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AICPA ISSUES PAPERS — QUASI-REORGANIZATIONS

Prepared by the Quasi-reorganizations Task Force

Accounting Standards Division

AICPA — September 22, 1988

NOTICE TO READERS

This issues paper is a research document intended for use by the Financial Accounting Standards Board and the Governmental Accounting Standards Board. Not all the alternative accounting methods and criteria described in the paper necessarily comply with generally accepted accounting principles. Accordingly, this issues paper is not intended to provide guidance on the preferability of accounting principles.

INTRODUCTION

The Accounting Standards Executive Committee's Task Force on Quasi-reorganizations has developed this issues paper to restudy the accounting procedures called quasi-reorganization.

> Need for Project

The term quasi-reorganization is currently used to denote two accounting procedures, both of which involve the concept of an accounting fresh start, but whose importance and pervasiveness in financial reporting can differ considerably. The simpler of the two procedures is limited to a reclassification of a deficit in reported retained earnings as a reduction of paid-in capital. In addition to such a reclassification, the other procedure includes restatement of the carrying amounts of assets and liabilities. Clarification is needed as to:

Whether one or the other or both of the procedures should be permitted or required,
What criteria should be met for each of the procedures to be permitted or required, and
Whether the two procedures should be alternatives.

Present authoritative literature on quasi-reorganizations pre-dates several important evolutionary steps in present generally accepted accounting principles related to procedures involving restatements of assets and liabilities, for example:

The clean surplus theory adopted by APB Opinion 9,
The detailed rules specified in APB Opinion 16 for accounting for business combinations using the purchase method,
Experimentation with supplementary disclosure of information on changing prices, and
The use of pushdown accounting in certain circumstances involving a change in the ownership of a reporting entity.

Further, formally reorganized companies emerging from bankruptcy only infrequently restate their assets and liabilities, and, if they do, the restatement is often referred to as a quasi-reorganization. Thus a formal reorganization does not generally result in restatement, but the term quasi-reorganization, which suggests an accounting simulation of a formal reorganization, is used to refer to a restatement.

Moreover, the authoritative literature in this area is permissive rather than mandatory, whereas financial accounting standards are now generally mandatory. Further, there are financial accounting and reporting issues concerning quasi-reorganizations for which the authoritative accounting literature provides no guidance or for which the guidance provided is unclear or conflicting.

> Income Taxes

There are a number of issues in quasi-reorganizations on accounting for income taxes, such as how operating loss carryforwards and investment tax credit carryforwards should be accounted for after a quasi-reorganization. Those issues are not dealt with in this issues paper. The FASB has issued Statement No. 96, "Accounting for Income Taxes," which significantly changes existing standards for accounting for income taxes. Paragraph 54 of that Statement deals with accounting for the tax benefits of carryforwards subsequent to a quasi-reorganization. (See "Authoritative Literature and SEC Releases" below.) Questions have arisen as to how to interpret paragraph 54, and the FASB staff may provide guidance in a Questions and Answers booklet. In issuing Statement No. 96, the Board did not readdress basic issues in quasi-reorganizations. Certain conclusions on certain issues in this paper would suggest that paragraph 54 should be reconsidered. It was considered that the usefulness of this issues paper would not be measurably improved by a discussion of possible changes in accounting for income taxes that might be suggested by the resolution of the various issues in the paper.

HISTORY OF QUASI-REORGANIZATIONS

According to James Schindler's 1958 study, Quasi-reorganization, 1 the quasi-reorganization had its beginnings in the write-ups of the 1920s. At that time, managements determined that the depreciated cost bases of land, buildings, and equipment did not reflect their current values and adjusted assets upward to appraised amounts. Schindler stated that the practice followed this pattern:

To the extent that an explanation, if any, was made with respect to a write-up, usually it was a brief statement indicating that an "appraisal" had been made. This explanation, it is apparent, has little if any direct meaning, especially when the appraisal, usually implying an independent appraisal, was prepared after reaching the decision to revalue the assets. The statement that there was a discrepancy between book value and "present value" likewise offered little assistance to indicate why the revaluation action was taken by the management at that particular time. (p.12)

A 1928 survey by the American Institute of Accountants (later AICPA) indicated that 85% of those surveyed believed the results of write-ups should not be recorded in income for the period. Similarly, according to Schindler:

The view favored by most accountants throughout the 1920's was that the income statement and the earned surplus account were to reflect the cost basis even though appreciation had been recognized. That is, depreciation on cost should be charged to the profit and loss account and depreciation on the appreciation increase should be charged to the recorded appraisal surplus or reserve account. (p. 27)

From 1930 to 1934, many companies wrote down their assets. As Warren Nissley explained in the April 1933 Journal of Accountancy:

I think that the outstanding effect… of the happenings of 1932, on balance sheets and income accounts will be the burial of the remains of that period once described as the "new era." In most cases, the statements will show the interment in the full light of day because such burials are fashionable now and appear to cause little criticism. Most executives appear to think that those errors of judgment during the 'new era,' which were the cause of the major adjustments now necessary in the accounts of their companies, were errors universally made by all managements. And they realize that if these adjustments are not made now, they will have to be made in the future. So far as the adjustments apply entirely to the past, it appears proper to clean house now, but it is important to ascertain whether or not any of them are designed to relieve the future of any charges that should properly be borne by later periods. (pp. 283-84)

That led to the adoption of the AICPA's Rule No. 2 of 1934 as it appears in ARB No. 43, Chapter 7A. At about the same time, the newly formed Securities and Exchange Commission issued Accounting Series Releases (ASR) Nos. 1,15, and 16, and in 1941, ASR No. 25. Those pronouncements and others are discussed in the next section.

AUTHORITATIVE LITERATURE AND SEC RELEASES

Quasi-reorganizations are addressed in ARB No. 43, chapter 7A, which states:

A rule was adopted by the Institute in 1934 which read as follows:
Capital surplus, however created, should not be used to relieve the income account of the current or future years of charges which would otherwise fall to be made thereagainst. This rule might be subject to the exception that where upon reorganization, a reorganized company would be relieved of charges which would require to be made against income if the existing corporation were continued, it might be regarded as permissible to accomplish the same result without reorganization provided the facts were as fully revealed to and the action as formally approved by the shareholders as in reorganizations.
Readjustments of the kind mentioned in the exception to the rule fall in the category of what are called quasi-reorganization. This section does not deal with the general question of quasi-reorganizations, but only with cases in which the exception permitted under the rule of 1934 is availed of by a corporation. Hereinafter such cases are referred to as readjustments. The problems which arise fall into two groups: (a) what may be permitted in a readjustment and (b) what may be permitted thereafter.
Procedure in Readjustment
If a corporation elects to restate its assets, capital stock, and surplus through a readjustment and thus avail itself of permission to relieve its future income account or earned surplus account of charges which would otherwise be made thereagainst, it should make a clear report to its shareholders of the restatements proposed to be made, and obtain their formal consent. It should present a fair balance sheet as at the date of the readjustment, in which the adjustment of carrying amounts is reasonably complete, in order that there may be no continuation of the circumstances which justify charges to capital surplus.
A write-down of assets below amounts which are likely to be realized thereafter, though it may result in conservatism in the balance sheet at the readjustment date, may also result in overstatement of earnings or of earned surplus when the assets are subsequently realized. Therefore, in general, assets should be carried forward as of the date of readjustment at fair and not unduly conservative amounts determined with due regard for the accounting to be employed by the company thereafter. If the fair value of any asset is not readily determinable a conservative estimate may be made, but in that case the amount should be described as an estimate and any material difference arising through realization or otherwise and not attributable to events occurring or circumstances arising after that date should not be carried to income or earned surplus.
Similarly, if potential losses or charges are known to have arisen prior to the date of readjustment but the amounts thereof are then indeterminate, provision may properly be made to cover the maximum probable losses or charges. If the amounts provided are subsequently found to have been excessive or insufficient, the difference should not be carried to earned surplus nor used to offset losses or gains originating after the readjustment, but should be carried to capital surplus.
When the amounts to be written off in a readjustment have been determined, they should be charged first against earned surplus to the full extent of such surplus; any balance may then be charged against capital surplus. A company which has subsidiaries should apply this rule in such a way that no consolidated earned surplus survives a readjustment in which any part of losses has been charged to capital surplus.
If the earned surplus of any subsidiaries cannot be applied against the losses before resort is had to capital surplus, the parent company's interest in such earned surplus should be regarded as capitalized by the readjustment just as surplus at the date of acquisition is capitalized, so far as the parent is concerned.
The effective date of the readjustment, from which the income of the company is thereafter determined, should be as near as practicable to the date on which formal consent of the stockholders is given, and should ordinarily not be prior to the close of the last completed fiscal year.
Procedure after Readjustment
When the readjustment has been completed, the company's accounting should be substantially similar to that appropriate for a new company.
After such a readjustment earned surplus previously accumulated cannot properly be carried forward under that title. A new earned surplus account should be established, dated to show that it runs from the effective date of the readjustment, and this dating should be disclosed in financial statements until such time as the effective date is no longer deemed to possess any special significance.
Capital surplus originating in such a readjustment is restricted in the same manner as that of a new corporation; charges against it should be only those which may properly be made against the initial surplus of a new corporation.
It is recognized that charges against capital surplus may take place in other types of readjustments to which the foregoing provisions would have no application. Such cases would include readjustments for the purpose of correcting erroneous credits made to capital surplus in the past. In this statement the committee has dealt only with that type of readjustment in which either the current income or earned surplus account or the income account of future years is relieved of charges which would otherwise be made thereagainst.

ARB No. 43, Chapter 9(b), as amended by APB Opinion No. 6, states that:

property, plant and equipment should not be written up by an entity to reflect appraisal, market or current values which are above cost to the entity. This statement is not intended to change accounting practices followed in connection with quasi-reorganizations or reorganizations. . . Whenever appreciation has been recorded on the books, income should be charged with depreciation computed on the written up amounts.

ARB No. 46 amended paragraph 10 of ARB No. 43, Chapter 7(a) to indicate that dating of retained earnings "would rarely, if ever, be of significance after a period of ten years." SEC Regulation S-X Rule 5-02.31 requires dating of retained earnings for 10 years and disclosure of the amount of deficit eliminated for 3 years.

APB Opinion 9, paragraph 28, states that adjustments made pursuant to a quasi-reorganization should be excluded from the determination of net income or the results of operations under all circumstances. The Opinion deals only with entries giving effect to the quasi-reorganization and does not deal with effects on postquasi-reorganization reporting of adjustments made pursuant to the quasi-reorganization, for example, depreciation on assets whose carrying amounts have been restated.

Accounting for the tax benefits of net operating loss carryforwards emerging before quasi-reorganizations is addressed in APB Opinion 11, paragraph 50, which states that the

tax effects of loss carryforwards arising prior to a quasi-reorganization (including for this purpose the application of a deficit in retained earnings to contributed capital) should, if not previously recognized, be recorded as assets at the date of the quasi-reorganization only if realization is assured beyond any reasonable doubt. If not previously recognized and the benefits are actually realized at a later date, the tax effects should be added to contributed capital because the benefits are attributable to the loss periods prior to the quasi-reorganization.

AICPA Accounting Interpretation of APB Opinion 11, No. 8 states that permanent tax differences frequently result from "writedowns of assets in a reorganization."

PASB Statement No. 96 supersedes APB Opinion 11 effective for fiscal years beginning after December 15, 1988. Paragraph 54 of that Statement provides:

The tax benefit of an operating loss or tax credit carryforward for financial reporting as of the date of the quasi reorganization as defined and contemplated (involving write-offs directly to contributed capital) in ARB No. 43, Chapter 7, "Capital Accounts," is reported as a direct addition to contributed capital if the tax benefits are recognized in subsequent years. Some quasi reorganizations involve only the elimination of a deficit in retained earnings by a concurrent reduction in contributed capital. For that type of reorganization, subsequent recognition of the tax benefit of a prior operating loss or tax credit carryforward for financial reporting is reported as required by paragraph 52 and then reclassified from retained earnings to contributed capital. Regardless of whether the reorganization is labeled as a quasi reorganization, if prior losses were charged directly to contributed capital, the subsequent recognition of a tax benefit for a prior operating loss or tax credit carryforward for financial reporting is reported as a direct addition to contributed capital.

(Under paragraph 52, the manner of reporting the tax benefit of a loss carryforward is determined by the source of income in the current year, that is, the year in which the carryforward is utilized.)

FASB Statement No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructurings" indicates that it does not apply to a quasi-reorganization with which a troubled debt restructuring coincides if "the debtor restates its liabilities generally."

The Securities and Exchange Commission has issued various Accounting Series Releases on quasi-reorganizations. The most recent is ASR No. 25 (FRR 210), issued May 29, 1941, which states:

It has been the Commission's view for some time that a quasi-reorganization may not be considered to have been effected unless at least all of the following conditions exist:

(1) Earned surplus, as of the date selected, is exhausted;

(2) Upon consummation of the quasi-reorganization, no deficit exists in any surplus account;

(3) 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;

(4) 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, in order to obviate so far as possible the necessity of future reorganizations of like nature.

It is implicit in such a procedure that reductions in the carrying value of assets at the effective date may not be made beyond a point which gives appropriate recognition to conditions which appear to have resulted in relatively permanent reductions in asset values; as for example, complete or partial obsolescence, lessened utility value, reduction in investment value due to changed economic conditions, or, in the case of current assets, declines in indicated realization value. It is also implicit in a procedure of this kind that it is not to be employed recurrently but only under circumstances which would justify an actual reorganization or formation of a new corporation, particularly if the sole or principal purpose of the quasi-reorganization is the elimination of a deficit in earned surplus resulting from operating losses.

In the case of the quasi-reorganization of a parent company, it is an implicit result of such procedure that the effective date should be recognized as having the significance of a date of acquisition of control of subsidiaries. Likewise, in consolidated statements, earned surplus of subsidiaries at the effective date should be excluded from earned surplus on the consolidated balance sheet.

Previous ASRs related to quasi-reorganizations and asset revaluation included these:

ASR No. 1 (4/1/37), "Treatment of Losses Resulting from Revaluation of Assets." The Chief Accountant states,
To my mind, the revaluation of the assets involved was simply a recognition by the company, as of the date of the write-down, of an accumulation of depreciation in values incidental to the risks involved, in the ordinary operation of its business. This depreciation did not occur as of a given date; it took place gradually over a period of years coincident with the evolution of the industry. Thus it was an element of production costs applicable to an indefinite period prior to the write-down and as such would have been charged against income had it been discerned and provided for currently.
It is my conviction that capital surplus should under no circumstances be used to write off losses which, if currently recognized, would have been chargeable against income. In case a deficit is thereby created, I see no objection to writing off such a deficit against capital surplus, provided appropriate stockholder approval has been obtained. In this event, subsequent statements of earned surplus should designate the point of time from which the new surplus dates. (Rescinded.)
ASR No. 7 (5/16/38) — Cites common deficiencies in financial statements filed with the SEC including (1) use of capital to absorb writedowns in plant and equipment that should have been charged to earned surplus and (2) failure to date the earned surplus account after a deficit has been eliminated (with stockholders' approval) by a charge to capital surplus. (Rescinded.)
ASR No. 8 (5/20/38), "Creation by Promotional Companies of Surplus by Appraisal." This ASR required a company to reverse a writeup of assets to appraised value. (Superseded by ASR 215 — enforcement.)
ASR No. 15 (3/16/40), "Description of Surplus Accruing Subsequent to Effective Date of Quasi-Reorganization," requires full disclosure of the effects of quasi-reorganization for a minimum of three years. ASR No. 16 (3/16/40) would require specific disclosures in cases in which stockholder approval is not required. (Rescinded.)
ASR No. 50 (1/20/45), "The Propriety of Writing Down Goodwill by Means of Charges to Capital Surplus." Similarly to ASR No. 1, the ASR indicates writeoffs of goodwill to capital surplus are improper. (Rescinded.)

On August 25, 1988, the SEC staff issued Staff Accounting Bulletin (SAB) 78 on quasi-reorganizations. The SAB states

FACTS: As a consequence of significant operating losses and/or recent write-downs of property, plant and equipment, a company's financial statements reflect an accumulated deficit. The company desires to eliminate the deficit by reclassifying amounts from paid-in-capital. In addition, the company anticipates adopting a discretionary change in accounting principles2 that will be recorded as a cumulative-effect type of accounting change. The recording of the cumulative effect will have the result of increasing the company's retained earnings.

Question 1: May the company reclassify its capital accounts to eliminate the accumulated deficit without satisfying all of the conditions enumerated in Section 210 3of the Codification of Financial Reporting Policies for a quasi-reorganization?

Interpretive Response: No. The staff believes a deficit reclassification of any nature is considered to be a quasi-reorganization. As such, a company may not reclassify or eliminate a deficit in retained earnings unless all requisite conditions set forth in Section 2104 for a quasi- reorganization are satisfied.5

Question 2: Must the company implement the discretionary change in accounting principle simultaneously with the quasi-reorganization or may it adopt the change after the quasi-reorganization has been effected?

Interpretive Response: The staff has taken the position that the company should adopt the anticipated accounting change prior to or as an integral part of the quasi-reorganization. Any such accounting change should be effected by following generally accepted accounting principles with respect to the change.6

Chapter 7A of Accounting Research Bulletin (ARB) No. 43 indicates that, following a quasi-reorganization, a "company's accounting should be substantially similar to that appropriate for a new company." The staff believes that implicit in this "fresh-start" concept is the need for the company's accounting principles in place at the time of the quasi-reorganization to be those planned to be used following the reorganization to avoid a misstatement of earnings and retained earnings after the reorganization.7 Chapter 7A of ARB No. 43 states, in part, "...in general, assets should be carried forward as of the date of the readjustment at fair and not unduly conservative amounts, determined with due regard for the accounting to be employed by the Company thereafter (emphasis added).

In addition, the staff believes that adopting a discretionary change in accounting principle that will be reflected in the financial statements within 12 months following the consummation of a quasi-reorganization leads to a presumption that the accounting change was contemplated at the time of the quasi-reorganization.8

Question 3: In connection with a quasi-reorganization, may there be a write-up of net assets?

Interpretive Response: No. The staff believes that increases in the recorded values of specific assets (or reductions in liabilities) to fair value are appropriate providing 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 value. In other words, a quasi-reorganization should not result in a write-up of net assets of the registrant.

Generally, SAB 78 precludes a registrant from undertaking a quasi-reorganization that involves only a reclassification of the deficit in retained earnings to paid-in capital. The SAB reaffirms the condition of ASR No. 25 (Section 210 of the Codification of Financial Reporting Policies) that any quasi-reorganization should accomplish "the restatement of assets in terms of present conditions. . ." Thus, either the carrying amounts of all assets and liabilities must approximate their fair values at the date of the quasi-reorganization, or the quasi-reorganization must entail a revaluation of all assets and liabilities. According to the SEC staff, the SAB applies equally to companies emerging from formal reorganization (that is, bankruptcy) and other registrants.

The SAB specifically precludes a write-up of net assets. However, the SEC staff states that, in some, cases, asset write-downs or similar losses recognized in income may be viewed as part of a quasi-reorganization if the timing and nature, relative to other revaluations reflected directly in equity, are such that they can be considered a single event. Thus, in some cases, it may be appropriate to consider such charges to income as one component and a net credit to equity for revaluation of other assets or liabilities as the other, provided that there is a resulting overall decrease in net assets. The staff of the SEC should be consulted in those instances.

OTHER LITERATURE

In A Concise Textbook on Legal Capital, Bayless Manning discusses provisions of the Model Business Corporation Act related to quasi-reorganizations:

The (Model Business Corporation Act) explicitly makes place for the so-called "quasi-reorganization." This strange term requires a little explanation. If the only permissible statutory basis for dividend payments is earned surplus, the management has a considerable incentive to avoid making other kinds of charges against "earned surplus" and, where some surplus charge must be made, to try to arrange for the charge to be made against some sub-category of "capital surplus" as defined in the statute. It would be nice, for example, if an uninsured fire loss could be charged against a paid-in surplus account, leaving the earned surplus account intact. That particular instance is denied by generally accepted accounting principles and met by the Model Act, for the definition of earned surplus makes it clear that the management will not be free to protect and immunize its earned surplus account in this fashion. But after having taken this step, Section 64 of the Act provides:

1. A corporation may, by resolution of its board of directors, apply any part or all of its capital surplus to the reduction or elimination of any deficit arising from losses, however incurred, but only after first eliminating earned surplus, if any, of the corporation by applying such losses against earned surplus and only to the extent that such losses exceed the earned surplus, if any. Each such application of capital surplus shall, to the extent thereof, effect a reduction of capital surplus.

What this means is that a corporation that has distributed assets to shareholders to the full extent of its earned surplus and later develops a negative earned surplus, may then apply a portion of its capital surplus to the deficit to bring the deficit up to zero and thereafter pay out additional assets to its shareholders as soon as there are any earnings. As has been described earlier, capital surplus is not difficult to generate; a simple reduction of par or other reduction of stated capital will do it. The net result of these provisions of the Model Act, therefore, is that in addition to permitting direct distribution of capital surplus a corporation may, through use of capital surplus and an offset to deficit, pay all current earnings to its shareholders despite a deficit in the earned surplus account prior to the offset. Thus, by going through the right moves, capital surplus, or even stated capital can be set off against a corporate deficit. That is a so called "quasi-reorganization." The operational consequence is precisely antithetical to the creditor protection purposes of the stated capital scheme in general — and to the earned surplus standard in particular.9

Section 64 was renumbered and then deleted from the Model Act in 1979 in connection with basic revisions to the financial provisions of the Model Act. Those revisions included "(a) the elimination of the outmoded concepts of stated capital and par value, (b) the definition of 'distribution' as a broad term governing dividends, share repurchases and similar actions that should be governed by the same standard, [and] (c) the reformulation of the statutory standards governing the making of distributions..."10

Prentice Hall's Corporation Statutes discusses the legality of charging dividends to revaluation surplus:

Whether an increase in surplus arising from an increase in the value of the assets owned by the corporation is available for dividends, is highly controversial.

Surplus is the excess of the aggregate value of all assets of a corporation over the sum of all its liabilities, including its capital stock. So in order to arrive at the amount of surplus from which dividends may be paid you must determine the value of the assets.

Under conventional accounting practice, fixed assets are valued on the corporation's books at acquisition cost less depreciation; current assets at lower of cost or market value. But suppose the value of the assets has appreciated, although this appreciation hasn't been realized through a sale of the asset. Can the directors enter the appreciated value on the corporate books, and thus create "revaluation surplus" from which dividends may be paid? The answer depends on (1) state law, (2) the kind of assets revalued, whether fixed or current, (3) the kind of dividends paid, whether cash or stock dividends, and whether on preferred or common.

The first step toward an answer is to check the state statutes. Statutes in some states expressly prohibit the payment of cash or property dividends from unrealized appreciation in any kind of assets — others only from unrealized appreciation in fixed assets. Statutes in other states expressly or impliedly permit the payment of dividends from unrealized appreciation, but many require that stockholders be notified of the source of the dividend.

Court decisions are confusing. Many concern impairing capital by overcapitalization or fictitious writeup of assets, not actual appreciation in a general rise in prices. But generally courts have accepted the common law rule that unrealized appreciation in the value of fixed assets is not available for dividends.

An increase in the market price of the corporations' inventories would not be a proper source of dividends. (paragraph 2531 pp. 2517–2518)

Schindler discussed the relationship between state laws and accounting procedures for quasi-reorganizations:

The provisions of the state incorporation acts related to conditions precedent as well as to procedures to carry out such a reorganization have been accepted as minimum requirements to effect a quasi-reorganization. In the development of a formal quasi-reorganization procedure, the accounting profession attempted to prescribe conditions precedent to general applicability for effecting such a reorganization. When the legal conditions did not accomplish the accounting requirements, additional procedures were to be followed to meet recognized standards of accounting, or a quasi-reorganization was not deemed to have been effected. (pp. 50–51)

PART I — ISSUES AND ARGUMENTS

> Organization of Issues and Arguments Section and Terminology

The issues and arguments section of this paper is divided into two parts. Part I deals with quasi-reorganizations that result solely in eliminating deficits in reported retained earnings without restating assets or liabilities. Such quasi-reorganizations are referred to in the rest of this paper as deficit reclassifications. Part II deals with quasi-reorganizations that result both in eliminating a deficit and in restatements of assets or liabilities. Such quasi-reorganizations are referred to in the rest of this paper as accounting reorganizations.

> Part I — Deficit Reclassification

ISSUE 1: Should a deficit reclassification ever be permitted?

Some believe a deficit reclassification should, under certain conditions, be permitted. They offer these reasons:

Deficit reclassifications enable reporting entities that have the resources and the desire to pay dividends but are not permitted to do so under state law because of reported deficits in retained earnings to eliminate their reported deficits and to be permitted to pay dividends under state law. Many in the financial community believe the legal prohibition on paying dividends that could otherwise be paid causes unnecessary hardship for many reporting entities and their stockholders.
Though many states allow payment of dividends to be charged to paid in capital, dividends charged to paid in capital may be perceived differently by the financial community from dividends charged to retained earnings, an unnecessary and unsatisfactory condition.
Because subdividing equity according to its sources appears to be based on legal concepts and not accounting concepts, there is no reason to prohibit a change in that subdivision if the law permits it. FASB Concepts Statement No. 6, paragraph 49 defines equity as "the residual interest in the assets of an entity that remains after deducting its liabilities." Footnote 29 to that Statement states:
This Statement defines equity of a business enterprise only as a whole, although the discussion notes that different owners of an enterprise may have different kinds of ownership rights and that equity has various sources. In financial statements of business enterprises, various distinctions within equity such as those between. . . contributed capital and earned capital, or between stated or legal capital and other equity, are primarily matters of display...

Further, the reported amount of retained earnings or deficit provides incomplete and usually inconclusive information about legal restrictions on the payment of dividends. For example, in some states dividends may be charged against capital surplus; and typically, if treasury stock is not accounted for as retired, its cost reduces retained earnings available for dividends.

Apart from providing some inconclusive information about legal restrictions on payments of dividends, statistics about the sources of a reporting entity's equity provide little useful information. For many reporting entities those statistics have already been affected by capitalizations of earnings in connection with stock distributions, business combinations accounted for by the pooling of interests method, and the like. Further, though a deficit in reported retained earnings could result from cumulative losses from operations, a deficit is also a function of the reporting entity's dividend policy and the extent of, and the accounting for, its treasury stock transactions. The fact that there is a deficit, or its amount, may provide little useful information by itself.
If an entity could pay dividends by changing its state of incorporation, a deficit reclassification would permit such payment without incurring the cost of such a change.
A deficit reclassification provides a means of formally recognizing contraction in the size of a reporting entity in terms of its stated capital.
Permitting deficit reclassifications would allow managements to have fresh starts in reporting the discharge of their responsibilities to shareholders, which some believe is reflected in the amount of retained earnings or deficit.

Others believe a deficit reclassification should never be permitted. They offer these reasons:

Reported retained earnings or deficit is a useful statistic reflecting historical transactions and its integrity should be protected.
If reporting entities are permitted to reclassify deficits and start fresh in accumulating retained earnings, they may be encouraged to record discretionary expenses or losses before a deficit reclassification.
Financial reporting should not attempt to change economic circumstances such as the ability to pay dividends; it should only describe changes that have occurred.
It would be impossible to define with sufficient clarity which circumstances should justify a deficit reclassification and thus the procedure would be largely discretionary.
If a reclassification of a deficit is to be justified on the basis of a fresh start, it should not be confined solely to reclassification of equity accounts. Rather, it should occur only in an accounting reorganization, because only a complete restatement of the balance sheet is consistent with the fresh start objective.
It is contended that presentations in balance sheets of separate amounts for paid in capital and retained earnings can be misleading:
Because dividends are deducted from earnings and only the difference is presented, financial statements users can't tell from the balance sheet the amount of equity obtained from successful operations. They also can't tell from such a presentation when equity was obtained from its various sources. The amounts presented as components of equity can be misleading for both of those reasons.11

Because quasi-reorganizations further obscure the history the equity sections of balance sheets purport to present concerning the profitability of the reporting entities that record them, they make those sections even more misleading.

> Conditions Under Which a Reporting Entity Should Be Permitted to Record a Deficit Reclassification

The following section discusses some of the possible criteria for permitting deficit reclassifications, assuming deficit reclassifications should be permitted.

ISSUE 2: If a deficit reclassification should be permitted, should a reporting entity demonstrate a reasonable prospect of future profitability to qualify for a deficit reclassification?

Some believe a deficit reclassification should not be permitted unless a reporting entity can demonstrate a reasonable prospect of future profitability, so that recurrence of a deficit is unlikely; otherwise it is pointless to provide a fresh accounting start.

Others believe that a reasonable prospect of future profitability should not have to be demonstrated. They believe that an accounting procedure should be beneficial to the users of the financial reports for it to be justified. If a deficit reclassification passes that test by leading to balance sheets that are more informative to the users, for example, by measuring retained earnings (deficit) from the date a fresh start is deemed to have occurred, that advantage should not be denied them merely because present indicators suggest that the reporting entity may not be profitable in the future. Further, they point out that satisfying such a condition would entail the reporting entity's auditors being able to conclude that a reasonable prospect of future profitability has been demonstrated.

ISSUE 3: If a deficit in retained earnings should be required in order for a reporting entity to qualify for a deficit reclassification, what consideration, if any, should be given to separate accounts reported in equity that result from cumulative translation adjustments, investments in noncurrent marketable equity securities, certain investments of insurance companies, and pensions in determining whether a reporting entity should qualify for a deficit reclassification?

The financial statements of a reporting entity may reflect positive retained earnings or a deficit in retained earnings and may have in addition separate components of equity resulting from:

The valuation allowance for noncurrent marketable equity securities (FASB Statement No. 12),
Net unrealized investment gains and losses of insurance companies (FASB Statement No. 60),
Cumulative translation adjustments (FASB Statement No. 52), or
Recording of an unfunded accumulated pension benefits obligation (FASB Statement No. 87).

Some believe a reporting entity with positive retained earnings should qualify for a deficit reclassification if its financial statements contain separate components of equity that would create a deficit in reported retained earnings were those items charged to retained earnings. They offer these reasons:

Such separate components of equity represent real economic detriments to a reporting entity's financial position at a point in time.
Because accumulated changes in the various separate components of equity are reported in equity, some users of financial statements may consider them together with retained earnings in evaluating a reporting entity's financial position.
FASB Concepts Statement No. 5 includes changes in the valuation allowance for noncurrent marketable equity securities and translation adjustments in comprehensive income.

Others believe that whether separate components of equity would create a deficit in reported retained earnings were they charged against retained earnings should not be considered in determining whether a reporting entity should qualify for a deficit reclassification. They offer these reasons:

In the absence of a deficit in reported retained earnings, the issue becomes whether to permit a procedure the purpose of which would be to eliminate the separate components of equity reported under FASB Statement Nos. 12, 52, 60, and 87. There is no basis in authoritative accounting literature or state corporation laws for such a procedure.

Further, it is unclear how such separate components of equity would be eliminated without either restating the balance sheet generally or changing (and at least complicating) the reporting in future periods for the kinds of transactions that give rise to the separate components of equity. For example, to report the subsequent realization of an unrealized gain by an insurance company in an income statement subsequent to a deficit reclassification, it would be necessary to charge paid in capital for the amount of the unrealized gain transferred to that account in the deficit reclassification.

Accumulated changes in the various separate components of equity are not in fact charged against retained earnings. What the balance in reported retained earnings might have been were accounting principles related to noncurrent marketable equity securities, certain investments of insurance companies, translation of foreign currency financial statements, and pensions different from what they are should not affect whether an entity should qualify for a deficit reclassification any more than what the balance in reported retained earnings might have been were other accounting principles different from what they are.
Accumulated changes in the various separate components of equity probably do not impair reporting entities' ability to legally pay dividends.

A reverse situation would involve an entity with a deficit in retained earnings (and possibly debit balances in other separate components of equity) exceeded by a credit balance in a separate component of equity. The question would arise whether such an entity should qualify for a deficit reclassification, and the arguments would be similar to those above.

ISSUE 4: Should a reporting entity have to have a substantial, factually supportable change in circumstances to qualify for a deficit reclassification?

Some believe there should be a substantial, factually supportable change in circumstances, for example, a change in the line of business, marketing or operating philosophy, management personnel, equity control, or a legal reorganization to justify a deficit reclassification. Some believe a substantial contribution to capital by existing owners could also constitute a change in circumstances justifying a deficit reclassification.

Others believe a change in circumstances is merely an indication, of a reporting entity's ability to achieve future profitability. They believe a change in circumstances should not be, in itself, a condition for allowing or disallowing a deficit reclassification.

ISSUE 5: Should the deficit that is to be reclassified have to have resulted from net losses other than preoperating, start-up, or development stage losses?

Some believe the deficit that is to be reclassified should have to have resulted principally from net losses other than preoperating, start-up, or development stage losses unless the reporting entity changes its business or changes the direction of its business and that change in direction is a change other than coming out of the preoperating, start-up, or development stage. They observe that application of generally accepted accounting principles generally results in the resorting of losses and accumulated deficits in such periods. They believe permitting reporting entities to reclassify deficits resulting solely from preoperating, start-up, or development stage losses would result in circumvention of current generally accepted accounting principles that are sound and accordingly would impair the usefulness of financial statements.

Others believe reporting entities should be permitted to reclassify deficits regardless of the causes of those deficits.

ISSUE 6: Should the deficit to be reclassified have to have resulted principally from net losses and not from dividends or transactions involving the reporting entity's own stock?

Some believe the deficit to be reclassified should have to have resulted principally from net losses and not from dividends or transactions involving the reporting entity's own stock. They believe the purpose of a deficit reclassification should be to provide relief to reporting entities that have suffered net losses, not to mitigate the financial reporting consequences of equity transactions or to facilitate such transactions.

Others who favor permitting a reporting entity to reclassify a deficit that resulted from dividends or transactions involving the reporting entity's own stock believe that an entity that could otherwise pay dividends, for example, when state law would permit dividends to be charged against unrealized appreciation in assets, should not be precluded from reclassifying its deficit.

ISSUE 7: In the absence of a requirement in state law or the corporate charter for shareholder approval of a deficit reclassification, should a deficit reclassification have to be approved by a reporting entity's shareholders in order to be permitted?

It is assumed that, if there is a requirement in state law or the corporate charter for shareholder approval of a deficit reclassification, shareholder approval would be obtained. (It is also assumed that the procedure would not be undertaken if it would violate existing debt covenants.) At issue, then, is whether deficit reclassifications for which shareholder approval is not required by state law or the corporate charter should be required to be approved by the reporting entity's shareholders in order to be permitted.

Some believe a deficit reclassification should have to be approved by a reporting entity's shareholders in order to be permitted. They observe that, unless a deficit reclassification is mandatory (see Issue 10), it is discretionary. They believe requiring shareholder approval of a deficit reclassification makes sure that shareholders approve of eliminating the deficit and will be aware that dividends paid after the deficit reclassification will be charged to retained earnings accumulated thereafter. Also, they point out that ARB 43 requires shareholder approval for quasi-reorganizations.

Others believe that in the absence of a requirement in state law or the corporate charter for shareholder approval of a deficit reclassification, shareholder approval of a deficit reclassification should not be required. They argue hat shareholder approval is not a precondition for using other accounting procedures and believe deficit reclassifications should not be singled out for such a requirement. They also argue that disclosure in the notes to the financial statements would adequately inform shareholders about the procedure.

ISSUE 8: Should the separate financial statements of a wholly owned subsidiary be permitted to reflect a deficit reclassification if the parent company does not record its own deficit reclassification?

Some believe that if a reporting entity is permitted to reclassify its deficit, by extension the same procedure should be permitted for a wholly owned subsidiary that is a separate reporting entity.

Others believe there is no need or reason for a deficit reclassification by a wholly owned subsidiary. They believe deficit reclassifications are directed primarily to shareholders, rather than to creditors or other user of financial statements. They point out that a parent company can obtain funds from its wholly owned subsidiary by means other than dividends and that eliminating a deficit will not affect the parent company's perceptions of distributions made after a deficit reclassification or of its wholly owned subsidiary's financial position.

ISSUE 9: Should a reporting entity be permitted to record a deficit reclassification more than once?

Some believe a reporting entity should be permitted to record a deficit reclassification only once. They believe permitting a reporting entity to record a deficit reclassification more than once could result in manipulation of financial reporting.

Others believe that, because a corporate lifetime is indefinite, permitting only one deficit reclassification in a corporate lifetime is too severe a limitation. They would not preclude a deficit reclassification solely because the reporting entity had previously recorded one. Some would permit additional deficit reclassifications at any time but would require that the degree of justification for each additional deficit reclassification be greater than for the previous one, and some would permit additional deficit reclassifications only after reasonable intervals.

ISSUE 10: Should a deficit reclassification ever be mandatory?

Some believe a deficit reclassification should be solely voluntary. They believe a standard requiring deficit reclassifications in specified circumstances could not be written with sufficient clarity and precision to make sure the standard is applied uniformly.

Others believe a deficit reclassification should be discretionary unless the reporting entity undergoes a formal reorganization, in which case they believe it should be mandatory.

Still others believe a deficit reclassification should be mandatory if certain other events take place. Examples are a settlement with creditors, a troubled debt restructuring accompanied by owners' contribution of capital, and a significant change in a reporting entity's circumstances.

ISSUE 11: Should reported retained earnings accumulated after a deficit reclassification be reasonably determinable in light of applicable state laws to support payment of dividends for a reporting entity to qualify for a deficit reclassification?

Some believe that, for a reporting entity to qualify for a deficit reclassification, it should be reasonably determinable in light of applicable state laws that retained earnings accumulated after a deficit reclassification will support payment of dividends. They believe that a principal objective of deficit reclassification is to permit reporting entities that have the money and the desire to pay dividends to be permitted to do so and that, in the absence of a prospect of being permitted to pay dividends as a result of deficit reclassification, sufficient justification for the procedure does not exist.

Others believe the availability of reported retained earnings accumulated after a deficit reclassification for payment of dividends should not be a condition for permitting a deficit reclassification. They believe reporting entities should be permitted to reclassify their reported deficits in order to present their financial positions in a more favorable light.

> Implementation Issues

ISSUE 12: Should the separate accounts reported in equity that result from cumulative translation adjustments, investments in noncurrent marketable equity securities, certain investments of insurance companies, and pensions be eliminated in a deficit reclassification?

Issue 3 asked what consideration, if any, should be given to separate accounts reported in equity that result from cumulative translation adjustments, investments in noncurrent marketable equity securities, certain investments of insurance companies, and pensions in determining whether a reporting entity should qualify for a deficit reclassification. This issue asks whether those separate components of equity should be eliminated in a deficit reclassification, regardless of whether they were considered in determining whether a reporting entity should qualify for a deficit reclassification.

Some believe the separate components of equity should be eliminated in a deficit reclassification. They believe a deficit reclassification in which the separate components of equity are not eliminated is only a halfway measure.

Others believe the separate components of equity should not be eliminated in a deficit reclassification. They believe that if the separate components of equity are eliminated, accounting for subsequent changes in the related asset or liability accounts would produce results that were not intended in FASB Statement Nos. 12, 52, 60, and 87.

> Post-Deficit Reclassification Issues

ISSUE 13: If the separate financial statements of a subsidiary reflect a deficit reclassification and the parent company does net record its own deficit reclassification, should the effects of the subsidiary's deficit reclassification be reversed in consolidation?

Some believe that if the separate financial statements of a subsidiary reflect a deficit reclassification and the parent company does not record its own deficit reclassification, the effects of the subsidiary's deficit reclassification should be reversed in consolidation. They compare deficit reclassifications recorded by subsidiaries to stock dividends declared by subsidiaries. ARB 51 states in that connection that

Occasionally, subsidiary companies capitalize earned surplus arising since acquisition, by means of a stock dividend or otherwise. This does not require a transfer to capital surplus on consolidation, inasmuch as the retained earnings in the consolidated financial statements should reflect the accumulated earnings of the consolidated group not distributed to the shareholders of, or capitalized by, the parent company.

Others believe such deficit reclassifications should not be reversed in consolidation; they believe the parent company's retained earnings should be increased by the amount of the deficit reclassified in the subsidiary's accounts.

ISSUE 14: Should reported retained earnings be dated after a deficit reclassification?

Some believe reported retained earnings should be dated after a deficit reclassification. They believe reported retained earnings ordinarily indicates the cumulative result of the reporting entity's earnings and dividends history. Dating puts users on notice that retained earnings is not such a cumulative result. Also, dating discloses that a deficit reclassification has been recorded and emphasizes the significance of the procedure.

Others believe dating reported retained earnings after a deficit reclassification creates an unnecessary stigma. They believe other disclosures would provide sufficient notice. Further, they observe that the reclassified deficit may have resulted from dividends paid during profitable periods or from other capital transactions.

PART II — ISSUES AND ARGUMENTS

> Part II — Accounting Reorganizations

Part II deals with quasi-reorganizations that result both in eliminating deficits and in restatements of assets or liabilities. Such quasi-reorganizations are referred to here as accounting reorganizations.

ISSUE 1: Should accounting reorganizations be permitted?

Some believe accounting reorganizations should be permitted. In their view, the disparity between the acquisition costs at which assets and liabilities are reported and their current fair values may be so great that financial statements are not meaningful. An accounting reorganization would enable a reporting entity to report assets, liabilities, and earnings of periods after the reorganization more satisfactorily.

Others believe accounting reorganizations should not be permitted. They offer these reasons:

The literature supporting accounting reorganizations — ARB 43, Chapter 7A — is an anachronism. It predates the clean surplus theory adopted by APB Opinion 9, and, being discretionary, it lacks the discipline that mandatory standards provide.
The current accounting model permits writing the costs of assets down only when the costs of assets are not recoverable. Though accounting for impairment of long-lived assets continues to be unsettled, an accounting reorganization could possibly permit a writedown that could not be otherwise justified. Moreover, as long as the requirement in APB 9 that adjustments made pursuant to a quasi-reorganization be excluded from the determination of net income is in place, an accounting reorganization would possibly permit an impairment or other writedown to bypass the income statement. 13
The realization principle prohibits writing assets up. Though there are acknowledged deficiencies in that principle, it is well understood and has stood the test of time. Accounting reorganizations should not be permitted to depart from that principle, particularly because it will be difficult to define with clarity and precision the circumstances that would justify an accounting reorganization and thus the procedure may be largely discretionary.

Other arguments for and against permitting accounting reorganizations are essentially the same as the arguments in Issue 1 in Part I.

> Conditions Under Which a Reporting Entity Should Be Permitted to Record an Accounting Reorganization

ISSUE 2: If an accounting reorganization should be permitted, should there have to be a deficit in reported retained earnings to qualify for an accounting reorganization?

Some believe elimination of a deficit should be the principal objective of an accounting reorganization and therefore believe a deficit should be a precondition for an accounting reorganization.

Others believe allowing a reporting entity to make a fresh reporting start by cleansing the balance sheet of unrealistic reported amounts should be the principal objective of an accounting reorganization and therefore believe a deficit in retained earnings should not be a precondition for an accounting reorganization. Some believe an accounting reorganization should always follow a legal reorganization.

(If the answer to Issue 2 is "no," that would raise questions about the current accounting model that are beyond the scope of this paper. Accordingly, the remaining issues are based on the assumption that a deficit in reported retained earnings should be required to qualify for an accounting reorganization.)

ISSUE 3: If a deficit in retained earnings should be required in order for a reporting entity to qualify for an accounting reorganization, what consideration, if any, should be given to separate accounts reported in equity that result from cumulative translation adjustments, investments in noncurrent marketable equity securities, certain investments of insurance companies, and pensions?

Some believe a reporting entity with positive retained earnings should qualify for an accounting reorganization if its financial statements contain separate components of equity that would create a deficit in reported retained earnings were those items charged to retained earnings. They point out that the requirements for separate components of equity contained in FASB Statement Nos. 12, 52, 60, and 87 resulted from a desire to exclude those items from the income statement. Because accounting reorganizations are directed toward the balance sheet, income statement considerations should not determine whether a reporting entity should qualify for an accounting reorganization.

Others believe that whether separate components of equity would create a deficit in reported retained earnings were they charged against retained earnings should not be considered in determining whether a reporting entity should qualify for an accounting reorganization. They say that unrealized losses should not be considered to provide adequate proof of the need for such a radical accounting procedure.

Other arguments in this issue are essentially the same as the arguments in Issue 3 in Part I.

Also, the reverse situation described in Issue 3 in Part I, involving an entity with a deficit in retained earnings (and possibly debit balances in other separate components of equity) exceeded by a credit balance in a separate component of equity, would also apply to accounting reorganizations and the arguments would be similar to those above.

ISSUE 4: If a deficit in retained earnings should be required in order for a reporting entity to qualify for an accounting reorganization, should the deficit have to have existed before the restatement of assets and liabilities?

Some believe a deficit should have to have existed before a restatement of assets and liabilities in an accounting reorganization, because they believe the principal objective of an accounting reorganization is to enable a reporting entity to pay dividends. Also, they point out that permitting reporting entities without deficits to qualify for accounting reorganizations if restatements of their assets would create deficits would encourage reporting entities to understate the amounts of their assets in the restatement.

Others believe assets and liabilities should be restated to fair values and any resulting deficit eliminated because current and future operations should not be burdened with unrealistic reported amounts.

ISSUE 5: Should a reporting entity demonstrate a reasonable prospect of future profitability to qualify for an accounting reorganization?

The arguments in this issue are essentially the same as the arguments in Issue 2 in Part I.

ISSUE 6: Should a reporting entity have to have a substantial, factually supportable change in circumstances to qualify for an accounting reorganization?

The arguments in this issue are essentially the same as the arguments in Issue 4 in Part I.

ISSUE 7: Can the prospect of future profitability hinge on the new (presumably lower) bases of assets resulting from the accounting reorganization itself?

Some believe the prospect of future profitability should be permitted to hinge on the new (presumably lower) bases of assets resulting from the accounting reorganization itself. They offer these reasons

Those who would require a reporting entity to demonstrate a reasonable prospect of future profitability to qualify for an accounting reorganization would do so to avoid recurrence of a deficit in reported retained earnings. Future reported profits would avoid recurrence of a deficit regardless of the cause of those future profits.
New asset bases are more reliable than are many other matters as indicators of changes in future profitability.
Permitting the prospect of future profitability to hinge on new asset bases is consistent with the concept of a fresh start.

Others believe the prospect of future profitability should not be permitted to hinge on new asset bases, because they believe an accounting reorganization should be a response to a substantial, factually supportable change in circumstances and that a prospect of future profitability that hinges only on the accounting reorganization itself belies the existence of such a change in circumstances.

ISSUE 8: Should a reporting entity be permitted to record an accounting reorganization if total equity would be negative after the accounting reorganization?

Some believe the principal objective of an accounting reorganization should be to allow assets and liabilities to be reported satisfactorily and believe the prospect of continuing to report negative total equity after an accounting reorganization should not prevent more satisfactory reporting of assets and liabilities.

Others believe a reporting entity should not be permitted to record an accounting reorganization if negative total equity would remain after the accounting reorganization. They point out that such accounting reorganizations would contradict the idea of permitting a reporting entity to report the way it would were it starting fresh, because reporting entities do not start with negative total equity. They also point out that such accounting reorganizations would not permit payment of dividends, which some believe to be the principal objective of an accounting reorganization.

ISSUE 9: Should a reporting entity be permitted to record an accounting reorganization if a deficit in retained earnings would remain after the accounting reorganization?

The arguments in this issue are essentially the same as the arguments in Issue 8.

ISSUE 10: Should reported retained earnings accumulated after an accounting reorganization be reasonably determinable in light of applicable state laws to support payment of dividends for a reporting entity to qualify for an accounting reorganization?

Some believe that for a reporting entity to qualify for an accounting reorganization, it should be reasonably determinable in light of applicable state laws that retained earnings accumulated after an accounting reorganization will support payment of dividends. They believe that a principal objective of accounting reorganizations is to permit reporting entities that have the money and the desire to pay dividends to be permitted to do so and that, in the absence of a prospect of being permitted to pay dividends as a result of an accounting reorganization, sufficient justification for the procedure does not exist.

Others believe enabling reporting entities to report assets, liabilities, and earnings of periods after the reorganization more satisfactorily is sufficient justification for the procedure. They believe deficiencies in the current accounting model make necessary a corrective mechanism for use when financial statements no longer satisfactorily portray the conditions and events they purport to portray. They believe financial reporting should not be governed by state laws that govern distributions to shareholders (for example, the laws of some states prohibit charging dividends against revaluation surplus) and believe maintaining separate accountability for dividend and financial reporting purposes would not cause reporting entities undue hardship and would not be misleading to users.

ISSUE 11: Should the deficit that justifies an accounting reorganization have to have resulted from net losses other than preoperating, start-up, or development stage losses?

The arguments in this issue are essentially the same as the arguments in Issue 5 in Part I.

ISSUE 12: Should the deficit that justifies an accounting reorganization have to have resulted principally from net losses and not from dividends or transactions involving the reporting entity's own stock?

The arguments in this issue are essentially the same as the arguments in Issue 6 in Part I.

ISSUE 13: Should a reporting entity whose reported equity is believed to be understated because application of generally accepted accounting principles results in assets being reported at less than their current fair values or liabilities being reported at more than their current fair values be precluded from recording an accounting reorganization?

Some object to permitting reporting entities whose reported equity is believed to be understated because application of generally accepted accounting principles results in the assets being reported at less than their current fair values or liabilities being reported at more than their current fair values to record accounting reorganizations. Whether an accounting reorganization would result in a net increase in equity depends on how a number of subsequent issues are resolved, including what assets should be restated, how those assets should be restated, whether any or all liabilities should be restated, and whether restatement should be based on the values of identifiable assets and liabilities or on a valuation of the entity as a whole. This Issue 13 is therefore a threshold issue, dealing with whether a reporting entity whose reported equity is believed to be understated should be precluded from recording an accounting reorganization regardless of the accounting rules that will be devised. If it should not be so precluded, Issue 22 addresses whether adjustments in the reorganization should be limited so that there is no increase in equity.

Those who object to permitting reporting entities whose reported equity is believed to be understated to record accounting reorganizations believe that it would contradict the idea of a troubled entity that is implicit in the concept of an accounting reorganization. Also, they believe the reasons for restatement of assets and liabilities are to recognize currently the excess of the amounts at which assets are stated over their current fair values so that future earnings will not be burdened with that excess and to prevent the need for future accounting reorganizations. Only accounting reorganizations of entities whose reported equity is overstated are consistent with that belief.

Others believe the fact that a reporting entity's reported equity is believed to be understated should not preclude it from reporting its assets and liabilities more satisfactorily.

ISSUE 14: Should the separate financial statements of a subsidiary be permitted to reflect an accounting reorganization if the parent company does not record its own accounting reorganization?

The arguments in this issue are essentially the same as the arguments in Issue 8 in Part I.

ISSUE 15: In the absence of a requirement in state law or the corporate charter for shareholder approval of an accounting reorganization, should an accounting reorganization have to be approved by a reporting entity's shareholders in order to be permitted?

It is assumed that, if there is a requirement in state law or the corporate charter for shareholder approval of an accounting reorganization, shareholder approval would be obtained. (It is also assumed that the procedure would not be undertaken if it would violate existing debt covenants.) At issue, then, is whether accounting reorganizations for which shareholder approval is not required by state law or the corporate charter should be required to be approved by the reporting entity's shareholders in order to be permitted.

The arguments in this issue are essentially the same as the arguments in Issue 7 in Part I. However, those who believe an accounting reorganization should have to be approved by a reporting entity's shareholders in order to be permitted offer as an additional consideration the radicalness of the procedure which, they emphasize, is discretionary (assuming that Issue 17 is answered "no").

ISSUE 16: Should a reporting entity be permitted to record an accounting reorganization more than once?

The arguments in this issue are essentially the same as the arguments in Issue 9 in Part I.

ISSUE 17: Should an accounting reorganization ever be mandatory in circumstances other than those described in Issue 32?

The arguments in this issue are essentially the same as the arguments in Issue 10 in Part I.

> Accounting Procedures

ISSUE 18: Should all identifiable assets be restated in an accounting reorganization?

Some believe only assets for which there is evidence of impairment should be restated. They believe the purpose of an accounting reorganization is to permit a reporting entity to avoid having future results of operations burdened by charges that do not result from earning activities that benefit its operations commensurately. Under this view, restatement is applied only to significant assets that would otherwise result in such future charges.

Some would focus on major classes of assets and would restate all the assets in a class provided the net effect was to reduce the carrying amount of the class; for example, of three buildings owned by a reporting entity, two might require reduction whereas the value of the third exceeds its carrying amount.

Others believe an accounting reorganization should permit a reporting entity to report as though it is starting fresh and that requires a comprehensive restatement of assets. They believe a comprehensive restatement is a feature that distinguishes an accounting reorganization from a writedown of assets to reflect impairment. In their view, permitting selective restatement would be far too discretionary.

ISSUE 19: Should liabilities be restated in an accounting reorganization?

Some believe liabilities should be restated in an accounting reorganization. They believe restating liabilities is consistent with the idea of permitting a reporting entity to report the way it would were it starting fresh. They also point out that liabilities (usually monetary) should be more susceptible of objective restatement than nonmonetary assets.

Others believe liabilities should not be restated in an accounting reorganization. They point out that ARB 43 does not suggest restatement of liabilities. They also point out that if liabilities were restated to their fair values, that would typically result in credits to equity because of financial difficulties of the reporting entity.

Still others believe that only some liabilities should be restated. They note, however, that FASB Statement No. 15 might apply when a troubled debt restructuring coincides with an accounting reorganization unless "the debtor restates its liabilities generally."

ISSUE 20: Should the restatement be based on the values of identifiable assets and liabilities or should it be based on a valuation of the reporting entity as a whole?

Some believe the reporting entity should ideally be valued as a whole; the value of all the reporting entity's common stock should be determined and amounts should be assigned to assets and liabilities, including possibly goodwill, as would be done in a business combination accounted for by the purchase method under APB Opinion 16. They argue that, if the value of a reporting entity's stock is a reasonable basis for reporting assets and liabilities in a business combination accounted for by the purchase method, it is a reasonable basis for restatement of assets and liabilities in an accounting reorganization. They also argue that an equity infusion, which may accompany an accounting reorganization, could provide evidence of value of the entire enterprise and may include a payment for existing goodwill. They also believe that, if unidentifiable intangibles constitute a significant portion of a company's value, they should not be ignored in an accounting reorganization. Further, goodwill (unidentified intangibles) can exist in any business enterprise; its existence should not be ignored in an accounting procedure that purports to restate all assets to fair values.

Others believe only identifiable assets, tangible and intangible, and liabilities should be restated. They offer the following reasons for that position:

Valuation is not an exact science, and, in the absence of a purchase transaction or a significant equity infusion, there would undoubtedly be more difficulty in valuing a reporting entity as a whole than in restating individual assets and liabilities.
Though market prices may exist for some of a reporting entity's stock, there are no market prices available for all of a reporting entity's stock. An accounting reorganization can be distinguished from a business combination accounted for by the purchase method in which stock is the consideration and the value of the stock is the basis for accounting by the purchase method. The amount of stock of the acquiring company issued in the combination is typically less than the amount of the acquiring company's stock already outstanding.
Reporting goodwill would contradict the idea of permitting a reporting entity to report the way it would were it starting fresh, because there is no goodwill when buying individual new assets to form a new entity. Reporting goodwill also contradicts the idea of a troubled entity that is implicit in an accounting reorganization.
Valuing equity varies too drastically from the acquisition cost basis unless it is accompanied, as a separate consideration, by an application of pushdown accounting resulting from a major change in ownership.
There is little support in ARB 43 and little, if any, in practice for revaluation of the entity as a whole.

Still others would base the restatement on the value of the entity as a whole if such value is clearly determinable, and on the value of identifiable assets and liabilities if the value of the entity as a whole is not clearly determinable.

ISSUE 21: Should amounts be assigned to individual assets and liabilities in accordance with the guidelines in paragraph 88 of APB Opinion 16, or should amounts be assigned to individual assets and liabilities another way?

Some believe individual assets and liabilities that are to be revalued should be stated at fair values, because they believe that is most consistent with the concept of a fresh start. They would use the guidelines in paragraph 88 of APB Opinion 16 to determine those fair values, because those guidelines are widely used and well understood.

Others favor stating assets at the amounts of the net future cash flows those assets are expected to generate.

Still others would discount the net future cash flows or would otherwise derive amounts that would allow profit to be reported on the sale or use of those assets. They believe that the concept of recoverable amount or of value in use to the enterprise, as used in FASB Statement No. 33, is useful. Opponents of such methods argue that it is difficult if not impossible to predict future cash flows to be generated by assets and to attribute estimated future cash flows to individual assets, that interactions among assets make the procedure meaningless, that the choice of a discount rate, at least with respect to nonmonetary items, is too subjective, and that predictions do not belong in historical reports.

ISSUE 22: If a reporting entity whose recorded equity is believed to be understated because application of generally accepted accounting principles results in the assets being recorded at less than their current fair values or liabilities being recorded at more than their current fair values is permitted to record an accounting reorganization, should assets and liabilities be restated only to the extent that the restatement would not cause an increase in equity?

Issue 13 discusses whether a reporting entity whose recorded equity is believed to be understated because application of generally accepted accounting principles results in the assets being recorded at less than their current fair values or liabilities being recorded at more than their current fair values should be precluded from recording an accounting reorganization. This issue discusses whether, if such an entity is not precluded from recording an accounting reorganization, adjustments in the reorganization should be limited so that there is no net increase in equity.

The limitation is proposed by those who believe that reporting entities whose reported equity is believed to be understated should not be precluded from recording accounting reorganizations, but they believe that the reorganization should not result in a net increase in equity. They argue that restatements that result in increases in equity would deviate too much from the prohibitions against appraisal write ups in current GAAP. They observe that, in industries such as real estate, for which it is often asserted that current value financial statements are more relevant than financial statements based on acquisition costs, such restatements could permit introduction of current values into financial statements prepared in conformity with generally accepted accounting principles that are otherwise precluded. While they might agree that current values are more relevant in such industries, they believe that accounting reorganizations should not be the means to achieve that result.

In determining whether an accounting reorganization results in a net increase in equity for this purpose, some would consider associated writedowns due to impairment or other losses charged to income in the same or a proximate reporting period.

Others believe that the limitation is inconsistent with permitting a reporting entity to report as if it is starting fresh. They believe that assets and liabilities should be restated to the same extent that they would be were a new corporation created and that corporation acquired the assets and liabilities of the existing corporation. They point out that accounting reorganizations sometimes accompany bankruptcy proceedings and that, in such proceedings, creditors often agree to significantly reduce obligations under debt agreements. They further observe that the application of FASB Statement No. 15 to such debt restructurings may preclude recognizing in the period of restructuring the concessions made by the creditors and may, in the absence of an accounting reorganization that increases equity by writing the restructured debt down to its current value, preclude emergence from bankruptcy with positive equity. They also believe the limitation would require that an arbitrary procedure be specified for putting the limitation into effect; they observe that at least some assets or liabilities would not be restated to fair values. They further question the usefulness of an accounting reorganization that does not affect equity but only reallocates carrying amounts of assets and liabilities.

Still others believe that restatements of assets that must be written down by a charge to income under generally accepted accounting principles should be distinguished from restatements that are discretionary and that are permitted only on the basis of an accounting reorganization. They believe net discretionary restatements in an accounting reorganization should not be permitted to result in a net increase in equity.

ISSUE 23: Should the separate accounts reported in equity that result from cumulative translation adjustments, investments in noncurrent marketable equity securities, certain investments of insurance companies, and pensions be eliminated in an accounting reorganization?

Some believe that the separate accounts reported in equity that result from cumulative translation adjustments, noncurrent marketable equity securities, certain investments of insurance companies, and pensions should be eliminated in an accounting reorganization. They point out that the requirements for separate components of equity in FASB Statement Nos. 12, 52, 60, and 87 resulted from a desire to exclude those items from the income statement and at the same time to adhere to the clean surplus theory in APB Opinion 9. Given the radical nature of accounting reorganizations, neither excluding those items from income nor adhering to the clean surplus theory should be a significant consideration in deciding how the balance sheet should appear after an accounting reorganization. The amounts reported as separate components of equity are, stated broadly, amounts that will eventually be cleared to income. (Of course, they may also be reversed if, for example, unrealized appreciation or depreciation of equity securities is eliminated by market price changes.) An accounting reorganization provides a fresh start, a new balance sheet from which to measure future results. Accordingly, amounts lodged in separate components of equity at the date of the accounting reorganization should not be reflected in future income statements and should be eliminated in the accounting reorganization.

Others believe the separate accounts reported in equity should not be eliminated in an accounting reorganization. They believe accounting reorganizations should be directed at the reporting entities' assets and liabilities, not at the classification of the residual amounts that result from those assets and liabilities. Further, they argue that the separate accounts reported in equity are required by authoritative literature and that that literature should not be disregarded.

Other arguments in this issue are similar to those in Issue 3 in Part I and to Issue 3 in Part II.

ISSUE 24: Should accumulated depreciation and amortization be eliminated when restating assets in an accounting reorganization?

Some believe that to write depreciable or amortizable assets up or down, their acquisition costs should be left intact and only accumulated depreciation or amortization should be adjusted. They believe the resulting financial statement presentation is more informative.

Others believe accumulated depreciation and amortization should be eliminated and the related assets adjusted to the intended amounts. They believe that approach is consistent with the concept of a fresh start.

ISSUE 25: Should an accounting reorganization result in a new reporting entity?

Some believe an accounting reorganization, which is based on the concept of a fresh start, creates a new reporting entity and that financial statements following the accounting reorganization should be those of the new reporting entity. They observe that the accounting reorganization destroys comparability of prereorganization and postreorganization financial statements, and they believe that it follows that postreorganization financial statements are those of a new reporting entity. They believe pro forma financial information should be presented for periods before the accounting reorganization as it is in business combinations accounted for by the purchase method; such information would reflect the values assigned in the reorganization. They also believe historical financial statements should, if presented, be considered those of a predecessor entity. Creating a new reporting entity would eliminate the issue of whether to include the restatement adjustment in income, but it would raise other issues, not dealt with in this issues paper, such as whether the accounting policies for the new reporting entity should be allowed to be selected or changed without concern for preferability.

Others believe that, because the reporting entity after the accounting reorganization is the same legal and economic entity it was before the accounting reorganization, treating the reporting entity in financial statements following the accounting reorganization as a new reporting entity would mislead. They believe it should be enough to label results of operations as before and after the accounting reorganization.

ISSUE 26: If an accounting reorganization does not result in creating a new reporting entity and the restatement adjustment results in a net decrease in recorded equity, should the adjustment be reported in income?

Some believe a restatement that results in a net decrease in recorded equity should be reported in income. They offer the all-inclusive (clean surplus) theory of income determination, described in APB 9, as support for their position.

Others believe the restatement adjustment should be reported as a direct charge or credit to equity. They view an accounting reorganization as directed toward the balance sheet and believe the income statement would be more meaningful if unencumbered by its effects. However, they believe that if the restatement adjustment would ordinarily be reported in income under GAAP, for example, a writedown or writeoff due to impairment of land, buildings, and equipment used in the business, equipment leased to others, or goodwill, it should be reported in the income statement for the period preceding the reorganization. Accounting reorganizations should not be used to avoid charges to income.

Proponents of reflecting the adjustment directly in equity observe that FASB Concepts Statement No. 5 establishes separate concepts of earnings and comprehensive income and believe net adjustments arising in accounting reorganizations might properly be excluded from earnings.

ISSUE 27: If an accounting reorganization does not result in creating a new reporting entity and the restatement adjustment results in a net increase in recorded equity, should the adjustment be reported in income?

Some believe that, if adjustments that result in net decreases in recorded equity are included in income, restatement adjustments that result in increases in recorded equity should also be included in income. They base that view on the concept of neutrality in financial reporting.

Others believe restatement adjustments that result in increases in recorded equity should be included in income only to the extent they offset asset write downs or other losses charged to income in the same or a proximate reporting period.

Still others believe restatement adjustments that result in increases in recorded equity should never be included in income. They believe including such restatement adjustments in income would deviate from the prohibition against including unrealized profits in income in ARB 43, Chapter 1A.

ISSUE 28: If the restatement adjustment should be reported in income, should it be reported as an extraordinary item?

Some believe that if the restatement adjustment should be reported in income, it should, be reported as an extraordinary item. They believe income before extraordinary items should represent the results of a reporting entity's customary business activities and believe including the restatement adjustment in income before extraordinary items would impair the ability of the income statement to help users make predictions as the basis for decisions.

Others believe that if the restatement adjustment should be reported in income, it should be included in income before extraordinary items. They believe that, though the adjustment may meet the criterion in APB Opinion 30 that extraordinary items be infrequent, it would not meet the criterion that extraordinary items be unusual, that is, of a character significantly different from the typical or customary business activities of the entity. Further, they believe that the restatement adjustment may be largely indistinguishable from an impairment writedown and, consequently, they believe the entire restatement adjustment should be included in income before extraordinary items. Moreover, they believe there is no reason to exclude the restatement adjustment from income before extraordinary items. They believe the ability of the income statement to help users make predictions as the basis for decisions would not be impaired by including the adjustment in income before extraordinary items, because the current period's income statement will have little such ability after the accounting reorganization in any event.

> Post Accounting Reorganization Issues

ISSUE 29: If an accounting reorganization (1) results in a new reporting entity or (2) does not result in a new reporting entity and the restatement adjustment is not reported in income, how should changes made after an accounting reorganization to amounts assigned to assets and liabilities in an accounting reorganization be presented?

Amounts assigned to assets and liabilities in an accounting reorganization sometimes are changed after the accounting reorganization, because management decides those amounts are unsatisfactory. For example, the stated amount of an asset that reflects an estimate of the cost to dispose of that asset might be changed before the asset is disposed of if it appears that the cost to dispose of the asset will differ substantially from the previously estimated cost, or an asset or liability that was not recorded in an accounting reorganization might subsequently be seen to have existed at the time of the accounting reorganization.

Similarly, disposition of an asset or settlement of a liability at an amount different from that assigned to it in the accounting reorganization results in a gain or loss, which may be deemed to be an adjustment of the amount assigned to the asset or liability in the accounting reorganization. The question is whether such changes should be reflected in income of the post accounting reorganization period or whether they should be used to adjust the amounts assigned in the accounting reorganization. If the latter, the adjustments would be reflected directly in equity if the accounting reorganization is based on identifiable assets and liabilities (Issue 20) and if the accounting reorganization is based on valuation of the entity as a whole, would be used to adjust the allocation to individual assets and liabilities of the value of the entity as a whole. (It is assumed that there would be general agreement that if the accounting reorganization does not result in a new reporting entity and the restatement adjustment is reported in income, post reorganization changes would also be reflected in income, and that therefore there is no issue to address that circumstance.) This issue does not address tax loss carryforwards or investment tax credit carryforwards.

Some believe such changes in stated amounts of assets and liabilities should be reflected in income in the years they are made, because they believe those changes reflect changes in economic circumstances subsequent to the accounting reorganization. In their view, it is not practical after the passage of time to determine whether a revaluation represents an improvement in an estimate or a change due to changed circumstances.

Others believe such changes in stated amounts of assets and liabilities should be excluded from income only if they are made within a specified period of time after the accounting reorganization. They believe such changes are similar to changes in allocations of purchase prices of acquired enterprises that result from resolution of preacquisition contingencies, such as settlements of litigation pending at acquisition dates. FASB Statement No. 38 states that if preacquisition contingencies assumed in business combinations accounted for by the purchase method are resolved within an allocation period, usually not to exceed one year, they should be included in the purchase allocation and that otherwise they should be included in the determination of net income.

Still others believe that all such changes in stated amounts of assets and liabilities should be reflected directly in equity. They believe the income statement would be more meaningful if unencumbered by items related to the accounting reorganization. Further, they observe that if changes to amounts assigned in the accounting reorganization are reflected in income, there may be an incentive to assign values that will result in post accounting reorganization credits.

For assets to be disposed of after the accounting reorganization, some believe changes in stated amounts should be reflected in income unless disposal of the assets was planned at the time of the accounting reorganization.

Some believe that how such changes should be presented may depend on whether assets and liabilities should be restated individually in an accounting reorganization or whether amounts assigned to assets and liabilities should be based on a revaluation of the reporting entity as a whole.

ISSUE 30: Should reported retained earnings be dated after an accounting reorganization?

The arguments in this issue are essentially the same as the arguments in Issue 14 in Part I.

ISSUE 31: If the separate financial statements of a subsidiary reflect an accounting reorganization and the parent company does not record its own accounting reorganization, should the effects of the subsidiary's accounting reorganization be reversed in consolidation?

Some believe that if the separate financial statements of a subsidiary reflect an accounting reorganization and the parent company does not record its own accounting reorganization, the effects of the subsidiary's accounting reorganization should be reversed in consolidation. They offer these reasons:

Not reversing in consolidation the effects of a subsidiary's accounting reorganization would constitute, in effect, a partial accounting reorganization of the consolidated group. They believe partial accounting reorganizations should not be permitted.
The consolidated group likely has not met the requisite conditions for an accounting reorganization (assuming the procedure is not completely discretionary).
Not reversing in consolidation the effects of a subsidiary's accounting reorganization would constitute an unjustified departure from the acquisition cost basis.

Others believe that if the separate financial statements of a subsidiary reflect an accounting reorganization and the parent company does not record its own accounting reorganization, the effects of the subsidiary's accounting reorganization should be reflected in the consolidated financial statements. They offer these reasons:

The consolidated financial statements should reflect the same amounts for the subsidiary as are reflected in the subsidiary's financial statements.
The subsidiary's accounting reorganization may provide sufficient evidence of a loss of value to the parent company to permit the parent company to write down its investment in the subsidiary.

ISSUE 32: If consolidated financial statements reflect an accounting reorganization of the parent company, should the parent company's accounting reorganization be pushed down to the separate financial statements of its wholly owned subsidiary or subsidiaries?

Some believe that if consolidated financial statements reflect an accounting reorganization of the parent company, the reorganization should be pushed down to the separate financial statements of its wholly owned subsidiaries. They believe the subsidiaries' separate financial statements should reflect the same amounts as are reflected for the subsidiaries in the consolidated financial statements. They further observe that, when the subsidiaries have met the requisite conditions for recording accounting reorganizations, whether the subsidiaries record their own accounting reorganizations is likely a matter of the parent company's discretion, and they believe permitting the parent company discretion in such cases could result in manipulation of financial reporting. Finally, they point to the trend in practice toward more frequent push down to the subsidiary's financial statements of APB 16 purchase accounting adjustments.

Others believe a parent company's accounting reorganization should not be pushed down to its subsidiaries' separate financial statements. They point out that the subsidiaries may not have met the requisite conditions for recording accounting reorganizations. They also point out that, even if the subsidiaries meet the requisite conditions, accounting reorganizations are discretionary and that the subsidiaries have not chosen to record accounting reorganizations. They further point out that pushing a parent company's accounting reorganization down to the separate financial statements of its subsidiaries without the formal approval of the subsidiaries' directors or shareholders may conflict with provisions of state laws governing distributions to shareholders. They are also concerned that there might be circumstances — for example, a subsidiary is regulated or has debt held by third parties — that would further suggest that the parent company's accounting reorganization should not be pushed down to its subsidiaries' separate financial statements.

Those opposing pushing down an accounting reorganization point out the absence of the circumstances in an accounting reorganization that argue for push down accounting in a business combination accounted for by the purchase method — a transaction at arm's length that provides objective evidence of the value of the subsidiary and one that typically involves only the subsidiary whose financial statements give rise to the push down accounting question. Further, the assets and liabilities of the subsidiary may be carried at different amounts in the subsidiary's separate statements and in consolidation if the subsidiary was acquired in a purchase business combination in which push down accounting was not applied. There could be various implementation difficulties, for example, the amount and even the direction (write up or write down) of the net adjustment to equity could be different.

Footnotes

Quasi Reorganizations, Footnote 1 — James S. Schindler, Quasi-reorganization, Ann Arbor, Michigan, University of Michigan, School of Business Administration, 1958.

Quasi Reorganizations, SAB 78, Footnote 1 — Discretionary accounting changes require the filing of a preferability letter by the registrant's independent accountant pursuant to Item 601 of Regulation S-K and Rule 10-01(b)(6) of Regulation S-X, 17 CFR sections 229.601 and 210.l0-01(b)(6), respectively.

Quasi Reorganizations, SAB 78, Footnote 2 — Accounting Series Release No. 25 (May 29, 1941)

Quasi Reorganizations, SAB 78, Footnote 3 — Section 210 indicates the following conditions under which a quasi-reorganization can be effected without the creation of a new corporate entity and without the intervention of formal court proceedings:

Earned surplus, as of the date selected, is exhausted;
Upon consummation of the quasi-reorganization, no deficit exists in any surplus account;
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 laws 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, in order to obviate so far as possible the necessity of future reorganizations of like nature.

Quasi Reorganizations, SAB78, Footnote 4 — In addition, Accounting Research Bulletin (ARB) No. 43, Chapter 7A, outlines procedures that must be followed in connection with and after a quasi- reorganization.

Quasi Reorganizations, SAB 78, Footnote 5 — Accounting Principles Board Opinion No. 20 provides accounting principles to be followed when adopting accounting changes. In addition, many newly-issued accounting pronouncements provide specific guidance to be followed when adopting the accounting specified in such pronouncements.

Quasi Reorganizations, SAB78, Footnote 6 — Certain newly-issued accounting standards do not require adoption until some future date. The staff believes, however, that if the registrant intends or is required to adopt those standards within 12 months following the quasi-reorganization, the registrant should adopt those standards prior to or as an integral part of the quasi- reorganization. Further, registrants should consider early adoption of standards with effective dates more than 12 months subsequent to a quasi-reorganization.

Quasi Reorganizations, SAB 78, Footnote 7 — Certain accounting changes require restatement of prior financial statements. The staff believes that if a quasi-reorganization has been recorded in a restated period, the effects of the accounting change on quasi-reorganization adjustments should also be restated to properly reflect the quasi-reorganization in the restated financial statements. Quasi Reorganizations, SAB 78, Footnote 7 — Certain accounting changes require restatement of prior financial statements. The staff believes that if a quasi-reorganization has been recorded in a restated period, the effects of the accounting change on quasi-reorganization adjustments should also be restated to properly reflect the quasi-reorganization in the restated financial statements.

Quasi Reorganizations, Footnote 2 — Bayless Manning, A Concise Textbook on Legal Capital (Mineola, New York: Foundation Press 1977), pp. 74-75

103

Quasi Reorganizations, Footnote 3 — Committee on Corporate Laws, "Changes in the Model Business Corporation Act — Amendments to Financial Provisions," The Business Lawyer, 34, No. 4 (July 1979), 1867.

114

Quasi Reorganizations, Footnote 4 — Paul Rosenfield versus Steven Rubin, "Minority Interest: Opposing Views," Journal of Accountancy, March 1986, page 80.

125

Quasi Reorganizations, Footnote 5 — A similar issue could be raised about requiring board of directors' approval in circumstances in which it is not required by law or corporate charter. The arguments for and against would be similar to those in this issue.

136

Quasi Reorganizations, Footnote 6 — The FASB is considering a request from the AICPA that it address the accounting for the inability to recover fully the carrying amounts of long-lived assets, which was the subject of an AICPA issues paper.