Exit and Disposal Cost Accounting and Reporting

Overview

In September 2020, an iconic American brand, Harley-Davidson, reported it expected to record $169 million in 2020 restructuring costs related to actions including discontinuing its sales and manufacturing operations in India and other low volume markets to focus on its U.S. core market.

As the pandemic continues to cause economic pain, many businesses are taking a hard look at moving or closing facilities, exiting some activities, laying off employees, or reducing rental space. These actions may create restructuring costs and termination benefits that entities don’t normally have.

This article offers basic information to help you understand and apply the accounting standards for exit and disposal activities and does not constitute professional advice on facts and circumstances specific to any person or entity. Other FASB topics address the accounting and reporting for employee termination benefits. These include ASC 715 – Compensation – Retirement Benefits, ASC 712 – Compensation – Nonretirement Postemployment Benefits, and ASC 710 – Compensation – General.

Using its conceptual framework for recognition of liabilities and fair value measurements, FASB ASC 420 establishes an accounting model for costs associated with exit or disposal activities. An exit activity includes but is not limited to a restructuring. Restructuring is defined as “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.”

Exit and Disposal Costs may include:

• Sale or termination of a line of business
• Closure of business activities in a particular location
• Relocation of business activities from one location to another
• Changes in management structure
• A fundamental reorganization that affects the nature and focus of operations

Even though exit and disposal activities may not necessarily have a material effect on the scope of an entity’s business or manner in which that business is conducted, they would still be within the scope of ASC 420. (Restructuring has a materiality threshold.)

Costs Included in the Scope of ASC 420

One-time termination benefits Severance payments, outplacement job training, and counseling all are examples of one-time specified termination events or for a specified future period. A one-time benefit arrangement exists when management or a board of directors with the requisite authority to approve the action:

• Commits to an approved written plan of termination that identifies the specific classification, function or location of employees to be terminated, and
• Establishes the terms of the benefit arrangement as well as required actions to complete the plan indicate it is unlikely that significant changes to the plan will be made or the plan will be withdrawn. 

ASC 420 applies to a one-time benefit arrangement that is not an enhancement to an ongoing benefit arrangement. Ongoing benefit arrangements should be accounted for under ASC 712. 

Example of an enhancement to an ongoing termination benefit: A company has a written policy for all employees at date of hire that provides for one week of severance for each year of service for an involuntary termination. The entity has a current year reduction in force (RIF) and provides an additional two weeks of severance pay for each year of service. 

The additional benefit applies to all employees affected by this RIF and all future involuntary terminations. Because this is an additional benefit to the company’s written policy, it is considered an enhancement to an ongoing termination benefit, and would be accounted for under Topic 712. The benefit would accrue when the likelihood of future settlement is probable as that term is used in ASC 450. 

However, if the additional termination benefit applies only to the employees affected by the RIF, and not all future involuntary terminations, and similar benefits had not been provided for a past RIF, the additional benefits would be accounted for under ASC 420.

The timing of the measurement of a liability for one-time termination benefits depends on the service period required to receive the termination benefits. A liability is measured at fair value at the communication date. If employees are entitled to their termination pay regardless of whether they stay or leave, the expense is recognized on the communication date. 

If future service is required (beyond a minimum retention period), the liability should be measured initially at the communication date based on its fair value as of the termination date and recognized ratably over the future service period. The liability would then be accreted from the termination date to the payment date. A minimum retention is a period not based on future service, such as, a legal notification requirement, or in the absence of a legal notification requirement, would not exceed 60 days.

Costs to Terminate a Contract

Costs to terminate a contract (excluding leases within the scope of Topic 842) are either:

• Costs to terminate the contract before the end of its term, or
• Costs that will continue to be incurred under the contract for its remaining term without economic benefit to the entity.

A liability is recognized at fair value when written notice is given to the counterparty within the notification period specified by the contract or otherwise negotiated at termination with the counterparty. A liability for costs that will continue to be incurred under a contract for its remaining term without economic benefit to the entity must be recognized at fair value at the cease-use date. 

Other Associated Costs

A liability for other costs associated with an exit or disposal activity, such as costs to consolidate or close facilities and relocate employees, is recognized in the period in which the liability is incurred (generally, when goods or services associated with the activity are received). Goods or services received might include consulting services, relocation services or new computer software. 

ASC 420 specifies that a liability should not be recognized before it is incurred even if the costs are incremental to other operating costs and will be incurred as a direct result of the planned exit or disposal activity. Future operating losses that an entity expects to incur in connection with the exit or disposal activity do not meet the definition of a liability and should be recognized as incurred. Likewise costs of maintaining idle property cannot be recognized at the commitment date and would be recognized as incurred.

Costs Associated with Discontinued Operations

Costs associated with an exit or disposal activity involving a discontinued operation are included with the results of discontinued operations in accordance with Topic 205-20, or if they don’t involve a discontinued operation they are included in income from continuing operations before income taxes in the income statement of a business entity and income from continuing operations in the statement of activities of a non-for-profit entity.

Separate presentation of exit and disposal costs in the income statement is not prohibited. If a subtotal such as income from operations is presented, it should include the amounts of those costs. Accretion expense is not considered interest cost for purposes of classification in the income statement (statement of activities). If an event or circumstances change that discharges or removes an entity’s responsibilities to settle a previously accrued liability, the related exit and disposal costs should be reversed through the same line item(s) in the income statement (statement of activities) used when those costs were recognized initially.

Disclosure Requirements

In periods which have expenses that qualify under ASC 420 as exit or disposal activities and any subsequent period until the activity is completed, the financial statement notes should include the following:

• A description of the activity, the facts and circumstances leading to the activity, and the expected completion date;
• For each major type of cost, the total expected amount to be incurred with the activity, the amount incurred in the current period, and cumulative to date amounts; and a reconciliation of the beginning and ending liability balances showing separately the changes during the period attributable to costs incurred and charged to expense, costs paid or otherwise settled, and any adjustments to the liability with an explanation of the reasons(s) why;
• The line items in the income statement or the statement of activities in the costs in (b) are aggregated;
• If an entity is within the scope of Topic 280, for each reportable segment, as defined in Subtopic 280-10, the total amount of costs expected to be incurred in connection with the activity, the amount incurred in the period, and the cumulative amount incurred to date, net of any adjustments with an explanation of the reason(s) why; and
• If a liability for a cost associated with the activity is not recognized because fair value cannot be reasonably estimated, that fact and the reasons why.

If you have questions or concerns about exit and disposal cost accounting, contact us. We are here to help.

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