The reorganization value of the reporting entity is determined through the plan of reorganization in the Chapter 11 process and generally approximates the fair value of the reporting entity before considering liabilities. The reorganization value approximates the amount a willing buyer would pay for the assets of the reporting entity immediately after the restructuring. In some cases, all of the assets in the bankrupt reporting entity will not be included in the reporting entity that emerges from bankruptcy. In that case, the reorganization value should include the value attributed to the reconstituted entity, as well as the value of those assets that will be disposed of before reconstitution occurs.
The reorganization value is the basis for determining the value received by the reporting entity's creditors and equity holders determined after extensive arm's-length negotiations between the interested parties as overseen and approved by the Court. The reorganization value is usually determined as a range of value rather than a single point estimate; however, the reporting entity will choose a value within the range to use to apply fresh-start reporting. Though several methods can be used to determine the reorganization value, it is generally derived using a discounted cash flow approach.
Question BLG 4-2 discusses whether it is appropriate for a reporting entity to utilize a reorganization value outside of the Court approved range.
Question BLG 4-2
For a reporting entity emerging from bankruptcy with a Court approved reorganization value between $100 and $120, are there circumstances where management can utilize a reorganization value outside of that Court approved range (i.e., either below $100 or above $120)?
The reorganization value represents the arm’s length negotiations between all parties interested in the bankruptcy proceedings. Accordingly, it would not be appropriate in most instances to use a value outside of the Court approved range even in circumstances where market conditions have changed and indicate that the reorganization value is either above or below the range approved by the Court.
The reorganization value used in bankruptcy accounting is different from the business enterprise value (also referred to as "market value of invested capital" or "total invested capital"). A reporting entity's enterprise value represents the fair value of its interest-bearing debt and its shareholders' equity. In most bankruptcy proceedings, a valuation specialist will determine the emerging entity's enterprise value. The reorganization value can usually be derived from the enterprise value by adding back liabilities other than interest-bearing debt. However, reporting entities should evaluate the specific inputs and assumptions used by the valuation specialist in determining the enterprise value to appropriately reconcile to the reorganization value. For instance, consideration of other items (e.g., non-core assets, estimated cash balances, environmental liabilities, working capital deficiencies/surpluses, as applicable) may be necessary. Deferred taxes that will be recorded in connection with fresh-start reporting may also impact reorganization value.
Figure BLG 4-2 depicts a comparison of reorganization value and enterprise value.
Figure BLG 4-2
Reorganization value and enterprise value
As an example, assume a reporting entity's enterprise value is $1,250,000, and $200,000 of working capital liabilities and other liabilities exist at emergence date. Reconciliation between the enterprise and reorganization values is described below.
Working capital and other liabilities (at emergence date)
In most instances, enterprise value will not include the value of cash and noncore assets and liabilities of the enterprise. For instance, assets to be sold in reorganization, excess cash, tax credits, and net operating loss carryforwards are often excluded from the enterprise valuation. Also, legacy pension costs or environmental liabilities may not be included in the reconstituted entity and, therefore, may not be considered when determining the enterprise value of the reconstituted entity. In such cases, a reporting entity may need to also adjust for these items to derive the reorganization value. If these items were already included in the cash flows used to derive the enterprise value estimate, they would not be adjusted when determining the reorganization value.