On Monday the US Financial Accounting Standards Board (FASB) released a standard that provides guidance for firms on when and how to prepare financial statements using the liquidation basis of accounting.
In the past private equity firms and their portfolio companies have relied on a hodgepodge of past audit guidance when preparing financial statements ahead of an expected wind down or bankruptcy.
FASB specifically defines liquidation as the “process by which a company converts its assets to cash or other assets and settles its obligations with creditors in anticipation of ceasing all of its activities”.
The board, whose job it is to develop US GAAP, said firms undergoing liquidation must prepare financial statements that communicate to others how much the organization will have available for distribution to investors after disposing of its assets and settling its obligations.
This standard addresses their concerns and reduces the diversity in practice that has resulted in the reporting of these activities
Firms will follow the new standard when liquidation is “imminent”. FASB considers liquidation imminent when there is a remote chance a firm will return from liquidation and it seems unlikely that any party with the necessary authority will prevent the liquidation from occurring.
A market source familiar with the new standard said private equity funds with a limited life span (typically 10 years) would not follow the liquidation standard when selling off portfolio companies near the end of their life. Only funds that deviate from the original investment and divestiture timelines spelled out in the investment vehicle’s governing documents would apply the standard, the source said.
“Stakeholders have requested guidance on when and how to prepare financial statements using the liquidation basis of accounting,” stated FASB Chairman Leslie Seidman. “This standard addresses their concerns and reduces the diversity in practice that has resulted in the reporting of these activities.”