[IMGCAP(1)]According to recent news it appears advisory firms have started to increase their hiring efforts for seasoned restructuring professionals. This may signal a coming potential increase in bankruptcy filings. If so, fresh start reporting may once again become a critical issue.

Public and private entities that emerge from Chapter 11 bankruptcy are subject to Accounting Standards Codification 852. Previously, fresh start accounting was covered under AICPA Statement of Position 90-7. Under ASC 852, entities that meet certain criteria are required to adopt fresh start accounting. The accounting treatment calls for a debtor entity to use fair value concepts to determine its reorganization value and establish a new basis for financial reporting.

According to ASC 852-10-45-19, an entity must meet the following criteria in order to adopt fresh start reporting:

1. 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.

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

Reorganization Value
In applying fresh start accounting, the company emerging from bankruptcy allocates its reorganization value based on its estimated fair value. The reorganization value is basically the price a willing buyer would pay for the new entity. The reorganization value is the basis for the emerging entity's fresh start reporting process, and is often based on pro forma cash-flow projections that become part of the reorganization plan.

For accounting purposes, the emerging entity is treated similarly to how a new acquisition would be treated. As such, the entity must follow the accounting rules for business combinations outlined in Accounting Standards Codification 805 (formerly SFAS No. 141R). The reorganization value of the entity must be allocated to the entity's assets in accordance with ASC 805. If any portion of the reorganization value cannot be attributed to specific tangible or intangible assets of the emerging entity, such amount must be reported as goodwill.

The valuation must also be in accord with ASC 820 (formerly SFAS No. 157, Fair Value Measurements). Compliance with ASC 820 requires an understanding of the major concepts contained in the rule including exit price, highest and best use, market participants and the principle market.

As a result of adopting fresh start reporting, a new entity emerges with no beginning retained earnings or deficit. Financial reporting for the new entity requires resetting the values of the assets and liabilities on the balance sheet to fair value. Certain disclosures are also required for fresh start accounting purposes, including the following:

• Adjustments to the historical carrying values of assets and liabilities;
• The amount of debt forgiveness;
• Significant issues pertaining to the reorganization value, such as the methods, variables and assumptions used to determine the valuation.

Case Study
1. Following its emergence from Chapter 11 bankruptcy, one of our clients, a leading producer of specialty fiber-based materials that meet industrial and consumer needs worldwide, with facilities in the U.S. and Europe, retained VRC to determine the fair value of its tangible and intangible assets for fresh start accounting purposes. The tangible assets valued included real property consisting of land, buildings and building improvements, personal property consisting of leasehold improvements, paper manufacturing and converting equipment, office furniture and fixtures, office machines, lift trucks, vehicles, and computer and lab equipment. The identifiable intangible assets valued included trademarks, trade names, technology, software and customer relationships.

2. After its emergence from Chapter 11 bankruptcy, our client, a leading two-way wireless messaging and mobile information company with operations throughout the U.S., Canada, Mexico, Puerto Rico and the Caribbean, retained VRC to determine the fair value of its tangible and intangible assets for fresh start accounting purposes. The tangible assets valued included real property consisting of land, buildings and building improvements, personal property consisting of leasehold improvements, network equipment, transmission equipment, telephone equipment, office furniture and fixtures, computer equipment, vehicles and messaging devices. The identifiable intangible assets valued included FCC licenses and the customer subscription base.

Complying with fresh start accounting rules requires an understanding of valuation principles and methodologies. We recommend engaging an independent valuation firm that is experienced in these types of engagements.

Bryan Browning, CFA, ASA, is managing director of Valuation Research Corporation and specializes in the valuation of intellectual property, capital stock, and business enterprises and the development of opinions concerning solvency, fairness and capital adequacy. He can be reached at (414) 221-6249 or BBrowning@ValuationResearch.com.

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