Preparing for Bankruptcy? Five Accounting Considerations to Keep in Mind Before You File
As the coronavirus continues to impact businesses around the world, many finance and accounting leaders are realizing that filing for bankruptcy may be a necessary step to alleviate debt and redeploy cash flow into growth opportunities. Filing for bankruptcy is a time- and labor-intensive process, made more complicated by the fact that most finance leaders have never navigated its murky waters. As a result, companies are often unprepared, leading to unnecessary late nights and increases in costs and errors.
Understanding the information required for regulatory filings and the downstream impacts on the bankruptcy process and the business is key to avoiding costly mistakes down the road. Controllers and their teams must familiarize themselves with the increased reporting standards under ASC 852 – Reorganizations, with which they are required to comply, as well as the reporting requirements of the court. To gain a better understanding of the bankruptcy process from a controllership perspective, here are five things to consider before filing.
Controllers should understand the landscape under which their business is operating to ensure the proper guidance is applied.
Understand the timing and nature of the proceedings
Companies are often surprised by the time and resources needed to navigate a bankruptcy proceeding. The process may last anywhere from a few months to a few years, depending on the chapter of the bankruptcy code under which a company files. For instance, a Chapter 7 filing (also known as a liquidation bankruptcy) involves the sale of a debtor’s assets to pay its creditors and is usually the quickest from start to finish. A Chapter 11 bankruptcy, however, allows debtors to remain in business while restructuring their debt obligations, which can be a lengthy process. Businesses operating under the bankruptcy code carry increased responsibilities, such as expanded financial statement disclosure requirements, monthly statutory and compliance reporting unique to a bankruptcy and reconciliation of potentially thousands of payables, and other liabilities filed by counterparties.
One way to ease this burden is to bring in help—and lots of it. Advisors who have been through the grind of a bankruptcy proceeding can assist with the tasks that a company is unable to complete on its own. Engaging advisors prior to filing is crucial so that well-developed processes can be established early on. These processes include setting up new general ledger accounts and cost centers for bankruptcy accounting, implementing a plan to navigate the complexities in valuing assets and liabilities when the company emerges from bankruptcy, and establishing a project management team to ensure tasks are completed on time.
Establish a bankruptcy cutoff
The date on which a company files for bankruptcy has financial reporting and operational implications that controllers should be aware of prior to filing. Once a company is in bankruptcy, liabilities for which the service was provided or the product received prior to the filing are required to be reported within the liabilities subject to compromise (LSTC) line item on the balance sheet. LSTCs are liabilities incurred prior to filing that are not fully secured (e.g., trade payables, accruals and some types of debt). Unless permitted by the bankruptcy court, LSTCs cannot be paid. Having controls in place to identify these liabilities will allow companies to remain compliant throughout the proceedings.
Mapping out the timing of a filing can be advantageous. Filing on the first day of a given month will allow teams to prepare for the ramp up in additional procedures during the monthly close process. Further, accounts payable, payroll, and treasury processes are all impacted significantly by these new requirements and can result in a heavier burden on these departments if a filing is not planned in advance.
Measure and classify LSTCs and other reorganization items
Once companies have entered bankruptcy and tackled the cutoff procedures, the additional workload continues. Accounting guidance requires companies to present the LSTC balance for each reporting period while in bankruptcy. Maintaining this balance can be time consuming, especially for companies with large liability balances. Controllers should establish processes early on to keep track of changes in the LSTC balance (e.g., critical vendor payments) so that the rollforward of the balance is manageable for future periods.
LSTCs are not the only bankruptcy item to keep track of. Reorganization items, or transactions and events directly related to the bankruptcy, must be reported on the income statement and are separately stated after income/loss from continuing operations. These reorganization items include bankruptcy-related professional fees and adjustments to claim amounts.
Establish processes for compliance reporting and statutory reporting
While in bankruptcy, a company must comply with certain reporting requirements of the court in addition to the regulations under United States General Accepted Accounting Principles (US GAAP). Monthly operating reports (MOR) must be filed with the court to provide creditors and other interested parties information on the debtor’s business. The primary schedule within the MOR is the schedule of receipts and disbursements, which resembles a cash flow statement using the direct method.
Many jurisdictions also have additional requirements that debtors must comply with once a filing has occurred. Controllers should review these requirements to ensure compliance with all local reporting regulations.
Public companies undergoing bankruptcy often have the misconception that they can delay or cease filing their quarterly and year-end financial statements. While the reporting requirements for filers will have vastly increased, the deadlines to submit the financial results to the Securities and Exchange Commission are unchanged. Controllers need to ensure they have the bandwidth to take on the uptick in tasks required by the court, in addition to the routine periodic financial reporting.
Conduct financial reporting upon emergence
Simply agreeing to a plan with creditors is not an automatic qualifier to emerging from bankruptcy. Pursuant to ASC 852, companies that have filed Chapter 11 bankruptcy must apply fresh-start accounting if the following two conditions are met: a debtor must be balance sheet insolvent (fair value of assets of the emerging company is less than the post-petition liabilities and allowed claims) and voting shares must turn over more than 50 percent upon emergence. If a company does qualify for fresh-start accounting, additional disclosures are required, including a four-column balance sheet to present the adjustments made to arrive at the successor balance sheet (newly emerged company). Applying fresh-start accounting properly will require deep technical accounting and valuation knowledge.
If a company does not qualify for fresh-start accounting, it will be subject to ASC 805 – Business Combinations, a quasi-reorganization under ASC 852, troubled debt restructuring, or liquidation. Controllers should understand the landscape under which their business is operating to ensure the proper guidance is applied.
If a company determines that bankruptcy is the right course, being prepared for the journey is half the battle. Understanding the implications of a filing and bringing on knowledgeable third parties to help along the way will allow companies to maneuver through the complexities that arise during the process and provide a path forward for the business once again to be successful.