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Sometimes businesses liquidate upon bankruptcy, meaning that its operations cease and its assets sold to meet as much of its economic obligations as possible. Such obligations include both liabilities -- obligations incurred through the business' operations -- and shareholders' equity -- the claim its owners have on its assets. Accounting for a business' liquidation is largely recording the sale of its assets and the use of those proceeds to satisfy the business' obligations.
Bankrupt businesses liquidate for several reasons; one is that stakeholders in the business, meaning its creditors and investors, cannot come to an agreement on how the business should restructure itself under Chapter 11 to restore its profitability. Another is when a business cannot restore its profitability and any attempt at restructuring is doomed to failure. Alternately, restructuring might be undesirable because the costs are too high.
Proceeding of the Liquidation
A sequence of events occurs once a business begins its liquidation. First, the court will appoint a representative to take charge of the business upon filing for bankruptcy. During a liquidation, the representative will be responsible for overseeing the sale of the business' assets, the winding down of its operations, and the usage of the proceeds to meet the business' obligations.
Order of Precedence
Businesses must pay off their obligations in a specific order -- liabilities incurred since bankruptcy, secured debt, unsecured debt and then shareholders' equity. Liabilities incurred since bankruptcy include both legal expenses and labor costs to end the business' operations. Secured debt refers to debt with collateral and unsecured debt refers to debt without collateral. Collateral is assets that the debtor agrees to pay to the creditor if he defaults on the debt.
Sales of assets by the business are deductions from the asset accounts while the proceeds from the sales add to the cash account. Liabilities incurred since the business declared bankruptcy are paid from the cash account. Secured debts are paid after the sale of the agreed upon collateral assets. If you do not satisfy the secured debts by selling the collateral, you must remit the remaining balance from the business' cash account if its available.
In most cases, a corporation will have no resources remaining to return the investments of its shareholders. If it does, however, preferred shareholders take precedence over common shareholders when it comes to repayment. This benefit is not in the terms of all preferred shares and will be explicitly mentioned amongst them if it does exist. In terms of accounting, the amount a shareholder invested in the business deducts from the cash account similar to a refund. If there isn't enough cash remaining to repay those investments, the shareholders suffer the loss of their investments.
Alan Li started writing in 2008 and has seen his work published in newsletters written for the Cecil Street Community Centre in Toronto. He is a graduate of the finance program at the University of Toronto with a Bachelor of Commerce and has additional accreditation from the Canadian Securities Institute.