Mergers & acquisitions —a snapshot Changing the way you think about tomorrow’s deals

Mergers & acquisitions
—a snapshot
Changing the way you think
about tomorrow’s deals
Stay ahead of the accounting and reporting standards for M&A1
November 13, 2014
What's inside
The bankruptcy process ............ 2
Reporting considerations
during bankruptcy .................... 4
Conclusion ................................. 5
Companies in distress: Bankruptcy
process and reporting considerations
Bankruptcy filings have slowed from their highs immediately after the financial
crisis, but continue to be significant. While the reasons vary, the bankruptcy
process may provide a valuable opportunity for a company to start fresh and
reorganize in a way that is more economically feasible for future periods. But it
is important to remember that a company’s activities through the
reorganization period, including its communication with stakeholders, will be
affected by the actions of the Bankruptcy Court and no longer rest within the
control of management. Those involved in this process often find it unique,
challenging and time consuming to navigate.
This edition of Mergers & acquisitions—a snapshot, is the second in a series
focused on companies in distress. The first edition focused on the leading
indicators of distress and key considerations for management as they attempt
to turn around the business to avoid bankruptcy. This snapshot provides an
overview of the bankruptcy process and some of the key reporting
considerations that companies need to be aware of when faced with a
bankruptcy.
1 Accounting Standards Codification 805 is the U.S. standard on business combinations,
Accounting Standards Codification 810 is the U.S. standard on consolidation (collectively the
“M&A Standards”), and Accounting Standards Codification 852 is the U.S. standard on
reorganizations (the “Reorganization Standard”).
M&A snapshot
1
The bankruptcy process
The term “bankruptcy” comes from the Latin term
“bankus,” which means bench, and “ruptus,” which means
broken. During the Roman empire, a vendor who did not
pay his debts had his table, or bench, broken and was put
out of business. In the United States, the Bankruptcy Code,
which was codified as Title 11 of the United States Code in
1978, is the uniform federal law that governs all bankruptcy
cases. A company files under Chapter 11 of the Bankrtupcy
Code if it plans to reorganize its business and get a "fresh
start" without the full burden of its pre-bankruptcy
liabilities. In contrast, Chapter 7 calls for the liquidation of
a business. As their plan of reorganization progresses,
companies that file for Chapter 11 may find that a Chapter 7
liquidation becomes the reality.
The players
It is important to identify who the key players are in a
Chapter 11 bankrupcy process. The debtor is the entity that
will file for bankruptcy, and once the bankruptcy petition is
filed, the debtor becomes a debtor-in-possession. A debtorin-possession will continue to operate the business
throughout the bankruptcy proceedings, subject to
approvals by the Bankruptcy Court.
The creditors of a company in bankruptcy typically fall into
the four main categories listed below, shown in the usual
order of priority for payment:
Class
Secured creditor
Description
Holds claims secured by validly
perfected security interests in assets
of the debtor to the extent of the
value of the related collateral
Administrative
creditor
Holds claims to full payment for
services provided to the debtor
during the period subsequent to the
bankruptcy filing. This also includes
vendors that have delivered inventory
to the debtor within 20 days of the
bankruptcy filing
Priority unsecured
creditor
Holds claims in areas specifically
entitled to priority over other
unsecured claims, such as wages,
benefits, critical supplies, and some
tax claims
General unsecured
creditor
Holds claims in all other areas for
debts arising prior to the bankruptcy
filing, such as general trade payables
and other unsecured debts
The different classes of creditors are important because
payments generally cannot be made to a subordinate class
unless the prior class has either been paid in full or
otherwise settled in an equitable manner, as determined by
the Bankruptcy Court. Typically, a creditors’ committee,
consisting of representatives from each class of creditors, is
formed to represent the rights of the various classes of
creditors. While equity holders may hold equity in the
company at the time of its bankruptcy filing and may have a
residual claim to the net assets of the debtor, their interests
are usually eliminated during bankruptcy proceedings. The
U.S. Trustee is responsible for overseeing the process and
monitoring the debtor-in-possesion’s compliance with the
applicable reporting requirements, bankruptcy laws, and
procedures.
The process
A Chapter 11 case begins with the filing of a petition for
bankruptcy in a Bankrupcy Court (the Court). Once the
petition is filed, the debtor receives an automatic stay,
which provides the debtor relief from collection efforts
while it reorganizes its business affairs. After the petition is
filed, the Court will set an initial bar date, the date by which
all claims against the debtor will need to be filed by the
creditors. At various times, different bar dates can exist,
such as a secondary bar date for tax and governmental
claims. Claims that are allowed by the court or undisputed
by the Company become known as allowed claims,
although this amount often differs from the actual
settlement amount of the claim. Once its petition is filed, a
debtor typically will have to file a plan of reorganization
within 120 days, unless that date is extended by the Court.
The debtor then has another 60 days to obtain acceptance
of the plan by its creditors and equity holders. After that
period, other interested parties can file an alternative plan.
A critical process for the debtor in reorganizing is deciding
whether to assume or reject existing contracts, including
leases, labor contracts, and other executory agreements.
Rejected contracts are terminated once approved by the
Court and any damages to the counterparty from the
termination become unsecured claims. Assumed contracts
will continue and the debtor must become current on all
past due payments and remain current throughout the
proceedings. However, assumed contracts are often
renegotiated for more favorable terms during this process.
M&A snapshot
2
After filing the plan of reorganization with the Court, the
debtor prepares a disclosure statement to provide key
information to creditors so they are able to make informed
decisions about whether to accept the plan of
reorganization. While the Bankruptcy Code does not
contain specific requirements, the disclosure statement
usually includes the following:

A summary of the plan of reorganization.

Historical financial information, including the financial
statements for at least the year before the petition was
filed and the period during which the company has
been in Chapter 11.

Prospective financial statement information, including
cash projections that will be used to calculate the
reorganization value of the debtor.

A pro forma balance sheet based on the reorganization
value, showing the expected financial structure of the
company when it emerges from Chapter 11.

Information about the history of the company and the
causes of its financial difficulty.

Information about the current and future management
of the company, including the makeup of the Board of
Directors.

A statement showing the amount creditors would be
expected to receive if the company was liquidated
rather than reorganized—known as the "Best Interest
Test."

A summary of the key points from the business plan
that describes the future operations of the debtor.

A liquidation value that shows an alternative to the plan
being presented.
Common challenges in developing the disclosure statement
include determining the estimated recovery percentages,
compiling and analyzing claims, and development of the
future business plan.
The timeline
The following timeline provides some general guidance as
to how a common reorganization case under Chapter 11
might move through the process. Once it determines that a
bankruptcy filing is its best course of action, a company
may want to consider engaging professional advisors to
assist with the various filing and other legal requirements
that will need to be met throughout the bankruptcy process.
Petition date
The date the petition for bankruptcy is
filed with the Court.
Within 45
days after
petition date
First and Second Day hearings occur that
set the course for the Chapter 11 process.
Shortly thereafter, in most cases, the
initial meeting of creditors, known as a
341 meeting (named after the applicable
section of the Bankruptcy Code), will take
place.
Bar date
The date set by the Court by which all
creditors that have claims against the
debtor have to file information to support
the validity of their claims. Multiple bar
dates may be assigned for different
classes of claims.
120 days
after petition
date
(exclusivity
period)
Unless extended by the Court, the
debtor's plan of reorganization and
disclosure statement must be filed by this
date.
180 days
after petition
date
If the debtor's plan has not been
confirmed by this date (after considering
any extensions for filing the plan of
reorganization), its creditors, trustees or
other parties of interest can file
competing plans.
Solicitation
and voting
The debtor’s plan of reorganization is
distributed to creditors and others, and
each class of creditors votes to accept or
reject the plan.
Confirmation
date
The date the Court approves the plan of
reorganization.
Emergence
date
The date on or after the confirmation
date that the reorganization plan
becomes effective and all material
conditions for emergence have been
satisfied. The emergence date is also
referred to as the effective date.
M&A snapshot
3
Reporting considerations during
bankruptcy
Once a company files a petition for bankruptcy under
Chapter 11, its accounting and financial reporting fall under
the Reorganization Standard. Generally, a company’s
financial reporting for most items will not change as a result
of the bankruptcy filing and will reflect the financial
evolution of the proceedings. For example, the impairment
guidance will still apply for goodwill both before and after
the filing. However, certain changes in reporting practices
are necessary because the needs of financial statement
users change upon filing for bankrupcty. Following are
some of the more unique reporting considerations.
Presentation of financial statements
While a company will continue to present balance sheets
and statements of operations, cash flows, and changes in
stockholders’ equity after filing a petition, the labeling of
the statements will change. All financial statements should
be clearly labled as “Debtor-in-possession” until emergence
from bankruptcy. Upon emergence, and when applying
fresh-start reporting, if applicable, a blackline format
distinguishing the predecessor and successor periods is
necessary.
Balance sheet
The most significant impact of the Reorganization Standard
on the financial reporting of balance sheet items involves
the classification and presentation of liabilities.
Presentation of liabilities
Liabilities are separated into obligations that were incurred
prior to the filing, pre-petition liabilities, and those
incurred after the filing, post-petition liabilities. Prepetition liabilities are further segregated into those that are
subject to compromise (not fully secured and having the
possibility of not being repaid at the full amount) and those
that are not subject to compromise. Classification is initially
made at the date of the filing based on whether the liability
is adequately secured, but the liability may change
classification as the bankruptcy evolves.
Liabilities subject to compromise are reported based on the
company’s best estimate of the expected amount of the
allowed claims, which may differ from the final settlement
amount. Final settlement amounts are not considered for
financial reporting until the plan is confirmed by the Court.
A subsequent adjustment to reflect the allowed claim at the
settlement amount is recorded as a reorganization item in
the statement of operations.
Treatment of debt and debt issue costs
Debt subject to compromise, including debt discounts,
premiums and issue costs, is adjusted to the expected
allowed claim and presented net as a single amount. While
debt not subject to compromise is not adjusted, changes to
the amortization periods and classification may need to be
considered.
Companies may incur professional fees in conjunction with
obtaining debtor-in-possession financing while in
bankruptcy. In many cases, costs related to such debt that
will be paid in full prior to emergence may need to be
expensed as incurred.
Income statement
The income statement of an entity in bankrcupty will reflect
changes recorded during the evolution of the bankruptcy
process. The financial statements for the period in which
the petition is filed and all subsequent periods will
distinguish the ongoing operations of the business from
those transactions that are directly associated with the
reorganziation.
Reorganization items
Transactions and events associated with the reorganization
are distinguished from the ongoing operations of the
business primarily through the use of a separate line on the
statement of operations called reorganization items. This
category reflects the expenses, gains and losses that are the
result of the reorganization of the business. As a general
rule, only incremental costs directly related to the
company’s bankruptcy filing should be presented as
reorganization items. Impairment charges and
restructuring activities would not usually be considered
reorganization items because these costs are associated with
the ongoing operations of the business. Expenses related to
the preparation of the petition for bankruptcy might be
incurred prior to the filing date. These expenses should be
recognized in earnings when the associated services are
rendered. Classification of these expenses as a
reorganization item may be appropriate in certain
circumstances.
Other professional fees
Professional fees that become payable upon emergence
from bankruptcy, often referred to as contingent fees, are
typically expensed upon emergence and recorded as
reorganization costs.
Interest
The bankruptcy code specifically limits post-petition
interest on unsecured debt, but allows claims for postpetition interest on secured debt in certain instances.
Interest accruing on unsecured debt subsequent to the filing
will generally not be allowed as a claim unless there is
surplus (a solvent debtor) and all unsecured creditors have
received full payment for their claims. Accruing interest on
secured debt is allowed when the collateral securing the
M&A snapshot
4
claims exceeds the principal amount of the debt and any
accrued interest is secured. Therefore, interest expense
should be recorded if it will be paid during the proceedings
or it is probable the Court will allow it as a priority, secured
or unsecured claim. The contractual interest that would
have accrued absent the bankruptcy filing should be
disclosed.
Other accounting considerations
A bankruptcy filing can trigger other accounting and
reporting implications such as the following:

The ability to continue as a going concern should
continue to be evaluated.

Deconsolidation of a subsidiary filing for bankruptcy
due to loss of control will likely trigger a gain or loss
upon remeasurement of the parent’s retained,
noncontrolling interest at fair value.
Stay tuned for future editions in our series on companies in
distress, which will highlight considerations when emerging
from a bankruptcy filing.
For more information on this publication, please contact
any of the following individuals:
Perry Mandarino
Deals Partner, Business Recovery Services Leader
(646) 471-7589
[email protected]
Steve Lilley
Deals Partner, Capital Markets and Accounting Advisory
Services
(214) 754-4804
[email protected]
Principal Authors:

Held-for-sale classification for certain planned asset
sales will not be appropriate until Court approval is
obtained.
Lawrence N. Dodyk
Partner, U.S. Business Combinations Leader
(973) 236-7213
[email protected]

Derivative contracts may lose their hedge effectiveness
in the period leading up to bankruptcy filing and many
derivative contracts are automatically terminated upon
the filing of bankruptcy, triggering recognition of
previously deferred amounts.
Sara DeSmith
Partner, National Professional Services Group
(973) 236-4084
[email protected]

Changes to assumptions underlying share-based
compensation awards, such as the probability of
achieving performance targets or estimating
fortfeitures, will likely need to be considered.
Modifications or cancellations of awards by the Court
should be accounted for on the date such actions
become effective.

Realization of deferred taxes and consideration of a
valuation allowance should be assessed to reflect the
changes to operational and tax planning strategies
brought on by a bankruptcy filing.
Rajeeb Das
Deals Managing Director,
Capital Markets and Accounting Advisory Services
(214) 754-4552
[email protected]
John Stieg
Senior Manager, National Professional Services Group
(614) 225-8703
[email protected]
Conclusion
A key objective of the financial reporting of companies in
bankruptcy is to reflect the financial evolution of the
proceedings. The filing of the bankruptcy petition will
trigger application of the Reorganization Standard, which
may result in changes in the timing of accounting charges
and a company’s reporting practices. The actions of the
Bankruptcy Court will also directly impact a company’s
reporting. Companies will want to be particularly mindful of
the disclosures during the bankruptcy period as the needs
of financial statements users change.
M&A snapshot
5
PwC has developed the following publications related to
business combinations and noncontrolling interests, covering
topics relevant to a broad range of constituents.
 Market participants: how their views impact your values
 How timing your transactions in light of the new
standards will impact your business and communication
with stakeholders
 Don't let push-down accounting push you around
 Goodwill impairment testing: What's old is new again
 Deal or no deal: Why you should care about the new
M&A standards
 Even your tax rate will change
 Accounting for partial acquisitions and disposals—it's not
so simple!
 Doing a deal? Be careful about employee compensation
decisions
 Did I buy a group of assets or a business? Why should I
care?
 Financial risk management considerations in an
acquisition
 We’re in the process of acquiring a company with
significant in-process research and development
(IPR&D) activities. What's next?
 Cross-border acquisitions – Due diligence and preacquisition risk considerations
 Cross-border acquisitions – Navigating SEC reporting
requirements

 Acquired assets not intended to be used: You may need to
record them, even if you don't use them!

 Accounting for contingent consideration—Don't let
earnouts lead to earnings surprises

 The Consolidation Standard—determining who
consolidates is just the beginning
 Carve-out Financial Statements—A challenging process
 Noncontrolling interests—why minority shareholder
rights matter
Cross-border acquisitions – Accounting considerations
relating to income taxes
Cross-border acquisitions – Post-acquisition
considerations
Companies in distress: A successful turnaround requires
decisive action
PwC clients who would like to obtain any of these publications
should contact their engagement partner. Prospective clients
and friends should contact the managing partner of the
nearest PwC office, which can be found at www.pwc.com.
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