In order to comply with generally accepted accounting principals (GAAP), the financial statements of an enterprise, including the related notes to financial statements, should contain all necessary information for a fair presentation of the enterprise's financial position and results of operations. Data presented in the financial statements and the related notes should be clearly presented and relevant. Particularly in the case of an enterprise experiencing financial difficulty, the footnote disclosures related to liquidity issues, basis of presentation and other matters describing the risk factors associated with the enterprise's operations take on increased importance.

SOP 90-7

Readers of financial statements of companies operating under chapter 11 generally recognize the financial statement disclosures required by the American Institute of Certified Public Accountants (AICPA) Statement of Position 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" (SOP 90-7). As required by SOP 90-7, financial reporting during reorganization proceedings should distinguish transactions and events that are directly associated with the reorganization from those related to a debtor's ongoing business operations. The distinction between the reorganization and the ongoing business is made on each of the debtor's principal financial statements. On the balance sheet, the debtor separately classifies pre- and post-petition obligations, distinguishing those pre-petition obligations that are subject to compromise from those that are not. Reorganization- and restructuring-related income and expenses are separately presented on the statement of operations. Within the operating, investing and financing categories of the statement of cash flows, cash flows in each of those categories resulting from the reorganization process itself are separately presented.

When a consolidated financial reporting entity has one or more companies operating under court protection and one or more companies not subject to bankruptcy proceedings, the consolidated financial statements should include condensed combined financial statements for the debtor entities.

Additional required disclosures include the difference between interest expense recognized and interest at the stated contractual rate, and the components of the reorganization expense line. Where earnings-per-share disclosures are required, the potential for dilution of existing interests should be disclosed if it is probable that a plan of reorganization will require the issuance of common stock or common stock equivalents.

When it was introduced in 1990, SOP 90-7 provided financial statement preparers with concise guidance for relevant aspects of debtor financial statement presentations. It clarified required conventions among existing alternatives and established guidelines for disclosure in those circumstances. This guidance built upon an existing body of disclosure requirements. Beyond SOP 90-7 and for companies that are experiencing financial difficulty but are not yet undergoing a reorganization under the Bankruptcy Code, there are other disclosure requirements that alert the financial statements readers to the nature of a company's financial difficulties.

Other GAAP Requirements

Disclosure requirements for enterprises in financial difficulty, including receivership, bankruptcy or liquidation, are found in a variety of authoritative accounting and regulatory literature. These include the Financial Accounting Standards Board (FASB) Current Text, AICPA Statements of Position, other FASB and AICPA publications and, for registrants, Securities and Exchange Commission (SEC) rules. In many cases, these disclosures are not specifically targeted to the financially troubled enterprise. Following the requirements of the related rule or pronouncement, however, results in disclosure that is relevant to identifying a company in financial trouble and understanding its problems.

Basis of Presentation

A fundamental concept of financial reporting is the basis of presentation. The usual basis of presentation for most entities is the "going-concern" basis. Going-concern basis assumes that the entity is an ongoing enterprise and that it will continue to be so, at least for its next operating cycle. Other bases of presentation may be used, such as a modified cash basis for tax-based financial statements or a liquidation basis for enterprises that are in the process of liquidation.

The financially troubled enterprise should disclose the basis for the presentation of the financial statements, specifying whether the financial statements are presented on a going-concern basis, liquidation basis or other basis of accounting.

If the going-concern basis of accounting is used and there is a concern about the entity's ability to continue in business, the footnote disclosures should contain a statement that the asset and liability carrying amounts do not purport to represent realizable or settlement values in the event of liquidation. GAAP also requires disclosure of the fair value of the enterprise's financial instruments (whether or not these assets or liabilities are on or off of the balance sheet) for which it is practicable to estimate those values. Included in these disclosures are the method or methods and significant assumptions used to estimate the fair values.

For liquidation-basis financial statement presentations, the enterprise should disclose the method or methods used to estimate realizable and settlement values for the enterprise's assets and liabilities. Accompanying this disclosure should be a statement as may be applicable that the estimated values may differ from the actual amounts realized, and that those differences may be material. Additionally, any assets or liabilities that may not have been "revalued" should be identified with an explanation of the reasons for not doing so.

Special Risk Factors

Similar to development stage companies, the financially troubled enterprise should disclose and describe the special risk factors that impact its ability to remain in existence as an operating enterprise. Such disclosures would include the nature of the enterprise's activities and its competition.

The financially troubled enterprise should disclose its dependence on individuals or products as well as its dependence on future events such as additional financing, the occurrence of some operational event, governmental regulation changes or similar risks.

Everyone has heard the phrase, "Cash is king." Liquidity problems are a common element among financially troubled enterprises. The financially troubled enterprise should disclose the nature of its liquidity problems, such as working capital or expansion program needs, and discuss the significance of these problems to the entity's continued operations.

Disclosures for the financially troubled enterprise also should include information with respect to significant contingencies (such as rejected executory contracts and leases, damage claims asserted or interest claimed), including disclosure of what amounts have been provided for in the financial statements related to these contingencies. The fact that creditor claims, particularly in bankruptcy, may exceed the amounts recorded also should be disclosed. However, it is not required that the difference between the amounts recorded for creditor claims and the amounts claimed be disclosed.

Plans

When an enterprise is in a receivership proceeding, operating under bankruptcy protection or has adopted a plan of liquidation, the footnotes should indicate those facts and disclose the restrictions imposed by such status and other pertinent information related to the proceeding or plan.

When a plan of arrangement with creditors or reorganization has been developed, the key elements of that plan, its status and the degree to which it has been reflected in the financial statements should be noted.

Where substantial doubt about an enterprise's ability to continue as a going-concern has been alleviated because of management's plans, the footnotes to the financial statements should include a disclosure of the principal conditions and events giving rise to the going-concern question and possible effects of those conditions and events.

Most importantly, the enterprise should disclose the mitigating factors that have alleviated the concern about the enterprise's ability to continue as a going concern, including a discussion of management's plans.

MD&A

SEC Regulation S-K contains the requirements applicable to the content of the non-financial statement portions of a registrant's annual and interim reports. The requirements for Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) are outlined in Item 303 of Regulation S-K. MD&A is not part of the financial statements and is not required by GAAP for companies that do not have public reporting requirements. However, when the financially troubled enterprise is a public company, MD&A is a valuable source of information on the entity's financial troubles and action plans. The requirements for discussion related to the entity's results of operations, financial condition, and liquidity and capital resources are focused on identifying situations where material events and uncertainties known to management would cause the reported historical financial information not to be necessarily indicative of future results or financial condition.