Does Liquidation Basis of Accounting Apply to Investment Companies (and How)?

Liquidation basis of accounting is generally applicable to both private and public companies when liquidation is “imminent.” Investment companies regulated under the Investment Company Act of 1940 are specifically exempt, as they cannot legally change the way they measure their net asset value. However, all other “nonregulated” investment companies, such as private equity and hedge funds, are allowed to use this accounting method should they need it. 

When Should a Nonregulated Investment Company Use Liquidation Basis of Accounting?

When liquidation is “imminent” of course! According to FASB, liquidation is imminent when the likelihood of an entity returning from liquidation is remote and either: 

1. A plan of liquidation is approved by the authoritative party of the entity, and it is remote that other parties can block the plan; or
2. A plan of liquidation is imposed by outside forces, such as a key investor redeeming out of a fund or an involuntary bankruptcy. 

Note that certain investment companies are limited-life entities, such as private equity funds, and their governing documents have specified terms for liquidation. These types of funds should only apply the liquidation basis of accounting if the approved liquidation plan differs from those established in the governing documents at inception. 

What is Required Under the Liquidation Basis of Accounting?

Once an investment company has determined the liquidation basis of accounting is appropriate, the measurement and recognition of assets, liabilities, costs or expenses, and income would change as well as the presentation and disclosures in the financial statements: 

• Measure assets to reflect the estimated amount of cash or similar consideration the entity expects to collect in settlement or disposal of the assets. This may be different than fair value.
• Generally measure liabilities under normal GAAP, except that costs should be evaluated and estimates accrued through the estimated liquidation period. For example, evaluate and estimate professional fees for legal and compliance matters as well as operational and administrative costs through the estimated liquidation period, even if the period is in excess of a year.
• Plan to accrue other income and expenses expected to be incurred or earned through the end of liquidation, if and when a reasonable basis for such estimation exists.
• Re-measure and adjust all of the above at each reporting period.
• There are additional disclosure requirements as well as financial statement presentation options once liquidation basis is adopted, so be sure to check FASB ASC 946-205 and ASC 205-30 for implementation guidance. 

If your nonregulated investment company is nearing a liquidation event, talk with your financial advisory team to discuss using the liquidation basis of accounting.

Contact Aly Cottam at acottam@cohenco.com or a member of your service team to discuss this topic further.

Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.