In the wake of the pandemic, with bankruptcy and business closures rising to record levels, it is not uncommon to see a relative increase in employee benefit plan (EBP) terminations. In light of these unfortunate events, many questions on how to appropriately account for these terminations have arisen. Financial Accounting Standards Board Accounting Standards Codification (FASB ASC) 205-30, Presentation of Financial Statements: Liquidation Basis of Accounting provides general guidance relative to the application of the liquidation basis of accounting.
When Should I Apply the Liquidation Basis of Accounting?
The liquidation basis of accounting must be applied under the circumstance in which liquidation is considered imminent. While determination of the immanency of liquidation is a matter of judgement, application of the liquidation basis of accounting is neither a policy choice nor an election. Liquidation may be considered imminent if a plan of liquidation is approved by someone who holds the authority to effectively execute the plan with minimal risk or a plan of liquidation is imposed (e.g., through involuntary bankruptcy).
Termination of Defined Contribution Plans
Typically, the termination process for a defined contribution plan (DCP) consists of the following:
- Selection of the proposed date of termination (by resolution of the EBP’s governing body or an amendment to the Plan document)
- Amendment of the DCP to terminate and cease benefit accruals
- Notification of affected parties
- (Optional) Application for a determination letter from the IRS about whether the DCP termination affects the qualified status of the plan
- Distribution of the DCP’s assets as soon as it is administratively feasible
Once liquidation is deemed imminent, the liquidation basis is applied prospectively from that date.
Applying the Liquidation Basis of Accounting
Assets should be reported at the estimated amount of cash or other expected asset to be collected in the settling or disposition of those assets in carrying out the liquidation plan. Due to the uncertainty in determining the cash to be received upon selling the assets of the DCP, an EBP’s best estimate of the liquidation may be its current fair value.
Liabilities must be recognized in accordance with the general recognition criteria included in other sections of GAAP (excluding the accrual of estimated disposal costs and expected income and expenses as further discussed below).
Accruing Income and Expenses
Estimated costs of disposal or other items expected to be sold in liquidation should be accrued when the liquidation basis of accounting is adopted. Costs that should be accrued include administrative costs, legal costs, and professional fees.
EBP income is primarily related to its investment that are typically reported at fair value. Accrual of such appreciation or depreciation of the investments is generally not necessary, as the mix of the EBP’s investment portfolio changes as the EBP progresses to liquidation, thus there may not be a reasonable basis for estimating appreciation or deprecation in the investments.
The following disclosures are required to be included in the statements:
- Disclosure of the liquidation basis of accounting
- A description of the plan for liquidation including –
- The manner the entity expects to dispose of assets and other items
- The manner the entity expects to settle liabilities
- The expected date of completion for the liquidation
- Methods and significant assumptions used in measurements and any subsequent changes to them
- Type and amount of costs and income accrued in the statement of net assets in liquidation and the period it covers
What About Partial Plan Terminations and Plan Mergers?
The conditions of a partial plan termination are complicated. Management should consult with legal counsel as to whether the plan is subject to partial termination under law. Typically, a partial termination occurs when more than 20% of the total plan participants are laid off in a given year. Judgement is required to determine whether the plan is ceasing all activities, which is a somewhat rare occurrence; therefore, a partial plan termination is not an event that triggers the application of the liquidation basis of accounting.
When two plans are merged or an entity acquires another, such activity would not spur the liquidation basis of accounting due to the plan obligations being transferred to another plan, rather than being settled directly with the participants.
Although rare in the case of EBPs, going concern issues may arise more frequently due to the pandemic. If you’re unsure how to apply the liquidation basis of accounting to EBPs, we can help.