In Episode #3 of GAAP Chats, hosts Mike Walworth and Chris Brundrett talk about the spate of recent layoffs, especially in the tech industry, and the related accounting considerations.
The following content is a detailed outline of Episode 3 of the GAAP Chats podcast. It does not represent a full transcript of the show. You can listen to the full audio here.
Mike: Hang on, baby Jesus, this is gonna get bumpy! This quote by Ricky Bobby, played by Will Ferrel, in Talladega Nights aptly describes the current state of the job market in certain sectors of the economy. It’s no secret that the U.S. economy is slowing down and, as a result of rapid expansion and over-hiring (and over paying) workers during the last few years, many of these companies are bloated. They need to slash costs and, unfortunately for workers, the biggest cost for most companies is payroll. In this episode of GAAP Chats, Chris and I talk about the spate of recent layoffs, as well as the related accounting considerations.
Welcome to GAAP Chats, the podcast dedicated to all things accounting, brought to you by GAAP Dynamics. I’m your host, Mike Walworth and with me, as always, is my faithful partner, Chris Brundrett. We hope you’ll join us on our journey today as we share our passion for accounting and help change the way you train.
Mike: You’re fired!
Chris: You can’t fire me. I own part of this company and, according to our bylaws, the only way a partner can be removed is for dereliction of duty or gross negligence.
Mike: Or being declared mentally incompetent by at least 2 medical doctors.
Chris: Don’t you think that is more of an issue for you, than me?
Mike: Fair point. And I’m not firing you. It was just my intro into today’s topic which is layoffs.
Chris: There certainly has been a lot of them lately.
Mike: Definitely, here’s a list of the companies that have announced layoffs in 2023, and we are recording this on January 20th, so this is only the first month of 2023.
- Amazon - 2% of workforce
- Salesforce: 10% of workforce
- Vimeo: 11% of workforce
- Goldman Sachs: 8% of workforce
- Stitch Fix - 20% of workforce
And this is fresh off the wires. Coinbase just announced an additional 20% reduction in staff following an 18% reduction already announced in June 2022. That’s more than a third of the entire company let go in less than 6 months! And just today, Google announced it is laying off 12,000 workers, or 6% of its workforce.
Chris: All this comes less than a month into 2023, and it comes on the heels of a bunch of layoffs in the 4th quarter of 2022 including:
- Cisco - 5% of workforce
- DoorDash - 6% of workforce
- Redfin - 13% of workforce
- Amazon - 1% of workforce
- Meta (otherwise known as Facebook) - 13% of workforce
- Twitter (which has a lot of issues going on there) - 50% of workforce
- Zillow - 5% of workforce
- Peloton - 12% of workforce
Mike: So, I mentioned Amazon, but they already had layoffs in 2022?
Chris: Yep. And as you mentioned they announced in January 2023 that they are laying off an additional 18,000 employees concentrated in its corporate ranks.
Mike: So, not the front line workers. As NYU professor and podcaster Scott Galloway predicted, this will primarily be a Patagonia-vested recession. In other words, a white-collar recession affecting people like you and me. And in honor I’m wearing my Patagonia vest today.
Chris: Back in the 80’s we probably would have called it a “Members Only” recession but we’ll go with Patagonia in the modern times.
Chris: Yeah, that kind of sucks, but these things happen every once in a while.
Mike: On the flip side, it will create buying opportunities, especially in the real estate market which was smokin’ hot there for a while. A bit of schadenfreude for the millennials and Gen Zers who were constantly complaining, and rightly so, that they had been priced out of the market.
Chris: Things did get crazy there for a while, especially with first time home buyers. A lot of workers have seen some pretty good pay raises and bonuses in this inflated economy leading up to these layoffs, so hopefully there is some money to put down to buy a home.
Mike: Assuming of course they didn’t spend it all on daily Starbucks runs!
Chris: Whoa. That’s a bit unfair.
Mike: I kid. I kid. But seriously, I think a good life lesson, and it's the lesson my dad taught me and one that I’ve taught my kids, is that the key to “getting ahead” in life is to spend less than you make. Full stop. Oh, and don’t take out debt, except for maybe a house.
Chris: What is this, the Dave Ramsey show? Can we get back to talking about layoffs?
Mike: My bad. So, Chris, what is your opinion of the plethora of recent corporate layoffs?
Chris: Well, there are a lot of things going on out there, but obviously, the big elephant in the room is the recession. We’ve been talking about the recession; “are we leading up to a recession? Are we in a recession?” for the last year or so. Historically, recessions happen every 5 years or so. As we are in recessions or leading up, or there is a fear of a recession, companies usually try to get ahead of the curve. Unfortunately, workforce is a huge cost for a lot of companies. That’s one of the first things that senior management looks at when they are trying to go into a recession ahead of the curve, cutting costs. This one has been unique because of the duration. There’s a lot of other complicating factors out there. Which I know you are going to talk about one.
Mike: Yeah, I know layoffs may be necessary every once in a while, but personally, I think it is a bunch of BS. I place the blame solely at the feet of the executives who over hired and, in my opinion, over paid for these people in the war for talent that was the Great Resignation. And now they’re feeling the consequences.
Mike: Here’s what Salesforce's co-CEO, Mark Benioff, said in a letter to employees: “The environment remains challenging and our customers are taking a more measured approach to their purchasing decisions. As our revenue accelerated through the pandemic, we hired too many people leading into this economic downturn we’re now facing, and I take full responsibility for that.”
Chris: I applaud him for taking ownership. Sometimes as the chief executive, you have to make tough decisions, including letting people go. To our point, this is just unique. While we have recessions every five years or so, this is a unique situation. As you mentioned, and as the CEO mentioned, we had the pandemic. So, we had people being laid off as a result of the pandemic and when we were in the depths of the pandemic. Then there was the Great Resignation that resulted after the pandemic. Then, things opened up faster than expected. Then there was the Great Hiring or the War of Talent, as you called it. That has created a volatile situation as we are coming into, or already in, a recession.
Mike: To take it back to that Salesforce CEO again. I don’t know if I’d be giving him a medal. The dude has made $26 million per year over the last two years and, I strongly doubt, he will be taking a paycut this year! And I guess that’s my problem, it seems the compensation for CEOs and other executives always goes up, regardless of the actual results of the company. The rich keep getting richer in the “good ole’ boys club!”
Chris: Your political transformation since I’ve known you over the 20 plus years is quite astonishing!
Mike: Let’s move on to the accounting issues associated with layoffs. First, let me preface this discussion with the fact that we are only talking about the termination benefits associated with the layoffs in this podcast. We won’t get into the accounting for related exit costs, such as plant closures, that are often included in an overall restructuring plan.
Chris: I like it. Narrow our scope. Otherwise this discussion could drag on! But, I do think that it is important for people to realize there is specific guidance for restructuring, exit costs, disposal costs, but we are just focusing on the narrow subset, which is termination benefits.
Mike: Definitely. Also, we are going to limit our discussion to U.S. GAAP. If we start to talk about GAAP differences with IFRS, it might get a little confusing. Maybe we will do IFRS on a different day.
Chris: Sounds like a plan.
Mike: But before we get started, quick question: Why is this an issue? In other words, why do companies wish to show such costs as “restructuring” in their income statement?
Chris: Great question, Mike! Entities like being able to classify costs as “restructuring” because it allows them to isolate these costs, “clean up” their income statement, and show improved performance from “normal” operating activities. Under U.S. GAAP you are only able to show costs as “restructuring” when certain conditions are met. These rules are very restrictive. Companies have to be careful as they go through those rules and make sure they are following the criteria.
Mike: And I’ll bet such restructuring charges make their way into the computation of non-GAAP financial measures, which we’ve discussed in previous podcasts.
Chris: You better believe it!
Mike: OK, so under U.S. GAAP, what is the appropriate guidance related to the accounting for termination benefits?
Chris: Well, first, let’s talk about the definition of termination benefits so everyone knows what we are talking about. Termination benefits are benefits provided by an employer to employees in connection with the termination of their employment. They may be either special termination benefits offered only for a short period of time or contractual benefits required by the terms of the plan only if a specified event, such as a plant closing, or something of that nature occurs.
Chris: The accounting for termination benefits depends on whether they fall under:
- Topic 420 - Exit or Disposal Costs Obligations; or
- Topic 712 - Compensation - Nonretirement Postemployment Benefits
Chris: And, to determine which Codification topic is relevant and the proper accounting, which is important because 420 and 712 have different accounting guidance. And it’s difficult to show in a podcast, but you can Google some of the several flowcharts out there, we even have one in our training program that really shows how to navigate whether you are under 420 or 712. But, in words, to determine which one is relevant under proper accounting, we need to answer the following 3 questions:
- Is the termination benefit involuntary or voluntary?
- If the termination benefit is involuntary, then is it a “one-time” benefit or is it “contractual?”
- If it is a “one-time,” involuntary termination benefit, is the benefit based on past service or is the employee required to provide future service in order to get the benefit?
Mike: Okay, let’s take it one at a time. The first question was: Is the termination benefit involuntary or voluntary? What is a voluntary termination benefit? I’m assuming nobody wants to be fired.
Chris: Voluntary termination benefits are considered a “special termination benefit” within the scope of Topic 712. Special termination benefits are benefits offered for a short period of time in exchange for the employees’ voluntary termination of service.
Mike: Oh, so like when my buddy who worked for Altria got a “special package” to retire early at age 59 and a half. He’s living the dream!
Chris: Exactly. An offer to retire early is a great example. Under Topic 712, voluntary termination benefits are recognized when the employee accepts the offer and the amount of the benefit can be reasonably estimated. So, your friend’s severance package basically, or a special retirement package if you take an early retirement.
Mike: It’s voluntary because the company makes the offer, but estimates a certain takeup, so I have to be about to reasonably estimate an amount.
Mike: What if the company makes this offer at year-end and they know that all the employees that were offered this voluntary retirement package will eventually take them up on the offer, can they go ahead and accrue the liability at year end.
Chris: No. The key here is that the employee has actually accepted the offer. A company cannot book a liability (and a corresponding restructuring charge) until that formal acceptance has been received.
Mike: Got it! Well, that takes care of question #1, at least for voluntary termination benefits. What about involuntary termination benefits?
Chris: Now we are moving to question #2 and, that is, whether the involuntary termination benefits are “one-time” or “contractual.” Let’s talk about involuntary, contractual termination benefits first.
Mike: Can you give me an example of such “contractual” benefits to put it into context?
Chris: Sure. Let’s say I want to layoff a bunch of people. However, these people are unionized and their employment agreement states that in the event of termination, they will receive 1 week of pay for every year of service. Because it is part of a union workforce, the company is bound by this agreement. This is an example of an involuntary, contractual termination benefit.
Mike: That was helpful. How do we account for involuntary, contractual termination benefits?
Chris: Involuntary, contractual termination benefits that are given in accordance with the law, an HR policy, a union contract, or even a widely distributed plan are also under the guidance of Topic 712. Such benefits are recognized when it is probable that the employees will be entitled to the benefit and the amount can be reasonably estimated.
Mike: Whenever we talk about benefits, communication gets thrown out a lot. Is it required to formally communicate the benefit to the employees before accruing the liability and recording the associated expense? I’m talking about these involuntary contractual benefits. Is formal communication necessary?
Chris: No, not for involuntary contractual termination. That's because it is part of a contract, the company is not required to formally communicate the termination benefits to potentially-affected employees since they are presumed to understand the termination benefit to which they are entitled.
Mike: Ok, that leaves us with involuntary, “one-time” termination benefits. What was the last question we needed to answer?
Chris: Are employees required to provide future service to receive the benefit or is the benefit based on past service? “One-time” involuntary termination benefits are accounted for in accordance with Topic 420. Finally we have moved out of 712. One-time benefits are not under a contractual arrangement as we discussed. So determine the accounting under 420, again we have to separate these out and say “are the employees required to provide a future service (do they have to work for the benefit) or is it the benefit based on their past service.
Mike: I’m assuming if future service is required then the company should probably wait to record the liability and corresponding expense until that service has been provided?
Chris: Yes, and one thing to point out is that under 420, communication is required. Since they are one- time benefits, and they are kind of special, the employees wouldn’t know about them. But to get back to your question, If the benefit is a one-time benefit, and the employee is required to render service for a period of time in order to get the benefit, then the benefit is measured initially at the communication date based on the fair value of the liability at the termination date, recognized ratably over the future period of service.
Mike: That leaves us with “one-time” involuntary termination benefits for which future service is not required. I assume that this is the case with most layoffs.
Chris: You know what they say about making assumptions, Mike! Actually, if you really look at it, a lot of involuntary termination benefits might actually be considered “contractual.”
Mike: That’s good to know!
Chris: Anyways, back to “one-time” involuntary termination benefits. As we said, such termination benefits are governed by Topic 420. The following criteria must be met in order for a company to accrue a liability and recognize a related expense:
- The plan must be communicated to employees.
- Management, with the relevant authority, 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. ( It doesn’t have to get down to details such as the names of the employees, but you need enough information that you know the number, what job classification, where they are located, stuff like that.)
- 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; (the employees can kind off estimate what they will get) and
- 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.
Mike: Wowza! That’s quite the list!!
Chris: It is. You are kind of far along in this plan before you are able to recognize the liability. The FASB is very clear that these requirements must be met in order to recognize a liability for such termination benefits.
Mike: And I imagine that companies don’t always have all of these things checked off at year end.
Chris: You got it! This is definitely something I’d advise my auditors to pay special attention to!
Mike: Chris, do you mind if I put you on the spot a bit before you sign off?
Chris: No, go for it.
Mike: All right. So I'm reading directly from the Wall Street Journal article. Today's, January 20th, Wall Street Journal article about the Google layoffs that I mentioned earlier. I want to sort of walk through those three questions. So, here is what they say.
Alphabet said it would offer US based employees two months notice plus 16 weeks of severance pay, along with two additional weeks for each year. An employee being laid off from the nearly 25 year old company has worked there. In other countries, the companies will follow local processes and laws, which sometimes require consultations with employee representatives before workers are laid off.
And so, Chris, if we go back through those three questions, I just want to kind of unpack that a little bit with how we would account for that in the US GAAP. So, the first question was was it involuntary or voluntary? It's clear to me that this is an involuntary termination, right?
Chris: Yeah, it sounds like it. They don't use that term, but it sure sounds like it.
Mike: So this question is the termination benefit a one time benefit or is it contractual? What would you want to look for in that?
Chris: Alright. So, based on the very limited information that was in this article, looking at the countries outside of the United States, it's leaning towards contractual, because you mentioned that countries outside of the United States, employees affected in countries outside the United States are going to follow local laws and regulations. So, that's starting to think contractual. The US, on the other hand, we just don’t know enough. Is there something in their employment agreement that stipulates this? Is there something in the general HR policy? Is there just a wide practice that they always do this? (that would be topic 712) But, maybe these could be the non-contractual involuntary benefits that follow under 420.
But, I will caution you most don't fall under 420 because there's some sort of a policy or something that dictates.
Mike: Let's assume they give 16 weeks of severance, plus two additional weeks for every year of service. Now, if let's assume, they always give the two additional weeks for each year of service, then maybe you could actually have sort of split benefits, right?
Chris: You absolutely could. You can have a situation where the standard benefit is given. Everybody knows that it's in the HR policy. We always give 16 weeks of severance. But this time, and only this time we're going to do something extra special and we're going to give you an extra two weeks For every year of service. So you could have a split benefit. You've got the standard one, the 16 weeks, and that would be a contractual under 712. Then this special one time involuntary benefit would be under 420.
So you can have two different standards applying to one sort of termination situation. But again, just as a disclaimer, we don't know enough about Google here. We're just sort of using this as an illustration. We'll find out when their financial statements come out.
Mike: Yeah, that's true. The other thing I wanted to talk about just real quickly, and then we'll wrap it up. They give two months notice. That sounds to me like the employees are still working there. So, that would be involuntary. Maybe involuntary one time, but there is future service that is required. So, I would measure it as of today, but then I would recognize it ratably over that two months of service.
Chris: Exactly, and that's very common. You want to give people some notice, maybe you need them for a period of time, something like that. But, the reverse is true. Sometimes there's terminations, and you walk into work one day and you walk out with a box of stuff, unfortunately. You do have to look at that because that service requirement changes the expense recognition. That's really important.
Mike: Yeah. Sorry I sprung that on you.
Chris: Well, it’s Hot off the press. It’s always good to look at an example.
Mike: As a summary, we have a nice blog summarizing the accounting for restructuring charges under U.S. GAAP. We’ll put a link to it in the notes section of the podcast.
And, if you need further training on the accounting for restructuring provisions under either U.S. GAAP or IFRS, we’ve got you covered. We have an eLearning course for both GAAPs:
- Accounting for Restructuring Provisions and Related Termination Benefits (U.S. GAAP)
- Provisions and Contingencies: IAS 37
Chris: Alright, Mike. I’m going to say we need to wrap this one up because it has been a long one.
Mike: That’s what…
Chris: Don’t you say it! I’ll take us out.
That’s all for this episode of GAAP Chats, your source for all things accounting. Notes and resources from today’s episode are linked in the description and as always you can find us online at GAAPDynamics.com, and @gaapdynamics across social media. It’s never too late to become a GAAPologist! Head over to our website and subscribe to our blog so that you’re the first to know what’s new with GAAP Dynamics.
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