Liquidation basis of accounting: Practical challenges and key considerations

‘Going concern’ is one critical consideration in the preparation of financial statements². Going concern consideration requires the management to make an assessment of the entity’s ability to continue as a going concern. In making this assessment, management takes into account all available information about the future period, covering a minimum of 12 months from the end of the reporting period. The 12-month period for considering the entity’s future is a minimum requirement. If there is evidence of events occurring after 12 months impacting the entity’s ability to continue as a going concern, then the entity needs to consider those events as well. For example, if an entity has decided to cease its operations 16 months after the reporting date, the entity may still not be able to prepare financial statements on a going concern basis.

The extent of assessment required by management to form a view on the entity’s ability to continue as a going concern is a matter of significant judgment and depends on the specific facts and circumstances of each case.

For instance, where an entity has a consistent history of profitable operations, a positive net worth, strong working capital position and ready access to financial resources, and where there are no indicators suggesting that such performance is unlikely to continue, the management may conclude that the going concern basis of accounting remains appropriate without the need for a detailed analysis.

However, in certain situations, management may be required to perform a comprehensive evaluation of multiple financial, operational and regulatory factors. Based on such an assessment, including appropriate legal considerations where necessary, management can arrive at a well-informed conclusion on the appropriateness of the going concern assumption.

Key considerations may include:

• Whether there are any regulatory restrictions or actions impacting operations (e.g., Reserve Bank of India (RBI)-imposed lending restrictions on financial institutions).
• Whether there are investigations or actions by regulatory authorities such as Securities and Exchange Board of India (SEBI), Ministry of Corporate Affairs (MCA), Serious Fraud Investigation Office (SFIO), or Goods and Services Tax (GST) authorities that could affect business continuity.
• Whether critical licenses or approvals are at risk of suspension, cancellation, or non-renewal (e.g., telecom spectrum, mining leases, environmental clearances).
• Whether the business model remains commercially viable or is being challenged by new entrants, technological changes, or shifting market dynamics (e.g., traditional retail vs. e-commerce, thermal power vs. renewable energy transition).
• Whether sustained losses or weak financial performance have adversely impacted investor confidence and funding prospects.
• Whether there are material litigations, tax disputes, or arbitration matters that could result in significant outflows (e.g., GST demands, retrospective tax claims).
• Whether the company has adequate liquidity to meet its obligations over the next 12 months (e.g., Non-Banking Financial Company (NBFC) facing asset-liability mismatches due to delayed recoveries).
• Whether loan repayments and interest servicing are being made on time, and whether any defaults or delays have been reported to lenders or regulators (e.g., classification as SMA-2 or NPA by banks).
• Whether long-term assets are being financed through short-term borrowings (e.g., infrastructure projects funded through working capital lines).

² Under Indian GAAP, going concern is treated as a fundamental accounting assumption in the preparation of financial statements, whereas under Ind AS, it is considered as one of the critical considerations requiring active assessment and appropriate disclosure.

Key considerations may include: (continued)

• Whether there are ongoing or planned debt restructuring arrangements or one-time settlements (OTS) with lenders.
• Whether financial or operational covenants have been breached, and the stance of lenders in such cases.
• Whether the entity has entered, or is likely to enter, insolvency proceedings under the Insolvency and Bankruptcy Code (IBC), such as admission into the Corporate Insolvency Resolution Process (CIRP) by the National Company Law Tribunal (NCLT).
• Whether there is significant dependency on key customers or suppliers, and potential risks arising from the loss of major contracts or markets.
• Whether the entity relies on financial support from promoters or group entities, and whether such parties are themselves under financial or regulatory stress.
• Whether the going concern assumption depends on the sale of assets or investments, and whether such assets are realistically realizable at expected values.
• Whether there are weaknesses in internal controls or indications of fraud affecting the reliability of financial information.
• Whether any post-balance sheet events (e.g., loan recalls, adverse legal orders, loss of funding) have materially worsened the position.
• Whether the company has lost key contracts, customers, or funding arrangements after the reporting date.

Paragraph 25 of Ind AS 1 Presentation of Financial Statements states that an entity will prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so. The paragraph also states that if there are uncertainties which may cast doubt on the entity’s ability to continue as a going concern, then those uncertainties need to be disclosed.

Depending on management’s assessment of the entity’s ability to continue as a going concern, the following outcomes seem possible:

Possible outcomes of the going concern assessment

a) No material uncertainty exists

There are no material uncertainties regarding the entity’s ability to continue as a going concern. Financial statements of the entity are prepared on a going concern basis, and a disclosure is made in the financial statements of this fact, along with the entity’s basis for reaching the conclusion.

b) Material uncertainties exist, but the entity remains a going concern

Though there are material uncertainties regarding the entity’s ability to continue as a going concern, the management/shareholders are working on mitigating actions and do not intend to liquidate the entity or to cease trading. The going concern evaluation performed by management indicates that realistic alternatives exist for the entity to continue as a going concern.

Financial statements of the entity may be prepared on a going concern basis. However, the uncertainties involved and the basis of conclusion should be disclosed.

Disclosures required include:

• A description of principal events or conditions giving rise to significant uncertainty regarding the entity’s ability to continue in operation and management’s plans to deal with these events or conditions.
• A clear statement as to whether there is a material uncertainty related to events or conditions which might cast significant doubt on the entity’s ability to continue as a going concern, such that it might be unable to realize its assets and discharge its liabilities in the normal course of business.

c) Going concern basis is no longer appropriate

The management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so. Financial statements of the entity are prepared not on a going concern basis. The entity will disclose this fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern.

Ind AS 10 Events after the Reporting Period is clear that an entity should not prepare its financial statements on a going concern basis even if the management determines after the reporting period either that it intends to liquidate the entity or to cease trading, or that it has no realistic alternative but to do so. Hence, any event after the reporting period indicating that it is not appropriate to apply the going concern basis of accounting is always an adjusting event.

How to prepare financial statements when the going concern basis is inappropriate?

Paragraph 25 of Ind AS 1, among other matters, requires an entity to prepare its financial statements on a going concern basis unless the management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. The paragraph further states that when an entity does not prepare financial statements on a going concern basis, it will disclose that fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern.

Similar requirements are reiterated in paragraph 16 of Ind AS 10. Further, paragraph 3.9 of the Conceptual Framework for Financial Reporting under Indian Accounting Standards (Ind AS), issued by the Institute of Chartered Accountants of India (ICAI), indicates that if the going concern basis is not appropriate, financial statements may need to be prepared on an alternative basis and the financial statements should describe the basis used.

Ind AS are primarily written from the perspective of an entity which is a going concern. Ind AS 1, Ind AS 10 and the Conceptual Framework recognize that the financial statements may be prepared on an alternative basis with appropriate disclosures if the going concern basis of accounting is no longer appropriate. However, they do not address what an alternative basis of accounting should be.

To deal with this matter further, the Research Committee of the ICAI has recently issued a report titled Liquidation Accounting. Though the report is not mandatory, it provides useful guidance on the matter, which may help generate further evaluation of this matter.

Based on practices prevalent globally, the report recognizes three broad approaches to prepare financial statements on a non-going concern basis/liquidation basis of accounting. While the approaches outlined below refer to Ind AS, similar considerations would be relevant under Indian GAAP as well, in the absence of specific guidance.

Approach I: Continue to apply Ind AS recognition and measurement principles

Under this approach, the entity continues to prepare financial statements in accordance with the requirements of applicable Ind AS. In applying those Ind AS, appropriate adjustments are made to reflect the fact that the entity is no longer a going concern.

Given below are a few examples:

1. For non-financial assets such as property, plant and equipment and intangible assets, impairment testing is performed in accordance with Ind AS 36 Impairment of Assets. In most cases, the fact that the entity is no longer a going concern may be considered an indicator of impairment requiring detailed impairment testing. Further, in performing the impairment assessment, value in use may no longer be relevant or may shrink significantly once the entity intends to liquidate or cease operations. The recoverable amount may therefore move closer to fair value less costs of disposal.
2. For financial assets such as trade receivables and loans, expected credit loss measurement under Ind AS 109 Financial Instruments may become more relevant.
3. The requirement for the entity to wind up operations in the foreseeable future may require it to settle obligations such as decommissioning and extended producer responsibility (EPR) obligations earlier than originally estimated. This may potentially impact the discounting and measurement of such obligations.
4. An assessment of whether an executory contract is onerous may change, requiring the entity to create an additional provision.
5. The fact that financial statements are no longer prepared on a going concern basis may trigger non-compliance with debt covenants. This may impact the current versus non-current classification of liabilities.

However, under this approach, no adjustment is made to the carrying amount of assets and liabilities which are otherwise not allowed under Ind AS. For example, the following adjustments will not be made:

1. The carrying amount of the financial liability is not reduced merely because management expects a haircut or a negotiated settlement. Under Ind AS 109, derecognition of a financial liability occurs only when the liability is extinguished or settled.
2. Expected profit on the sale of an asset cannot be recognized before the asset is sold, unless that asset is measured at fair value through profit or loss, as per the applicable Ind AS.
3. An expected gain on disposal of one asset or cash-generating unit (CGU) cannot be offset against the impairment of another asset or CGU.
4. A provision or liability for potential obligations such as closure or restructuring costs is not recognized unless there is a present obligation at the reporting date.

Approach II: Net realizable or realization-based approach

Under this approach, assets are measured at the amounts expected to be realized or collected upon sale of the asset (e.g., net realizable value), which may be higher or lower than the carrying amount. The net realizable value may be the same as or different from the fair value. For example, a difference from fair value can arise if the process of liquidation is expected to involve distressed or forced sales of assets.

Some likely implications of this approach are:

1. Trademarks and internally generated intangible assets not previously recognized may get recorded.
2. Property, plant and equipment and intangible assets may not be depreciated or amortized.
3. Instead of testing assets for impairment, they may be measured at the amount of cash expected to be realized or collected upon sale. This amount may be higher or lower than their carrying amounts.
4. Prepaid expenses and other assets which will not be converted to cash or other consideration are written off.

Under this approach, liabilities continue to be measured at the amounts required by the applicable Ind AS. However, as explained in Approach I, assumptions in the measurement of liabilities may need to be adjusted to reflect current expectations. Even under this approach, anticipated haircuts or negotiated settlements should not be recognized unless the relevant derecognition or measurement requirements are met.

Approach III: Break-up value basis

Under this approach, assets are measured at the amounts expected to be realized or collected on their sale. Hence, this approach is very similar to Approach II in the measurement of assets. With regard to recognition and measurement of liabilities, a provision is recognized even for losses arising subsequent to the end of the reporting period and for the costs of winding up the business, irrespective of whether an irrevocable decision to cease trading has been made at or after the end of the reporting period.

For example:

1. A provision is recognized for losses subsequent to the reporting period even if no legal or constructive obligation existed as at the reporting date.
2. The cost of winding up the business is accrued even if the decision to cease trading was made after the end of the reporting period.

While this approach may provide useful wind-up information to the users, it seems to involve recognition and measurement outcomes that may not be strictly Ind AS compliant.

Other key considerations

Limited-life entities

A limited-life entity is an entity that has a predetermined lifespan, often specified in its formation or governing documents. For example, an Alternative Investment Fund (AIF) may be established with a specific duration, such as 10 years, during which it conducts its business activities, such as investing in other entities with the goal of capital appreciation. The entity's purpose and exit strategies for its investments are typically outlined at the time of its formation, and it may plan to liquidate or dispose of its assets upon reaching the end of its designated life.

It seems clear that in the initial years of its life cycle, the Fund will prepare financial statements using the going concern basis of accounting. However, toward the end of its life, say, while preparing financial statements for years 8 and 9, an issue may arise whether the Fund can still prepare financial statements using the going concern basis of accounting or whether the liquidation basis needs to be used.

The Research Report, among other matters, states that in such cases, the benefits of switching to the liquidation basis of accounting may not justify the costs. An entity may also determine that the liquidation basis of accounting would not be useful to users of the financial statements if the majority of assets held by the entity are already measured at fair value. Entities should therefore use judgement to determine the most appropriate basis for users of financial statements based on the facts and circumstances.

Consolidation

Consider a scenario where a subsidiary in the consolidated group ceases to be a going concern because it has decided to cease operations. In this case, it seems clear that the financial statements of the subsidiary will be prepared using the liquidation basis of accounting. It also seems clear that if the consolidated group has other operations which are expected to continue for the foreseeable future, then consolidated financial statements (CFS) of the group will be prepared using the going concern basis of accounting.

In preparing CFS of the group, an issue may arise whether the parent should use financial statements of the subsidiary prepared using the liquidation basis of accounting for consolidation, or whether the subsidiary should prepare another set of financial statements using the going concern basis of accounting for consolidation.

The Research Report states that in accordance with Ind AS 110 Consolidated Financial Statements, uniform group accounting policies need to be used to determine the amounts to be included in the CFS for like transactions and other events in similar circumstances. Thus, consolidation adjustments should be made whereby the subsidiary’s transactions and other events in similar circumstances are measured using accounting policies followed in the Group CFS.

Comparative information

A change from a going concern basis to a liquidation basis of accounting is a change in circumstances in which the financial statements are prepared. Thus, the new basis of accounting is applied prospectively, and it does not impact comparative information presented in the financial statements for the period in which the liquidation basis of accounting is applied for the first time.

Disclosure

When financial statements of an entity are prepared using a liquidation basis of accounting, appropriate disclosure needs to be provided in the financial statements so that the users of the financial statements have the relevant information. In addition to the requirements of Ind AS 1 and Ind AS 10, the Research Report suggests the following disclosures:

1. The fact that the entity is not a going concern.
2. The reason why the entity is no longer a going concern.
3. The accounting policies followed for the recognition and measurement of income, expenses, assets and liabilities.
4. The methods and significant assumptions used to measure assets and liabilities.
5. The plan for liquidation, including the manner of realizing assets and settling liabilities.
6. The expected date for the completion of the liquidation.

How we see it

We welcome the Research Report on Liquidation Accounting issued by the Research Committee of the Institute of Chartered Accountants of India (ICAI). We believe that the Report will help in providing clarity and generating discussion on accounting in scenarios where it is concluded that the going concern basis is no longer appropriate. In our view, the following aspects may need further clarification:

1. It is clear that Approach I referred to in the Report complies with the requirements of Ind AS and, therefore, an entity (which is no longer a going concern) using Approach I will be able to demonstrate and state compliance with Ind AS in the basis of preparation of the financial statements. However, an issue may arise whether financial statements can be stated as compliant with Ind AS if they are prepared using Approach II or III.

   One argument can be that Ind AS are written from the perspective that an entity is a going concern. Thus, in the case of a non-going concern entity, the recognition and measurement requirements of Ind AS must be assessed to determine whether they provide relevant information that faithfully represents the “non-going concern” circumstances. If they do not, the entity may apply accounting policies other than those applicable to entities that are going concerns.

   The counter argument is that neither Ind AS 1 nor Ind AS 10 nor any other Ind AS provides exemption from the application of Ind AS requirements to an entity which is no longer a going concern. Hence, Ind AS, to the extent relevant, should be followed after making appropriate adjustments such as those described in Approach I to reflect the fact that the entity is no longer a going concern.

2. Ind AS 1 does not differentiate between limited-life entities and other entities with regard to going concern assessment and consequent application of liquidation basis of accounting. Hence, one may argue that even limited-life entities need to apply the liquidation basis of accounting toward the end of their life.

   Since most of the assets are already stated at fair value, this may not have any material impact on the recognition and measurement of assets and liabilities in the financial statements. In any case, the entity may need to state that financial statements are prepared on a basis other than the going concern basis of accounting.

3. With regard to consolidated financial statements (CFS) of the group where a subsidiary ceases to be a going concern, one may argue that the facts and circumstances of the group differ from other entities in the group. Hence, adoption of a different basis of accounting in accordance with Approach I for the subsidiary transactions, income, expenses, assets and liabilities may still be justified, and there is no need to reverse those impacts while preparing the CFS.

We recommend that the ICAI, the National Financial Reporting Authority (NFRA), and/or the Ministry of Corporate Affairs (MCA) consider providing authoritative guidance on the matter to address it comprehensively.