What Is a Quasi Reorganization in Accounting?

A quasi reorganization is a voluntary accounting procedure allowing a company to reset its financial statements for a “fresh start” without formal legal proceedings. The method is used to eliminate an accumulated deficit from the balance sheet, which can be an obstacle to paying dividends or attracting new investment. This readjustment restates the company’s assets and equity to reflect current economic realities, avoiding the costs and complexities of court processes. The goal is to present a more accurate financial picture when a company has resolved past issues and is poised for future profitability. This procedure is governed by the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) Topic 852.

Conditions for a Quasi Reorganization

A company must meet a set of criteria to ensure the process is appropriate. The primary condition is the existence of a deficit in retained earnings, as the procedure is designed to remedy a negative balance from accumulated losses. This procedure cannot be used if retained earnings are positive. The process is for companies that have resolved the issues causing past losses and can demonstrate a strong likelihood of future profitability.

Before any accounting changes are made, the company must revalue its assets and liabilities to their current fair values. If assets are overstated on the books compared to their actual market worth, they must be written down, a process that can increase the deficit.

A procedural requirement is obtaining formal consent from the company’s shareholders. The company must provide full disclosure to shareholders about the circumstances and financial impact of the proposed adjustments before they vote. This approval, combined with authorization from the board of directors, ensures the action is properly sanctioned. The U.S. Securities and Exchange Commission (SEC) also requires a comprehensive restatement of assets to their present values.

The Accounting Procedure

After meeting all preconditions, the company executes a series of accounting entries. The first step is the formal adjustment of all assets and liabilities to their fair market values. Any net write-down from this revaluation is charged against retained earnings, which often increases the deficit.

The main action is eliminating this total deficit. The negative balance in retained earnings is reset to zero by charging it against the company’s capital accounts in a specific order. The deficit is first absorbed by Additional Paid-In Capital (APIC), which represents the amount paid by shareholders over the stock’s par or stated value.

If the APIC account is insufficient to cover the entire deficit, the company must then use its common or preferred stock accounts. This is done by reducing the par or stated value of its stock, a legal process that also requires shareholder approval. This reduction creates new APIC, which can then be used to absorb the remaining portion of the deficit.

For example, if a company has a $5 million deficit in retained earnings and only $3 million in APIC, it must take further action. The company would need to reduce the par value of its common stock to create at least $2 million in additional APIC. Once created, the entire $5 million deficit can be offset, leaving the retained earnings account with a zero balance.

Post-Reorganization Financial Reporting

Following a quasi reorganization, a company’s financial reporting must clearly communicate this fresh start. The retained earnings account on the balance sheet begins with a zero balance as of the reorganization date. To ensure transparency, accounting rules require that the retained earnings be “dated.” This means the line item on the balance sheet will read, “Retained earnings since [Date of Reorganization],” for a number of years.

This dating is a clear signal that the current accumulation of earnings began on that specific date and that the prior deficit was eliminated. According to accounting standards, this dating should continue until the reorganization date no longer has special significance, which is often up to 10 years. For companies registered with the SEC, the requirement is stricter, mandating that retained earnings be dated for at least 10 years.

In addition to dating retained earnings, SEC rules require that for at least three years the company must disclose the total amount of the deficit that was eliminated on the face of the balance sheet. Companies must also provide detailed disclosures in the footnotes to their financial statements. These notes must describe the reorganization, including the date it occurred, the fair value adjustments made, and the total amount of the deficit that was eliminated.