Accounting for Termination and Other Postemployment Benefits
It has been almost three years since the pandemic started. Workforce reductions have continued, with recent mass layoffs at large tech companies. These workforce reductions often involve termination benefits such as severance. The accounting for these events depends on the type and nature of the benefits. The differences in type can impact the period the associated costs are recorded.
Scope
The types of benefits and the associated guidance is summarized below:
Type of benefit | Applicable guidance | Description of benefits in scope |
Special termination benefits | ASC 712, Compensation – Nonretirement Postemployment Benefits | Benefits that are offered by the employer for a short period of time, in exchange for an employee’s voluntary termination. |
Contractual termination benefits | ASC 712, Compensation – Nonretirement Postemployment Benefits | Benefits that are required by an existing agreement or plan based on the occurrence of a specified event that causes employees’ services to be terminated involuntarily. |
Other postemployment benefits | ASC 712, Compensation – Nonretirement Postemployment Benefits | Benefits, other than special or contractual termination benefits, based on a mutually agreed-upon arrangement between the employer and the employee that requires a plan that is either written or substantive (e.g. HR policy). The benefits are not dependent on a specified event occurring. These benefits include severance benefits, salary continuation, disability, unemployment benefits, workers’ compensation, job training, and COBRA. |
One-time termination benefits | ASC 420, Exit or Disposal Cost Obligations | One-time involuntary termination benefits that are not based on an ongoing benefit arrangement. These one-time termination benefits are typically incurred as part of an exit or disposal activity such as a restructuring. |
ASC 712 establishes the accounting for other postemployment benefits provided by a company to former or inactive employees after employment but before retirement. Benefits provided in these arrangements are considered part of the compensation provided to employees in exchange for their service.
ASC 420 establishes the accounting for costs associated with exit or disposal activities, such as restructuring activities.
Both ASC 712 and ASC 420 generally apply to benefits provided to a group of employees. Individual benefits or arrangements are generally in the scope of ASC 710-10, Compensation — General.
Accounting Models
Type of Benefit | Accounting Recognition |
Special termination benefits | The liability is recognized when the employee irrevocably accepts the company’s offer of voluntary termination and the amount is reasonably estimable. Since the employees are the ones who elect termination (and not the company), no obligation arises until the employees makes the irrevocable election. |
Contractual termination benefits | The liability is recognized when the obligation is probable and estimable. A company is legally bound to pay contractual termination benefits whenever the specified event occurs. |
Other postemployment benefits | For benefits that don’t vest or accumulate, a liability is recorded when an obligation has been incurred, the amount can be reasonably estimated, and it is probable the benefits will be paid. For benefits that vest or accumulate, the accounting depends on whether it is within the scope of ASC 710. When the following four conditions in ASC 710 are met, the liability for benefits are accrued over time as the employees provide the services to earn the benefits. · The benefits relate to past service · The benefits vest or accumulate · Payment is probable · Payment can be reasonably estimated Vested rights are those that the company has an obligation to pay even if an employee voluntarily terminates (i.e. they are not required to provide future services). Benefits that accumulate are those that are carried forward to one or more subsequent periods if unused, and generally increases with additional employee service. When the four conditions in ASC 710 are not met, the benefits are accounted for under the loss contingency model in ASC 450. A liability is recorded when it is probable and the amount is reasonably estimable. |
One-time termination benefits | Per ASC 420, the date that one-time employee termination benefits are recognized is when the plan of termination meets all of the following criteria and has been communicated to employees (i.e. communication date): a. Management, having the authority to approve the action, commits to a plan of termination. b. The plan identifies the number of employees to be terminated, their job classifications or functions and their locations, and the expected completion date. c. The plan establishes the terms of the benefit arrangement, including the benefits that employees will receive upon termination (including but not limited to cash payments), in sufficient detail to enable employees to determine the type and amount of benefits they will receive if they are involuntarily terminated. d. 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. The timing of recognition of the liability for one-time termination benefits under ASC 420 depends on whether employees are required to render services until they receive the termination benefits and whether the employee will be retained beyond a minimum retention period. If employees are not required to render service to receive the termination benefits or they will not be retained beyond the minimum retention period, a liability would be measured at fair value and recognized at the communication date. If employees are required to render services beyond a minimum retention period, the liability is initially measured at the communication date based on the estimated fair value as of the termination date. That liability is then recognized over the future service period on a ratable basis. |