Accounting for Liquidation of Company

The liquidation of company accounting occurs in businesses that are ending operations. Liquidation is the process of settling any liabilities, selling all assets of an entity, taking the remaining funds and distributing them to shareholders, and closing the legal entity down.

Liquidation Basis Accounting and Reporting:

Liquidation basis accounting is concerned with preparing the financial statements of a business in a different way if its liquidation is considered to be imminent.?“Imminent” refers to either of the following two conditions:

1.??Liquidation Plan:

A plan for liquidation has been approved, and is likely to be achieved.

2.??Forced Liquidation:

A third party is forcing the business into liquidation, and is likely to achieve this goal.

In liquidation accounting, assets are measured at the estimated amount for which they can be sold, which may or may not be their fair market value. If the liquidation is rushed, this could mean that the estimated selling price is less than fair market value.

It is not permissible to anticipate a release from a liability that has not yet occurred. Instead, continue to recognize the liability until such time as an actual release has been confirmed.

Do not discount disposal costs to their present value. Also, there is no discounting of accrued income. There is no real point in doing so, since the business will presumably be liquidated so soon that the amount of any discount would be immaterial.

The Difference Between Liquidation Basis and Accrual Basis Accounting:

The accounting under the liquidation basis of accounting differs in several respects from normal accrual basis accounting.

The Key Differences Are:

1.??Recognize any assets that had not previously been recognized, but which you expect to either sell in liquidation or use to pay off liabilities. This means it is possible to recognize internally generated intangible assets – which would not normally be the case. The main point is to only recognize items if they are actually worth something in liquidation.

1. It is allowable to recognize in aggregate those assets that had not been previously recognized, rather than individually.
2. Accrue for the expected disposal costs of assets that will be liquidated.
3. Accrue for those income and expense items that will be earned or incurred through the end of the expected liquidation period. An example of such an income item is the expected profits from orders that have not yet been fulfilled. An example of such an expense item is wage and salary costs expected to be incurred.

Liquidation Basis Financial Statements:

Under the liquidation basis of accounting, a business must issue two new statements, which are noted below.

The Statement of Net Assets in Liquidation:

This statement shows the net assets available for distribution at the end of the reporting period.

The Statement of Changes in Net Assets in Liquidation:

This statement shows the changes in net assets during the reporting period.

Basics of Liquidation Accounting:

Liquidation is the process by which an entity converts its assets to cash or other assets and settles its obligations with creditors in anticipation of ceasing all operating activities. During liquidation, assets not used to settle creditors’ claims are distributed to the entity’s owners. Liquidation may occur voluntarily (e.g., based on economic conditions), upon a specified event (as for a limited-life entity), or involuntarily [e.g., by an entity’s creditors, a court (as in bankruptcy), or other parties].

As per the expanded guidance introduced in ASU, an entity is required to prepare its financial statements using the liquidation basis of accounting whenever liquidation is imminent, that is, when the likelihood is remote that the entity will return from liquidation, and a plan for liquidation is either:

1.??Approved by the person or persons with the authority to make such a plan effective when the likelihood that its execution will be blocked by other parties is remote.

2.??Imposed by other forces, such as in an involuntary bankruptcy proceeding (ASC). When the decision to liquidate is made by others outside the control of the entity, and it is remote that the entity will return from liquidation, the entity should adopt liquidation basis accounting even without formal board or management approval. Management must use judgment and should consider seeking the guidance of legal counsel in determining when an involuntary liquidation is imminent.

Four Exceptions to the Foregoing Accounting Requirements Follow:

1.??If the expected liquidation is mandated under the governing documents from the entity’s inception (e.g., for joint ventures or other limited life entities), the liquidation basis is applied only if and when the approved plan differs from the one specified in the governing documents.

1. In the event of a dissolution of an entity as a result of its being acquired by, or merged into, another entity in its entirety with the expectation of continuing its business, the liquidation basis is not used because such an event is excluded from the definition of “liquidation” in FASB.
2. Entities that adopted the liquidation basis of accounting in accordance with the limited guidance about when and how to apply the liquidation basis provided by other (e.g., for terminating employee benefit plans).
3. Investment companies regulated under the Investment Company Act of 1940 are not subject to the provisions of ASC.

FASB (The?Financial Accounting Standards Board):

Information about the past is usually less useful in assessing prospects for an enterprise’s future if the enterprise is in liquidation or is expected to enter liquidation. Then, emphasis shifts from performance to the liquidation of the enterprise’s resources and obligations. The objectives of financial reporting do not necessarily change if an enterprise shifts from expected operation to expected liquidation, but the information that is relevant to those objectives, including measures of elements of financial statements, may change.

GAAP (Generally Accepted Accounting Principles):

It should be noted that the liquidation basis of accounting clearly is part of US GAAP; it is an alternative to going concern accounting (also part of GAAP) that is to be applied in designated circumstances. It differs from going-concern GAAP principally in that neither the use of the historical cost model nor the presentation of historical operating results, cash flows, or a classified balance sheet are generally considered relevant.

Main Provisions:

The main provisions of the standard are as follows:

1.????Financial Statements prepared using the liquidation basis of accounting are now required by GAAP to include a statement of net assets in liquidation and a statement of changes in net assets in liquidation, as well as all disclosures necessary to present relevant information about an entity’s expected resources in liquidation. Subject to the exception set forth below, the liquidation basis of accounting may be applied only prospectively from the day liquidation becomes imminent, and the initial statement of changes in net assets in liquidation may present only changes in net assets that occurred during the period since that date (ASC) The Accounting Standards Committee.

1. Assets are measured at the amount of their expected cash proceeds or other consideration from liquidation, including any assets previously unrecognized under GAAP but that the reporting entity expects to either sell in the course of its liquidation or use in settling liabilities, such as trademarks or other intangibles (ASC) does not presume that a fair value measurement pursuant to ASC should be applied to all assets, especially in a forced or hurried liquidation. Such an approach might not be appropriate because it may involve distressed sales of assets (i.e., at “fire sale prices”) without a sufficient period either to market the assets or wait for an illiquid or depressed market to recover or for a highly motivated buyer to appear.
2. An Entity reporting under the liquidation basis is required to accrue and present separately, without discounting, the estimated disposal and other costs, including any costs associated with sale or settlement of its assets and liabilities and the estimated operating income or loss that it reasonably expects to incur during the remaining expected duration of the liquidation period (ASC).
3. Liabilities may not be adjusted to estimated fair values (as was commonly the case prior to ASU), but rather recognized in all respects in accordance with other GAAP (as they would have been under the going-concern basis) without providing for any expected extinguishments in advance of legal releases from the reporting entity’s primary obligation by either a court or creditors (ASC).

Thus, they may not be reduced to expected settlement values prior to settlement.

1. Minimum Disclosure requirements include:

a.???A statement that the financial statements are prepared using the liquidation basis.

b.???The facts and circumstances surrounding the adoption of the liquidation basis and the entity’s determination that liquidation is imminent.

c.????A description of the entity’s plan for liquidation, including the manner by which it expects to dispose of its assets and settle its liabilities.

d.???the expected date by which the entity expects to complete its liquidation.

e.???the methods and significant assumptions used to measure assets and liabilities (with any subsequent changes therein).

f.?????the type and amount of costs and income accrued in the statement of net assets in liquidation and the period over which those costs are expected to be paid or income earned (ASC).

1. All other disclosures required by other GAAP should continue to be made in liquidation-basis financial statements if relevant and material.

Consolidation Issues:

Because the liquidation basis of accounting is applied at the reporting level only for an entity in liquidation, consolidated financial statements for an entity not in liquidation, but with a subsidiary that has adopted the liquidation basis of accounting for its stand-alone financial statements, must continue to be prepared on a going-concern basis, no matter how significant the subsidiary in liquidation, and the subsidiary’s financial statements should be adjusted back to the going-concern basis for inclusion in the consolidated financial statements. In such cases, the status of a subsidiary in liquidation and a summary of the likely future effects of its liquidation on the consolidated financial statements should be disclosed if material. Nevertheless, it should be considered whether the subsidiary in liquidation requires deconsolidation due to loss of control, for example due to an involuntary bankruptcy, or qualifies under GAAP for treatment as a discontinued component.

On the other hand, in the case of a reporting entity using the liquidation basis, but with a subsidiary that is not in liquidation, if the reporting entity intends to retain its controlling interest in the subsidiary until said interest and the cash proceeds of its liquidation are distributed to the owners, the subsidiary’s net assets must continue to be included in the consolidated financial statements on the going-concern basis without adjustment (ASC).

Supplemental Guidance:

The standard provides no illustrative financial statements or disclosures. Accordingly, sample financial statements and a sample transitional note are provided in?Exhibits 1,?2, and?3,?and some practical, nonauthoritative guidance is provided below.

Exhibit 1

Sample Consolidated Statement of Net Assets in Liquidation

Exhibit 2

Sample Consolidated Statement of Changes in Net Assets in Liquidation

Exhibit 3

Sample Transitional Note

The differences in presentation requirements described and illustrated here effectively preclude meaningful presentations of comparative financial statements on a liquidation basis in traditional columnar form with those of pre liquidation periods prepared on a going-concern basis. When liquidation begins after the start of a fiscal year, it is not necessary to present financial statements on the going-concern basis for the immediately preceding stub period (ASU). If deemed necessary to suit the needs of users, accompanying prior stub period or annual financial statements may be presented, preferably separately. Notes, however, would typically be combined.

For practical reasons, the liquidation basis may be adopted as of a date shortly before or after the date the criteria for adoption are met (e.g., the beginning or end of the month or quarter in which such criteria are met), but only if the use of this practical expedient is disclosed and the impact of employing it is not material. The basis for such a materiality assessment should be well documented.

The statement of changes in net assets should separately present the summarized increases and decreases in net assets that are expected to result from the liquidation of net operating activities, including liquidation of dividends. Judgment may be required to segregate these activities in cases where it is difficult to distinguish the effects of liquidation from results of winding down operations during liquidation.

The liquidation basis of accounting does not apply, however, to a planned wind-down of an entity’s activities that is expected at the outset to occur indefinitely over time and where the legal entity will be kept active and may continue (or increase) operations in an improved business climate. When the liquidation process is expected to occur indefinitely over a lengthy period that will likely include significant future operating decisions, the entity should carefully consider whether it has met the GAAP requirements for using liquidation accounting. In such circumstances, it may be difficult for an entity to assert that the likelihood it will return from liquidation is remote.

Because assets are measured at the amount of cash the entity expects to collect upon sale, material gains or losses on asset dispositions would be provided for in advance based on estimates, and therefore not be expected in liquidation basis financial statements. Deferred charges and other assets that will not be converted to cash or contra liabilities (e.g., deferred debt issuance costs) should be written off at the date of adoption of liquidation-basis accounting, and there should be no accumulated depreciation or amortization shown.

Pursuant to GAAP (ASC), it is not appropriate to reduce a liability that is based on contractual provisions to the extent of assets available, unless a legally binding settlement agreement has been executed with the related creditor or a court has ordered such reduction; to do so would constitute an inappropriate, premature extinguishment (rather than a revaluation) of the liability. Liabilities such as accruals measured based on estimated settlement amounts (and timing, if discounted) and without contractually specified amounts should be adjusted periodically to incorporate all changes to assumptions that are affected by the entity’s decision to liquidate. Particularly when liabilities exceed the aggregate estimated liquidation value of an entity’s assets, or when the estimated period of liquidation is long, there may be significant uncertainty to warrant mention in a discretionary emphasis-of-matter paragraph in an audit report.

Although technically not a change in basis, which is generally defined in the authoritative literature as a widely used alternative to U.S. GAAP and referred to as a “special purpose framework,” a change from the going-concern to the liquidation basis is an accounting change consisting of the adoption of GAAP requirements necessary to recognize events or transactions that are clearly different in substance from those previously occurring. Thus, they are not considered to be “changes in accounting principle,” as defined in ASC, which effectively consist solely of

1.??Changes prescribed or permitted by new GAAP.

2.??The use of an allowable alternative accounting principle that can be justified on the basis that it is preferable.

3.??An election by a private entity of certain simplified GAAP alternatives made available only to it. Changes from the going-concern to the liquidation basis do not fit into any of these three categories and, unlike most changes in accounting principle, may never be applied retrospectively.

Transitional accounting adjustments necessary to apply the liquidation basis should not be reflected in the initial statement of changes in net assets in liquidation, since these adjustments do not reflect events or transactions of the initial liquidation period. If an entity presents financial statements for a period prior to adopting liquidation accounting (i.e., when still a going concern), the adjustments to adopt the liquidation basis of accounting also should be excluded, except to reflect asset impairments as appropriate (e.g., for goodwill). Whether the prior period is presented or not, it would be appropriate for an entity to disclose these adjustments in the year of adoption of the liquidation basis, if material, along with the fact that the preceding period was prepared on the going-concern basis even though it is not considered a “change in accounting principle”.

GAAP that would otherwise be applicable to the presentation of discontinued operations (or assets held for sale) does not apply when the financial statements of the reporting entity are presented on the liquidation basis.

When the threshold of imminence is met after the balance sheet date but prior to the release of the financial statements, the financial statements should continue to be prepared on a going-concern basis, with appropriate disclosure about management’s plans to liquidate and consideration of pro forma subsequent events information, as if the liquidation basis of accounting had been employed in the earlier period recommended.

Reporting on Liquidation Basis Financial Statements:

Auditors are required to evaluate whether the current-period financial statements are consistent with those of the preceding period, regardless of whether the financial statements for the preceding period are presented and whether the financial statements for all periods being reported upon are consistent with the previously issued financial statements for the comparable period and Auditing Standard (AS). The auditing standards also provide, however, that a reference to consistency in an audit report is required only when it refers to consistent application of principles within a basis of presentation (AU). Therefore, a change in accounting basis does not require an auditor to modify the report for a lack of consistency. The use of “basis” in that context is generally understood to refer only to a special-purpose alternative to GAAP (e.g., cash or income tax basis) and not to the liquidation basis, which is part of GAAP.

Nevertheless, when reporting on the initial period after an entity switch from the going-concern basis to the liquidation basis of accounting, auditors are required to include an emphasis-of-matter paragraph (following the opinion paragraph) in the audit report for any matter that is appropriately presented or disclosed in the financial statements if, in their professional judgment, it is deemed fundamental to users’ understanding of the financial statements. Accordingly, an emphasis-of-matter paragraph is required when the reporting entity has changed the basis of accounting used to determine the carrying amounts of assets and liabilities from the going-concern basis to the liquidation basis if the effect of the change is material (AU Auditing Interpretation and AS).

Three sample paragraphs for audit reports on liquidation basis financial statements can be found in?Exhibits 4,?5, and?6.

Exhibit 4

Sample Scope Paragraph for Initial Period of Adopting Liquidation Basis with Comparative Financial Statements for Prior Period Presented (Separately)

Exhibit 5

Sample Audit Opinion Paragraph for Initial Period of Adopting Liquidation Basis with Comparative Financial Statements for Prior Period Presented (Separately)

Exhibit 6

Sample Emphasis-of-Matter Paragraph for Initial Period of Adopting Liquidation Basis whether Prior Period Financial Statements Are (Are Not) Presented

There is no authoritative guidance regarding liquidation-basis accounting available for review and compilation engagements, but similar reporting modifications should be adapted for such purposes and made to standard report forms.

Liquidation of Companies and IFRS:

International Financial Reporting Standards (IFRS) do not specify what should be done when an entity cannot continue as a going concern, either because shareholders have decided not to continue operations, bankruptcy has been declared, or an external cause (COVID 19, State of Internal Commotion, Competition, War or Political Sanctions) has forced it to end its operations. The IFRS establish that the financial statements of entities are prepared on the assumption of going concern, that the company will continue to operate, and if not any significant uncertainty or intention not to proceed should be disclosed.

IAS 1 states “When preparing financial statements, management shall make an assessment of an entity’s ability to continue as a going concern. An entity shall prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so. When an entity does not prepare financial statements on a going concern basis, it shall disclose that fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern” (IAS 1).

IAS 10 states that “an entity shall not prepare its financial statements on a going concern basis if management determines after the reporting period date either that it intends to liquidate the entity or to cease trading, or that it has no realistic alternative but to do so”

What to do?

According to the IFRS, in the absence of explicit guidance, an entity's management “may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards.” (IAS 8).

Management should choose accounting policies (based on geography, country, or national professional body statements) that allow for a fair presentation. Therefore, entities/companies will need to determine the most appropriate basis for preparation given their circumstances and its environment.

One of the standards that an entity could take into account is the pronouncement of the FASB, the body responsible for the issuance, discussion and promulgation of the generally accepted accounting principles in the United States. This promulgated in April 2013, the Accounting Standards Update No. 2013-07, Presentation of Financial Statements (Topic 205), Liquidation Basis of Accounting, for companies that are in the process of liquidation or that are declared in liquidation.

In accordance of the standard, an entity will prepare its financial statements using “the liquidation basis of accounting” when liquidation is imminent, whether decided by authorised persons or imposed by external forces.

The pronouncement requires that the financial statements of an entity in liquidation must be prepared using “the liquidation accounting base” to present relevant information about the expected resources and the resources that are committed when that situation arises.

“An entity shall measure assets to reflect the estimated amount of cash or other consideration that it expects to collect in settling or disposing of those assets in carrying out its plan for liquidation. In some cases, fair value may approximate the amount that an entity expects to collect. However, an entity shall not presume this to be true for all assets.”

Regarding other filing matters states that “At a minimum, an entity that applies the liquidation basis of accounting shall prepare the following:

a.???A statement of net assets in liquidation

b.??A statement of changes in net assets in liquidation.

Disclosure:

IAS 1 requires adequate disclosure of the basis of preparation and its effects when an entity prepares its financial statements on a basis other than the going concern basis. Therefore, it is advisable to disclose the nature of any deviation from IFRS, the reason for any reclassification of non-current assets or liabilities to the current one, the revaluation or impairment of assets, key assumptions and judgments made by management. Any legal matter to be taken into account based on the law of the corresponding jurisdiction should also be explained.

Recognition and Measurement:

Recognition:

The proposed ASU requires an entity to apply the liquidation basis of accounting when liquidation is deemed imminent. The Board tentatively decided to change the definition of “imminent.” Under the new definition, liquidation is imminent when there is an “approval of a plan of liquidation” (or when a liquidation plan has been imposed on the entity).

To eliminate the need for two definitions (i.e., one for limited life entities and one for nonlimitative entities, as currently proposed), the Board tentatively agreed that an entity should use the liquidation basis only when the liquidation is “unplanned.” Although it did not define this term, the Board explained that it does not intend limited life entities to apply the liquidation basis of accounting unless the liquidation date is unplanned (e.g., the governing documents of a limited life entity indicate that its life is 10 years but the entity has to be liquidated after two years).

Measurement:

The Board tentatively agreed to clarify the proposed requirement under which entities applying the liquidation basis of accounting must accrue all expected future income and costs that they will incur during liquidation provided that they have a reasonable basis for estimating these amounts. This clarification is intended to address concerns that certain future income or costs may not be estimated because of:

1.????????????The nature or type of these costs OR

2.????????????An anticipated long liquidation period.

The proposed ASU (Accounting Standards Update) requires entities to measure their assets and liabilities at the amount of consideration they expect to receive or pay. The Board tentatively agreed to clarify that if the expected consideration to be collected approximates the fair value of the asset, the entity may measure the asset at fair value. After making this tentative decision, the Board requested the staff to perform additional research and bring back suggestions to address how the proposed measurement principles related to the liquidation basis of accounting interact with other specific measurement bases that entities may need to use in presenting their asset and liabilities in accordance with certain statutory reporting requirements (e.g., fair value, which may not represent the cash flows an entity expects to collect or pay). Further, the Board tentatively decided that an entity should record its contractual liabilities at the contractual amount and should subsequently adjust these amounts when the liability is forgiven, relieved, or settled. The Board agreed to discuss the measurement of non contractual liabilities (e.g., legal or environmental accruals accounted for in accordance with ASC).

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