Chapter 5

Corporate Liquidation and Reorganization

PROBLEM 5-1: THEORY

1. D 6. D
2. D 7. E
3. A 8. B
4. D 9. A
5. D 10. C

PROBLEM 5-2: THEORY & COMPUTATIONAL

1. Solutions:

Requirement (a):

Assets pledged to fully secured creditors:

Land 1,300,000

Loan payable (750,000)

Available for unsecured creditors 550,000
Assets pledged to partially secured creditors:
Equipment - net 150,000

Notes payable (500,000)

Available for unsecured creditors -
Free assets:
Excess of land over loan payable 550,000
Cash 200,000
Accounts receivable 450,000
Total free assets 1,200,000
Unsecured liabilities with priority:

Administrative expenses (180,000)

Salaries payable (800,000)

Net free assets 220,000

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Requirement (b):

Unsecured liabilities with priority:

Administrative expenses 180,000
Salaries payable 800,000
980,000
Fully secured creditors:
Loan payable 750,000
Partially secured creditors:
Notes payable 500,000
Unsecured liabilities without priority:
Notes payable - excess 350,000
Accounts payable 700,000
1,050,000

Requirement (c):

Total realizable value of assets 2,100,000

Less: Unsecured liabilities with priority
Salaries (800,000)
Administrative expenses (180,000) (980,000)
Less: Fully secured liabilities
Loan payable (750,000)
Less: Secured portion of partially secured
Liabilities
Notes payable (fair value of equipment) (150,000)
Excess available to unsecured liabilities
220,000
without priority (Net free assets)
Less: Unsecured liabilities without priority
Notes payable - excess over fair value
of
equipment (500K - 150K) (350,000)
Accounts payable (700,000)
Estimated deficiency to unsecured non-
priority creditors (830,000)

Requirement (d):

Estimated recovery Net free assets

percentage of unsecured = Total unsecured
creditors without priority liabilities without priority

= 220,000 ÷ 1,050,000 (see requirement ‘b’) = 20.95%

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Requirement (e):
500,000 x 20.95% = 104,761.90

Requirement (f):

BYE-BYE CORPORATION
STATEMENT OF AFFAIRS
AS OF JANUARY 1, 20X1
Available
for
Book Realizabl unsecured
values ASSETS e values creditors
Assets pledged to fully
secured creditors:
1,000,000 Land 1,300,000
Loan payable (750,000) 550,000
Assets pledged to
partially secured
creditors:
600,000 Equipment - net 150,000
Notes payable (500,000) -
Free assets:
200,000 Cash 200,000
500,000 Accounts receivable 450,000 650,000
Total free assets 1,200,000
Less: Unsecured liabilities
with priority (see below) (980,000)
Net free assets 220,000
Estimated deficiency
(squeeze) 830,000
2,300,000 Totals 1,050,000
Unsecured
Book Realizabl non-priority
values LIABILITIES e values liabilities
Unsecured liabilities with
priority:
- Administrative expenses 180,000
800,000 Salaries payable 800,000 -
Fully secured creditors:
750,000 Loan payable 750,000 -
Partially secured
creditors:
500,000 Notes payable 500,000
Equipment - net (150,000) 350,000
Unsecured creditors:

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 700,000 Accounts payable 700,000 700,000
(450,000) Shareholders' equity - -
2,300,000 Totals 1,050,000

2. A

3. A

4. D

5. C - Classes 1 through 6 have higher priority than Class 7.

PROBLEM 5-3: EXERCISES

EXERCISE 1:

Solutions:

Requirement (a):

Assets pledged to fully secured creditors:

Building - net 1,000,000

Mortgage payable (700,000)

Available for unsecured creditors 300,000

Assets pledged to partially secured creditors:
Machinery - net 300,000

Short-term bank loan (500,000)

Available for unsecured creditors -
Free assets:
Excess of building over mortgage payable 300,000
Cash 100,000
Accounts receivable 500,000
Inventories 500,000

Total free assets 1,400,000

Unsecured liabilities with priority:

Legal and other fees (60,000)

Income tax payable

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 (1,000,000)

Net free assets 340,000

Requirement (b):

Unsecured liabilities with priority:

Legal and other fees 60,000

Income tax payable 1,000,000

1,060,000
Fully secured creditors:

Mortgage payable 700,000

Partially secured creditors:

Short-term bank loan 500,000

Unsecured creditors without priority

Short-term bank loan - excess 200,000

Accrued payables 300,000

Accounts payable 700,000

1,200,000

Requirement (c):

Total realizable value of assets 2,400,000

Less: Unsecured liabilities with priority
Income tax payable (1,000,000)
Legal and other fees (60,000) (1,060,000)
Less: Fully secured liabilities
Mortgage payable (700,000)
Less: Secured portion of partially secured
liabilities
Short-term bank loan (fair value of
(300,000)
machinery)
Excess available to unsecured liabilities
340,000
without priority (Net free assets)
Less: Unsecured liabilities without priority
Accrued payables (300,000)

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Accounts payable (700,000)
Short-term bank loan - excess (500K -
300K) (200,000) (1,200,000)
Estimated deficiency to unsecured
non-priority creditors (860,000)

Requirement (d):

Estimated recovery Net free assets

percentage of unsecured = Total unsecured
creditors without priority liabilities without priority

= 340,000 ÷ 1,200,000 (see requirement ‘b’) = 28.33%

Requirement (e):
100,000 x 28.33% = 28,330

Requirement (f):
None.

Requirement (g):
GONE CORPORATION
STATEMENT OF AFFAIRS
AS OF JANUARY 1, 20X1
Available for
Realizabl unsecured
Book values ASSETS e values creditors
Assets pledged to fully secured
creditors:
800,000 Building - net 1,000,000
Mortgage payable (700,000) 300,000
Assets pledged to partially
secured creditors:
600,000 Machinery - net 300,000
Short-term bank loan (500,000) -
Free assets:
100,000 Cash 100,000
600,000 Accounts receivable 500,000
900,000 Inventories 500,000 1,100,000
Total free assets 1,400,000
Less: Unsecured liabilities with
priority (see below) (1,060,000)
Net free assets 340,000

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 Estimated deficiency (squeeze) 860,000
3,000,000 Totals 1,200,000
Unsecured
Realizabl non-priority
Book values LIABILITIES e values liabilities
Unsecured liabilities with
priority:

- Legal and other fees 60,000

1,000,000 Income tax payable 1,000,000 -
Fully secured creditors:
700,000 Mortgage payable 700,000 -
Partially secured creditors:
500,000 Short-term bank loan 500,000
Machinery - net (300,000) 200,000
Unsecured
creditors:
300,000 Accrued payables 300,000
700,000 Accounts payable 700,000 1,000,000
Shareholders'
(200,000) equity - -
3,000,000 Totals 1,200,000

EXERCISE 2:
1. Solution:
Realizable Available for unsecured
value creditors
Assets pledged to fully
secured creditors 370,000
Fully secured creditors (260,000) 110,000
Free assets 320,000
Total free assets 430,000
Liabilities with priority (70,000)
Net free assets 360,000

2. Solution:
Secured and Unsecured liabilities
Priority claims without priority
Partially secured creditors 200,000
Assets pledged with
(120,000)
partially secured creditors 80,000
Unsecured creditors 540,000
Total unsecured liabilities 620,000

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without priority

Net free assets 360,000

Divide by: Total unsecured liabilities without
620,000
priority
Recovery percentage 58.06%

3. Solution:
Assets pledged with partially secured creditors 120,000
Partially secured creditors 200,000
(120,000
Assets pledged with partially secured creditors )
Excess to be paid from net free assets 80,000
Multiply by: Recovery percentage 58.06% 46,448
Total amount paid to partially secured
creditors 166,448

4. Solution:
Unsecured creditors 540,000
Multiply by: Recovery percentage 58.06%
Amount paid to unsecured creditors 313,524

PROBLEM 5-4: CLASSROOM ACTIVITY

Solutions:

Requirement (a):

Assets pledged to fully secured creditors:

Building - net 1,300,000

Notes payable (700,000)

Available for unsecured creditors 600,000
Assets pledged to partially secured creditors:
Inventories 300,000

Short-term bank loan (500,000)

Available for unsecured creditors -
Free assets:
Excess of building over loan payable 600,000
Cash 200,000
Total free assets 800,000
Unsecured liabilities with priority:

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Net defined benefit liability (600,000)

Legal and other fees (100,000)

Net free assets 100,000

Requirement (b):

Unsecured liabilities with priority:

Net defined benefit liability 600,000

Legal and other fees 100,000

700,000
Fully secured creditors:

Notes payable 700,000

Partially secured creditors:

Short-term bank loan 500,000

Unsecured creditors without priority:

Short-term bank loan - excess (500K - 300K) 200,000

Accounts payable 300,000

500,000

Requirement (c):

Total realizable value of assets 1,800,000

Less: Unsecured liabilities with priority

(600,000
Net defined benefit liability )

(100,000
(700,000)
Legal and other fees )
Less: Fully secured liabilities

Notes payable (700,000)

Less: Secured portion of partially secured
liabilities
Short-term bank loan (fair value of inventories)

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 (300,000)
Excess available to unsecured liabilities without
priority (Net free assets) 100,000
Less: Unsecured liabilities without priority
Short-term bank loan - excess over fair value of
inventories (500K - 300K) (200,000)

Accounts payable (300,000)

Estimated deficiency to unsecured non-
priority creditors (400,000)

Requirement (d):

Estimated recovery Net free assets

percentage of unsecured = Total unsecured
creditors without priority liabilities without priority

= 100,000 ÷ 500,000 (see requirement ‘b’) = 20%

Requirement (e):
Amount Estimated Estimated
of claim recovery % recovery
Unsecured liabilities with
priority:
Net defined benefit liability 600,000 100% 600,000
Legal and other fees 100,000 100% 100,000
Fully secured creditors:
Notes payable 700,000 100% 700,000
Partially secured
creditors:
Short-term bank loan (fair
100% 300,000
value of inventories) 300,000
Excess - unsecured portion 200,000 20% 40,000
Total 500,000 340,000
Unsecured creditors
without priority:
Accounts payable 300,000 20% 60,000
Shareholders' equity
Share capital 1,000,000 0% -
Total realizable value of
assets 1,800,000

Requirement (f):

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FIREWOOD CORPORATION

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 STATEMENT OF AFFAIRS
AS OF JANUARY 1, 20X1
Available
for
Book Realizabl unsecured
values ASSETS e values creditors
Assets pledged to fully
secured creditors:
800,000 Building - net 1,300,000
Notes payable (700,000) 600,000
Assets pledged to
partially secured
creditors:
450,000 Inventories 300,000
Short-term bank loan (500,000) -
Free assets:
200,000 Cash 200,000
100,000 Prepaid assets -
Total free assets 800,000
Less: Unsecured liabilities
with priority (see below) (700,000)
Net free assets 100,000
Estimated deficiency
(squeeze) 400,000
1,550,000 Totals 500,000
Unsecured
Book Realizabl non-priority
values LIABILITIES e values liabilities
Unsecured liabilities with
priority:
- Net defined benefit liability 600,000
600,000 Legal and other fees 100,000 -
Fully secured creditors:
700,000 Notes payable 700,000 -
Partially secured
creditors:
500,000 Short-term bank loan 500,000
Inventories (300,000) 200,000
Unsecured creditors:
300,000 Accounts payable 300,000 300,000
(550,000) Shareholders' equity - -
1,550,000 Totals 500,000

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PROBLEM 5-5: THEORY
1. B 6. D
2. C 7. B
3. A 8. D
4. D 9. A
5. C 10. D

PROBLEM 5-6: THEORY

1. A 6. C
2. C 7. B
3. A 8. C
4. C 9. D
5. B 10. C

PROBLEM 5-7: MULTIPLE CHOICE: COMPUTATIONAL

1. B
Solution:
Assets pledged to fully Realizable Available for
secured creditors: value unsecured creditors
Accounts receivable 320,000
Notes payable (280,000) 40,000
Land and building 450,000
Bank loan (250,000) 200,000
Estimated amount out of assets pledged
with fully secured creditors 240,000

2. C
Solution:
Assets pledged to fully Realizable Available for
secured creditors: value unsecured creditors
Accounts receivable 320,000
Notes payable (280,000) 40,000
Land and building 450,000
Bank loan (250,000) 200,000

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Inventories 70,000
Inventories pledged to partially
(40,000)
secured creditors 30,000
Net free assets 270,000

3. B
Solution:
Available for
Realizable value
unsecured creditors
Assets pledged with fully
secured creditors 190,000
Fully secured creditors (130,000) 60,000
Free assets 140,000
Total free assets 200,000
Liabilities with priority (20,000)
Net free assets 180,000
Secured and Unsecured liabilities
Priority claims without priority
Partially secured creditors 100,000
Assets pledged with
(60,000)
partially secured creditors 40,000
Unsecured creditors 260,000
Total unsecured liabilities
without priority 300,000
Net free assets 180,000
Divide by: Total unsecured liabilities without
300,000
priority
Recovery percentage 60.00%

Assets pledged with partially secured creditors 60,000

Partially secured creditors 100,000
Assets pledged with partially secured creditors (60,000)
Excess to be paid from net free assets 40,000
Multiply by: Recovery percentage 60.00% 24,000
Total amount paid to partially secured
creditors 84,000

4. D
Solution:
Unsecured creditors 260,000
Multiply by: Recovery percentage 60.00%
Amount paid to unsecured creditors 156,000

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5. C
Solution:
Available for unsecured
creditors
Free assets 160,000
Liabilities with priority (16,000)
Net free assets 144,000

6. D
Solution:
Unsecured portion of partially secured
25,000
creditors
Unsecured creditors 155,000
Total unsecured liabilities without priority 180,000

Net free assets 144,000

Divide by: Total unsecured liabilities without
priority 180,000
Recovery per peso 0.80

7. A
Solution:

Assets pledged with partially secured creditors 50,000

Free assets 160,000

Liabilities with priority (16,000)

Partially secured creditors (75,000)

Unsecured creditors (155,000)

Deficiency (36,000)

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