As we continue our blog posts on financial reporting considerations related to the COVID-19 pandemic, this post highlights the requirements of another area we mentioned in our top 5 issues vlog, restructuring provisions and termination benefits. Unfortunately, during these times of economic uncertainty and government mandated closures, many industries are faced with having to close facilities and lay off employees. At the time of this post, calendar-year public companies are beginning to issue Q1 press releases that will probably include a description of business impacts, risk factor updates, and restructuring initiatives as a result of COVID-19; however, I’ve already seen separate Form 8-K filings to announce restructuring initiatives, including Groupon, Yelp and Wyndham Hotels (to name a few). It’s important to understand the details of the restructuring plan as there are different recognition thresholds for different types of restructuring costs.
ASC 420, Exit or disposal cost obligations
The following transactions and activities are governed by ASC 420, Exit or Disposal Cost Obligations, (which typically relate to restructuring-type activities):
- Termination benefits (e.g., severance) provided to current employees that are involuntarily terminated under the terms of a benefit arrangement that, in substance, is not an ongoing benefit arrangement (referred to as “one-time” employee termination benefits)
- Costs to terminate a contract that is not a lease
- Costs to consolidate facilities or relocate employees
- Costs associated with a disposal activity covered by ASC 205-20 (discontinued operations)
- Costs associated with an exit activity, including those associated with an entity that is newly acquired in a business combination or an acquisition of a not-for-profit entity
The objective of ASC 420 is to improve financial reporting by requiring that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. Let’s take a look at an example:
On December 31, 2020, G. Gekko Inc. publicly announced a major restructuring plan calling for layoffs and termination of its operations in Wall Street, USA. Gekko’s detailed, formal plan outlines the following costs:
- Contract cancellation penalty of $500,000 which relates to a contract with Hungry, Inc., who provided Gekko’s employees at the Wall Street location with daily catered meals, snacks and beverages. Gekko intends to formally notify Hungry on January 2, 2021 that the contract will be terminated.
- Costs associated with We-Are-Clean, a cleaning service company that kept the Wall Street location spotless and shiny. Gekko was in the middle of a 5-year cleaning contract that prohibited a cancellation. Gekko will be moving out of the Wall Street location on January 31, 2021 and the service runs through December 31, 2023. The present value of the remaining service payments is $100,000.
- $3 million of relocation costs for personnel moving from Wall Street to Greed, VT (to be relocated in 20X2).
- $5 million of relocation costs for inventory/office equipment moving from Wall Street to Greed, VT (to be relocated in 20X2).
In this example, the restructuring provision to be recognized by Gekko at December 31, 2020 is $0!
- The $500,000 food service cancellation penalty can’t be recognized as a December 31, 2020 obligation because Gekko isn’t going to cancel the contract until 2021.
- The remaining cleaning service payments of $100,000 should be recognized at fair value on the “cease-use” date (which would be the day that the office location was vacated, January 31, 2021).
- The relocation costs for personnel ($3 million) and the office equipment/inventory ($5 million) should be recognized at fair value when the goods or services associated with the activity are received (i.e., in 20X2).
“One-time” employee termination benefits
The example above did not discuss any “one-time” employee termination benefits, which are also under the scope of ASC 420. “One-time” employee termination benefits are benefits that the company has never historically granted or does not expect to grant again in the future (i.e., the severance was not included or described in the terms of an employee’s contract). If employers are providing their employees with severance as a result of COVID-19 impacts, this would generally classify as a “one-time” termination benefit (unless the company had specific severance terms in each employee contract addressing a layoffs due to a global pandemic!). The following criteria must be met in order for a company to recognize and measure the severance obligation:
- The plan must be communicated to employees (this is also referred to as the communication date)
- Company management (with the appropriate authority to approve) commits to the termination plan
- The termination plan identifies the number of employees to be terminated, the related job classifications or functions and locations of the terminated employees, and the expected completion date
- The termination plan establishes the terms of the benefit arrangements in sufficient detail to enable employees to determine the type and amount of benefits they will receive
- Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn
If employees can receive their termination benefits regardless of when they leave (i.e., not required to render service), which is probably the case with most of the COVID-19 layoffs, or if employees are not retained to render service beyond a minimum retention period (or 60 days in absence of an explicit period), the liability for the termination benefits is recognized at the communication date and measured at fair value. If employees are required to render service, then the liability is initially measured at the communication date (based on the fair value of the liability as of the termination date), and ratably recognized over the future service period.
“Contractual” termination benefits
We’ve highlighted the fact that termination benefits resulting from COVID-19 restructuring are probably considered to be a “one-time” benefit and will be accounted for under ASC 420. However, there is another type of termination benefit we’d like to discuss, referred to as “contractual” benefits, which must be accounted for under ASC 712, Compensation – Nonretirement Postemployment Benefits. “Contractual” benefits have been communicated to the employee, whether its explicitly stated in an employee’s contract, or there is some form of severance policy in place. There is no explicit requirement to communicate “contractual” termination benefits to potentially affected employees because those employees are presumed to understand the benefit.
This type of benefit is measured at the amount of any lump sum payments, plus the present value of any expected future payments, and the employer is required to recognize the benefit liability when it’s probable that the employees will be entitled to the benefits (i.e., when management commits to the plan) and the amount can be reasonably estimated.
If you have any questions, please contact us and we would be happy to answer any questions! Our course on Accounting for Restructuring Provisions and Related Termination Benefits also includes more information, and even some fun scenarios and exercises!
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