Accounting theory and practice, Volume 2 (of 3) : a textbook for colleges and…

proceedings. Under the National Bankruptcy Act, a person is insolvent “when the aggregate of his property, exclusive of any property that he has conveyed, transferred, concealed or removed, or permitted to be removed with intent to hinder, delay or defraud his creditors, is not, at a fair valuation, sufficient in amount to pay his debts.” _Voluntary Dissolution._ A corporation may or may not be insolvent when making a voluntary dissolution. The reasons for the decision on the part of the stockholders to take this step may be various. Perhaps business is falling off and further profitable use cannot be made of the capital, or the company while solvent is losing money and drawing on its surplus. Again the cause may be due to legal complications, especially when concerns are adjudged combinations in restraint of trade. Voluntary dissolution in general is due to the fact that the condition of affairs seems to be unprofitable and the near future promises nothing better. _Receivership._ One method of liquidating an insolvent corporation is by means of a receivership. The appointment of a receiver in equity is different in purpose from that of a receiver in bankruptcy. The function of the receiver in equity is to continue the business until it is wound up. In bankruptcy proceedings a receiver is appointed temporarily to preserve the property until a trustee can be elected. He does not conduct the business, but merely takes care of the goods, and pays taxes and dues, until the election of the trustee. A receivership in equity is frequently a preliminary step to reorganization. While the concern is technically insolvent in that the quick assets are not sufficient to meet maturing obligations, the total assets really exceed the total liabilities. Were the fixed assets sold, only a small fraction of their value might be realized. Under these circumstances the appointment of a receiver in equity is a valuable measure, giving time to provide for permanent remedies. Liquidation under Bankruptcy In involuntary bankruptcy proceedings the creditors file a petition in the federal courts located in the judicial district where the bankrupt has his place of business or in which his property is located. A copy of the petition is served on the bankrupt. The petition generally asks for the appointment of a receiver to protect the property until a trustee can be elected. The receiver is appointed by the court and is given charge of all property of the bankrupt until the first meeting of the creditors. The proceedings are generally conducted before a referee in bankruptcy appointed by the court. After the expiration of 20 days, during which the bankrupt is allowed to make his reply, he is required to file a list of all claims against him. A meeting of all creditors whose claims have been allowed by the court is then called and, if the petition is granted, a trustee is elected. Creditors who have some security for their claims are not allowed to vote for the trustee unless the security is insufficient to cover their claims, in which case they may vote on the amount of claim which is unsecured. As soon as the trustee has been elected the creditors should file their claims with him together with the proof of the claims. This may consist of an affidavit stating the nature and amount of the claim, and the security held, if any. The bankruptcy proceedings are carried through unless the creditors and debtor agree to compromise. The trustee’s first duty on his appointment is to collect all the property and any debts owing to the bankrupt, and to turn everything into cash in as short time as possible without unduly sacrificing the assets. As a general rule it is necessary to keep the business going for some time in order to get the most out of it. From the receipts the trustee pays taxes, filing fees, court costs, attorney’s fee and wages due, and then the creditors. Servants and persons employed for three months prior to the bankruptcy proceedings are entitled to be paid before any other claims are settled. After that the secured debts are discharged to the value of the security. When these items have been paid, if there remains enough to pay 5% of the total amount of all other claims, the creditors are entitled to have a dividend declared within 30 days after the debtor has been adjudged a bankrupt. If not, they must wait until the trustee has collected a sufficient amount. Afterwards the creditors are entitled to dividends from time to time until the entire amount in the hands of the trustee has been paid out. When the final dividend has been paid the trustee makes up his accounts, presents them at court, and asks for a discharge. He then is entitled to his fee based on the value of the funds that have gone through his hands. Liquidation under Voluntary Dissolution A corporation may be dissolved and its affairs wound up by the proper procedure if all its stockholders consent. In some states a majority is sufficient, and in certain cases even less. Statutory provisions prescribe the procedure in most of the states. The process of voluntary dissolution consists simply of gradually closing down the business by realizing on the assets, and distributing the funds among the creditors and stockholders. This usually involves a vast amount of detail work, such as the transfer of contracts, the sale of parts of the business, the taking of inventories, the making of appraisals, and so on. Liquidation under Receivership The receivership in bankruptcy is only a step in the chain leading to the appointment of a trustee under whom the process of liquidation takes place. As already stated, the receivership in equity is sometimes not a process of liquidation but a means of carrying on the business pending reorganization. In case the assets are greater than the liabilities, it may be advisable to effect some sort of reorganization to continue the business. The receiver can continue the business in whatever way the court will permit. Any of its unprofitable and unessential parts may be sold and in this way a partial liquidation may be effected. With permission of the court the receiver may issue receiver’s certificates to meet immediate and necessary running expenses. The certificates usually have the first claim on the assets. It seldom happens that these remedies are sufficient to put the company on its feet and the receiver in the end will wind up the business by disposing of the assets and distributing the proceeds as instructed by the court. A receiver is an officer of the court and acts under its instructions. In all dubious matters he can protect himself from liability by procuring an order of court or by refusing to act until authorized by an order of court. Status of Creditors in Liquidation Creditors may be divided into two groups—secured and unsecured. Those that have a lien upon some specific part of the assets, such as buildings, machinery, or materials, and holders of bonds are among those whose claims are secured. Trade credits and bank loans often have no other security than the standing of the firm. If the business has been in a receiver’s hands and receiver’s certificates, have been issued, these may be given priority over all debts except those for taxes. The bondholders are usually given the opportunity to appear and present their arguments for or against the issuance of receiver’s certificates. The court directs the issuance at its discretion. Preferred and common stockholders receive what is left after everyone else has been paid. If the preferred stock is preferred as to assets, it takes priority over the common stock. Often, however, the preference is only as to earnings, in which case the two stock issues share equally in the liquidation. Directors are prohibited by law from declaring dividends except out of earnings. If it should appear that dividends have been paid out of capital and not out of earnings, the stockholders are liable for any amounts thus paid out to them. If the stock issued is only partly paid, the stockholders are liable up to the amount which remains unpaid. Accounting for Liquidation Accounting for liquidation may be simple or complex, depending upon circumstances, but it involves practically nothing new in principle. The main bookkeeping features for a liquidation which takes place because of bankruptcy or receivership are treated in Chapter XXXV where some specialized forms of statement are discussed and illustrated. Here it is purposed merely to point out the accounting procedure necessary in the case of a voluntary dissolution. Under a voluntary liquidation the same books of account are used as for the regular record of business transactions, and the procedure is merely a matter of recording the conversion of assets into cash. This involves taking into consideration, in the case of depreciating assets, the adjustment between the asset account, the depreciation reserve, and the loss or gain realized upon the final disposal of the asset. It may be desirable to separate these losses and gains on the sale of fixed properties from the losses and gains of the stock-in-trade, particularly if operations are continued up to the point of the final disposal of the merchandise stock on hand through the regular channels of trade. If, however, the sale of the whole property, including stock-in-trade, is effected, there is no occasion for the separation of the results of the liquidation of the two types of assets. But if this is desirable a separate clearing account, sometimes called “Liquidation Profit and Loss,” may be opened to summarize the losses and gains on fixed assets before transferring the net result of both into surplus. As the assets are sold and converted into cash the liabilities will be liquidated in due course, the accounting features here being the same as during the period of regular operation. After all assets have been converted into cash and all liabilities liquidated, only the cash and net worth accounts will remain on the books of the corporation. If the net result of the liquidation has been to encroach upon the original capital, the net worth accounts will consist of a deficit account and one or more capital stock accounts. If, however, a profit has resulted or if the resulting deficit is not sufficient to wipe out any previously accumulated surplus, the net worth accounts will consist of a surplus account and the various capital stock accounts. The final step in liquidation will be the declaration of a liquidating dividend of the amount of cash on hand; this will be apportioned, just as all other dividends, on the basis of the stockholdings of the various shareholders. The books will be finally closed by charging the dividend and deficit, if any, to the various capital stock accounts in the one case; or by charging the dividend against the various capital stock accounts and surplus in the other case. In practice the closing of all accounts on the books is seldom carried out, the bookkeeping ceasing with the declaration of the liquidating dividend which disposes of the cash. Except as a matter of complete record, nothing is to be gained by closing off the accounts.