In today’s current economy, companies are finding themselves in unexpected financial and operational distress that is leading to the potential for companies to find protection from creditors. When a company files for Chapter 11 bankruptcy protection, and then emerges, they must apply fresh start reporting. Fresh start reporting is a concept that provides stakeholders with a clear understanding of an entity’s financial position after emerging from bankruptcy. This article explores the statistics on Chapter 11 filings, principles of fresh start reporting under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 852 Reorganizations, its key differences from ASC 805 Business Combinations, the valuation and accounting challenges that could arise, and the importance of selecting a reliable valuation and accounting advisory partner.
Surge in Chapter 11 Filings
The economic fallout from the Covid-19 pandemic, high inflation and interest rates, and supply chain disruptions have had a significant impact on companies, leading to a surge in bankruptcy filings. Commercial Chapter 11 filings increased by 105 percent in May 2023, with 680 filings compared to 332 filings in May 2022. This alarming rise reflects the increasing levels of economic, financial, and operational distress faced by companies across industries.
Understanding Fresh Start Reporting
Fresh start reporting is a requirement under US GAAP pursuant to ASC 852 Reorganizations. The requirements of ASC 852 apply to financial reporting both during the reorganization process and for entities that have emerged from bankruptcy protection, specifically under Chapter 11 of the U.S. Bankruptcy Code. Typically, their balance sheet is reorganized with a fresh set of equity owners and creditors. When an entity undergoes this reorganization, its post-bankruptcy assets and liabilities are measured at their fair values on the emergence date, which is when a confirmed plan of reorganization is in place. These values are then recorded on a “fresh” or “Newco” balance sheet.
Differentiating ASC 852 vs. ASC 805
While both ASC 852 Reorganizations and ASC 805 Business Combinations deal with assigning fair values to assets and liabilities, there are notable differences between them. ASC 852 focuses on allocating the reorganization value, determined during bankruptcy proceedings, to the fair value of post-bankruptcy assets and liabilities. On the other hand, ASC 805 is used when one company acquires another or when two companies combine, assigning fair values to the acquired assets and assumed liabilities. In both cases, any excess amount not allocated to assets and liabilities is recorded as goodwill.
Valuation, Accounting and Financial Reporting Challenges in Fresh Start Reporting
The application of ASC 852 presents several challenges when it comes to fresh start valuations. These include:
- Performing a valuation for fresh start purposes requires significant data and management knowledge. Companies that have been in bankruptcy may have lost key employees, or data needed to perform the valuation analysis may be difficult to obtain.
- Assets and liabilities should be measured and recognized at fair value. Fair value requires that assets properly consider appropriate obsolescence. Quantifying economic obsolescence, especially for personal and real property, can be complex. Economic obsolescence refers to the decrease in an asset’s value due to external factors and changes in the market or industry, beyond its physical characteristics.
- Entities emerging from bankruptcy must navigate tax issues, including those associated with net operating loss carryforwards.
- Other valuation challenges may include determining the most appropriate market participants, deriving discount rates, and developing reasonable and contemporaneous prospective financial information.
- Preparing comprehensive disclosures that clearly communicate the outcome of the Chapter 11 process, the impacts of fresh start accounting and the go-forward viability of the company can be challenging.
These complexities require expertise in valuation and accounting to ensure accurate and reliable reporting.
Auditors face additional challenges in fresh start reporting audits compared to typical purchase price allocations under ASC 805. The complexity and materiality of financial transactions involved in bankruptcies often require auditors to spend more time performing audit procedures. The valuation and accounting advisory team should be able to work efficiently with the company’s auditors.
Choosing a Reliable Valuation and Accounting Provider
Given the intricacies and challenges associated with fresh start reporting, it is vital to select a valuation and accounting advisory provider with experience and expertise in this specialized field. The WilliamsMarston team, for example, offers the necessary knowledge and skills to navigate the complexities of fresh-start accounting-related valuations and financial reporting challenges. Their understanding of the unique requirements of fresh start reporting ensures clarity and transparency in financial reporting after emerging from bankruptcy.
There are many stakeholders in the fresh start reporting process, including the company, the bankruptcy court (if applicable), the company’s equity holders/creditors and their advisors, and the external auditors. Fresh start reporting plays a critical role in giving all stakeholders a clear understanding of an entity’s financial position after emerging from bankruptcy. Despite the challenges involved in fresh start valuations, it is essential to ensure accuracy and transparency through thorough data collection, valuation analysis, and diligent audit preparation. By selecting a reliable valuation provider with expertise in fresh-start accounting, entities can achieve the clarity and transparency necessary for a successful fresh start.
Connect with the WilliamsMarston team today to learn more.