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SEC Insights - May 2014

 

Liquidation Basis of Accounting

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Overview

In order to increase consistency and comparability of financial statements of businesses and other organizations that are ceasing operations and selling assets to settle debts with creditors, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2013-07 “Liquidation Basis of Accounting”. Financial statements should allow anyone reading them to "develop expectations about how much the organization will have available for distribution to investors after disposing of its assets and settling its obligations," as stated by the FASB. This ASU requires entities for which liquidation is imminent to prepare its financial statements on a liquidation basis of accounting. Before this ASU’s issuance, there had been limited guidance on this topic in the accounting literature.

Effective Date and Transition

ASU 2013-07 is effective for annual periods beginning after December 15, 2013 and interim periods therein. Early adoption is permitted.

The liquidation basis of accounting should be applied prospectively from the day liquidation becomes imminent. Entities that already are applying liquidation basis accounting as of the effective date will record a cumulative effect adjustment for any difference between previous measurements and those required by ASU 2013-07 (unless the entity is following existing accounting literature, such as those specified for terminating benefit plans, then the entity will continue with its current practice).

Scope

This ASU applies to both public and nonpublic entities; however, investment companies regulated under the Investment Company Act of 1940 (the “Act”) are excluded from its scope since such entities legally cannot change the way they measure their net asset values. Additionally, this ASU is applicable to limited life entities, if such entities liquidate differently from their original plan established at inception.

Recognition

  • Entities would be required to prepare financial statements in accordance with the liquidation basis when liquidation is imminent (even though the liquidation process may take years to execute), unless an entity is outside of the scope of this guidance or it is following a liquidation plan established at its inception in the entity’s governing documents.
  • If liquidation is imminent or in progress, an entity is not considered to be a going concern and financial statements are more meaningful if they presented on the liquidation basis of accounting. As such, the liquidation basis of accounting may be considered GAAP for entities in liquidation or for which liquidation is imminent.
  • Liquidation is imminent when either of the following occurs:
  • A plan of liquidation has been approved by the party or parties with the authority and the likelihood is remote that (a) the approved plan will be blocked and (b) the entity will return from liquidation.
  • A plan of liquidation is imposed by other forces (e.g. involuntary bankruptcy) and the likelihood is remote that the entity will return from liquidation.

Measurement

  • The liquidation value of assets may differ from their fair value because costs incurred for customary marketing and negotiating of selling an asset is not included in the fair value of such asset. Thus certain illiquid assets, in particular, are frequently sold for amounts below their fair value. When using the liquidation basis of accounting, entities should measure their assets at the amount of cash or other consideration they expect to collect upon sale.
  • Under the liquidation basis of accounting previously unrecognized assets may need to be recognized and measured. For example, trademarks that an entity expects to sell in liquidation or use to settle liabilities would be recorded.
  • Liabilities (e.g. debt) continue to be recognized at an amount required by other provisions of current accounting guidance, and are not remeasured to reflect any anticipation that the entity will be legally released from the obligation. However, changes in estimates resulting from its decision to liquidate (e.g., timing of payments) would be recorded. Other items, such as deferred charges or credits, debt premiums and debt issue costs should be written off upon adoption of the liquidation basis of accounting.
  • An entity also is required to accrue without discounting:
    • Cost to sell its assets**
    • Income that it expects to collect during liquidation process, when the entity has a reasonable basis for estimating such amounts**
    • Costs that it will incur through the end of liquidation, when the entity has a reasonable basis for estimating such amounts**

** The entity would remeasure all balances as of each subsequent reporting period.

Presentation and Disclosure

Financial statements include:

  • A statement of nets assets in liquidation (as of)
    • Initial statement shall present only changes in net assets that occurred during the period since liquidation became imminent
  • A statement of changes in net assets in liquidation (for the period)

(Stub period financials are not a requirement and going concern statements should not be combined with liquidation statements, however management should evaluate if they want to incorporate or present this transition in its financial statements)

Disclosures:

  • Includes the facts and circumstances surrounding the adoption of the liquidation basis of accounting and the entity’s determination that liquidation is imminent.
  • A description of entity’s plan for liquidation, including a description of each of the following:
  • The manner by which it expects to dispose of its assets and other items it expects to sell that it had not previously recognized as assets;
  • The manner by which it expects to settle its liabilities; and
  • The expected date by which the entity expects to complete its liquidation.
  • The methods and significant assumptions used to measure assets and liabilities, including any subsequent changes to those methods and assumptions.
  • The type and amount of costs and income accrued in the statement of nets assets in liquidation and period over which those are expected to be paid of income earned.

Christina Catalina, Assurance Services Partner, contributed to this article.

 
 
 
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