Bankruptcy Accounting

As the term implies, bankruptcy accounting deals with the laws surrounding the various chapters of the Bankruptcy Code.There is a growing need for this type of service.During the 1980s approximately 20,000 businesses a year filed for Chapter 11 protection, while individual bankruptcy filings exceeded 700,000 by the end of the decade (Quintero, 1991).

More significant still has been the recent trend of filings, with the majority of the 25 largest bankruptcies in U.S. history have been filed in the last 10 years.A number of companies languish in bankruptcy and appear to be unable to make any apparent progress toward rehabilitation. For instance, a report issued at the end of 1989 by the Administrative Office of the Courts indicated that:

  • More than one-quarter of Chapter 11 cases filed prior to 1987 were still pending in mid-1989.
  • Approximately half the Chapter 11 cases filed prior to 1987 were closed in Chapter 11 without confirmation of a plan of reorganization, or were closed as no-asset Chapter 7 cases.
  • Of the Chapter 11 cases whose plans were eventually confirmed, an average of 740 days elapsed from date of filing until confirmation.
  • The report also indicates that only 10% to 12% of Chapter 11 cases result in a successful reorganization of the debtor's business.

As a result of these constraints, the bankruptcy courts are becoming congested by a growing backlog of unresolved cases; and the size and complexity of many simply exacerbate the problem. While these existing cases remain unresolved, they are being added to by an inundation of new bankruptcy filings resulting from a different economic climate and a variety of other reasons.

The Bankruptcy Code requires debtors-in-possession to pay for professionals (including the bankruptcy examiner) who are approved by the court to assist the creditors, shareholders, and other parties in interest. "The administrative costs can be overwhelming--and many companies continue to hemorrhage while in bankruptcy. Meanwhile, the bankrupt entities face mounting hardship as nervous customers transfer business elsewhere, suppliers require more onerous terms, or key employees leave" (Quintero, 1991, p. 42).Therefore, a compelling reason for appointing an examiner is to facilitate the proceedings that can otherwise cause companies to languish and die while in Chapter 11.Examiner who limits their role to preparation of a report is depriving the court, the U.S. Trustee, and the parties in interest of the benefits that his or her knowledge and experience can provide. "Examiners have the opportunity to act as pivotal explosives in breaking the logjam of bankruptcy cases presently burdening the bankruptcy courts" (Quintero, 1991, p. 42).

To this end, examiners can play an invaluable role as advisors to the court and the U.S. Trustees. Further, CPAs are objective and may be better able to undertake detailed reviews of debtors' operations than the court or the U.S. Trustee. An examiner's insights can be useful to the judge or the U.S. Trustee in formulating responses to important issues. Such insights may be imparted informally in conversations with the U.S. Trustee or in the judge's chambers, or even formally by providing expert testimony. Nevertheless, the bankruptcy process is an inherently adversarial process. Typically, the debtor, the different classes of creditors, and shareholders have divergent views on important issues. Each of the parties in interest may present conflicting opinions based on identical data. In smaller cases, the parties in interest may argue about financial or business issues that even the attorneys advocating their viewpoints do not really understand. As a result, the expertise and objectivity of the examiner can be useful in reducing conflict, establishing alignment, and developing an equitable and reasonable basis upon which to proceed.

Examiners can also play an important role in reducing the duplication of services present in many bankruptcies. Today, many companies in bankruptcy are choked by administrative expenses because their activities are reviewed by multiple sets of accountants hired by secured creditors, unsecured creditors, and any other committees that have been formed. An alternative approach is for the examiner to fulfill the review function as an objective single source of professional accounting services.

The examiner can have a pronounced impact on a bankruptcy case by developing a reorganization plan or showing the parties in interest that a company is no longer a viable reorganization candidate and should therefore be dismissed or converted to Chapter 7. However, the examiner cannot recommend that management be replaced by a trustee and then serve as the trustee. "That is a clear conflict of interest and proscribed by the Bankruptcy Code" (Quintero, 1991, p. 42).