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Fresh-Start Reporting Can Save Your Business

Business Refresh Bankruptcy - Scrubbed

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Fresh-Start Reporting Can Save Your Business

Business Refresh Bankruptcy - Scrubbed

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Global challenges like the after-effects of the pandemic, high inflation, rising interest rates, the looming threat of recession, supply chain constraints, the emerging monkeypox virus, and the war in Ukraine continue to test businesses across many industries. The number of companies facing financial distress has increased, forcing some to file bankruptcy or reorganize. Though the bankruptcy process involves distributing the remaining assets to the failing business’s creditors, it also allows some organizations to make a fresh start by reorganizing to be more economically feasible. 

There are six different types of bankruptcy filings under the Bankruptcy Code, and the most common for US businesses is Chapter 11, which allows companies to reorganize. If your business is considering a bankruptcy filing, it’s important to understand the benefits, qualifications, and challenges of fresh-start reporting.

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What Fresh-start Reporting Allows

To reorganize under Chapter 11, a business must prepare a reorganization plan that is subject to court approval. Once that plan is approved by the court and the company has emerged from bankruptcy, the business can begin to apply fresh-start reporting if it meets the associated requirements under ASC 852 – Reorganizations (outlined below). 

Under fresh-start reporting, the business starts anew, with its balance sheet items adjusted based on newly determined fair values. The business is considered separate from its predecessor company (the organization that has undergone a default) and now has clean financials and possibly a stepped-up value of assets. Fresh-start reporting provides an opportunity for most companies, as it denotes that the emerging entity is more robust and has a promising future.

The Criteria for Fresh-start Reporting

As stated in the American Institute of Certified Public Accountants Statement of Position (SOP) 90-7, Financial Reporting Entities under Bankruptcy Code, a reporting entity must apply fresh-start reporting after emerging from bankruptcy if it qualifies on both of the following criteria:

Reorganization value test. The reorganization value of the emerging entity immediately before the date of confirmation (when the court approves the reorganization plan) must be less than the total of all post-petition liabilities (the liabilities incurred after the bankruptcy is filed) and allowed claims. This test aims to prevent companies that are solvent and able to finance their operations from applying fresh-start reporting.

Loss of control test. The holders of existing voting shares immediately before confirmation must receive less than 50% of the voting shares of the emerging entity. This test prevents companies from filing a bankruptcy petition to adopt fresh-start reporting and write-up value of assets.

A Closer Look at the Reorganization Value Test

The reorganization value is the approximate fair value of the company’s assets without considering its liabilities. Though it may sound straightforward, obtaining the reorganization value requires extensive arms-length negotiations among various parties. This process is vital, as it serves as the basis for determining the value received by the business’s creditors and equity holders.

The reorganization value is commonly determined as a range rather than a single-point estimate; however, an entity will choose a value within a range. Companies typically use the discounted cash flow (DCF) method to arrive at the fair value, as it is the most commonly used valuation method (although methods such as acquired cost or book value, appraised or replacement cost, multiples of revenue or turnover, projected cash flow, and earnings capitalization also may be used). 

The DCF approach discounts the business’s projected cash flows to present at a rate equal to the cost of capital. It comprises: