What is a 'Quasi-Reorganization'

A quasi-reorganization is a relatively obscure provision under U.S. GAAP which provides that under certain circumstances, a firm may eliminate a deficit in its retained earnings account by restating assets, liabilities, and equity in a manner similar to a bankruptcy. A firm's stockholders must agree to allow the accounting change, which essentially resets the firm's books as though a new company had incurred the assets and liabilities of the old firm.

BREAKING DOWN 'Quasi-Reorganization'

Although the idea of quasi-reorganization has seen some renewed interest, the provision is still rarely applied in practice. The idea of quasi-reorganization holds appeal for some as the idea of a "fresh start" and is more exciting to investors than slowly digging out from a large deficit of retained earnings. Some also argue that quasi-reorganization could be an effective method of more accurately resetting the accounting balances of a firm when a serious drop in asset values is not adequately reflected. Quasi-reorganization remains highly controversial, however, since it is not truly a change of economic reality, but rather a method to make books appear more favorable.

Many new businesses operate at a loss for several years after inception. During this period, the sales team makes contacts, workers are trained, processes are improved on and streamlined and brand recognition is cultivated. By the time the company turns its first profit, a significant retained earnings deficit may have developed. Additionally, a prolonged recession could turn a profitable company into a company with a retained earnings deficit.

It is often illegal or prohibited by debt covenants to pay a dividend from retained earnings while operating with a retained earnings deficit. In this instance, the equity cost of capital can increase materially as investors demand more return for perceived risk. Here, a quasi-reorganization could make financial sense.

Goal of Quasi-Reorganization

The main goal of a quasi-reorganization is to bring the retained earnings balance to zero. First, overvalued assets should be written down to fair value with a direct reduction in retained earnings. Although this increases the deficit momentarily, it will reduce future depreciation expense. Liabilities are also restated to their fair values with any resulting offsets going to the retained earnings deficit.

Once assets have been reduced to fair value, either additional paid-in capital or the par value of common stock is reduced to balance out the elimination of the retained earnings deficit. Companies have some flexibility when deciding how to proceed with the quasi-reorganization – it is possible to reduce par value, increase additional paid-in capital and zero out retained earnings at the same time.

RELATED TERMS
  1. Current Account Deficit

    A current account deficit occurs when the total value of goods ...
  2. Trade Deficit

    A trade deficit occurs a country's imports exceeds its exports. ...
  3. Retained Cash Flow - RCP

    Retained cash flow includes remaining cash after expenses and ...
  4. Revenue Deficit

    A revenue deficit occurs when realized net income is less than ...
  5. Paid-In Capital

    The amount of capital "paid in" by investors during common or ...
  6. Deficit Hawk

    Slang for someone who wants the government to keep the federal ...
Related Articles
  1. Investing

    Evaluating Retained Earnings: What Gets Kept Counts

    A company's retained earnings matter. Be investment-savvy and learn how to analyze this often overlooked information.
  2. Insights

    The Pros & Cons of a Trade Deficit

    Is a trade deficit, also known as a current account deficit, beneficial or detrimental to a country's economy?
  3. Personal Finance

    Current Account Deficits: Government Investment or Irresponsibility?

    Deficit can be a sign of trouble for some countries, and of health for others. Find out what it means when more funds are exiting than entering a nation.
  4. Insights

    Exploring the Current Account in the Balance of Payments

    Learn how a country's current account balance reflects the country's economic health.
  5. Investing

    The Gross Margin

    A business's "gross margin" is a rough gauge of how profitable its operations are. It measures how much sales revenue the company retains after all of the direct costs associated with making ...
  6. Investing

    The 5 Types Of Earnings Per Share

    Learn the five varieties of Earnings Per Share (EPS) and what each represents can help an investor determine whether a company is a good value, or not.
  7. Insights

    U.S. Trade Deficit Hits 5-year High in January

    Rising imports see trade deficit hit five-year high in January.
  8. Insights

    Trump Budget and CBO Budget Differ Widely

    The size of the difference between the administration’s assumption about economic growth and that of the CBO is unprecedented.
  9. Investing

    US Budget Deficit to Top $1 Trillion by 2020: CBO

    The budget office estimates the tax overhaul to cost $1.9 trillion over 10 years.
  10. Tech

    Understanding Facebook's Capital Structure (FB)

    Facebook's strong revenue and earnings have allowed solid expansion of the company's equity capitalization, resulting in little debt in its capital structure.
RELATED FAQS
  1. Which transactions affect retained earnings?

    Retained earnings is the cumulative total of earnings or net income that have yet to be paid to shareholders. Retained earnings ... Read Answer >>
  2. How Is Retained Earnings Different From Revenue?

    The difference between revenue and retained earnings is that revenue is the total amount of income made from sales while retained ... Read Answer >>
  3. Are retained earnings listed on the income statement?

    Retained earnings are the cumulative net earnings or tprofit of a company after paying dividends and can be reported on the ... Read Answer >>
  4. What is the difference between a current account deficit and a trade deficit?

    Learn the meanings of the macroeconomic terms "current account deficit" and "trade deficit," and understand the differences ... Read Answer >>
Trading Center