Liquidation basis of accounting definition
/What is the Liquidation Basis of Accounting?
The liquidation basis of accounting is used when an entity determines that liquidation is imminent and the organization will not continue as a going concern. Under this basis, assets are measured at the amount expected to be collected upon disposal, rather than historical cost or fair value based on ongoing use. Liabilities are measured at the amounts expected to be settled, including estimated costs to complete the liquidation process. The focus shifts from periodic income measurement to estimating net realizable value available to claimholders. Income statements are no longer presented; instead, changes in net assets available for distribution are reported. The liquidation basis provides users with information relevant to winding down operations rather than continuing them.
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Problems with the Liquidation Basis of Accounting
The liquidation basis of accounting can present several challenges, primarily due to the subjectivity and uncertainty involved in estimating the realizable value of assets and the total costs of liquidation. Asset values under distressed or forced-sale conditions often differ significantly from market or book values, making it difficult to provide accurate estimates. Additionally, identifying all future obligations—such as legal fees, severance costs, or environmental liabilities—can be complex and prone to error. This approach also requires a significant shift in accounting procedures and assumptions, which can introduce inconsistency and reduce comparability with prior financial statements. Overall, while it provides more relevant information during wind-down, its reliability depends heavily on management’s judgment and the availability of market data.
The Difference Between Liquidation Basis and Accrual Basis Accounting
The accounting under the liquidation basis of accounting differs in several respects from normal accrual basis accounting. The key differences are:
Additional asset recognition. Recognize any assets that had not previously been recognized, but which you expect to either sell in liquidation or use to pay off liabilities. This means it is possible to recognize internally generated intangible assets – which would not normally be the case. The main point is to only recognize items if they are actually worth something in liquidation.
Aggregate asset recognition. It is allowable to recognize in aggregate those assets that had not been previously recognized, rather than individually.
Charge off disposal costs. Accrue for the expected disposal costs of assets that will be liquidated.
Accrue future items. Accrue for those income and expense items that will be earned or incurred through the end of the expected liquidation period. An example of such an income item is the expected profits from orders that have not yet been fulfilled. An example of such an expense item is wage and salary costs expected to be incurred.
Liquidation Basis Financial Statements
Under the liquidation basis of accounting, a business must issue two new statements, which are noted below.
Statement of net assets in liquidation. The statement of net assets in liquidation shows the net assets available for distribution at the end of the reporting period.
Statement of changes in net assets in liquidation. The statement of changes in net assets in liquidation shows the changes in net assets during the reporting period.