Analysis of Insolvency Issues Using Contemporary Accounting Theory

This report delves into the contemporary issues surrounding insolvency within the construction sector, applying relevant accounting theories to understand the underlying causes and potential solutions. It examines the reasons for the rise in insolvencies, such as increasing costs, worker shortages, and reliance on fixed contracts, and discusses the implications for major stakeholders, including clients, contractors, architects, and subcontractors. The report further explores why lenders might not have been concerned about potential insolvency issues, considering factors like credit score assessments and cash flow projections. By analyzing theories like Maximisation of Social Welfare, Absolute Priority Rule, and Creditors' Bargain Theory, the report provides a comprehensive overview of the distribution of resources in insolvency cases and emphasizes the importance of predicting contingent events to mitigate business failure. Desklib offers a wealth of similar solved assignments and past papers for students.

Assessment 3
Contemporary issues in
Accounting theory

Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
1. Reasons for insolvency and relevant accounting theories..................................................3
2. Major stakeholders concerned............................................................................................4
3. Suggestions/reasons why the lenders would not have been concerned about potential
insolvency issues of their borrowers......................................................................................5
4. Personal Reflection.............................................................................................................6
CONCLUSION................................................................................................................................6
REFERENCES................................................................................................................................7

INTRODUCTION
In case of bankruptcy, the law mandates an entity to comply with the collection
requirements of its debts, and therefore distribution amidst the shareholders. Furthermore, the
provisions and regulations led down by the law, is meant to decipher the issues faced due to
business failure, which could be a result of the entity's actual or imminent downfall of the bankrupt
entity (Akinradewo and Onyia, 2020). The objective of the report is to explore applicable theories
guiding the technique of distribution in insolvency among the group of dealers. The report analyses
the upward thrust in insolvency problems in the construction sector, together with the relevant
theories and the factors contributing to a rise in insolvencies. The following report provide
solutions to the four case studies given in the assessment.
MAIN BODY
1. Reasons for insolvency and relevant accounting theories
One of the reasons that lead to increase in insolvencies was increasing costs and shortage of
workers in the construction industry. There had been a range of factors that more extensively
contributed to the civil industry accounting with increment of 20 percent related to the bankruptcy
for recent years in Australia. The reliability on fixed contracts was one of the crucial factors, which
fixes the prices before a build starts. Those contracts give homebuyers or builders peace of mind,
but can leave developers not able to turn a income. The problem is construction takes a long time
and over that time, prices go up, materials become unavailable, a pandemic develops. So, if the
owner has signed to deliver the particular house on a fixed date for the fixed sum of money, the
builders will often have to go bankrupt because they can't deliver the project. Substantial payments
of special dividends to related parties, a large investment in cryptocurrency and a number of
uncommercial and unreasonable transactions, all contributed to the collapse of Privium and its
related companies as reported by the liquidators of Privium.
The acknowledgement of issues faced during insolvency, henceforth develops the basis for
several theories thereon.
Maximisation of Social Welfare Theory: When economically withered corporations are dissolved,
however firms with similar situation are continued, is the period, when social welfare is maximised.
(Chuah and Vaccari, 2019). This could be due to creditors being more inclined towards the

available assets and how they can satisfy there claims, instead of ways to resolve the insolvency
situation of the organisation. Additionally, the creditors may attempt to seize all available assets
leading to piecemeal liquidation. For an entity with significant period of financial instability, the
organization may maximise the creditors insolvency payout, if the entity continues to follow going
concern concept.
Absolute Priority Rule: This law provides proper regulations and respects the priority claims
among the credit classes. According to the early theorists, the absolute priority law should be made
mandatory for the bankruptcy system (Joshi, 2021). With respect to such provision, the creditors
were meant to be settled as per the terms mentioned in the contract, or in case of absence of
relevant contract, the creditors should be settled according to the initial contract. The equity
shareholders must be paid at the end, since the dissolving entity is worth nothing and this method
can followed, only when creditors with higher priority are fully settled and afterwards no amount
remains.
Creditors' Bargain Theory: In this case, if all of the parties involved, are willing to negotiate and
arrive at a notional agreement, then this setting will position them in such a manner that they will
be able to manage strategically and as a result, reduce the related costs, thereby maximising the
outcome.
Risk sharing theory: A major drawback which criticises the creditor's bargain theory is inefficient
reallocation of company's wealth. In this theory, the fundamental value of business assets and
resources belonging to the debtors, is maximised and that being a crucial differentiation between
creditors bargain theory and the risk sharing theory. For achievement of such an objective, the
theory bounds all claim holders to contribute for some portion of the collective risk in relation to
the entity, to mitigate business failure as a whole.
Value based theory: The crises related to the bankruptcy law is analysed and explained via this
theory, in form of a system with multiple ranges, proportions and magnitudes. Moreover, in this
theory, the assets belonging to debtors are not identified as merely a dead property, which has no
use expect for being shared. Instead, such assets are seen as valuable resources which may help
increase company's potentials.
2. Major stakeholders concerned
The client: The clients are the investors in the projects and finance it adequately, hence they will
inarguably impact the project in which they have showcased interest.

The main contractor: The individual who is responsible for execution and implementation of
project and assessing all of the underlying activities of the project (Khoja, Chipulu and Jayasekera,
2019). Henceforth, he is responsible for completion of the project and failures related to it.
Architects: For designing the construction project, architects are hired, in order to assess the
creative aspect of the project(Yogeshwaran and Ariyachandra, 2018). However, they will have less
influence over the project as a whole, in comparison to the previously mentioned stakeholders.
Subcontractors: The subcontractors are the people working for the construction project and are
assigned to do so, by the main contractor. The person who is being assigned as the main contractor
may lack expertise in certain areas, hence individuals who are capable of bridging such gap are
appointed as subcontractors and they have minor influence over the project.
There are many more stakeholders like project employees, suppliers, government authorities which
have high level of influence over the project. When the builder fails to manage the project activities
productively, it adversely impacts other individuals such as the workers and suppliers, like a
domino effect. For example, even after four months of Privium collapsed, Ms. Kapuya is still
paying a mortgage on land she cannot use and paying rent. A lot of these people of Privium are
hard working families. She said that these are dreams that are crashing and they basically have to
pick up the pieces and they just feel there isn't a lot of support.
3. Suggestions/reasons why the lenders would not have been concerned about potential insolvency
issues of their borrowers
The lenders provide loan to the company when the company has demonstrated that the
clients yield the capability to pay off their dues along with the company having the enforceability
and validity of the receivables. Once a company apply for a loan, it will undergo a 'credit score
assessment'. The lender will then decide whether they are willing to loan the business money based
on the current (at the time of giving loan) economic conditions and their assessment of company's
creditworthiness.
The most fundamental characteristics most prospective lenders will focus on includes:
 Cash flow projections and history for the business
 Credit history
 Character
 Collateral available

 Loan documentation
Credit history, cash flow projections and collateral available for secured loan are largely objective
data. Character allows the lender to make a more subjective assessment of the company's market
appeal.
4. Personal Reflection
The project report is prepared with the help of reference article provided in the assessment.
The article name is “In Australia there are more insolvencies in the construction sector than any
other, and consumers are paying the price”. The name itself is somewhat self explanatory, however
the problem is so much more complicated and interesting. I hope that after this task, besides of the
knowledge we gained from the research itself, all four of us would improve even more on our
intercultural and interpersonal communication skills. Because at the end of the day, the
understanding that one have learnt is probably forgotten, but all of the competencies that one have
won will stay for a very long term.
CONCLUSION
The distribution of available inadequate resources owned by an insolvent entity among the
shareholders and other creditors, is entailed by the bankruptcy problem. The report examined and
explained five theories, which acted as the basis for the apportionment procedure in case of
insolvency. Furthermore, the maximisation of theory defining the social welfare, advocates for the
piecemeal liquidation system to be adopted, for significant increment in the economical value. In
case the absolute priority theory, distribution is made among the stakeholders, on the basis of
priority of the claims. For the creditors bargaining theory and risk sharing theory, analysation is
performed in relation to the bargaining position of the debtor, for adoption of adequate and relevant
insolvency procedure. However, only concentrating on mastering the theories, is neither sufficient
or ideal, for surviving in the long run. Hence, the ability to predict all possible occurrence or
contingent events, becomes mandatory, to mitigate risk related to business failure.

REFERENCES
Books and Journals
Akinradewo, O. and Onyia, M., 2020. Factors influencing the adoption of insurance as a risk
treatment tool by contractors in the construction industry. International journal of
construction management. pp.1-9.
Chuah, J. and Vaccari, E. eds., 2019. Executory contracts in insolvency law: A global guide.
Edward Elgar Publishing.
Gosnell, P., 2018. 30 years of the Journal. Australian Restructuring Insolvency & Turnaround
Association Journal, 30(1). pp.4-10.
Joshi, M., 2021. Distressed Assets Merger and Acquisitions and Insolvency and Bankruptcy Code
Nexus. Jus Corpus LJ. 2. p.642.
Khoja, L., Chipulu, M. and Jayasekera, R., 2019. Analysis of financial distress cross countries:
Using macroeconomic, industrial indicators and accounting data. International Review of
Financial Analysis, 66. p.101379.
Walters, R. and Trakman, L., 2020. The fragmented approach toward close-out netting provisions
in Australia, Indonesia, Malaysia and Singapore compared. Journal of Banking
Regulation, 21(3). pp.224-240.
Yogeshwaran, G. and Ariyachandra, M.M.F., 2018. Competencies expected of graduate quantity
surveyors working in developing countries. Journal of Financial management of Property
and construction.