We’re currently seeing certain industries hit hard due to growing too fast after the pandemic. To scale back, they are laying off a significant portion of their workforce and implementing other cost-cutting measures. The costs associated with restructuring are accounted for under ASC 420.

Scope

ASC 420 covers costs associated with exit or disposal activities as part of a restructuring. A restructuring can include a workforce reduction, sale or termination of a business, or business closure or relocation.  The following table shows which guidance to apply to which costs:

Types of Costs under ASC 420

1. One-time termination benefit arrangement

These include severance, COBRA, and job placement costs. A one-time termination benefit arrangement must meet all of the following criteria:

• Management commits to a plan of termination
• The affected employees are identified (job classification/function)
• The terms of the benefit arrangement are established
• It is unlikely that significant changes will be made to the plan

ASC 420 does not cover termination benefits associated with an ongoing arrangement that is defined in an HR policy or other agreement. For the accounting related to contractual termination benefits, see our article “Termination and Other Postemployment Benefits.”

2. Contract termination costs

Many contracts have early termination clauses. Any costs associated with the early termination of a contract should be recognized when the entity gives written notice to the other party. The communication of the decision to the other party is what triggers the entity’s legal obligation. The costs may include the remaining payments under the contract that are required to continue without benefit to the entity and any early termination penalty.

3. Other exit and disposal costs

Other exit and disposal costs include consolidating or closing facilities and relocating employees. Examples include costs associated with moving, consulting, security, and coordination. These are typically incremental costs due to a restructuring plan and do not generate revenues or benefit future periods.

Accounting Model

ASC 420 applies the general recognition principles of CON 6, Elements of Financial Statements. Therefore, a liability should be recognized for the exit or disposal cost when the liability is incurred. In other words, the event triggering the liability must have already occurred, which creates an obligation to transfer assets or provide services. A commitment to restructuring does not create an obligation in itself. The liability should be initially recognized at fair value. Often, a discounted cash flow is used to estimate the liability’s fair value. The discount rate used should reflect the credit-adjusted risk-free rate. If the time until payment is short, then the effect of time value may not be material.

For one-time termination benefits, recognizing the liability depends on whether the employees are required to provide future services. If employees are not required to provide future services to receive the benefits, a liability is recognized at fair value as of the communication date. However, if employees are required to provide future services to receive the benefits beyond the minimum retention period, the liability is measured on the communication date based on the estimated fair value as of the termination date. The liability is then recognized ratably over the future service period (akin to a stay bonus).

Subsequently, the liability should be updated for changes to the expected timing or amount of estimated cash flows. However, the original discount rate continues to be used and does not change over time. Therefore, the subsequent values do not reflect fair value. Changes should be recognized in the period they occur and reported in the same line item as the original costs. The discount due to time value should be accreted as an operating expense using the original effective rate.

Disclosures

ASC 420 requires the following to be disclosed in the notes to the financial statements in the period the exit or disposal activity is initiated until completion:

• A description of the exit or disposal activity (including the expected completion date)
• The amount of expense (broken out by major type of cost)
  • Incurred to date
  • Incurred in the period
  • Expected to be incurred in total
• The income statement line item where the amounts are recorded
• A reconciliation that includes the beginning liability balance, ending liability balance, and the changes during the period
• The fact that the liability was not recognized because the fair value could not be reasonably estimated and why

In addition, if the entity has multiple segments, the amounts must be broken out by reportable segment. These disclosures are also required in the MD&A per SAB Topic 5.P.4.