Accounting for Pre-petition Liabilities Not Always as Easy as It Sounds

Accounting for Pre-petition Liabilities Not Always as Easy as It Sounds

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For an entity in bankruptcy, accounting for pre-petition liabilities sounds like it should be a relatively easy task. However, when one really digs into it, there are a number of challenges and situations that result in making what seems like a straightforward task far more challenging.

Why should it be easy? For starters, the accounting for pre-petition liabilities while in bankruptcy is not very different from accounting for liabilities in the ordinary course. Companies are required to maintain systems and procedures to acknowledge obligations when accounting rules indicate they should. These systems and procedures encompass estimation, verification and cut-off. To the extent that the accounting for pre-petition liabilities is different while in bankruptcy, there is specific but limited guidance in the accounting literature to provide direction. For example, AICPA Statement of Position 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code (SOP 90-7)," specifically states that "pre-petition liabilities, including those that become known after the petition is filed, should be reported on the basis of the expected amount of the allowed claims in accordance with FASB Statement No. 5, 'Accounting for Contingencies'...."3 In addition, there is a claims bar date, which is the last day a creditor can file a proof of claim for a pre-petition liability. The claims bar date should make things easier because it provides a firm cut-off date, allowing the company to define the population of pre-petition claimants. The claims bar date allows the company to reassess the adequacy of its acknowledged pre-petition liabilities, at least as to identified claimants, if not amounts. With few exceptions, if a creditor does not file a proof of claim by the bar date, the creditor is forever barred from asserting a claim for a pre-petition liability. This applies whether the claim is a straightforward accounts payable-related claim or a very complex litigation-related claim.

So one would think that if there is some accounting guidance and there is a complete population of claims for pre-petition liabilities, it should not be all that difficult for an experienced accountant to do the accounting. However, accounting for pre-petition liabilities is much easier said than done. In many cases, a debtor will not file for bankruptcy at a normal month, quarter or fiscal year end. This results in the need to perform an accounting cut-off mid-month. Significant additional processes and procedures may need to be developed to distinguish the liabilities that fall before and after the bankruptcy filing, especially for larger companies. More importantly, the claims process can quickly become very data-intensive and complex. The voluminous and complex nature of the data makes the application of accounting rules challenging, even for an experienced accountant.

Where Claims Come From

Typically, all of a debtor's known creditors are listed on the debtor's schedules of liabilities: Schedules D, E and F. Included in the schedules is the debtor's value of the pre-petition liability owed to each creditor based on the debtor's books and records. In many cases, the value is listed as contingent, disputed and/or unliquidated, depending on the circumstances and the company's relationship with the party. The schedules are filed with or shortly after the bankruptcy petition is filed. At some point thereafter, a bar date is set by the court. When the bar date is set, each creditor listed on the schedules is mailed a bar date notice and a proof of claim form. In addition, the bar date notice and proof of claim form are typically mailed to many other parties who are potential creditors. Other potential creditors may include, but are not limited to, employees and former employees, customers and former customers as well as vendors and former vendors. At the same time, in larger cases, some amount of advertising of the bar date may take place often in widely read newspapers, such as The Wall Street Journal and USA Today.

During the period prior to the bar date, any creditor who disagrees with the amount of liability listed on the schedules or any creditor who is not listed on the schedules, or whose claim is scheduled as disputed, contingent or unliquidated, must file a proof of claim or forever forego the opportunity to make a claim against the debtor.

A second source of claims are those proofs of claim filed as a result of restructuring activities, such as the rejection of executory contracts. Depending on the circumstances, executory contracts may be rejected over the entire period of the bankruptcy, including the period after the bar date. The rejection of executory contracts has the effect of creating new pre-petition liabilities. Unless the court order provides otherwise, the counter-party to a rejected contract is allowed to file a proof of claim after the bar date for rejection damages, resulting in additional claims being added to the claims population.

The Complexities of Claims

So what is so complex about claims? For starters, the sheer volume of potential claims presents tremendous challenges. The bar date deadline combined with the widespread mailing and advertising can lead to a large number of proofs of claim being filed. In larger cases, it would not be unusual for there to be thousands, if not tens of thousands, of proofs of claim filed. In one recent case, because the debtor maintained separate contractual agreements with each location of its many national and international customers, the claims process addressed more than 300,000 executory contracts.

Included in this claim population are numerous claims that the company will ultimately find to be invalid. Nevertheless, each claim must be reviewed before it can be completely dismissed from an accounting perspective. Examples of likely invalid claims include various types of redundant or duplicate claims, claims by equity security-holders solely to record ownership interest or possession of such equity securities, and claims by creditors whose liabilities have already been satisfied. Unfortunately, invalid claims must be identified and excluded from the population of claims to arrive at a population that more closely resembles the debtor's true liabilities, for which an accounting analysis and related adjusting entry may be necessary.

In addition to the volume of claims, there are in many cases a large number of contingent or unliquidated claims. Some of these claims are valid and may require accounting recognition. However, many parties file proofs of claim before there is certainty that an obligation on the company's part actually exists. For example, the counterparty to an executory contract may file a proof of claim for rejection damages before knowing if the applicable contract is going to be rejected, only to find out later that the contract was assumed. In addition, proofs of claim are filed by issuers of letters of credit, both drawn and undrawn, as well as issuers of surety bonds. These types of claims must also be reviewed and analyzed to determine their validity and the appropriate accounting recognition, if any.

A third group of claims that result in accounting challenges are simply disputed claims. These range from complex litigation and tax disputes to what would seemingly be straightforward trade-vendor disputes. However, even trade-vendor claims can present some complexities. For a trade vendor, this is the last opportunity to make a claim for any unpaid pre-petition invoice, no matter how old. This fact, combined with any number of other reasons, typically results in a high percentage of trade creditor claims that are in dispute with the debtor's books and records. As with the other types of claims, these claims must be reviewed and analyzed to determine their validity and the appropriate accounting recognition.

When Does It End?

Depending on the circumstances, accounting for pre-petition claims may be complete when the debtor emerges from bankruptcy. However, emergence (the effective date of the plan) may not mean the end of the accounting challenges. It is likely that the overall resolution of claims will continue post-emergence with some aspects of the claims process continuing to affect the reorganized company. Depending on timing, bankruptcy circumstances and the size of the case, a number of claims will probably be unresolved at emergence. In large cases, a large number of claims may be unresolved.

The form of the reorganization plan is a significant factor in determining when a company has put its pre-petition liabilities and the related accounting and financial reporting behind it once and for all. In the best-case scenario from a debtor's perspective, a reorganization plan will provide for the transfer of claims and a fixed "pot" of value to a reorganization trust upon the company's emergence from bankruptcy. In such a case, the company must make a final estimation of the claims it has transferred to resolve its financial reporting obligations. In all likelihood, the company will have continued obligations to work with the reorganization trust supplying historic information and assistance to resolve disputes, but the "pot" plan and trust protect the reorganized company from having any continued financial reporting obligation if the claims are ultimately higher (or lower) than estimated when the transfer to the trust took place.

Under a reorganization plan that provides a fixed return to creditors regardless of what size the claims pool is or, in the case of the reorganized company, retaining the obligation to resolve claims, the ultimate outcome of adjustments to the estimated claims pool at emergence could result in adjustments that are recorded in the reorganized company's post-emergence results of operations.


One would think that the accounting for pre-petition liabilities should be a straightforward task, and in many cases, it is relatively simple. However, because of the numerous factors that can lead to significant challenges in the accounting for pre-petition liabilities, even in bankruptcy cases that do not appear to be overly complex, it is always best to prepare for the complexities that may arise by careful planning and staying ahead of the curve, even if the case turns out to be more easily handled than expected.


1 Steve Burns is a managing director in Huron Consulting Group LLC's Corporate Advisory Services practice who leads Huron's bankruptcy claims management practice. Return to article

2 Brian Linscott is a director in Huron Consulting Group LLC's Corporate Advisory Services bankruptcy claims management practice. Return to article

3 AICPA Statement of Position 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code," Nov. 19, 1990, paragraph 24. Return to article

Journal Date: 
Friday, October 1, 2004