Reference no: EM132325629

Question

On April 30thof this year, Kona Grill, Inc., an American restaurant chain based in Scottsdale, Arizona, filed for Chapter 11 bankruptcy. As of the filing date for bankruptcy, Kona Grill had $33.2 million in debt and only $1.2 million in cash on hand (Maze, 2019).

The main reason for the company's decision to file for Chapter 11 bankruptcy is the decline in sales coupled with the doubling of the number of restaurants. "Kona doubled its footprint between 2013 and 2017, growing from 23 restaurants to 46. Each restaurant cost $4 million to open" (Maze, 2019).

Despite the new restaurant locations, traffic was in decline and Kona Grill was not able to recuperate the expense of opening the new restaurants. The company's liquidity suffered when Kona Grill used $15 million in capital to repurchase shares in 2016 and 2017 (Maze, 2019).

As a result of the diminished liquidity and decline in revenue, investors were not taking Kona Grill to be a worthwhile investment. In 2018 the company was not able to invest further in its restaurants due to a new credit agreement which "restricted Kona's borrowing ability and tightened its financial covenants" (Maze, 2019). Furthermore, in 2018 Kona Grill's sales fell 12.4% to $156.9 million (Maze, 2019). With these shortcomings against the company, reorganization was the best option to salvage Kona Grill, Inc.

During this week's reading on bankruptcy and liquidation, the reorganization plan for Chapter 11 bankruptcy and financial reporting during reorganization are most applicable to the situation of Kona Grill.

Through a Chapter 11 reorganization, the company hopes to be salvaged and to continue operations. In the proceedings of filing for Chapter 11 bankruptcy, a plan of reorganization must be enacted. "A reorganization plan can contain an unlimited number of provisions: proposed changes in the company, additional financing arrangements, alterations in the debt structure, and the like" (Hoyle, Schaefer, & Doupnik, 2017). These provisions should provide an outcome where business can continue and the company can once again become a going concern.

Concerning financial reporting during reorganization, according to the assigned reading and U.S. GAAP, "any gains, losses, revenues, expenses resulting from the reorganization are known as reorganization items and are reported separately from normal operating activities" (Hoyle, Schaefer, & Doupnik, 2017).

These reorganization items will still be listed before any income tax expense or benefits on the income statement. During reorganization, the company may include in their plan a strategy to finance their liabilities and can take advantage of the interest expense not accruing.

"According to U.S. GAAP, liabilities that are subject to compromise must be shown separately and at the expected amount of allowable claims rather than estimated settlement figures" (Hoyle, Schaefer, & Doupnik, 2017). Like gains, losses, revenues, and expenses on the income statement, liabilities during reorganization are listed separately on the balance sheet. The claim amounts are disclosed rather than the final settlement at the end of reorganization.

Using a plan of reorganization and correct financial reporting, Kona Grill hopes to emerge as a going concern and can prosper as a salvaged company.

Required:

Identify the strengths and weaknesses in the above post