By CPAmerica A&A Technical Consultant Thomas A. Ratcliffe, Ph.D., CPA
Do you know when and how to apply the liquidation basis of accounting?
Amendments issued by the Financial Accounting Standards Board in April 2013 serve to clarify the answer to that question. The FASB’s Accounting Standards Update (ASU) 2013-07, Liquidation Basis of Accounting, amended the guidance in the FASB Accounting Standards Codification (FASB ASC) Topic 205, Presentation of Financial Statements.
The guidance applies to all reporting entities, whether they are public or private companies or not-for-profit entities. The guidance also provides principles for the recognition of assets and liabilities and disclosures, as well as related financial statement presentation requirements.
In the amendments, liquidation is considered a process by which a reporting entity converts its assets to cash or other assets and settles its obligations with creditors in anticipation of the reporting entity’s ceasing all activities. Upon cessation of reporting entity activities, any remaining cash or other assets are distributed to reporting entity investors or other claimants – directly or indirectly.
Liquidation may be compulsory or voluntary. Dissolution of a reporting entity does not qualify as a liquidation if the entity has the expectation of continuing its business following the entity’s:
- Acquisition by another entity or
- Merger into another entity in its entirety.
Reporting entities are required to use the liquidation basis of accounting when liquidation is deemed imminent. Liquidation is considered imminent when the likelihood is remote that the reporting entity would return from liquidation and either:
- The person or persons with the authority to make a liquidation plan effective approve the plan, and the likelihood is remote that other parties (e.g., those with shareholder rights) will block execution of the plan, or
- Other forces impose a plan of liquidation (e.g., through involuntary bankruptcy).
In certain situations, the governing documents of a reporting entity specify a liquidation plan. As an example, this would be the case when a limited-life entity is a partnership created specifically to complete a particular project. Then, upon completion of that project, the partnership is dissolved. In these situations, the liquidation basis of accounting would be used only if the approved plan for liquidation differs from the liquidation plan that was specified at the inception of the limited-life entity.
When using the liquidation basis of accounting, reporting entities are required to measure assets to reflect the estimated amount of cash or other consideration they expect to collect in settling or disposing of those assets in carrying out the liquidation plan. With that said, in certain situations, fair value may approximate the amount reporting entities expect to collect. However, this presumption should not be considered to hold true for all assets.
Reporting entities are required to recognize other items that previously had not been recognized in the financial statements (e.g., trademarks) but that the entities expect to either sell in liquidation or use to settle liabilities. These items may be recognized in the aggregate. Estimated costs to dispose of assets or other items expected to be sold in liquidation need to be accrued, and those costs should be presented in the aggregate separately from those assets or items.
Expected costs and income
Reporting entities need to accrue costs and income expected to be incurred or earned (e.g., payroll costs or income from pre-existing orders expected to be fulfilled during liquidation, etc.) through the end of the liquidation process if and when there is a reasonable basis for estimation.
Reporting entities need to recognize liabilities in accordance with the general recognition criteria otherwise spelled out in U.S. generally accepted accounting principles (U.S. GAAP). In applying other U.S. GAAP requirements, reporting entities will need to adjust amounts presented for liabilities to reflect changes in assumptions that result from the decision to liquidate (e.g., timing of payments).
However, reporting entities are precluded from anticipating that there will be a legal release from being the primary obligor under a liability, either judicially or by the creditor.
Financial statement preparation
In implementing the ASU 2013-07 amendments to FASB ASC 205, when preparing financial statements using the liquidation basis of accounting, reporting entities need financial statements to include the following at a minimum:
- A statement of net assets in liquidation
- A statement of changes in net assets in liquidation
Additionally, reporting entities need to present financial statement disclosures so that users of financial statements will be able to understand the financial statements prepared using the liquidation basis of accounting.
The amendments are effective for annual reporting periods beginning after Dec. 15, 2013, and interim reporting periods within those annual periods. Reporting entities are required to apply the requirements in ASU 2013-07 prospectively from the day that liquidation becomes imminent. Early adoption is permitted.