Restructuring costs [Exit and Disposal] have received a good deal of attention in recent years because of revelations of abuses that have characterized these charges as “big bath” write-offs but which have been used to create “cookie jar” reserves later employed to smooth future earnings.
What is structuring cost? What is accounting standard for structuring cost? This post provides definitions and describes accounting standard for restructuring cost. It is adapted from the Accounting Standard Codification [ASC] of the new GAAP. Read on…
Restructuring charges are costs that are incurred or will be incurred in connection with a plan of action that will materially change the scope of business undertaken by an entity or the manner in which a business is conducted. They typically include costs such as employee benefits, costs associated with product line elimination or relocation, costs for new systems development or acquisitions, retraining costs, and losses on asset impairment and dispositions.
Several standards address the costs commonly recognized in restructurings. They are:
- ASC 840, which discusses the accounting for a termination of a capital lease.
- ASC 715, which discuss an employer’s accounting for pension plans.
- ASC 715-60, which discusses an employer’s accounting for postretirement benefits other than pensions.
- ASC 712, which discusses an employer’s accounting for postemployment benefits.
- ASC 360, which discusses the accounting for long-lived assets that will be disposed of, including discontinued operations.
- ASC 420, which discuss costs in anticipation of a business combination.
- ASC 420, which discusses the accounting for certain onetime termination benefits, costs to terminate contracts other than capital leases, and costs to consolidate facilities or relocate employees.
Employee Termination Benefits
ASC 420, Exit or Disposal Cost Obligations, applies to termination benefits provided to current employees that are involuntarily terminated under the terms of a benefit arrangement that applies for a specified termination event or for a specified future period. Those benefits are referred to as “onetime termination benefits“. If an entity has a history of providing similar benefits to employees involuntarily terminated in earlier events, the benefits are presumed to be part of an ongoing benefit arrangement (rather than a onetime benefit arrangement) unless there is evidence to the contrary.
Specifically excluded from consideration are employee termination benefits:
- Paid pursuant to the terms of an ongoing employee benefit plan, regardless of whether the plan was preexisting or is newly created
- Paid under the terms of an individual deferred compensation agreement
A onetime benefit arrangement first exists at the date the plan of termination meets all of the following criteria:
- Management approves and commits to the termination plan.
- The termination plan specifies the number of employees to be terminated, their job classifications or functions, and their locations, as well as the expected completion date.
- The termination plan establishes the terms of the benefit arrangement in sufficient detail that employees are able to determine the type and amount of benefits that they will receive if they are involuntarily terminated.
- Actions required to complete the plan indicate that significant changes to the plan are unlikely.
- The terms of the plan have been communicated to employees (the communication date).
The timing of recognition of the liability for onetime termination benefits depends on whether the employees are required to render service beyond a “minimum retention period“. The minimum retention period is the notification period that an entity is required to provide to employees in advance of a termination event as a result of law, statute, or contract, or in the absence of a legal notification period, the minimum retention period cannot exceed sixty days:
- If employees are entitled to receive the termination benefits regardless of when they leave or if employees will not be retained to render service beyond the minimum retention period, the liability for the termination benefits is recognized and measured at its fair value at the communication date.
- If employees are required to render service until they are terminated in order to receive the termination benefit and will be retained beyond the minimum retention period, the liability for the termination benefits is measured at its fair value at the communication date and recognized ratably over the service period.
Determination of the Minimum Retention Period and Recognition [A Case Example]
Lie Dharma Mobile Communications announces that it will close one of its plant and terminate all 120 employees there. The terms of the plan meet the criteria above. There are three major groups of employees: management, union workers, and nonunion workers. Management is required to stay and render service until the plant’s closing, which is four months from now, and each of the twelve management employees will receive $10,000. The union workers’ contract states that they must be notified ninety days in advance before they can be terminated. The union workers will be terminated in ninety days. The termination benefit for each of the fifty union employees is one week per every six months of employment. The nonunion workers can leave at any time within the next three months and still collect the termination benefit. Each of the fifty-eight nonunion employees will receive a termination benefit of $1,000 for each year of service. There is no state statute specifying a notification period.
Case 1: The Management – Management is required to work until termination, so it is necessary to determine whether the service period is beyond the minimum retention period. There is no state statute specifying a notification period, but the Worker Adjustment and Retraining Act, which applies to entities with over 100 employees, requires a sixty-day notification period for this plant’s closing. Thus, the minimum retention period is sixty days. Management must work beyond the minimum retention period, so the $120,000 liability (12 × $10,000) is recognized at $30,000 per month for the next four months. Present value techniques are not necessary to measure the liability because the discount period is so short that the face amount would not differ materially from the fair value.
Case 2: The union employees – The union employees’ contract requires a ninety-day notification period, so the minimum retention period for these employees is ninety days. The union workers will be terminated at the end of the ninety-day period, so they will not be required to work beyond the minimum retention period. If the total of the termination benefits for the fifty union employees is $142,500, a liability of $142,500 is recognized at the communication date. Present value techniques are not necessary to measure the liability because the discount period is so short that the face amount would not differ materially from the fair value.
Case 3: The non-union workers – Nonunion workers are not required to work until the termination date to collect the termination benefit. Therefore, it is not necessary to determine the minimum retention period for these employees. If the 58 nonunion employees have 230 years of service among them, a liability of $230,000 is recognized at the communication date. Present value techniques are not necessary to measure the liability because the discount period is so short that the face amount would not differ materially from the fair value.
If subsequent to the communication date there are changes in either the timing or amount of the expected termination benefit cash flows, the cumulative effect of the change should be computed and reported in the same line item(s) in the income statement in which the costs were initially reported. If present value techniques were used to measure the initial liability, the same credit-adjusted risk-free rate should be used to re-measure the liability.
Changes in the liability due to the passage of time (accretion) are recognized as accretion expense in the income statement:
- If employees are not required to provide services or are required to provide services only during the minimum retention period, accretion expense is charged for the passage of time after the communication date.
- If employees are required to provide services beyond the minimum retention period, accretion expense is charged for the passage of time after the termination date. Accretion expense should not be titled interest expense or be considered interest costs subject to capitalization.
According to ASC 420-10-55, if newly offered benefits represent a revision to an ongoing arrangement that is not limited to a specified termination event or to a specified future period, the benefits represent an enhancement to an ongoing benefit arrangement:
- If a plan of termination changes, and employees that were expected to be terminated within the minimum retention period are retained to render service beyond that period, the liability amount should be recomputed as though it had been known at the initial communication date that those employees would be required to render services beyond the minimum retention period. The cumulative effect of the change is recognized as a change in the liability and reported in the same line item(s) in the income statement in which the costs were initially reported. The remainder of the liability is recognized ratably from the date of change to the termination date.
- If a plan of termination includes both voluntary and involuntary termination benefits, a liability for the involuntary benefits is recognized as described above. A liability for the incremental voluntary benefits (the excess of the voluntary benefit amount over the involuntary benefit amount) is recognized in accordance with ASC 715-30 (Chapter 18). That is, if the benefits are special termination benefits offered only for a short period of time, the liability is recognized when the employees accept the offer and the amount can be reasonably estimated. If, instead, the voluntary termination benefits are contractual termination benefits (for example, required by a union contract or a pension contract) the liability is recognized when it is probable that employees will be entitled to benefits and the amount can be reasonably estimated.
Contract Termination And Other Costs To Exit An Activity
In addition to employee termination costs, an entity may incur contract termination costs, relocation costs, plant consolidation costs, and other costs associated with the exit or disposal activity.
ASC 420 sets forth the following standards for recognition:
- A liability for the costs to terminate a contract before the end of its term is recognized and measured at its fair value when the entity actually terminates the contract in accordance with the contractual term (e.g., by written notice).
- A liability for the costs that will continue to be incurred under a contract for its remaining term without economic benefit to the entity is recognized and measured at its fair value when the entity ceases using the right conveyed by the contract (the cease-use date). If the contract is an operating lease, the fair value of the liability should be determined based on the remaining lease rentals, reduced by estimated sublease rentals, even if the entity does not intend to find a sublease. However, remaining operating lease payments should not be reduced to an amount less than zero by the estimated sublease payments.
- A liability for other costs associated with the exit or disposal activity should be recognized when the liability is incurred, which is generally when the goods or services associated with the activity are received. The liability should not be recognized before it is incurred even if the costs are incremental and a direct result of the exit or disposal plan.
Restructuring Cost Reporting and Disclosure
The costs of exit or disposal activities must be included in income from continuing operations before income taxes:
- If the subtotal “income from operations” is presented, the costs must be included in that subtotal.
- If the costs are associated with “exit or disposal activities” that involve a “discontinued operation“, they are included in the results of discontinued operations.
- If an entity’s responsibility to settle the liability associated with an exit or disposal activity is removed or discharged, the related costs are reversed through the same line item(s) in the income statement that were used when those costs were initially recognized.
The following information should be disclosed in the period in which an exit or disposal plan is initiated, and in each period until the activity is completed:
- A description of the activity and the expected completion date.
- For each of the major categories of costs (e.g., onetime termination benefits, contract termination costs, and other costs), the amount expected to be incurred, the amount incurred during the period, and the cumulative amount incurred to date, in total for the entity and for each reportable segment.
- For each of the major categories of costs, a reconciliation of the beginning and ending liability balances, showing separately the costs incurred during the period, the costs paid or otherwise settled during the period, and any adjustments.
- The reasons for any adjustments to the liability amounts.
- The line items(s) in the income statement in which the exit or disposal costs are aggregated.
If a liability for a cost associated with the exit or disposal activity is not recognized because the amount cannot be reasonably estimated, that fact and the reasons therefor.
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