These are tough times. But thoughtful choices can stretch the dollars you get.
What is fresh start?
Fresh start is an accounting term that refers to the accounting standards businesses must use after emerging from Chapter 11 bankruptcy.
Fresh start accounting standards differ significantly from the standards that businesses usually use. The standards are explained in the Statement of Position (SOP) 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code,” which was issued by the American Institute of Certified Public Accountants in 1990.
Businesses must meet three conditions to qualify for fresh start reporting.
- The business must reorganize in Chapter 11. Businesses that engage in an out-of-court solution do not qualify for the fresh start accounting standards.
- The business must experience a loss of equity control. The holders of the common voting stock must hold less than 50 percent of the common stock when emerging from Chapter 11.
- The company must be technically insolvent, meaning the worth of the business must be less than the face values of its liabilities before restructuring takes place.
Two benefits of the fresh start accounting practices are that they allow the company to start over with a clean balance sheet and the company’s assets are valued at the fair market value (also known as the reorganizational value), versus the historical cost basis of assets (also known as the enterprise value). Because of the methods used to calculate the two values, the value of assets is higher when using the reorganizational value standard.
Fresh start example
ABC Corp. has experienced significant financial difficulty. The company has become insolvent, meaning its debts outweigh its worth. It has had to sell so much stock that it no longer has controlling interest in the company. In consultation with attorneys and the CEO, the board of directors votes to file for Chapter 11 bankruptcy. Upon emerging from bankruptcy, ABC is able to restructure with a clean balance sheet and valuates its assets based on the presumed market value.