When a business is hemorrhaging cash with no reversal in sight, management must stop the bleeding. At this stage of the business's operational, market and/or financial deterioration, a sale to a third party may not be viable as the expected net proceeds from a sale may be significantly less than the cash burned during the intervening period. If this is the case, management may discontinue the operations and liquidate the business.

In reaching a decision to liquidate a business, management will need to consider whether the business (a) has come to the end of its useful life, (b) lost key employees, (c) lost market presence and (d) has any remaining subdivisions that are viable (stand-alone or those created via a transfer to another operating division). Further, in reaching a decision to liquidate, management must consider important issues (e.g., product warranties with customer end-of-life programs; employee severance; contractual obligations, including all capital and operating leases; taxes; payment of creditors; etc).

Once a decision and plan to liquidate has been made, the financial reporting considerations can be made. There are two basic approaches to reporting for an entity in liquidation. One approach is a complete liquidation basis of accounting, in which adjustments of individual assets and liabilities to estimated net-realizable values may result in either a net write-up or write-down of net assets/equity. The other is to continue the going-concern assumption and treat all activities of the entity as an APB-30 (Accounting Principles Board) discontinued operation; in this approach, adjustments of individual assets and liabilities to estimated net realizable values, where appropriate, may result in only a net write-down of net assets/equity. The fundamental distinction between these approaches is the prohibition of a net write-up when the going-concern assumption is retained; the liquidation basis may permit recognition of unrealized appreciation.

Financial statements prepared on a liquidation basis are contemplated in the accounting literature by the footnote to paragraph 117 of APB Statement 4, which states, "Šif liquidation appears imminent, financial information may be prepared on the assumption that liquidation will occur." In addition, the Financial Accounting Standards Board (FASB) makes the following observations in the footnote to paragraph 42 of Statement of Financial Accounting Concepts No. 1:

Investors and creditors ordinarily invest in or lend to enterprises that they expect to continue in operation—an expectation that is familiar to accountants as "the going-concern" assumption. Information about the past is usually less useful in assessing prospects for an enterprise's future if the enterprise is in liquidation or is expected to enter liquidation. Then, emphasis shifts from performance to the liquidation of the enterprise's resources and obligations. The objectives of financial reporting do not necessarily change if an enterprise shifts from expected operation to expected liquidation, but the information that is relevant to those objectives, including measures of elements of financial statements, may change.

Under either approach, all remaining obligations through completion of the liquidation that can be estimated with reasonable accuracy should be recognized.

Financial Statement Format

Financial statements on a liquidation basis of accounting generally consist of a statement of net assets in liquidation and a statement of changes in net assets in liquidation. In general, the statement of net assets would be unclassified; the excess of assets over liabilities would be presented as a single amount designated "net assets in liquidation," with disclosure of the related per-share amount. The statement of changes in net assets would include summarized increases and decreases in net assets resulting from (1) liquidating activities including liquidating dividends, if any, and (2) net operating results. Under a liquidation basis of accounting, it is important to segregate liquidating activities from operating activities, and judgment will be required in cases where it is difficult to distinguish the effects of liquidation from results of operations.

Although Statement of Position (SOP) 90-7 ("Financial Reporting by Entities in Reorganization Under the Bankruptcy Code") does not apply to entities that liquidate or adopt plans of liquidation under the Bankruptcy Code (see footnote 19 of SOP 90-7), some of the guidelines regarding reporting practices and objectives should be considered. Examples include the disclosure of secured and unsecured liabilities, reporting of operations and interest expenses, and classification of certain balance-sheet accounts.

If the going-concern assumption is retained for a liquidating entity, the entire entity has become an APB-30 discontinued operation for which a one-line presentation is technically required; thus, a full-income statement is a blow-up of the single line, and its heading should refer to discontinued operations or the liquidation. The measurement rules of APB 30 will apply, with the additional nuance that corporate general and administrative expenses will be considered as part of discontinued operations. A conventional financial statement format will continue to be appropriate if a net gain is expected in liquidation. When a net loss is expected, the provision for loss is made at the measurement date; thereafter, operating and liquidating activities would usually be reflected in an analysis of changes in the reserve for loss.

In all circumstances involving liquidation, financial statement headings should disclose the "in liquidation" status of the entity. Typically, the financials of entities that adopt a liquidation basis of accounting are presented along with the financial statements of a period prior to the adoption of a liquidation basis that were prepared on the basis of generally accepted accounting principles for a going concern. In these instances, the prior period statements should not refer to a "liquidation basis."

Other Financial Reporting Considerations

The question of whether amounts should be recorded at present value must be considered on a case-by-case basis. Generally, an APB-30 discontinued operation approach uses gross amounts rather than present values. When a liquidation basis is followed, the propriety of present values depends on the certainty with which amounts and timing can be predicted and the objectivity with which an appropriate rate of interest for a company in liquidation can be determined.

Corporate liquidations can vary considerably in length and complexity; this should be carefully considered in determining which basis of accounting is more appropriate in the circumstances. For example, where it is expected that liquidation of the net assets will not be accomplished for a number of years and operations will be significant during a substantial portion of that period, the going-concern assumption would presumably continue to be more appropriate, at least prior to the disposal of the major operating assets. Indeed, a change to a liquidation basis of accounting during the liquidation process suggests extreme difficulty in estimating net realizable values with any degree of precision. In other cases, when fair values are determinable within reasonable limits and realizable within a relatively short period of time, a liquidation basis of accounting may be more appropriate.

The practical implications of adjusting a business's assets and liabilities to estimated net realizable value are significant. Aside from estimating a net realizable value for existing account balances, management will need to consider:

• the costs associated with honoring warranty provisions and the costs of assigning these services to another vendor;
• establishing and/or estimating employee severance costs, as well as stay bonuses for key employees needed for the wind-down;
• performing a tax review to structure the wind-down and liquidation in the most efficient manner;
• settling creditor claims and estimating the costs of terminating any long-term commitments;
• estimating the termination costs of all off-balance-sheet lease commitments;
• establishing reserves and accruing for excess funding or future obligations for terminating pension, savings, health and insurance plans; and
• establishing reserves for legal actions, environmental costs and other contingent liabilities.

Determining a reasonable estimate of the costs and financial impact of the above items may not be feasible. If this is the case, adequate disclosure in the footnotes should be made.

Management may also be concerned about receiving a report from the company's independent accountants due to contractual compliance or shareholders' requirements. SAS 1/AU 9508.34 ("Reports on Audited Financial Statements: Auditing Interpretation of §508") indicates that the liquidation basis of accounting may be considered to be in accordance with generally accepted accounting principles for entities in liquidation or for which liquidation appears imminent. An unqualified opinion may be rendered on financial statements prepared under the liquidation basis of accounting, provided this basis has been properly applied, adequate disclosures are made and no significant uncertainties exist.

Conclusion

The liquidation of a business is a complex and evolving process. Liquidation basis financial statements, by their nature, are subject to significant estimates by management. Accordingly, care needs to be taken in preparing such statements, and users of liquidation-basis financial statements need to be cognizant of the significant estimates used by management and realize these estimates may not be as reliable as those used in financial statements of entities using a going-concern basis of preparation.