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Under the liquidation basis of accounting, the emphasis shifts from reporting about the reporting entity's economic performance and position to reporting that focuses on the amount of cash or other consideration that an investor might reasonably expect to receive upon liquidation. The financial statements of a reporting entity applying the liquidation basis should reflect the amount of cash or other consideration that an investor might reasonably expect to receive after the reporting entity's assets have been liquidated and liabilities have been settled. The recognition and measurement principle for a reporting entity which has adopted the liquidation basis of accounting may include items which the reporting entity did not previously recognize on its going concern balance sheet, such as internally developed intangible assets. If such assets are expected to generate sales proceeds, the assets should be recognized upon the reporting entity's adoption of the liquidation basis.
Prior to adopting the liquidation basis of accounting, a reporting entity should consider whether any adjustments to its assets and liabilities are necessary while preparing going concern financial statements. In the periods prior to the adoption of the liquidation basis of accounting, assets, including goodwill, intangible assets, and long-lived assets, should be evaluated for impairment under the applicable standards. Generally, financial statements after the adoption of the liquidation basis of accounting would not reflect goodwill because it usually does not have any realizable value in a liquidation. See BLG 2 for additional detail.

6.5.1 Valuation considerations in the liquidation basis of accounting

For a reporting entity in liquidation, the valuation premise used to prepare going concern financial statements may not always be appropriate. While ASC 820, Fair Value Measurements and Disclosures, requires the use of market participant assumptions and the consideration of the most advantageous market when estimating fair value, the liquidation basis is developed from the reporting entity’s point of view and is based on the expectations of its management. The definition of fair value under ASC 820 is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” This approach may not be appropriate for a reporting entity in liquidation because the process of liquidation can involve distressed or forced sales of assets without a sufficient period to market the assets or wait for an illiquid or depressed market to recover. In some cases, a fair value measurement may be appropriate to approximate the amount of cash or other consideration that a reporting entity expects to collect, but ASC 205-30 does not presume that a fair value measurement would be applied to measure all assets.
The more uncertain the future liquidation value becomes (e.g., due to the date of disposition being uncertain or because liquidation of the investment portfolio will not occur in the near term), the more relevant the current fair value of the investment position may become for purposes of reporting under the liquidation basis of accounting. However, discounting of cash flows from the expected exit/disposal date to the balance sheet date to reflect the time value of money is prohibited under ASC 205 when determining the liquidation values of assets and liabilities. Accordingly, management must eliminate the time value of money when measuring the liquidation value of investments such as private equity securities, structured products, or other distressed fixed income securities. The use of a discounted cash flow model to determine liquidation value, however, may be appropriate if such model results in a value that represents a best estimate for those cash flows expected to be received at the future disposition date. Management should clearly disclose in the notes to the financial statements its bases for determining the liquidation values of investments.
Example BLG 6-10 highlights the valuation concepts applied when measuring the liquidation value of investments.
EXAMPLE BLG 6-10
Determining liquidation value
A fund has adopted the liquidation basis of accounting as of January 1, 20X1. The fund holds a zero-coupon debt investment for which management uses a discounted cash flow model to estimate liquidation value at an expected date of sale two years out from the current balance sheet date.
Would it be appropriate to apply a valuation model that effectively discounts the expected proceeds in determining the liquidation value of the private equity investment?
Analysis
ASC 205 does not permit the use of discounted cash flows to measure the liquidation value of an asset at the reporting date. However, it would be acceptable to use a discount rate that reflects the risk (e.g., collection risk, market risks, etc.), to measure the value expected to be collected at a future disposition date.

6.5.2 Use of NAV as a practical expedient (liquidation basis)

When applying the liquidation basis of accounting, careful consideration should be given to the use of NAV as a practical expedient for measuring investments in funds. The practical expedient is allowable only if, among other requirements, the investee fund is following the ASC 946, Financial Services - Investment Companies, accounting model and if a sale at an amount that approximates NAV is probable (based on criteria in ASC 820-10-35-62).
If a fund is reporting under the liquidation basis of accounting, the fund is not reporting pursuant to ASC 946 or valuing its investments at fair value pursuant to ASC 820. Therefore, the NAV practical expedient is not available to be used for the measurement of an investment in a fund in liquidation.
If a reporting entity is reporting under the liquidation basis of accounting and intends to sell an investee fund in the secondary market instead of redeeming or receiving distributions from the underlying investee fund, the investee fund's net asset value may not be the best estimate of liquidation value. In addition, any restrictions on exit would need to be considered when determining liquidation value.

6.5.3 Accounting for assets under the liquidation basis of accounting

Assets of the reporting entity are measured at the estimated amounts of cash or other consideration it expects to collect, which may be different from fair value. ASC 205-30-25-4 requires recognition of assets that a reporting entity expects to sell in liquidation or use to settle liabilities that are not permissible for recognition under non-liquidation basis GAAP. Trademarks, which may have no basis in a reporting entity's going concern financial statements but would be recorded at liquidation value, are an example of such assets and may be recognized in the aggregate.
Assets presented under the liquidation basis are not depreciated, and accumulated depreciation is not presented. Impairment and other methodologies for adjusting asset values under a going concern basis are not relevant under the liquidation basis. In theory, since assets are measured at the amount of cash the reporting entity expects to collect upon sale, gains or losses on asset dispositions would not be expected in liquidation-basis accounting financial statements.
Deferred charges and other assets that will not be converted to cash or other considerations (e.g., deferred financing costs, prepaid expenses) should be written off at the date of adoption of liquidation basis of accounting.
The adoption of the liquidation basis of accounting might create adjustments that seem unusual in comparison with the financial statements of going concern entities. For example, a going concern manufacturing entity may present equipment classified as held and used at a carrying value of $400,000, but on a liquidation basis this equipment would be presented based on its estimated liquidation proceeds of only $200,000. The decrease in carrying value would be an effect of the adoption of the liquidation basis of accounting. On the other hand, a building may be presented at a carrying value of $1 million on a going concern basis but valued at $1.2 million based on its estimated proceeds under the liquidation basis. The recorded amount for the building would be written up when adopting the liquidation basis of accounting.
Example BLG 6-11 illustrates the concepts associated with measuring assets under the liquidation basis of accounting.
EXAMPLE BLG 6-11
Recognition of future income expected on investment in debt security
A nonregistered investment company with a December 31 year end has one fixed income investment with a 10% coupon rate paid annually. The investment company determines that liquidation is imminent on January 1, 20X1 and will likely dispose of its investment on December 31, 20X1. On January 1, 20X1, the investment company estimates the sales proceeds (net of selling costs) it expects to receive on the disposition date (December 31, 20X1) as $100, which is considered the liquidation value. The fair value on January 1, 20X1 is $95.
The investment company also concludes that it has a reasonable basis to estimate this security's interest income through the end of liquidation and accrues, as of January 1, 20X1, the undiscounted interest coupon payment of $10 expected to be received during the period from January 1, 20X1 to expected disposition on December 31, 20X1.
How should the investment company measure and record its fixed income investment upon adoption of the liquidation basis of accounting?
Analysis
Upon adoption of the liquidation basis of accounting on January 1, 20X1, the investment company would measure its total position (investment and accrued interest income) at the amount of cash it expects to receive during the period through liquidation on December 31, 20X1 as $110 (the $10 interest coupon payment plus the $100 of expected sales proceeds from disposition of the fixed income investment). The fair value of $95 is not directly considered in determining liquidation value nor recorded in the financial statements.

6.5.4 Accounting for liabilities under the liquidation basis of accounting

ASC 205-30-25-5 and ASC 205-30-30-2, respectively, requires a reporting entity in liquidation to continue to recognize and measure its liabilities in accordance with the recognition and measurement provisions of other accounting standards that would otherwise apply to those liabilities. Certain events that may occur in connection with a liquidation, such as a covenant violation or a troubled debt restructuring, have specific accounting guidance that a reporting entity should consider even when applying the liquidation basis of accounting. Further, liabilities of specified, contractual amounts should not be written down to their estimated settlement amounts until the liabilities are legally settled. However, liabilities without contractually specified amounts that are measured based on estimates of settlement amounts and timing should be adjusted to incorporate all changes to assumptions which are impacted by the reporting entity’s decision to liquidate.
For example, a reporting entity may have an asset retirement obligation (ARO) for which, prior to applying the liquidation basis, it estimated would be settled in five years. Upon adopting the liquidation basis of accounting, the reporting entity now expects the ARO will be settled in three months. The reporting entity should re-measure the ARO on the date it adopts the liquidation basis of accounting to incorporate its updated estimate of the settlement date of the liability. However, it should not reduce the estimated cash flows inherent in the ARO estimate for any anticipated forgiveness until such liability is legally forgiven.

6.5.5 Accounting for disposal costs under the liquidation basis of accounting

Upon adoption of the liquidation basis, a reporting entity should accrue the estimated disposal costs of the assets it expects to sell in liquidation in accordance with ASC 205-30-25-6. The expected disposal costs should be reported in the aggregate separately from the carrying amounts of the related assets. The measurement of a reporting entity’s estimate of its disposal costs for the liquidation should be made on an undiscounted basis.

6.5.6 Accounting for future income and costs under the liquidation basis of accounting

On the date it adopts the liquidation basis, as stated in ASC 205-30-25-7, a reporting entity should accrue all future income it reasonably expects to earn and costs it reasonably expects to incur, including those from any remaining operating activities, until its liquidation is complete. Expected income and costs should be measured on an undiscounted basis in accordance with ASC 205-30-30-3. Because the purpose of liquidation basis financial statements is to provide users with information regarding the resources and obligations of the reporting entity, accruing liquidation and other costs when liquidation is imminent provides an improved perspective on the resources that will be available to satisfy the reporting entity's obligations. That is, the expensing of such costs as incurred, although generally appropriate for going concern entities, would be inconsistent with the purpose of liquidation basis financial statements.
For example, on the date it adopts the liquidation basis, a reporting entity may expect to continue to employ five staff to assist with wind-down activities. Its liquidation is expected to last three months. On the adoption date, the reporting entity should accrue three months of payroll and related costs for the five employees, as long as it has a reasonable basis to estimate the anticipated costs.
In situations where a reporting entity is not able to reasonably estimate the amount of future costs it expects to incur or income it expects to earn, it would expense costs as incurred and recognize income as earned until such time it has sufficient information to make such an estimate.
The financial statements should include disclosure of the assumptions used with regard to the accrual of fees (and all other significant income or expense) and the related estimation uncertainty, if any.
Example BLG 6-12 illustrates the concepts associated with accounting for future income and costs under the liquidation basis of accounting.
EXAMPLE BLG 6-12
Recognition of future expenses expected to be incurred in a fund
A nonregistered fund with a management fee and incentive fee structure in place adopts the liquidation basis of accounting. Should the fund accrue expenses related to the management and incentive fee arrangement?
Analysis
Oftentimes, incentive fees and, sometimes, management fees of an investment manager are waived by the investment manager during the liquidation period. However, if the fee arrangements are not waived, the fees should be accrued when there is a reasonable basis for estimation. When fees are not estimable for the entire period of liquidation, in most instances at least the fees to be earned in the near term can be estimated and, if so, should be accrued by the fund.
A liquidation basis adoption adjustment for fee arrangements that are not waived is expected. As such, management should carefully consider facts and circumstances surrounding fee arrangements and evaluate whether an accrual for incentive and management fees is necessary upon the adoption of the liquidation basis of accounting and subsequently during liquidation.

The treatment of the various financial statement elements under the liquidation basis of accounting is summarized in Figure BLG 6-3.
Figure BLG 6-3
Impact on financial statement balances of adopting the liquidation basis of accounting
Financial statement element
Accounting
Assets
Estimated amount of cash expected to be collected in disposition, including assets not previously recognized (e.g., internally developed trade names that can be sold)
Liabilities
Continue to recognize and measure liabilities in accordance with the provisions of other accounting standards that would apply to those liabilities, incorporating any revised assumptions that are a result of the reporting entity’s decision to liquidate
Disposal costs
Accrue estimated disposal costs of assets in the aggregate, separately from those assets
Anticipated future income and costs
Accrue all expected future income and costs that are expected to be earned or incurred through the liquidation date, including interest income and expense; such income and costs should only be accrued if and when the reporting entity has a reasonable basis for estimation
Deferred charges and other assets that will not be converted to cash or other considerations (e.g., deferred financing costs, prepaid expenses)
Write off at the date of adoption of liquidation basis of accounting

At each reporting date after adopting the liquidation basis of accounting, a reporting entity should continue to remeasure its assets, liabilities, and accruals for disposal costs and other income and costs using the same measurement principles as it followed on the date it adopted the liquidation basis.
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