Chapter 10 — Equity Transactions and Disclosures

10.9 Quasi-Reorganizations

10.9.1 General

ASC 852-20

General

05-1 This Subtopic addresses the accounting applicable to a corporate readjustment procedure in which, without the creation of a new corporate entity and without the intervention of formal court proceedings, an entity restates its balance sheet to fair value. This corporate readjustment procedure may eliminate an accumulated deficit and/or prevent future charges to its income statement that otherwise would be made. The accounting permitted through such a procedure is an exception to the general rule discussed in paragraph 852-20-25-2.

05-2 Readjustments of this kind fall in the category of what are called quasi-reorganizations. This Subtopic does not deal with the general question of quasi-reorganizations, but only with cases in which the exception permitted in paragraph 852-20-25-2 is availed of by a corporation. Such cases are referred to as readjustments. The accounting and reporting issues that arise and are addressed in this Subtopic consist of what is permitted in a readjustment and what is permitted thereafter.

05-3 This Subtopic does not address quasi-reorganizations involving only deficit reclassifications.

Entities

15-1 The guidance in this Subtopic applies to all public and nonpublic entities that are corporations.

Transactions

15-2 The guidance in this Subtopic applies only to readjustments in which the current income, or retained earnings or accumulated deficit account, or the income account of future years is relieved of charges that would otherwise be made against it, and is therefore limited to readjustments of the type specified in paragraph 852-20-25-2.

15-3 The guidance in this Subtopic does not apply to the following transactions and activities:

Quasi-reorganizations involving only deficit reclassifications
Charges against additional paid-in capital in other types of readjustments such as readjustments for the purpose of correcting erroneous credits made to additional paid-in capital in the past
Financial reporting for entities that enter and intend to emerge from Chapter 11 reorganization, at the time of such reorganization.

SEC Staff Accounting Bulletins

SAB Topic 5.S, Quasi-Reorganization [Reproduced in ASC 852-20-S99-2]

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. . . .

Question 1: May the company reclassify its capital accounts to eliminate the accumulated deficit without satisfying all of the conditions enumerated in Section 21022 of 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 21023 for a quasi-reorganization are satisfied.24

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22 ASR 25.

23 Section 210 (ASR 25) 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 considerations as well as appropriate modifications of capital and capital surplus, in order to obviate, so far as possible, the necessity of future reorganization of like nature.

24 In addition, FASB ASC Subtopic 852-20, Reorganizations — Quasi-Reorganizations, outlines procedures that must be followed in connection with and after a quasi-reorganization.

A quasi-reorganization is an accounting concept that allows an entity to eliminate an accumulated deficit without going through a legal reorganization (i.e., the entity “resets” its accounting records as if it were a new company). If the conditions for a quasi-reorganization are met, an entity may eliminate an accumulated deficit by restating its assets and liabilities to fair value. Notwithstanding the language in ASC 852-20-15-3(a), SAB Topic 5.S does not permit an SEC registrant to reclassify its capital accounts to eliminate an accumulated deficit unless certain conditions are met. Further, entities are not subject to the guidance on quasi-reorganizations if they apply fresh-start accounting after a reorganization under Chapter 11 of the United States Bankruptcy Code (see ASC 852-10). For a discussion of the disclosures required when an entity completes a quasi-reorganization, see Section 10.10.3.12.

10.9.2 Conditions

ASC 852-20

General

25-1 This Section addresses the conditions under which a corporation may recognize a readjustment of its retained earnings or accumulated deficit balance.

25-2 The general requirement is that additional paid-in capital, however created, shall not be used to relieve the income account of the current or future years of charges that would otherwise be made to the income account. As an exception to this requirement, if a reorganized entity would be relieved of charges that would be required to be made against income if the existing corporation were continued, it may be 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 reorganization.

25-3 If a corporation elects to restate its assets, capital stock, additional paid-in capital, and retained earnings or accumulated deficit through a readjustment and therefore avail itself of permission to relieve its future income account or retained earnings account of charges that would otherwise be made against it, it shall make a clear report to its shareholders of the restatements proposed to be made, and obtain their formal consent. It shall 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 that justify charges to additional paid-in capital.

25-5 The effective date of the readjustment, from which the income of the entity is subsequently determined, shall be as near as practicable to the date on which formal consent of the stockholders is given, and shall ordinarily not be before the close of the last completed fiscal year. When the readjustment has been completed, the entity’s accounting shall be substantially similar to that appropriate for a new entity.

SEC Rules, Regulations, and Interpretations

FRR 210. Quasi-Reorganization (ASR 25) [Reproduced in ASC 852-20-S99-1]

Inquiry has been made from time to time as to the conditions under which a quasi-reorganization has come to be applied in accounting to the corporate procedures in the course of which a company, without the creation of a new corporate entity and without the intervention of formal court proceedings, is enabled to eliminate a deficit whether resulting from operations of the recognition of other losses or both and to establish a new earned surplus account for the accumulation of earnings subsequent to the date selected as the effective date of the quasi-reorganization.

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 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 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 of formation of a new corporation, particularly if the sole or principle 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.

For an entity to eliminate an accumulated deficit by restating its assets and liabilities to fair value, the conditions for a quasi-reorganization in ASC 852-20-25 and FRR 210 must be met. Furthermore, the effective date ordinarily cannot be before the end of the most recent financial year.

10.9.3 Initial Measurement

ASC 852-20

General

25-4 When the amounts to be written off in a readjustment have been determined, they shall be charged first against retained earnings to the full extent of such retained earnings; any balance may then be charged against additional paid-in capital. An entity that has subsidiaries shall apply this rule in such a way that no consolidated retained earnings survive a readjustment in which any part of losses has been charged to additional paid-in capital. If the retained earnings of any subsidiaries cannot be applied against the losses before application against additional paid-in capital, the parent entity’s interest in such retained earnings shall be regarded as capitalized by the readjustment just as retained earnings at the date of acquisition is capitalized, so far as the parent is concerned.

25-6 Additional paid-in capital originating in such a readjustment is restricted in the same manner as that of a new corporation; charges against it shall be only those which may properly be made against the additional paid-in capital of a new corporation.

25-7 The accounting for tax benefits arising from deductible temporary differences and carryforwards related to a readjustment is addressed in Subtopic 852-740.

General

30-1 This Section provides guidance on the adjustment of accounts required by paragraph 852-20-25-3 as of the readjustment date in connection with the readjustments addressed by this Subtopic.

30-2 A write-down of assets below amounts that are likely to be subsequently realized, though it may result in conservatism in the balance sheet at the readjustment date, may also result in overstatement of earnings or of retained earnings when the assets are subsequently realized. Therefore, in general, assets shall 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 subsequently employed by the entity.

30-3 If the fair value of any asset is not readily determinable a conservative estimate may be made, but in that case the amount shall be described as an estimate. Paragraph 852-20-35-2 describes the subsequent accounting for any material difference arising through realization or otherwise and not attributable to events occurring or circumstances arising after that date.

30-4 Similarly, if potential losses or charges are known to have arisen before the date of readjustment but such amounts are then indeterminate, provision may properly be made to cover the maximum probable losses or charges.

Upon the consummation of a quasi-reorganization, the entity adjusts its assets and liabilities to their fair value (or an estimate of fair value if fair value is not readily determinable). To the extent that the aggregate amount of the restated liabilities and equity exceeds the amount of restated assets, and there is no retained earnings balance, the excess is charged to APIC.

10.9.4 Subsequent Measurement

ASC 852-20

General

35-1 Section 852-20-30 addresses the adjustments required to be made at the date of a readjustment addressed by this Subtopic. This Section addresses the subsequent accounting if the amounts determined as of the date of readjustment are found to have been excessive or insufficient.

35-2 If the fair value of any asset was not readily determinable and a conservative estimate was made at the date of the readjustment, any material difference arising through realization or otherwise and not attributable to events occurring or circumstances arising after that date shall not be carried to income or retained earnings. Similarly, if provisions for losses or charges established at the date of readjustment are subsequently found to have been excessive or insufficient, the difference shall not be carried to retained earnings nor used to offset losses or gains originating after the readjustment, but shall be recorded as additional paid-in capital.

SEC Staff Accounting Bulletins

SAB Topic 5.S, Quasi-Reorganization [Reproduced in ASC 852-20-S99-2]

Question 5: If a company had previously recorded a quasi-reorganization that only resulted in the elimination of a deficit in retained earnings, may the company reverse such entry and “undo” its quasi-reorganization?

Interpretive Response: No. The staff believes FASB ASC Topic 250, Accounting Changes and Error Corrections, would preclude such a change in accounting. It states: “a method of accounting that was previously adopted for a type of transaction or event that is being terminated or that was a single, nonrecurring event in the past shall not be changed.” (emphasis added.)33

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33 FASB ASC paragraph 250-10-45-12.

While an entity cannot reverse a previously recognized quasi-reorganization, it may need to adjust the amounts recognized. Such adjustments would be recorded against APIC provided that they are not attributable to events or circumstances that occurred after the date of the quasi-reorganization.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.