What is a Quasi-Reorganization?
A quasi-reorganization is a lesser-known accounting provision, which enables a company to eliminate a deficit in its retained earnings by restating assets, liabilities, and equity in a manner comparable to bankruptcy. With shareholder approval, the firm essentially resets its financial records as though a new entity has taken over the assets and liabilities of the old one.
Key Takeaways
- A quasi-reorganization resets a company’s retained earnings to zero by fair valuing overvalued assets and liabilities.
- This provision is part of the U.S. Generally Accepted Accounting Principles (GAAP).
- Shareholders must agree to the reorganization process.
- It aims to address retained earnings deficits and improve financial statements without altering the firm’s actual economic position.
- While offering accounting flexibility, it also carries risks for lenders and suppliers who must scrutinize financial statements carefully.
A Fresh Start: Understanding Quasi-Reorganizations
Despite its benefits, a quasi-reorganization is rarely used in practice. This tool offers a ‘fresh start,’ appearing more enticing to investors compared to a gradual recovery from retained earnings deficits.
Implemented accurately, it allows a fair reassessment of the firm’s balances, particularly when asset values have plummeted. However, the controversial nature arises because it doesn’t change the economic reality— it merely makes financial statements look better than they might actually be.
One significant risk involves misleading lenders or suppliers who depend on these financial statements. They might extend credit more freely only to see higher risks if they were aware of the true situation. Companies opting for a quasi-reorganization must disclose this in their financial statements, enabling lenders to evaluate risks appropriately.
Reaping the Benefits of a Quasi-Reorganization
New businesses often face initial losses as they build networks, train employees, hone procedures, and establish brand identity. Additionally, prolonged recessions can turn profitable companies into ones with retained earnings deficits.
Many jurisdictions and debt covenants prohibit paying dividends when operating under a retained earnings deficit. This raises the cost of capital significantly as higher returns are demanded for increased perceived risks. In such scenarios, a quasi-reorganization can present a practical solution by preserving the ability to pay dividends, avoiding the time and costs linked with bankruptcy filings, and potentially enjoying tax advantages.
While a quasi-reorganization doesn’t inherently improve the operational side of a business, it often accompanies restructuring initiatives like consolidation and efficiency improvements.
Goals of a Quasi-Reorganization
The primary objective of a quasi-reorganization is resetting the retained earnings balance to zero. This involves writing down overvalued assets to their fair value, which momentarily increases deficits but reduces future depreciation expenses. Similarly, liabilities are revalued to their fair values; any resultant discrepancies reduce the retained earnings deficit.
After adjusting assets to fair value, adjustments may also involve reducing the par value of common stock or reallocating additional paid-in capital to strike a balance and eliminate the retained earnings deficit. Firms have the flexibility to configure these adjustments as they see fit, offering a strategic advantage in stabilizing the financial footing.
Related Terms: Retained Earnings, Fair Value, Paid-in Capital, Depreciation, Liabilities, Equity, Shareholders.
References
- Accounting Standards Codification. “852-20-05”.
- Accounting Standards Codification. “852-20-50”.
- Deloitte. “AICPA Issues Papers—Quasi-Reorganizations”.
