Oil & Gas Bankruptcies Bring Renewed Focus On Fresh-Start Valuations

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Continued market uncertainty has spurred a wave of recent corporate bankruptcies and restructurings across many industries and business segments.

For most businesses, the primary cause for uncertainty has been the worldwide spread of COVID-19. The oil and gas industry in particular began facing headwinds prior to the pandemic as a result of tensions between Russia and Saudi Arabia with respect to increasing crude oil supply. COVID-19 further exacerbated the situation, causing a significant decline in global crude oil demand.

"[T]here’s a renewed focus among auditors and regulators around fresh-start accounting, particularly the fresh-start allocations that must be performed when a company emerges from bankruptcy."

As a result of these larger market forces, there’s a renewed focus among auditors and regulators around fresh-start accounting, particularly the fresh-start allocations that must be performed when a company emerges from bankruptcy.

Fresh-Start Reporting Considerations in Bankruptcy

Companies that emerge from Chapter 11 bankruptcy may be subject to Accounting Standards Codification Topic 852, Reorganizations (ASC 852). Under ASC 852, companies that meet certain criteria are subject to fresh-start reporting. These criteria are as follows:

  1. The reorganization value of the emerging entity immediately before the date of confirmation is less than the total of all post-petition liabilities and allowed claims; and
  2. Holders of existing voting shares immediately before confirmation receive less than 50% of the voting shares of the emerging entity.

Under fresh-start reporting, a company emerging from bankruptcy must reset its balance sheet to fair value. To accomplish this, it will allocate its reorganization value to its identified tangible and intangible assets at fair value. The reorganization value, or emergence value, is typically set by the bankruptcy court.

Per ASC 852, for accounting purposes, the allocation of value is reported similarly to how a new acquisition would be reported (i.e., in accordance with the business combination rules set forth in ASC 805, Business Combinations). As such, all tangible and separately identified intangible assets must be fair valued and the total value of these assets should reconcile to the total company value, much like with a purchase price allocation.

This means that assets such as oil and gas reserves, midstream assets and customer contract assets will need to be separately fair valued. Any value not attributed to identified assets should be classified as goodwill, and appropriate goodwill accounting applied post-emergence.

These rules apply to both public and privately held companies. Therefore, companies emerging from Chapter 11 bankruptcy to which ASC 852 applies need to adequately address the associated financial reporting considerations, including valuation.

Third-party valuation providers are often engaged to perform the emergence allocation. Doing so in a timely manner after emergence will ensure that quarterly financial statement audits and reviews will proceed as smoothly as possible and will also lead to greater shareholder and stakeholder transparency.

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