
830
Ch. 21Exercises
EXERCISE 21-10
(1) The Rodak Corporation

Statement of Realization and Liquidation
For Period July 1, 20X9, to August 12, 20X9
Liabilities
Unsecured
Assets Fully Partially With Without Owners
Cash Noncash Secured Secured Priority Priority Equity
Beginning balances, assigned
July 1, 20X9 ............................ $ 12,000 $590,000 $200,000 $175,000 $54,000 $150,000 $
23,000
Cash receipts:
Sale of inventory ..................... 30,000 (25,000)
5,000
Collection on receivables ....... 39,000 (54,000)
(15,000)
Sale of securities .................... 22,500 (18,000)
4,500
Sale of machinery ................... 36,000 (45,000)
(9,000)
Cash disbursements:
Payment of loan...................... (12,000) (12,000)
Payment of accounts payable (25,000) (25,000)
Payment of bank loan ............. (36,000) (50,000) 14,000
Subsequently discovered:
Liabilities ................................. 15,000
(15,000)
Ending balance .......................... $ 66,500 $448,000 $163,000 $125,000 $54,000 $179,000 $
(6,500)
(2) Estimated assets available:

Cash ..................................................................................................... $ 66,500
Estimated value of noncash assets ...................................................... 410,000
$476,500
Value of all liabilities excluding unsecured creditors

without priority ...................................................................................... 342,000
Assets available for unsecured creditors without priority............................ $134,500
Estimated dividend to unsecured creditors without priority:

$134,500 $179,000 = 75%
831
Ch. 21Problems
PROBLEMS
Note: Some calculations may vary due to rounding or method of calculation. Answers presented have been
determined using Excel.
PROBLEM 21-1
Atoyo Fabricating, Inc.

Evaluation of Proposed Plan of Reorganization
Consideration Suggested
to Be Received if a Monthly See
Liability Type of Claim Book Value Liquidation Reorganization Payment Note
Accounts payable ............. Fully secured $ 40,000 $ 40,000 $ 40,000
............................ $13,601 A
Accounts payable ............. Partially secured 74,000 66,815 58,820 20,000 B
Accounts payable ............. Unsecured 20,000 14,868 14,560 3,000 C
Equipment note ................ Partially secured 338,000 334,664 338,000 9,732 D
Shareholder note .............. Partially secured 20,000 18,717 22,460 6,482 E
Mortgage payable ............ Fully secured 448,000 448,000 448,000 4,266 F
Other creditors ................. Unsecured 160,000 118,944 130,838
.............................. 17,099 G
$1,100,000 $1,042,008* $1,052,678 $74,180
*Difference due to rounding errors.
Note A: The payment is based on a present value of $40,000, a period of three months, and an interest
rate of 1% per month.
Note B: The present value of the three payments of $20,000 at a monthly interest rate of 1% is $58,820.
The amount to be received if a liquidation is the $46,000 plus the remaining unsecured amount of $28,000
times 74.34%.
Note C: The present value of the five payments of $3,000 at a monthly interest rate of 1% is $14,560. The
amount to be received upon liquidation is $20,000 times 74.34%.
Note D: The payment that would be the lowest is one based on a present value of $338,000, a term of 42
months, and an interest rate of 11%. The payment would be $9,732. The amount to be received upon liqui-
dation is $325,000 plus 74.34% of the unsecured portion of $13,000.
Note E: In addition to the $15,000 secured amount, the shareholder would have received 74.34% of the
remaining $5,000, or $3,717, for a total of $18,717. The payments to equal 120% of this amount ($22,460),
given a term of four semiannual periods and an interest rate of 12%, would be $6,482.
Note F: The payment is based on a present value of $448,000, a period of 360 months, and an interest rate
of 11%.
Note G: The unsecured creditors would have received 74.34% as a dividend, or $118,944. 110% of this
amount would be equal to $130,838. The payments necessary to equal this present value, given eight
monthly periods and an interest rate of 12%, is $17,099.
832
Ch. 21Problems
Problem 21-1, Concluded
Analysis of Creditor Claims if the Company Had Been Liquidated

Assets at Net Liabilities
Realizable Fully Partially
Value Secured Secured Unsecured
Original balance ................................ $1,042,000 $ 488,000 $432,000
$180,000
Distribution of assets:
To fully secured ........................... (488,000) (488,000)
To partially secured ..................... (386,000) (386,000)*
Reclassify partially secured .............. (46,000)
46,000
Balance ............................................. $ 168,000 $ 0 $ 0 $226,000
The dividend to unsecured creditors would be 74.34% ($168,000 $226,000).
*$46,000 + $325,000 + $15,000 from insurance policy.
The goals set by management have been met. The restructuring will result in monthly payments of $74,180
which is less than the target of $75,000 and the net present value of the restructuring is greater than the
amount that would be received under a liquidation.
PROBLEM 21-2
Mayne Manufacturing Company

Cash Budget
For Years Ended March 31,
20X6 20X7
Balance of cash at beginning .................. $ 0 $ 75,000
Cash generated from operations:
Collections from customers
(see Schedule A) ......................... $825,000 $1,065,000
Disbursements:
Direct materials (see Schedule B)..... $220,000 $ 245,000
Direct labor ........................................ 300,000 360,000
Variable overhead ............................. 100,000 120,000
Fixed costs ........................................ 130,000 130,000
Total disbursements................................ $750,000 $ 855,000
Excess of cash collections over cash
disbursements from operations ......... 75,000 210,000
Cash available from operations .............. $ 75,000 $ 285,000
Cash received from liquidation of existing
accounts receivable and inventories . 90,000 0
Total cash available ................................ $165,000 $ 285,000
Payments to general creditors ................ (90,000)a (270,000)c
Balance of cash at year-end ................... $ 75,000b $ 15,000
a
Proceeds from liquidation of accounts receivable and inventory.
833
Ch. 21Problems
b
This amount could have been used to pay general creditors or carried forward to the beginning of the next
year.
c
($600,000 60%) ($50,000 + $40,000)
834
Ch. 21Problems
Schedule A
Collections from Customers
20X6 20X7
Sales .................................................................................... $900,000 $1,080,000
Beginning accounts receivable ............................................ 0 75,000
Total ............................................................................... $900,000 $1,155,000
Less ending accounts receivable ......................................... (75,000)d (90,000)e
Collections from customers.................................................. $825,000 $1,065,000
d
$900,000/12 months
e
$1,080,000/12 months
Schedule B
Disbursements for Direct Materials
20X6 20X7
Direct materials required for production ............................... $200,000 $240,000
Required ending inventoryf .................................................. 40,000g 50,000h
Total ..................................................................................... $240,000 $290,000
Less beginning inventory ..................................................... 0 (40,000)
Purchases ............................................................................ $240,000 $250,000
Beginning accounts payable ................................................ 0 20,000
Total ..................................................................................... $240,000 $270,000
Less ending accounts payablei ............................................ (20,000) (25,000)
Disbursements for direct materials ...................................... $220,000 $245,000
f
Amount needed for next two months.
g
12,000 units 2/12 = 2,000; 2,000 $20 per unit = $40,000
h
15,000 units 2/12 = 2,500; 2,500 $20 per unit = $50,000
i
Amount to be paid in one month.
835
Ch. 21Problems
PROBLEM 21-3
(1) Original Adjusted

December 31, 20X7 December 31, 20X7
Dr. (Cr.) Debit Credit Dr. (Cr.)
Cash ...................................... $ (15,000) $
(15,000)
Accounts receivable (net)...... 500,000 (a) $ 75,000
425,000
Inventory ............................... 150,000 (a) 20,000
130,000
Plant and equipment (net) ..... 1,560,000 (b) 660,000
900,000
Goodwill ................................ 150,000 (b) 150,000
0
Other assets:
Current portion ................ 6,209 (c) $1,616
7,825
Noncurrent portion .......... 28,791 (c) 1,616
27,175
Accounts payable .................. (320,000)
(320,000)
7% Note payable:
Current portion ................ 0 (d) 240,000 (240,000)
Noncurrent portion .......... (1,500,000) (d)300,000
(1,200,000)
Common stock at par ............ (550,000) (e)475,000
(75,000)
Contributed capital in excess
of par ............................... (550,000) (e)1,025,000 (e) 475,000
0
Retained earnings ................. 300,000 (e) 300,000
0
20X7 Net income................... 240,000
360,000
Impairment loss ..................... (a) 95,000
Impairment loss ..................... (b) 810,000
(d) 60,000
(e) 725,000
Total ................................ $ 0 $2,706,616 $2,706,616$ 0
(a) To recognize impairment in the value of receivables and inventory.
(b) To recognize impairment in the value of equipment and goodwill.
(c) To reclassify note between current and noncurrent given the new payment of $10,450 ($35,000 is
the present value of four payments at 7.5% interest).
(d) To recognize restructuring gain. 12 payments of $120,000 = $1,440,000. Therefore, the restructur-
ing gain is $60,000, and all payments are considered to be principal only. Because the total of all
payments is less than the book value of the note, all payments are considered to be principal.
(e) To record quasi-reorganization by adjusting par value of common stock and eliminating contributed
capital in excess of par.
836
Ch. 21Problems
(2) Calculation of ratios: Before Actions After Actions
Current ratio ............................................ 2.00 0.98
Debt-to-equity.......................................... 3.25 NA*
*The debt-to-equity ratio is not meaningful in that there is negative equity. The adjusted assets total
$1,475,000 and the adjusted debt totals $1,760,000. All assets are being financed by debt capital.
837
Ch. 21Problems
(3) The above ratios have not improved as a result of managements actions. However, several benefits
may not be apparent from the ratio analysis. First, management has a balance sheet that more clearly
reflects market values. Second, the recognition of impairment losses on equipment will translate into
lower depreciation expense in future years. It is also possible that impairment losses on current assets
will result in lower near-term expense levels associated with bad debt expense and cost of sales. These
adjustments to expense levels will result in an improved measure of income. Third, the restructuring of
the 7% note payable results in the company paying out a lower net present value on the debt than
would have been the case had the debt not been restructured. Finally, the elimination of the deficit will
make it easier for the company to be in a position to return a dividend to its shareholders.
PROBLEM 21-4
Carlton Company
Statement of Affairs
April 30, 20X5
Estimated
Estimated Amount Estimated
Net Available for Gain (or
Book Realizable Unsecured Loss) on
Value Assets Value Creditors Liquidation
Assets pledged with partially secured creditors:
$ 82,500 .............................. Land and building (net) $ 75,000 $
(7,500)
10,000 ........................................ Notes receivable 0
(10,000)
40,000 ..........................................Equipment (net) 12,000
(28,000)
25,000 .................................. U.S. Treasury bonds 23,200
(1,800)
Free assets:
20,000 ............................ Subscriptions receivable 20,000 $ 20,000
3,750 ............................... Groves common stock 3,300 3,300
(450)
11,250 ........................................................... Cash 11,250 11,250
14,000 ................................... Accounts receivable 3,000 3,000
(11,000)
57,250 ........................ Inventory (see Schedule A) 52,175 52,175
(5,075)
Estimated amount available for unsecured
creditors with and without priority .............. $ 89,725
Less unsecured creditors with priority ............. (7,300)
Estimated amounts for unsecured creditors
without priority:
Net realizable amount available ................ $ 82,425
Deficiency (to agree to total unsecured
amount without priority) .......................... 52,375
$ 263,750* Total........................................................... $199,925 $134,800 $(63,825)
838
Ch. 21Problems
*The total represents the original $250,250 plus the notes receivable of $10,000 plus the additional labor
costs on work in process of $3,500.
839
Ch. 21Problems
Estimated
Estimated Unsecured Amount
Book Secured With Without
Value Liabilities and Owners Equity Amount Priority Priority
$ 87,500 .............First & second mortgages payable $ 75,000 $
12,500
10,000 ...................... Notes receivable discounted 0
10,000
62,500 ............................. Note payableWilliams 12,000
50,500
25,000 .............................. Note payableAerotex 23,200
1,800
Unsecured creditors with priority:
6,150 ...................................... Salaries payable** $6,150
1,150 .............................. Property taxes payable 1,150
Unsecured creditors without priority:
60,000 ....................................... Accounts payable
60,000
$252,300*** Totals ......................................................... $110,200 $7,300 $134,800
11,450 Owners equity
$ 263,750 Total liabilities and owners equity
**$2,650 + $3,500
***The total represents the original $238,800 plus the notes receivable discounted of $10,000 plus the un-
paid labor costs on work in process of $3,500.
Schedule A
Realization of Inventory
March 31 Additional Revised Net

Book Costs Book Realizable
Value (Transfers) Value Value
Raw materials ................................... $15,000 $(3,000) $12,000 $ 2,400
Work in process ................................ 11,250 3,000
3,500 17,750 19,525
Finished goods.................................. 27,500 27,500 30,250
$53,750 $ 3,500 $57,250 $ 52,175
This amount represents additional labor costs that are unsecured with priority.
840
Ch. 21Problems
PROBLEM 21-5
(a) Note PayableOfficer ..................................................................... 230,000

Patents (net) ............................................................................. 210,000
Gain on Patents ........................................................................ 20,000
To record transfer of patents against note.
(b) Mortgage Payable ............................................................................ 100,000

Cash ......................................................................................... 100,000
To record payment on mortgage payable.
(c) Bank A Note Payable ($980,000 + $95,000) ................................... 1,075,000

Development Land.................................................................... 700,000
Marketable Securities (other current assets) ............................ 80,000
Gain on Land ............................................................................ 280,000
Gain on Marketable Securities.................................................. 15,000
To record transfer of land and securities against note.
(d) Bank B Note Payable ....................................................................... 220,000

Loss on Equipment ................................................................... 20,000
Equipment (net) ........................................................................ 240,000
To record transfer of equipment against note.
Bank B Note Payable ....................................................................... 50,000
Gain on Restructuring ............................................................... 50,000
To record gain on restructuring. The 10 payments of $55,000

are less than the remaining balance on the note of $600,000
($820,000 $220,000).
(e) Note PayableOfficer ..................................................................... 33,327

Mortgage Payable ............................................................................ 23,178
Bank A Note Payable ....................................................................... 95,770
Bank B Note Payable ....................................................................... 55,000
Interest Expense .............................................................................. 45,075
Cash ......................................................................................... 252,350
To record June 30, 20X6, payments on notes (see Note A).
(f) Common Stock ($10 par value) ....................................................... 200,000

Common Stock ($5 par value) .................................................. 100,000
Paid-In Capital from Reduction in Par Value ............................ 100,000
To record reduction in par value.
Paid-In Capital from Reduction in Par Value.................................... 100,000
Paid-In Capital in Excess of Par....................................................... 100,000
Retained Earnings .................................................................... 200,000
To eliminate deficit in retained earnings.
841
Ch. 21Problems
Note A:
Implicit
Number Quarterly
Original Reduction Unpaid Quarterly of Interest
Balance in Balance Balance Payment Payments Rate
Note payableofficer....... $ 400,000 $ 230,000 $ 170,000$ 35,026.77 5
............................... 1.00%
Mortgage payable ............ 1,500,000 100,000 1,400,00051,178.05 40 2.00%
Bank A note payable ........ 2,100,000 1,075,000 1,025,000 111,145.03 10 1.50%
Bank B note payable ........ 820,000 270,000 550,000 55,000.00 10 0.00%
Quarterly
Unpaid Interest
Balance Rate Payment Interest Principal
Note payableofficer....... $ 170,000 1.00% $ 35,026.77 $ 1,700 $ 33,327
Mortgage payable ............ 1,400,000 2.00% 51,178.05 28,000 23,178
Bank A note payable ........ 1,025,000 1.50% 111,145.03 15,375 95,770
Bank B note payable ........ 550,000 0.00% 55,000.00 55,000
$252,349.85 $45,075 $207,275
842
Ch. 21Problems
PROBLEM 21-6
St. John Corporation

Statement of Realization and Liquidation
For the Period January 1, 20X6, to June 30, 20X6
Liabilities
Unsecured
Assets Fully Partially With Without Shareholders
Cash Noncash Secured Secured Priority Priority Equity
Beginning balances, assigned
January 1, 20X6 ...................... $ 42,000 $5,910,000 $100,000
Accounts payable.................... $ 400,000 $ 320,000 $ 92,000
Note payableofficer ............. 400,000
Bank A note payable ............... 2,100,000
Bank B note payable ............... 820,000
Mortgage payable ................... 1,500,000
Other liabilities ........................ 90,000 $ 35,000
95,000 .....................................
Beginning balances................. $42,000 $5,910,000 $2,810,000 $2,820,000 $
35,000 ......................... $187,000 $100,000
Subsequently discovered items:
Additional assets ..................... 15,000
Administrative expenses ......... 20,000 (20,000)
Cash receipts:
Sale of inventory ..................... 480,000 (430,000) 50,000
Sale of equipment ................... 700,000 (800,000) (100,000)
Sale of patent .......................... 250,000 (210,000)
Sale of development land ....... 360,000 (300,000)
Sale of other assets ................ 100,000 (130,000)
Collection of receivables ......... 150,000 (150,000)
Cash disbursements:
Inventory completion costs ..... (25,000) (25,000)
Payment of accounts
payable ................................ (400,000) (400,000)
Payment of accounts
payable ................................
Payment of brokers fee .......... (10,000) (10,000)
Payment to Bank A ................. (940,000) (940,000)
Payment of other liabilities ...... (110,000) (90,000) (20,000)
Payment of administrative
expenses ............................. (10,000) (10,000)
Ending balances ......................... $ 602,000 $3,890,000 $2,320,000 $1,880,000 $
25,000 ......................... $187,000 $ 80,000
843
Ch. 21Problems
PROBLEM 21-7
(1) Analysis of creditors proposal:

Book Assets Dividend
Value Available (Recovery)
Fully secured creditors .................................. $2,300,000 $2,300,000100.0%
Partially secured creditors (see Note A)........ 1,640,000 1,634,00099.6
Unsecured creditors:
With priority ............................................. 115,000a 115,000 100.0
Without priority (see Note A) ................... 1,200,000 1,080,00090.0
Owners equity .............................................. (345,000) 0
0
Total ........................................................ $4,910,000 $5,129,000
a
This includes the estimated trustees fees of $35,000.
Note A: Of the partially secured creditors claims, $60,000 ($1,640,000 $1,580,000) is un-
secured without priority. This amount and the previous balance for unsecured creditors
without priority result in a total claim of $1,260,000 ($60,000 + $1,200,000). Assets available
to satisfy this claim total $1,134,000 ($2,809,000 + $1,580,000 + $740,000 $2,300,000
$1,580,000 $115,000). This results in a dividend to unsecured creditors without priority of
90% ($1,134,000 $1,260,000). Therefore, the $60,000 of unsecured claims traceable to
partially secured creditors will receive $54,000 (90% of $60,000) in addition to the
$1,580,000 secured amount.
Analysis of managements proposal:

Fully secured creditors:
Original balance ........................................... $2,300,000
Loan collateralized by receivables ............... 250,000
$2,550,000 $2,550,000 100%
Original balance ........................................... $1,640,000
Satisfaction of bank loan .............................. (600,000)
Satisfaction of equipment loan ..................... (550,000)
$ 490,000 $ 490,000 100
Unsecured creditors:
With priority:
Original balance ..................................... $ 80,000
SG&A wages .......................................... 20,000
$ 100,000 $ 100,000 100
Without priority:
Original balance ..................................... $1,200,000
Current purchases unpaid ...................... 150,000
SG&A unpaid.......................................... 10,000
Unsecured loan ...................................... 424,000
Satisfaction of loan ................................. (400,000)
$1,384,000 $1,384,000 100
844
Ch. 21Problems
Problem 21-7, Continued

Owners equity:
Original balance (book value of assets less
liabilities)................................................. $ (310,000)
Net income from operations ......................... 270,000b
Write-off of receivables ................................ (30,000)
Restructured bank loan:
Gain on restructuring .............................. 100,000
Interest expense ..................................... (24,000)
Satisfaction of $400,000 unsecured claim:
Gain on restructuring .............................. 80,000
Issuance of preferred stock .................... 320,000
Satisfaction of equipment loan:
Loss on sale of equipment ..................... (120,000)
Gain on settlement of loan ..................... 30,000
$ 316,000 $ 253,000 80
Grand total ......................................................... $4,840,000 $4,777,000c
b
$1,480,000 + $210,000 $60,000 $1,100,000 $150,000 $80,000 $30,000
c
$4,777,000 = $2,750,000 + $506,000 + $1,521,000 per schedule below. The assets availa-
ble to owners equity is the $4,777,000 less the assets available to all creditors in the
amount of $4,524,000.
Schedule of Assets Available at Book Value

Assets Pledged with
Fully Partially
Secured Secured Free
Creditors Creditors Assets
Beginning balance.............................................. $2,400,000 $1,640,000 $ 870,000
Sales revenue .................................................... 1,690,000
Cost of sales ...................................................... (1,160,000)
SG&A ................................................................. (80,000)
Accounts receivable:
Written off ..................................................... (30,000)
Assigned ...................................................... 290,000 (290,000)
Collateralized loan proceeds ........................ 250,000
Satisfaction of bank loan:
Payment of cash .......................................... (100,000)
Reclassification of security ........................... (540,000) 540,000
Sale of equipment .............................................. (640,000)
Total book value ................................................. $2,690,000 $ 460,000 $1,690,
c
Net realizable value............................................ $2,750,000 $ 506,000 $1,521,
c
$460,000 110%
d
$1,690,000 90%
845
Ch. 21Problems
(2) The creditors proposal offers no opportunity for common shareholders to recover their in-
vestment. Managements proposal also offers no opportunity for recovery assuming the
company is liquidated at year-end 20X8. The issuance of preferred stock with a book value
of $320,000 effectively blocks any short-term recovery for the common shareholder. Howev-
er, if management can convince creditors to allow the company to continue to operate and
similar operating results are achieved, there may be some long-term recovery available to
common shareholders. As a common shareholder, nothing will be lost by pursuing this latter
alternative.
846
Ch. 21Problems
847

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24 Fischer10e SM Ch21 Final

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UNDERSTANDING THE ISSUES

(1) Effect on Net Income

Effect on Net Income

(1) Debt Restructuring

(2) Effect on Net Income If

Total consideration to be received by Note B:

(1) Nonbankruptcy Approach Bankruptcy Approach

$ 682,000 Grand totals ............................................... $641,000 $204,400 $(41,000)

Exercise 21-9, Concluded

Estimated Estimated Unsecured

(1) The Rodak Corporation

(2) Estimated assets available:

Value of all liabilities excluding unsecured creditors

Estimated dividend to unsecured creditors without priority:

Atoyo Fabricating, Inc.

Analysis of Creditor Claims if the Company Had Been Liquidated

Mayne Manufacturing Company

(1) Original Adjusted

March 31 Additional Revised Net

(a) Note PayableOfficer ..................................................................... 230,000

(b) Mortgage Payable ............................................................................ 100,000

(c) Bank A Note Payable ($980,000 + $95,000) ................................... 1,075,000

(d) Bank B Note Payable ....................................................................... 220,000

To record gain on restructuring. The 10 payments of $55,000

(e) Note PayableOfficer ..................................................................... 33,327

(f) Common Stock ($10 par value) ....................................................... 200,000

St. John Corporation

(1) Analysis of creditors proposal:

Analysis of managements proposal:

Book Assets Dividend

Schedule of Assets Available at Book Value

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