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5.4 Quasi-reorganizations
Publication date: 31 Mar 2023
us Bankruptcy & liquidation guide
A quasi-reorganization is a voluntary accounting procedure applied in rare circumstances by which a reporting entity with an accumulated deficit adjusts its accounts to obtain a "fresh start." A quasi-reorganization (sometimes referred to as a "readjustment") resembles a legally executed reorganization, but the procedure is accomplished without formal court proceedings and does not contemplate the creation of a new legal entity, a change in ownership, or a change in the rights and interests of creditors or shareholders.
5.4.1 Accounting for quasi-reorganizations
A readjustment may be desirable in order for a reporting entity to pay dividends. Often, jurisdictions require an entity to have retained earnings in order to pay dividends. To prevent reporting entities from creating retained earnings through a mere reclassification of paid-in capital, certain legal and accounting requirements must be satisfied. A reporting entity may apply the accounting guidance in ASC 852-20 to effect a quasi-reorganization provided that it (1) discloses to its shareholders all of the facts and circumstances surrounding the nature of the distressed situation and the impact of the readjustment on its financial statement balances and (2) obtains formal shareholder approval prior to any readjustment. In addition, the legal approval of either the board of directors or shareholders is usually required, depending on the laws in the state of incorporation for US companies.
While ASC 852-20 discusses the accounting to be applied in a quasi-reorganization, it provides limited guidance surrounding the conditions under which a quasi-reorganization is permissible. ASC 852-20-25-2 states the general requirement that additional paid-in capital should not be used to relieve the income account of charges that would otherwise be made to the income account. However, one of the conditions specified in ASC 852-20-25-3 for when a quasi-reorganization is permissible is when “there may be no continuation of the circumstances that justify charges to additional paid-in capital.” In other words, the conditions that gave rise to the reporting entity’s deficit should be resolved such that the recurrence of losses giving rise to a future deficit is unlikely.
The SEC staff has provided additional conditions that should be met for a public company to perform a readjustment. In the SEC's view, as described in ASC 852-20-S99, each of these conditions should be met to effect a quasi-reorganization.
- Retained earnings, as of the quasi-reorganization date, is exhausted.
- Upon consummation of the quasi-reorganization, no deficit exists in any surplus account (i.e., shareholders’ equity is positive).
- The entire procedure is made known to all persons entitled to vote on matters of general corporate policy and the appropriate consents to the particular transactions are obtained in advance in accordance with the applicable law and charter provisions.
- The procedure accomplishes, with respect to the accounts, substantially what might be accomplished in a reorganization by legal proceedings—namely, the restatement of assets in terms of present conditions as well as appropriate modifications of capital and capital surplus, to obviate the need, so far as possible, of future reorganizations of like nature.
Justification for quasi-reorganization accounting rests largely on circumstances that indicate that fresh-start reporting is appropriate. However, an entity emerging from a Chapter 11 reorganization that does not qualify for fresh-start reporting under ASC 852-10 should not use quasi-reorganization accounting at the time of its emergence.
The SEC staff has further interpretive guidance in ASC 852-20-S99-2 that addresses certain matters pertaining to the accounting for quasi-reorganizations, as summarized below.
- Elimination of an accumulated deficit by reclassifying amounts from capital surplus without satisfying all of the conditions set forth in ASC 852-20-S99 is prohibited. Therefore, a quasi-reorganization that does not involve a revaluation of balance sheet amounts is not allowed for public companies.
- Anticipated discretionary accounting changes should be adopted prior to or as part of the quasi-reorganization. Such changes are presumed to have been contemplated at the time of the quasi-reorganization and, as such, should be reflected as an integral part of the quasi-reorganization.
- Increases in the recorded values of specific assets (or reductions in liabilities) to fair value may be appropriate, provided such adjustments are factually supportable; however, the amount of such increases are limited to offsetting adjustments to reflect decreases in other assets (or increases in liabilities) to reflect their new fair values, such that a write-up of net assets in connection with a quasi-reorganization is prohibited.
- A quasi-reorganization cannot be reversed or “undone” in a subsequent period unless it is the correction of an error.
Nonpublic companies may want to effect a quasi-reorganization solely for the purpose of reclassifying an accumulated deficit to capital surplus. An AICPA Task Force prepared an issues paper on this topic (Issues Paper 88-1, dated September 22, 1988), which indicated that it would not be appropriate to combine paid-in capital with an operating deficit in the absence of a quasi-reorganization. In addition, ASC 852-20-15-3 does not apply to “quasi-reorganizations involving only deficit reclassifications.” As a result, this type of reclassification is not acceptable for nonpublic entities.
5.4.2 Balance sheet revaluation in quasi-reorganizations
In the absence of a formal reorganization, generally it is not acceptable to use quasi-reorganization accounting that would result in revaluation of balance sheet amounts involving a net write-off charged directly to equity. Prior to completing quasi-reorganization accounting, an entity should review the carrying amounts of its assets and recognize any impairments or write-downs otherwise necessary through profit and loss in accordance with the applicable guidance. When determining whether a further write-down to fair value is necessary, the determination of fair value should not be unduly conservative which would result in the overstatement of earnings subsequent to the quasi-reorganization. Only after the reporting entity is satisfied that it has appropriately recognized any impairments or other required asset adjustments through earnings and determined the fair values of its assets and liabilities would a net write-off directly to equity be permitted (assuming all other conditions to effect the readjustment have been met).
There may be instances when the write-up of assets to fair value is limited such that some assets may not be recorded at fair value after reflecting the quasi-reorganization. As noted in the SEC staff’s interpretive guidance in ASC 852-20-S99-2 (see Section 5.4.1), an entity’s net assets (i.e., shareholders’ equity) should not be increased as the result of a quasi-reorganization. As a result, when recording a readjustment, any excess fair value of an entity’s net assets over the book value of its shareholders’ equity would need to be systematically allocated to reduce the assets’ fair values so that shareholders’ equity is not increased.
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