Introduction: Why Is Liquidation Accounting Necessary?

Liquidation is a process that most firms will not go through unless they face severe financial difficulties and cannot pay off their debts. The process involves selling the company’s assets to convert them to cash for creditors.^{1 2}

Liquidation affects several stakeholders, leading to employee job loss and shareholder investment losses. The process must account for debt, severance and investment repayments through liquidation accounting.³

Liquidation accounting is a specialised accounting process that helps businesses assess their asset value accurately. It differs from liquidity accounting, which measures a business’s ability to pay off debts with liquid assets.²² 

Since liquidation accounting is not as standardised as regular accounting, some business owners and accountants may be unsure about what it is and how to start.⁶ 

This article outlines key considerations for accountants to ensure a smooth and legally transparent liquidation process.

What Does Liquidation Accounting Include?

Liquidation accounting evaluates a company’s asset value to determine the liquidation order and repayment amounts for stakeholders.^{3 4}

Liquidation accounting includes:

1. NRV (Net Realisable Value) 

Net Realisable Value (NRV) is a valuation method that reflects the asset’s liquid value at sale. The company’s assets — usually their inventory and accounts receivables — are recorded at the fair market value, not their expected future value or historical cost.^{6 7}

NRV is part of the company’s inventory value assessment. It helps determine the amount of money acquired from selling the company’s assets.⁸ Calculating inventory value using NRV ensures the balance sheet accurately reflects the company’s actual liquidation value.

The company’s assets are listed in order of how quickly they can be liquidated. Assets that are the easiest to liquidate or sell are listed first.⁵

The general order is as follows ^{7 10}:

• Most Liquid Assets: Assets that will be used in the short term (within a year). Examples include liquid cash investments, accounts receivable, and inventory goods.
• Least Liquid Assets: Assets that are fixed or intended to be used long-term. Examples include equipment, real estate, and trademarks.

To calculate NRV, accountants typically subtract the selling costs (transportation and handling expenses incurred during the asset’s sale) from the market sale price. It is then recorded as an adjusted value on the balance sheet. Here’s an example of how it is calculated ⁹: 

NRV = Inventory value – transport costs – marketing costs

The accountant will also assess the firm’s cash ratio to determine the cash on hand for creditor repayment. If the cash ratio is low, they will plan to sell liquid assets.

2. Liabilities 

Liabilities are recorded at settlement amounts, meaning the amount of cash needed to pay them off now, not their future value.⁶ Liabilities can be classified into three types:

• Secured Liabilities are debts backed by assets that creditors can claim for non-repayment.¹¹
• Unsecured Liabilities are debts not backed by assets that creditors can claim for non-repayment.¹²
• Contingent Liabilities are potential liabilities that may occur in the future.¹³

These three liabilities can be contractual when a business issues an invoice or receives payment for work that has not yet been completed for a client or customer.¹⁴

3. Financial Reporting Objectives 

Liquidation accounting no longer prepares financial statements on a going-concern basis. Instead, it writes off long-term assets, assuming the company will cease business operations. Financial statements are thus prepared on a ‘break-up basis’ or ‘liquidation basis’. These terms are used informally, as they are not defined in the global IFRS.¹⁵

The financial reporting objective also changes from financial performance reporting to asset assessment. It evaluates if the assets are enough for creditors and if a surplus is available for distribution to shareholders.

4. Liquidation Fees

Liquidation accounting also considers the liquidation costs of winding up the business.⁶ These include liquidator’s service fees, legal fees, valuation fees, and advertising and transport costs for selling off assets.^{16 17 18}

5. Liquidation Timeline

The business entity or its liquidator should provide the liquidation timeline, which helps the accountant align financial reporting with the duration. The liquidation timeline differs depending on the type of liquidation and company size. 

• Creditors’ Voluntary Liquidation (CVL): 6 to 18 months¹⁹
• Members’ Voluntary Liquidation (MVL): 6 to 12 months¹⁹
• Compulsory Liquidation: Varies, can range from several months to years²⁰

6. Distribution Plan

Accountants must prepare a distribution plan among creditors and shareholders with the payment amount and order. The liquidation process prioritises creditors first, and any surplus is distributed to shareholders.²

In Singapore, the Insolvency, Restructuring and Dissolution Act (IRDA) 2018 provides laws on repayment hierarchy during liquidation. 

Accountants and liquidators must adhere to this legal framework when planning the creditor repayment order ^{10 21}:

• 1st Lien: Secured Claims with top priority, like creditors holding fixed charges on company property, machinery, and vehicles. Example: a bank with mortgage fees on company property.
• 2nd Lien: Second claims, like creditors holding floating charges over changing assets. Example: a bank with a loan for a company inventory.
• Preferential Creditors include employees (unpaid wages) and government agencies (unpaid taxes).
• Unsecured Creditors include accounts payable to suppliers and customers.
• Shareholders are the last to receive funds after all creditors have been paid. If the company does not have any surplus, the shareholders receive nothing.

Accountants handling liquidation accounting must ensure there are no preferential payments. For instance, directors or company owners should not be repaid before employees to prevent legal complications.

Tips for Businesses Doing Liquidation Accounting

Liquidation accounting is a niche, complex process that business owners and even professional accountants may find unfamiliar. We’ve provided some tips to help firms and accountants navigate it:

1. Accountants: Ask The Right Questions

Accountants may work with insolvency practitioners (IP) or liquidators while doing liquidation accounting. Before starting, discuss the firm’s financial position and reasons for liquidation with the IP or liquidator.²³ You may ask these questions:

• What is the company’s current financial position? – This helps you gather information needed to prepare the financial reports, such as asset, cash flows, and debt details.
• Are there irregularities or signs of fraud? – This could reveal underlying reasons for liquidation.
• How are the assets valuated? – Understand the valuation methods used to determine asset value and future fund distribution to creditors.
• What is the liquidation timeline? – This information is necessary for liquidation accounting, as previously mentioned.
• What are the projected recovery amounts? – Run through different liquidation scenarios to understand how much you can recover from selling assets.
• What fees are included? – Ask about IP, accountant, auditor, and lawyer fees. These must be included in the liquidation costs mentioned previously.
• How will the firm communicate with creditors during liquidation? – Timely communication with creditors and investors is essential to prevent allegations of misleading information and legal complications.
• What are the accountant’s responsibilities? – This ensures efficient collaboration and prevents duplicate work.

2. Businesses: Outsource Liquidation Accounting

The liquidation process is distressing for business owners and can become disorganised if not handled well. We recommend outsourcing your liquidation accounting to an accounting service provider, especially if your team lacks manpower or expertise. 

Pros of outsourcing liquidation accounting²⁴:

• Access to specialists: Third-party accounting services are offered by trained accountants specialising in liquidation accounting.
• Expertise and familiarity with laws: Third-party accounting services understand liquidation laws and accounting standards well.
• Time constraints: Third-party accounting services streamline liquidation accounting, allowing you to focus on other legal and operational aspects of business closure.
• Resource constraints: Third-party accounting services have access to paid accounting software and other resources that your business may not have.

Conclusion

Liquidation accounting aims to provide the most accurate financial representation of a company’s finances. It ensures that all stakeholders are repaid reasonably to minimise the financial damage caused by a business winding up.

Accountants handling liquidation accounting should familiarise themselves with the process or outsource it to a third-party service provider.

CorrectCounts offers liquidation accounting services for small businesses through our team of professional freelance accountants. Enquire about our liquidation accounting services at correctcounts.com.

References

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