Shareholder Debt

[Diane]

I have a small retail store. They had 3 shareholders. Each shareholder used personal credit cards to pay for a lot of store expenses, mostly inventory. Each shareholder has a loan payable on the books. Last year one of the shareholders declared bankruptcy and their credit card debt was canceled. The store paid back some of the debt to the shareholder, but not all. Since the ex-shareholder did not pay cash for anything, only credit card purchases, and her debt was canceled she no longer owed any money. But, the balance of the debt is still on the store books. I'm not sure how to handle the Liability on the store books. The shareholder was never out of pocket for any of the debt because she used credit cards; the debit of which has been canceled. How do I book the Liability on the books? Since the debt was accrued in prior years as purchases and expenses for the store it affected the bottom line of the store. What is the journal entry that I have to make?

Diane

[rfassett]

There would be no journal entry. You are talking about two separate entities - the shareholder and his/her personal life; and the corporation. Unless the shareholder tells the corp and/or the other shareholder or you, even though it is public info, you would probably not even be aware that the bankruptcy was filed - unless the bankruptcy trustee had petitioned the corporation to pay the money due the shareholder to the bankruptcy court so it could be distributed to the shareholder's creditors. The corp owed the shareholder money before the bankruptcy and the corp owed the shareholder money after the bankruptcy. No journal entry. Now that said, I think another question would be, from the shareholder perspective outside of the corp, how does the bankruptcy affect the shareholder's basis?

[Diane]

I'm thinking that the shareholder no longer has a basis.

Diane

[jainen]

>>from the shareholder perspective outside of the corp<<

How could the shareholder loan have survived the bankruptcy? I don't know the legalities, but it may be that the shareholder has abandoned it by not listing it as an asset in the court filing. That would presumably be ordinary income to the corporation, or at least an adjustment to Cost of Goods Sold.

[JohnH]

Interesting question. I don't see that the personal bankruptcy affects the corporation at all - the money is still owed to the shareholder. If the shareholder listed it in the personal bankruptcy as an asset then the debt to the shareholder still exists. If they failed to list it in the personal bankruptcy, the shareholder may have a potential problem with the bankruptcy court, but that isn't the concern of the corporation and the debt still exists.

[rfassett]

>>from the shareholder perspective outside of the corp<<

How could the shareholder loan have survived the bankruptcy?

Lots of assets survive bankruptcy. And this IS an asset in the hands of the shareholder. It could very well have been that the shareholder did everything legitimately on the bankruptcy filing and used a "wild card" exemption (if available in his/her district) to exempt the stock of the corp as well as the loan. My comments have been made on the assumption that this is a chapter 7 bankruptcy. The answer may be somewhat different if it was a different type bankruptcy.

[Diane]

The shareholder debt of the corporation came about using her own credit cards. She bought inventory for the store on her personal credit card. Apparently with the bankruptcy, the credit card debt was taken care of. There was no mention of the corporation.

Diane

[OldJack]

I agree with JohnH! The corporation still owes the shareholder and I see no indication that the shareholder is not still in good standing with the corporation and still owns the shares. To the corporation the shareholder's personal bankruptcy is irrelevant.

[Bart]

The shareholder debt of the corporation came about using her own credit cards.

Diane

The shareholder debt of the corporation did NOT come about using her own credit cards to purchase inventory. The shareholder charged stuff on her credit card. She could do anything she wanted with that stuff. She then decided to sell that stuff to the corporation. The corporation could not currently pay for that stuff so the corporation gave her a note promising to pay her later. Her charging stuff on her credit card has nothing to do with the loan from the corporaion.

[Diane]

The shareholder debt of the corporation did NOT come about using her own credit cards to purchase inventory. The shareholder charged stuff on her credit card. She could do anything she wanted with that stuff. She then decided to sell that stuff to the corporation. The corporation could not currently pay for that stuff so the corporation gave her a note promising to pay her later. Her charging stuff on her credit card has nothing to do with the loan from the corporaion.

Thanks, I like the way you put that. It now makes more sense to me. I guess I just didn't look at it in the most logical way.

Diane

[OldJack]

>>Her charging stuff on her credit card has nothing to do with the loan from the corporation.<<

However, Depending upon the kind of "stuff" or fraud, the bankruptcy judge may have a claim for some of the stuff. Not very likely.