When evaluating the premise of a company’s worth, liquidation value often is pitted against other more “normal” descriptors such as fair value and going concern value. Though liquidation value can vary dramatically depending on whether a liquidation is orderly or forced, there are important, more fundamental differences between liquidation value and fair value. For example, whether to apply a valuation discount because a company is under threat of bankruptcy, and the size of the discount taken are common questions. Amid the backdrop of numerous bankruptcies following the Great Recession and a sometimes halting economic recovery, two developments under U.S. generally accepted accounting principles (GAAP) may help accounting and forensic practitioners, attorneys and investors make the important distinction of which premise of value to apply.
Black’s Law Dictionary defines liquidation as “the act or process of converting assets into cash, especially to settle debts.” Liquidations can take a variety of forms, but they typically are categorized as orderly or forced. Fair value, on the other hand, is the price a seller would receive to sell an asset (or transfer a liability) in an orderly transaction between market participants at the measurement date. Do you choose liquidation value or fair value? How do you even know if a business will be liquidating in the near future? What is an orderly as opposed to forced liquidation? These are just a few of the difficult questions practitioners regularly face, but recent accounting rules changes should help clarify some of the answers.
