Modeling Fresh Start Accounting

Modeling Fresh Start Accounting

When To Use

• Debtor has confirmed a Chapter 11 plan and meets both ASC 852 eligibility tests: (1) reorganization value of emerging entity's assets is less than total post-petition liabilities and allowed claims, and (2) pre-petition voting shares lost majority control
• Preparing day-one emergence balance sheet for SEC filing, lender reporting, or investor due diligence
• Allocating reorganization value across identifiable assets and goodwill for a post-emergence entity
• Modeling the financial impact of plan-of-reorganization scenarios on emergence equity value
• Advising distressed investors on expected book-value basis in post-emergence equity or debt

Inputs To Gather

• Pre-emergence balance sheet — last filed debtor balance sheet (10-Q/10-K or monthly operating report)
• Confirmed plan of reorganization — treatment of each class, new equity allocation, reinstated/new debt terms
• Enterprise / reorganization value — from disclosure statement valuation (DCF, comparable companies, precedent transactions) or negotiated plan value
• Fair value appraisals — third-party or management estimates for PP&E, intangibles, real estate, inventory
• Debt schedules — exit facility term sheets, reinstated debt terms, accrued interest through effective date
• Tax attributes — NOL carryforward schedule, Section 382 limitation estimate, deferred tax asset/liability detail [VERIFY against debtor's tax advisors]
• Claim reconciliation — allowed claims by class versus scheduled amounts, any disputed/contingent reserves

Workflow

1. Confirm fresh-start eligibility

   • Test reorganization value < total post-petition liabilities + allowed claims
   • Test pre-petition shareholders received < 50% of new voting equity
   • Document both tests with specific figures and sources

2. Establish reorganization value

   • Use midpoint of disclosure-statement valuation range unless plan specifies a different basis
   • Reconcile enterprise value to equity value: EV − exit debt − other priority claims = equity reorganization value
   • Note any negotiated plan adjustments that override standard valuation

3. Mark assets to fair value

   • Revalue each asset class to fair value: cash (par), receivables (net realizable), inventory (NRV or replacement), PP&E (appraised), identified intangibles (relief-from-royalty, multi-period excess earnings, or cost approach as appropriate)
   • Eliminate historical goodwill entirely
   • Record deferred tax impact of fair-value step-ups/step-downs [VERIFY — jurisdiction-specific tax rates and Section 382 limitations apply]

4. Mark liabilities to fair value

   • Exit debt at par (new issuance) or fair value (reinstated obligations)
   • Record lease liabilities under ASC 842 at emergence terms
   • Adjust pension/OPEB to current actuarial value
   • Settle pre-petition claims per plan: convert to new equity, cash, or new notes

5. Allocate reorganization value excess

   • Compute excess: reorganization value of assets − sum of fair-valued identifiable net assets
   • Positive excess → new goodwill on emergence balance sheet
   • Negative excess → reduce long-lived asset values pro-rata (intangibles first, then PP&E) until eliminated; any remainder recognized as a bargain-purchase gain [VERIFY — rare but occurs in deeply distressed cases]

6. Build emergence balance sheet

   • Present a clean day-one balance sheet with all fresh-start adjustments in a bridge/waterfall format
   • Columns: pre-emergence book → plan adjustments (debt discharge, equity conversion) → fresh-start adjustments (fair value marks, goodwill) → post-emergence balance sheet
   • Equity section: new common equity at reorganization value, no retained earnings (reset to zero), no AOCI carryover

7. Sensitivity and scenario analysis

   • Flex reorganization value ±10–20% and show impact on goodwill and emergence equity
   • Scenario-test key valuation assumptions (discount rate, terminal growth, EBITDA margin)
   • Show impact of Section 382 limitation on usable NOLs and resulting DTA adjustment

Output

• Fresh-start bridge table — waterfall from pre-emergence to post-emergence balance sheet with plan-adjustment and fresh-start-adjustment columns
• Reorganization value allocation schedule — line-by-line asset/liability fair values, identifiable intangible breakdown, and residual goodwill
• Emergence balance sheet — day-one balance sheet formatted for 8-K or lender-presentation use
• Sensitivity matrix — goodwill and equity sensitivity to reorganization value range
• Assumptions log — numbered list of every material assumption with source reference and [VERIFY] flags

Quality Checks

• Emergence balance sheet balances (assets = liabilities + equity) — confirm to the dollar
• Reorganization value of total assets ties back to enterprise value build-up
• Goodwill is non-negative; if negative, confirm long-lived assets were reduced per ASC 852-10-45
• Eliminated items: historical goodwill is zero, retained earnings is zero, AOCI is zero
• Exit debt face value matches confirmed plan term sheets
• DTA/DTL reflects post-382 limitation on NOLs, not pre-petition full carryforward [VERIFY]
• All fair-value marks have a cited source (appraisal, management estimate, or model output)
• No stale pre-petition accrual balances carried through — each liability line reconciled to plan treatment