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6.2 Overview of the liquidation basis of accounting
Publication date: 31 Aug 2021 (updated 30 Jun 2023)
us Bankruptcy & liquidation guide
A liquidation is the process by which a reporting entity converts its assets to cash or other assets and settles its obligations with creditors in anticipation of ceasing all activities. During this process, cash and other assets are used to settle claims with any remaining assets distributed to the owners of the reporting entity.
Regardless of the reason for the liquidation, the need for relevant financial reporting remains critical even when a business is liquidating. FASB Concepts Statement 8 (CON 8) highlights the needs of financial statement users, regardless of whether the users are investors, lenders, or creditors of the reporting entity, as all users need relevant information upon which to base their decision making with respect to the business.
Excerpt from the Basis for Conclusions of CON 8
1.34 Some constituents have suggested that the main purpose of the statement of financial position should be to provide information that helps assess the reporting entity’s solvency. The question is not whether information provided in the financial reports should be helpful in assessing solvency; clearly, it should. Assessing solvency is of interest to investors, lenders, and other creditors, and the objective of general purpose financial reporting is to provide information that is useful to them for making decisions.
For a reporting entity facing liquidation, the operating results and cash flows of the going concern reporting entity are not particularly relevant. Instead, the reporting entity’s outstanding obligations and the cash or other resources on hand that can be used to satisfy those obligations are the information that is relevant for financial statement users. Accordingly, the measurement of assets and liabilities under the liquidation basis of accounting reflects the resources available to satisfy the obligations of the reporting entity as well as the expected settlement of those obligations. Historical reporting of results changes to a presentation of the resources that the liquidating reporting entity possesses and how those resources compare to its obligations. In many respects, this presentation is developed from, and is based on, the expectations of management as the liquidation process evolves.
When a reporting entity has adopted the liquidation basis of accounting, its financial statement requirements change from a balance sheet and statements of comprehensive income and cash flows to a statement of net assets in liquidation and a statement of changes in net assets in liquidation. These formats better reflect the needs of the users and are illustrated later in this chapter.
ASC 205, Presentation of Financial Statements, dictates when a reporting entity should apply the liquidation basis of accounting, provides principles for the measurement of assets and liabilities when in liquidation, and establishes financial reporting requirements once a reporting entity is in liquidation. ASC 205-30-20 defines "liquidation."
Definition from ASC Master Glossary
Liquidation: The process by which an entity converts its assets to cash or other assets and settles its obligations with creditors in anticipation of the entity ceasing all activities. Upon cessation of the entity's activities, any remaining cash or other assets are distributed to the entity's investors or other claimants (albeit sometimes indirectly). Liquidation may be compulsory or voluntary. Dissolution of an entity as a result of that entity being acquired by another entity or merged into another entity in its entirety and with the expectation of continuing its business does not qualify as liquidation.
The remainder of this chapter reflects the guidance under ASC 205-30. Refer to BLG 7.5 for disclosure requirements for a reporting entity in liquidation.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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