Reorganizing an ailing business under Chapter 11 of the federal bankruptcy laws can be difficult. But the future of companies that survive this painful process has just become a little brighter, thanks to an new accounting standard called "fresh-start reporting."
In a recent statement of position, the American Institute of Certified Public Accountants -- the chief rule-making body for the accounting profession -- announced that companies emerging from bankruptcy, if they meet certain technical conditions, may now list their assets on the basis of fair-market value instead of on the basis of historical cost.
As subtle as the change may appear to non-accountants, it means a major boost for companies struggling to regain their financial footing, said Terry L. Musika, a partner with the Baltimore accounting firm C. W. Amos & Co. and a specialist in bankruptcy matters.
With the recognition of fresh-start reporting, "the accounting profession is saying to business owners, 'When you come out of bankruptcy we'll allow you to make your balance sheet as strong as you really think you are,' " Mr. Musika said.
"The idea is this: If we're trying to reorganize a company, shouldn't we give it a new basis to work on, a 'fresh start'?" he said.
When the bankruptcy court confirms a reorganized company's plan of operation, it makes a legal determination of the company's liabilities, Mr. Musika said.
The question accountants have wrestled with for years, however, is how to value the other side of a company's balance sheet -- its assets.
Some accountants, for example, would value the assets of a reorganized company as though the company had been purchased outright, said Charles Goldstein, a C. W. Amos manager who works with Mr. Musika.
This treatment "left too many gray areas" because it ignored the value the company would generate as a going concern, Mr. Goldstein said.
Under the institute's new statement, accountants "can look at what the company can do in terms of profits in the future.
The present value of those future profits is then allocated to the assets," Mr. Musika said.
This figure is officially designated, in formal institute fashion, the "reorganization value in excess of amounts allocable to identifiable assets."
In essence, however, it represents a form of goodwill and is designed to give a reorganized company a fresh financial face to present to banks and other potential lenders, Mr. Musika and Mr. Goldstein said.
The institute released its statement on bankruptcy-related accounting in mid-November, after 18 months of study and more than 13 years after the federal bankruptcy code was overhauled.
The rising number of business bankruptcies nationwide spurred the action, Mr. Goldstein said. Also, with more and more accountants being sued for providing favorable audits to companies that later failed, the institute wanted to provide "a sort of safe haven for auditors," he said.
"After all, there's a risk in providing an audit to a company that was weak enough to seek the protection of the bankruptcy court in the first place," Mr. Goldstein said.