28 ASC 420 EXIT OR DISPOSAL COST OBLIGATIONS
Examples of the determination of the minimum retention period and recognition
Plan includes voluntary and involuntary benefits
Other Associated Costs to Exit an Activity
PERSPECTIVE AND ISSUES
Subtopics
ASC 420, Exit or Disposal Cost Activities, consists of one subtopic:
ASC 420-10, Overall, which provides guidance on the definition, reporting and disclosure of such costs.
Scope and Scope Exceptions
ASC 420 applies to all entities. It does not apply to:
- Costs associated with the retirement of a long-lived asset covered by ASC 410-20
- Impairment of an unrecognized asset while it is being used.
(ASC 420-10-15-5)
Overview
ASC 420-10-15-4 clarifies that an exit activity includes, but is not limited to:
- A restructuring
- The sale or termination of a line of business
- The closure of business activities in a particular location
- The relocation of business activities
- Changes in management structure
- A fundamental reorganization that affects the nature and focus of operation.
DEFINITIONS OF TERMS
Source: ASC 420-10-20
Acquiree
The business or businesses that the acquirer obtains control of in a business combination. This term also includes a nonprofit activity or business that a not-for-profit acquirer obtains control of in an acquisition by a not-for-profit entity.
Acquirer
The entity that obtains control of the acquiree. However, in a business combination in which a variable interest entity (VIE) is acquired, the primary beneficiary of that entity always is the acquirer.
Acquisition by a Not-for-Profit Entity
A transaction or other event in which a not-for-profit acquirer obtains control of one or more nonprofit activities or businesses and initially recognizes their assets and liabilities in the acquirer's financial statements. When applicable guidance in Topic 805 is applied by a not-for-profit entity, the term business combination has the same meaning as this term has for a not-for-profit entity. Likewise, a reference to business combinations in guidance that links to Topic 805 has the same meaning as a reference to acquisitions by not-for-profit entities.
Business
An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. Additional guidance on what a business consists of is presented in paragraphs 805-10-55-4 through 55-9.
Business Combination
A transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as true mergers or mergers of equals also are business combinations. See also Acquisition by a Not-for-Profit Entity.
Cease-Use Date
The date the entity ceases using the right conveyed by the contract, for example, the right to use a leased property or to receive future goods or services.
Communication Date
The date the plan of termination for one-time employee termination benefits meets all of the criteria in paragraph 420-10-25-4 and has been communicated to employees.
Legal Entity
Any legal structure used to conduct activities or to hold assets. Some examples of such structures are corporations, partnerships, limited liability companies, grantor trusts, and other trusts.
The notification period that an entity is required to provide to employees in advance of a specified termination event as a result of an existing law, statute, or contract.
Not-for-Profit Entity
An entity that possesses the following characteristics, in varying degrees, that distinguish it from a business entity:
- Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return
- Operating purposes other than to provide goods or services at a profit
- Absence of ownership interests like those of business entities.
Entities that clearly fall outside this definition include the following:
- All investor-owned entities
- Entities that provide dividends, lower costs, or other economic benefits directly and proportionately to their owners, members, or participants, such as mutual insurance entities, credit unions, farm and rural electric cooperatives, and employee benefit plans.
One-Time Employee Termination Benefits
Benefits provided to current employees that are involuntarily terminated under the terms of a one-time benefit arrangement.
Restructuring
A program that is planned and controlled by management, and materially changes either the scope of a business undertaken by an entity, or the manner in which that business is conducted, as defined by the International Accounting Standard No. 37 in 2002.
Variable Interest Entity
A legal entity subject to consolidation according to the provisions of the Variable Interest Entities Subsections of Subtopic 810-10.
CONCEPTS, RULES, AND EXAMPLES
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.
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.
(ASC 460-10-25-4)
Communicating the plan to employees creates a liability at the communication date (ASC 420-10-25-5).
Measurement.
Exit or disposal costs should be measured at fair value. Often, quoted market values are not available for those costs. A present value technique may be the best option. However, in some situations the use of estimates may not be materially different from present value techniques and those are acceptable if consistent with a fair value measurement objective. (ASC 420-10-30-1 through 3)
Timing.
(ASC 420-10-6 through 8) 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.
Master Mobile Communications announces that it will close its Donnybrook 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: 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: 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: Nonunion 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.
Subsequent measurement.
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 remeasure 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.
Plan includes voluntary and involuntary benefits.
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 712-10-25-1 through 25-3). 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 Costs
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.
Other Associated Costs to Exit an Activity
Other associated costs are items such as employee relocation costs and costs associated with facility closings or consolidations. 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. (ASC 420-10-25-14 and 15)
Reporting and Disclosure
The costs of exit or disposal activities must be included in income from continuing operations before income taxes and are specifically prohibited from being presented in any manner that implies they are similar to an extraordinary item. 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. (ASC 420-10-45-3)
Disclosure requirements can be found in the Appendix.