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
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 the 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.