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Because there was a lack of guidance on when it was appropriate to apply the liquidation basis of accounting for funds that were winding down or discontinuing operations, there was an inconsistency in practice. In a world where transparency is now expected, investors are most concerned with how much cash will be available to them once the fund is terminated and how long it will take to receive this cash. The Amendment was issued in April to clarify when and how an entity should apply the liquidation basis of accounting.
It also provides principles for the measurement of assets and liabilities under the liquidation basis of accounting as well as any required disclosures and financial statement presentation. The FASB believes that the new guidance will improve the consistency and comparability of financial reporting. ASU applies to all entities that issue financial statements that are presented in conformity with U.
RICs are legally restricted under the Act from re-measuring their assets or modifying the calculation of net asset value. The specific provision would apply when a fund determines that liquidation is imminent. The Amendment defines liquidation as imminent when the likelihood that the entity will return from liquidation is remote, and either of the following exists:.
However, a limited-life fund would not be required to adopt liquidation basis unless the fund deviates from the liquidation plan originally stipulated in the governing documents. Such deviations would include a change in the date that liquidation is expected to conclude earlier or later than the contractually stated expiration date due to the fund being forced to dispose of its investments in a manner that is not orderly or in exchange for an amount that does not reflect fair market value.
If the adoption of the liquidation basis of accounting is deemed appropriate by management, the estimated amount of cash or other consideration that a fund expects to collect or pay to carry out its plan for liquidation must be determined. The estimated costs to dispose of those assets or liabilities should be accrued for upon date of adoption. This could possibly include brokerage fees or sales commissions which are typically not considered when valuing investments at fair value under GAAP.
In addition, any other costs and income that a fund expects to incur or earn should be accrued for through the date at which the fund expects to complete its liquidation. This may include, but is not limited to, legal fees, accounting and administrative fees, management fees and performance fees, as well as interest and dividend income. For instance, if a fund expects the liquidation period to last 24 months and uses the services of a fund administrator to maintain fund books and records, there should be an accrual recorded representing 24 months of administration fees.
On the income side, if a fund holds a performing, interest bearing note, the interest expected to be collected until the note is disposed of or matures should be accrued for as of the liquidation date. Furthermore, remaining investments will no longer be valued at fair market value, but rather at their recoverable cash value. Fair market value assumes disposition in an orderly manner, whereas recoverable cash value could be a distressed sale or a disorderly transaction.
An example of this would be applying a blockage or other discount to the quoted price, which is normally not permitted under GAAP as this may be appropriate when valuing an investment under liquidation basis. That being said, in certain situations fair value may approximate the amount expected to be collected. At each reporting date, the fund will re-measure its assets, liabilities and the accruals of disposal to reflect the actual or estimated change in value since the previous reporting date.
The Amendment states that, at a minimum, a statement of net assets in liquidation and a statement of changes in net assets in liquidation be presented. The statement of net assets in liquidation must include information about the net assets available for distribution to remaining investors or other claimants such as creditors as of the end of the reporting period. The fund would need to accrue and disclose separately any additional costs estimated to be incurred as a result of the liquidation.
It should not include the results of operations during the going concern period, but only changes to net assets that occurred during the period since liquidation became imminent. ASU does not require reporting on the stub period, which is the period of time from the last reporting date through the date of determination that liquidation became imminent.
That being said, it would still be necessary to determine the initial net asset balance upon adoption of liquidation basis. FASB guides entities to consider the requirements of regulators i. In addition to changes in the preparation of the financial statements, the Amendment now requires funds to disclose all of the following when it prepares financial statements using the liquidation basis of accounting:.
Before you sell, compare the share price to the published NAV, which is available from the sponsor. If the share price is below the NAV, consider waiting for liquidation when shares typically sell at market value. Do your research before you invest in an ETF to help prevent putting your money in one that might close soon after.
Here are four criteria to consider:. The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
New York Stock Exchange. Internal Revenue Service. Table of Contents Expand. Table of Contents. Full Bio Follow Linkedin. Jeffrey M. Green is an expert in investing and financial planning with more than 40 years of experience in the financial services industry, including senior management positions at Citi, AXA Financial, and MetLife. He now writes about financial services, products, planning, and more. Read The Balance's editorial policies. Key Takeaways ETFs usually close because they do not attract enough assets.
Investors pay tax on any capital gains when the fund is liquidated. If possible, sell your shares when you receive the notice. Otherwise, wait for the liquidation.
As investment funds continue to face challenges in meeting performance benchmarks and as investors become less tolerant of paying management fees for underperformance, many fund managers are determining that liquidating their funds is the best course of action. As a result, questions concerning the implementation of the Financial Accounting Standards Board FASB accounting and financial reporting guidance on adopting the liquidation basis of accounting are becoming more frequent.
The Provisions of the Accounting Guidance The main provisions of the guidance revolve around determining when to apply the liquidation basis of accounting and how to present financial statements and disclosures on that basis. When an investment fund determines that it is appropriate to apply the liquidation basis of accounting, the estimated costs to dispose of assets and the estimated costs and income expected to be incurred or earned during the liquidation period should be accrued if and when the investment fund has a reasonable basis for estimation.
Such costs might include legal fees, management and incentive fees and administrative costs. In recognizing income earned during the liquidation period, expected earnings on assets would not be recognized when those earnings are already reflected in the net realizable values of the assets of the investment fund. Accruals for income earned and costs incurred during the liquidation period should not be discounted and estimates of income earned and costs incurred should be reevaluated at each subsequent reporting date.
Challenges for Investment Funds Determining the costs incurred during the liquidation period could present challenges because certain costs are dependent on how long the entity will exist under the liquidation basis of accounting. In certain cases, liquidation value may not equal fair value. An example of when net realizable value may differ from fair value is when an investment fund determines that it cannot dispose of illiquid investments during the liquidation period in an orderly fashion such as in a distressed or forced sale.
Although in some cases fair value may be an approximation of the amount an investment fund expects to collect, an investment fund should not presume this is true for all assets. Exceptions to Applying the Liquidation Basis of Accounting The accounting guidance does not apply to the following investment funds or situations: Funds registered under the Investment Company Act of Funds being merged or acquired Limited life entities; such as private equity funds that are liquidating in accordance with a plan of established at the inception of the fund and that is outlined in its governing documents.
Judgment is required as to whether this exception is met when a plan of liquidation deviates slightly from the pre-establish plan. When investors redeem mutual fund shares, the process is very simple. Mutual fund shares do not trade intraday. Instead, the shares are priced at the close of the market at 4 p.
With most mutual fund redemptions, the proceeds are distributed to the investor on the following business day. There are consequences that can be triggered when mutual fund shares are redeemed, yet many investors are not aware of these events. Examples of these consequences include fees, charges, commissions , and expenses that reduce an investor's anticipated return. All fund charges are described in a fund's prospectus.
It is important that investors read a fund's prospectus to understand all of the financial implications before buying, selling, or exchanging mutual fund shares. Many mutual funds offer several classes of shares, such as " Class A " and " Class B " shares.
Each share class owns the same fund securities but will have different fees and expenses. Investors can choose the fee and expense structure that best suits their investment goals. Class A shares typically impose a front-end sales load , which is a charge the fund uses to compensate brokers. Class B shares do not have a front-end sales load, but they may impose a deferred sales load charge when mutual fund shares are sold. Class C shares may have either a front-end load or a back-end load , but these charges tend to be lower than for Class A or B shares.
The front-end load percentage may decrease as the size of the investor's purchase increases. Back-end sales load charges cannot exceed 8. All three share classes also impose a range of shareholder fees and expenses. It is important to note that no-load funds do not charge fees for buying or selling shares, but, as with load funds, they do charge other fees and expenses that can lower a shareholder's return.
Shareholder fees include the mutual fund's operating expenses such as investment advisory fees, marketing and distribution 12b-1 fees , and other administrative expenses. The 12b-1 fees are paid out of the fund's assets, which means investors are paying these charges indirectly. The 12b-1 fees cover the expenses for marketing and selling fund shares, including advertising costs, broker compensation, and printing and mailing of prospectuses and sales literature. Some mutual funds charge early redemption fees to discourage short-term trading.
Generally, these fees take effect for holding periods ranging from 30 days to one year. The early redemption fees are paid to the funds, and are separate from potential back-end load charges, which are paid to the broker. A mutual fund can impose an exchange fee when a shareholder exchanges shares in one fund for shares in another fund within the same fund family. An investor holding mutual fund shares in a taxable account may owe tax on any net capital gains realized from the sale of his fund shares during the calendar year.
In addition, he may also have to pay taxes on his proportionate share of the fund's capital gains. The law requires a mutual fund to distribute capital gains to shareholders if it sells securities at a profit that cannot be offset by losses.