ASC 852: Financial Reporting for Reorganizations

The Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) 852, “Reorganizations,” provides the accounting framework under U.S. Generally Accepted Accounting Principles (U.S. GAAP) for companies that have filed for protection under Chapter 11 of the U.S. Bankruptcy Code. The standard mandates adjustments to a company’s financial statements to provide relevant information to stakeholders like creditors and investors.

The primary goal of ASC 852 is to distinguish a company’s ongoing business activities from the financial events directly associated with the reorganization. This guidance applies from the bankruptcy filing date until the company emerges from Chapter 11.

Triggering the Application of ASC 852

The trigger for a company to adopt this accounting guidance is the formal filing of a Chapter 11 bankruptcy petition. This requirement takes effect on the filing date, regardless of whether the court ultimately confirms the company’s reorganization plan.

ASC 852 is focused on reorganizations where the entity intends to continue operating as a going concern. It does not apply to other forms of bankruptcy, such as Chapter 7, which involves liquidation and is governed by ASC 205-30. The standard also does not apply to debt restructurings that occur outside of the court system. The financial statements must be clearly labeled with a “Debtor-in-Possession” title to indicate the company is operating under ASC 852.

Financial Reporting During Reorganization

Once a company is operating under Chapter 11, ASC 852 requires changes to its financial statements to distinguish between normal operations and reorganization activities. These modifications affect the balance sheet, statement of operations, and statement of cash flows to isolate the financial impact of the bankruptcy from underlying business performance.

Balance Sheet Presentation

The balance sheet must segregate liabilities into two main categories. The first is “Liabilities Subject to Compromise,” which represents all debts incurred before the Chapter 11 filing date (pre-petition liabilities). These are claims that may be altered or discharged as part of the court-approved reorganization plan.

The second category includes all other liabilities, such as post-petition debts incurred in the normal course of business and fully secured pre-petition claims. These liabilities are expected to be paid in full and are presented separately.

Statement of Operations Presentation

The statement of operations is modified to include a specific line item called “Reorganization Items.” This account reports all revenues, expenses, gains, and losses that are a direct result of the Chapter 11 proceedings.

Examples of costs reported as reorganization items include professional fees paid to attorneys and accountants for services related to the bankruptcy case. Other items are gains or losses from asset disposals prompted by the reorganization and adjustments to liabilities subject to compromise.

Statement of Cash Flows

The statement of cash flows must also be adapted to reflect the reorganization. While the overall structure remains the same, cash flows related to reorganization activities must be disclosed separately. For instance, payments for professional fees related to the bankruptcy would be segregated within operating cash flows. This presentation allows users to see the cash impact of the reorganization process distinctly from the company’s primary business activities.

Required Disclosures Under Reorganization

Beyond the changes to the financial statements, ASC 852 mandates extensive narrative disclosures in the accompanying footnotes. These disclosures provide context that cannot be conveyed through line items alone. Key disclosure requirements include:

• A detailed description of the Chapter 11 case, including the reorganization plan, its current status, and any material conditions for court confirmation.
• A breakdown of the amounts reported as “Liabilities Subject to Compromise” and “Reorganization Items” on the income statement.
• An evaluation of the significant risks and uncertainties the company faces, including its ability to continue as a going concern.
• Detailed information about any parts of the business that have been discontinued as part of the restructuring, in accordance with ASC 205-20.

Emergence and Fresh Start Accounting

The end of a successful Chapter 11 process is the company’s emergence from bankruptcy, which may require a specialized treatment known as “Fresh Start Accounting.” This process, governed by ASC 852, allows the company to reset its balance sheet to reflect its post-reorganization economic reality. Its use is required if specific conditions are met.

Conditions for Application

A company emerging from Chapter 11 must apply Fresh Start Accounting if it meets two tests. First, the reorganization value of the emerging entity’s assets must be less than the total of all its post-petition liabilities and allowed claims. This condition means the company was “balance sheet insolvent” before the plan was confirmed.

The second condition relates to a change in control. The holders of the company’s existing voting shares before confirmation must receive less than 50% of the voting shares of the new entity. This signifies that the original owners have lost control of the company to a new group, often former creditors.

Mechanics of Fresh Start

When Fresh Start Accounting is applied, the emerging company’s balance sheet is remeasured. All assets are restated to their individual fair values, similar to the accounting for a business acquisition. Any excess of the entity’s reorganization value over the fair value of its identified assets is recorded as goodwill.

Liabilities are restated to the present value of amounts to be paid under the reorganization plan. A significant outcome is the elimination of any prior accumulated deficit, allowing the emerging company to start with a zero balance in retained earnings.