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Timing of "disposal" of subsidiary in liquidation

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Good evening,

Yes, I have Googled my question and searched existing threads, but I can't find the specific answers I'm looking for. Yes, I'm a professional, and no, this is not an exam question.

Now I've pre-empted the usual unnecessary replies, consider the following scenario.

Company A owns company B. In A's individual separate statutory accounts it has previously disclosed its investment in B at historic cost (£1.7m) less impairments (£0.8m), being a net book value of £0.9m.

In 20X1 B enters liquidation. Prior to liquidation, B's balance sheet is reduced, with its entire distributable reserves paid as a dividend to A, leaving B with only £1 net assets (being an informal £1 interco receivable from A). The liquidator does not distribute this £1 until 20X2, and company B is not dissolved until 20X3.

My question is, at what point should A technically recognise a full disposal of shares in B, and no longer recognise it as a subsidiary. I'm fully aware that in this scenario the choice is pretty immaterial, and no one will really care, but I'm interested in what should happen in principle.

When dealing with these types of transactions in batches of liquidations previously I've used the following convention: 

  • when B pays its pre-liquidation dividend to A, I recognise an impairment of A's investment in B down to equal the value of B's net assets. In this scenario that would be £1. At this point A still has a £1,700,000 investment, with a related accumulated impairment of £1,699,999.
  • when B enters liquidation in 20X1, I make no entries. Rationale being A still owns the shares. I'm not sure on this though, because presumably the liquidator now has control.
  • when the liquidator distributes B's assets to the shareholders in 20X2, in this case this is just company A, I will recognise £1 investment income in A, and a further £1 impairment charge in A (net zero P&L). Under this (probably incorrect) convention, A still has a £1,700,000 investment, this time with a £1,700,000 total impairment, but because B still exists, I haven't deemed it to be disposed of yet.
  • Only when 20X3 rolls around and the liquidator has successfully dissolved the company will I deem company B to have been disposed by company A.

A few thoughts:

  • That convention is based on what seems most aesthetically pleasing and sensible to me, rather than any specific reference to accounting standards.
  • The problem with recognising a full disposal at the point B enters liquidation is that there is a timing mismatch in the P&L. To dispose of B is to derecognise it in A's accounts despite there still being value for A to extract from B. You would have a £1 impairment charge in 20X1, but then in 20X2 A receives the inevitable £1 distribution income.
  • So if full disposal shouldn't be recognised at the point B enters liquidation, should A's disposal of B be recognised at the point B distributes its remaining assets (but is not dissolved yet as per Companies House), or when it's actually dissolved?

I'm not interested in the tax treatment by the way, that's the easy bit :)... just the quirky accounting treatment in question here!

Any thoughts on this extremely tedious scenario would be appreciated.

Thanks

 

Replies (11)

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By paul.benny
02nd Jun 2021 08:38

Whether one company is a subsidiary of another is a question of control rather than shareholding. When a company enters liquidation, the liquidator assumes control.

Therefore I vote that B ceases to be a subsidiary on appointment of liquidator and so the investment should be derecognised at that point. The potential distribution is either a receivable or a contingent asset.

You do acknowledge that it's a something of a hypothetical question, but I still cant help wondering why.

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Replying to paul.benny:
By Duggimon
02nd Jun 2021 11:38

I disagree entirely. The liquidator does not own the company, the parent does. It owns one share, worth £1. It owns this share right up until the £1 is paid out by the liquidator and the company dissolved, which is when I would recognise the disposal.

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Replying to Duggimon:
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By kadabra064
02nd Jun 2021 11:54

Two different views, interesting.

Duggimon, when you say "until the £1 is paid out by the liquidator and the company dissolved", the difficulty is these events do not usually coincide with each other, the distribution happens before the entity is formally dissolved.

If company A loses control of the subsidiary, I lean towards paul.benny's argument that it is no longer a subsidiary. But is it not still an investment of sorts? So perhaps a reclassification from investment in subsidiaries to "other investments" would be the sensible entry. Alternatively, as paul.benny suggests, recognising a receivable instead of an investment for the net assets which are due to be distributed.

The reason I'm interested is that over the next couple of years I'm going to be dealing with a number of situations like this at work, and it's "fun" to discuss the "correct" approach to these scenarios.

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Replying to kadabra064:
By Duggimon
02nd Jun 2021 12:21

kadabra064 wrote:

Two different views, interesting.

Duggimon, when you say "until the £1 is paid out by the liquidator and the company dissolved", the difficulty is these events do not usually coincide with each other, the distribution happens before the entity is formally dissolved.

That's not how we liquidate companies, the final transfer of funds is after the dissolution. For the sake of clarity, the date the investment ceases to be an investment in a subsidiary is the date of dissolution, any time elapsing between that and the final transfer of funds is a debtor owed by the liquidator to the parent.

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Replying to Duggimon:
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By paul.benny
02nd Jun 2021 12:21

With respect, I didn't say the liquidator owns the company, I said the liquidator *controls* it. Frs102 s9.4 is explicit that a subsidiary is an entity controlled by the parent

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Replying to paul.benny:
By Duggimon
02nd Jun 2021 12:24

paul.benny wrote:

With respect, I didn't say the liquidator owns the company, I said the liquidator *controls* it. Frs102 s9.4 is explicit that a subsidiary is an entity controlled by the parent

But the investment hasn't ceased being an investment. I agree that it's no longer a subsidiary under the rules but the company still owns the investment and it should still be on the balance sheet.

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Replying to Duggimon:
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By paul.benny
02nd Jun 2021 12:40

Still on the balance sheet, yes. As an investment, less convinced.

By placing the company into liquidation, we've disposed of it and therefore all that is remaining is to realise the cash. "Disposed of" meaning we've ceded control and instructed the new controlling party (the liquidator) to close the company.

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Replying to Duggimon:
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By kadabra064
02nd Jun 2021 12:41

Agreed, so "other investment" seems like a reasonable classification.

As for your liquidation point, that might be the case when the company in liquidation controls physical/cash assets, but in most group rationalisations all the assets would have been transferred pre-liquidation, so the only thing left in the company in liquidation is intercompany balances.

In the experiences I've had with our liquidator so far, the "assets" being intercompany receivables, are distributed many months prior to dissolution. Most recent example was that assets were formally distributed in Dec 2020, but the entity wasn't dissolved until March 2021.

Thanks for your help.

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Replying to Duggimon:
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By Paul Crowley
02nd Jun 2021 13:49

If the thing will not last a year then it is a current asset

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Replying to Paul Crowley:
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By kadabra064
02nd Jun 2021 14:47

Agreed. Hmmmm, the position I'm settling on at the moment is:

> A recognises the disposal of its investment at the point B enters liquidation.
> At the same point, an "other receivable" is recognised (current asset if expected within 1 year, non-current if longer) equal to the value that we're virtually certain we'll be recovering from the entity when it distributes its assets in liquidation.

This seems like an elegant solution.

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By johnt27
03rd Jun 2021 09:37

I'm interested in what happened to Company B's trade and assets at the point of the distribution prior to being put into liquidation?

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