The Liquidation Basis of Accounting (#159)
/In this podcast episode, we discuss the details of the new liquidation basis of accounting. Key points made are noted below.
When the Liquidation Basis is Used
Liquidation basis accounting is basically about preparing your financial statements in a different way if the business is about to be liquidated. The official term is, “when liquidation is imminent.” You can consider “imminent” to mean when it’s unlikely that the business won’t be liquidated, or that liquidation is being imposed on the company – such as through an involuntary bankruptcy. And by the way, liquidation means the business is shutting down and paying off its creditors. Liquidation does not mean when a business is being acquired. Otherwise, a lot more companies would be using this.
Presentations Under the Liquidation Basis
Hopefully, you’re not in an imminent liquidation situation. But if you are, the basic rule of presentation is to include in the financials the amount of expected cash proceeds from the liquidation, and the expected expenditures needed to settle all remaining liabilities. This means the accounting is different from what you’d normally see in a couple of areas.
First, you can recognize any assets that had not previously been recognized, but which you expect to either sell in liquidation, or use to pay off liabilities. And that means you can recognize internally generated intangible assets – which would not normally be the case. The main point is that you can only recognize these items if they’re actually worth something in liquidation. And only when you’ve also accrued expected disposal costs for the assets.
Another point. In liquidation accounting, you’re measuring assets at the estimated amount that you can sell them for – which may or may not be their fair market value. If the liquidation is a bit of a rush, this could mean that the estimated selling price is less than fair market value.
Also, and this is no surprise – you’re supposed to accrue every expense that you expect to incur as part of the liquidation – such as legal fees. What is surprising is that you’re allowed to accrue the income you expect to earn during the liquidation period.
For example, let’s say there’s a plan to completely shut down a plumbing business in one month. You should estimate the amount of income expected from the remaining customer orders, and accrue that income right now. And yes, this means the business is recognizing income before it’s earned the income. This goes against GAAP in a big way, but then liquidation accounting no longer assumes that the business is a going concern. Instead, the main focus of attention is – as the name implies – to see what the company is worth in its liquidated state.
Now these rules changes don’t mean there’s a complete accounting free-for-all, where you can completely recast the balance sheet. In particular, you’re not allowed to anticipate being released from a liability until the release actually happens.
Another point is that you don’t discount disposal costs to their present value, and there’s no discounting of any accrued income. And that’s because there’s really no point. If the entire business is about to be liquidated, it won’t be around for very long, so the amount of any discount should be immaterial.
So, what if the company doesn’t liquidate just yet, and in fact drags along for a few reporting periods? Well, in each period, you’re supposed to remeasure the assets and liabilities and adjust them in the accounting records to their liquidation values as necessary.
And of course, you have to disclose all of this – the plan for liquidation, measurement assumptions, when liquidation should be completed, and details about the income and costs that you’ve accrued.
Additional Statements to Present
There’re also a couple of new statements to present. There’s the statement of net assets in liquidation, which shows the net assets available for distribution at the end of the period. There’s also the statement of changes in net assets in liquidation, which is just what the name implies – it shows only the changes in net assets during the reporting period.
Parting Thoughts
And finally, the liquidation basis has had a few references in the accounting literature in the past, but this is the first it’s been directly addressed. And it’s only been referred to in passing in the international standards. My guess is that this is not the last we’ve heard of the concept, and that more will appear in the international standards, too.