From the IFRS Institute - Aug 31, 2018
Both IFRS and US GAAP require certain restructuring costs to be recognized in the financial statements before the restructuring actually occurs. However, determining the timing of liability recognition, and which costs to include, differs. We revisit the IFRS requirements for restructuring, highlighting some of the practical accounting considerations and comparing them to US GAAP.
A restructuring can comprise numerous activities, including termination or relocation of a business, a change in management structure and lay-offs. At a high level, the associated costs are recognized when (1) the program is of such scale that it meets the IFRS definition of a restructuring, and (2) management has an obligation to proceed with the restructuring. In addition, the nature of the costs matters – certain costs cannot be recognized before being incurred, and employment termination costs may need to be recognized earlier than other restructuring costs.
Restructuring costs are in the scope of IAS 371 with the exception of employee termination benefits, which are accounted for under IAS 19.2
Restructuring vs. exit activities
IAS 37 defines a restructuring as a program that materially changes the scope of a business or the manner in which it is conducted. US GAAP uses the term ‘exit activities’, which may be broader than a ‘restructuring’ under IFRS. Understanding the scale of the restructuring is therefore important because not all programs may qualify for cost recognition under IFRS.
Restructuring costs are recognized as soon as there is a present obligation (legal or constructive) resulting from a past event, and a reliable estimate of costs can be made. Restructurings are rarely conducted for legal reasons. Therefore, determining whether a constructive obligation exists is the key challenge for deciding when to record a restructuring provision.
IAS 37 explains that a constructive obligation for a restructuring arises only when:
Given the level of judgment involved, companies should develop processes and controls to support their determination of whether a constructive obligation exists.
The announcement needs to be sufficiently detailed to create an expectation for those affected that the plan will be implemented.
In our view, this includes information about the impacted businesses, the estimated timing, functions and approximate number of employees affected. However, neither the estimated cost nor the specific individuals affected (e.g. employees, vendors) needs to be announced.
Implementation should commence as soon as practicable and be completed in a timeframe such that significant changes to the plan would not be expected.
While there is no specified limit on the timing, we believe the timeframe needs to be short enough that the possibility of the plan being changed is small.
Usually, a management or board decision approving a restructuring does not in itself establish a constructive obligation. This is because an expectation cannot be created until those affected are made aware of the plan.
However, we believe exceptions may occur, for example when the board decision requires prior communication with or approval from employee representatives – e.g. communications with unions or announcement of the restructuring through the filing of either Form 6-K or Form 8-K.
The requirements and considerations above apply to all restructuring costs other than employee termination benefits.
Measurement of a restructuring provision
Only incremental costs that are directly associated with the restructuring should be included in the provision. Additionally, IFRS prohibits the recognition of a provision for costs associated with ongoing activities, such as the cost of training or relocating continuing staff.
As a result, companies should carefully analyze their restructuring costs. Once the nature of the restructuring costs has been identified, the provision is measured at the best estimate of the anticipated costs. That amount is discounted using a pre-tax rate that reflects both the time value of money and risks specific to the liability, if the financing component is material. The recognition and measurement of restructuring costs under US GAAP depends on the applicable Codification Topic/Subtopic and can result in differences from IFRS.
Restructuring in business combinations – acquiree vs. acquirer
Restructurings are often triggered by mergers and acquisitions. Under IFRS 33 , the cost of restructuring an acquiree is recognized as a liability as part of the acquisition accounting – i.e. as a debit to goodwill rather than expensed – only if it is an obligation of the acquiree at the date of acquisition. Costs for planned or future actions of an acquirer are not recognized as a liability in the acquisition accounting.
This means that a restructuring initiated by the acquiree before the acquisition impacts goodwill, while a restructuring initiated by the acquirer impacts profit or loss subsequently to the accounting for the business combination.
Employee termination benefits
Employee termination benefits are provided in exchange for the termination of an individual’s employment, outside of normal retirement. While termination benefits represent one of the most common types of restructuring costs, they can also be payable outside of a restructuring program.
Employee termination benefits are in the scope of IAS 19 rather than IAS 37. The associated costs are recognized when the company can no longer withdraw the offer of those benefits. This may be earlier than when other restructuring costs are recognized, and typically before the benefits are paid. Assessing the point at which an offer cannot be withdrawn may be complex and depends on whether the employee’s acceptance is required – i.e. the termination is voluntary rather than involuntary.
Companies should also carefully assess the terms and conditions of the termination benefits arrangement to ensure that the benefits are indeed termination rather than post-employment benefits. Benefits conditional on future services (i.e. that are provided in exchange for services) are considered post-employment benefits and are accrued over an employee’s service period rather than at a single point in time.
Restructuring provisions – the takeaway
Accounting for a restructuring is rarely straightforward. Therefore, determining when to recognize a restructuring provision requires a careful examination of the facts, particularly in the context of assessing whether a constructive obligation exists. Companies should also pay close attention to the terms and conditions of employee termination benefits arrangements (voluntary versus involuntary) and whether the payments are conditional on future services.
Identifying which costs should be included in the measurement of the restructuring provision and coming up with a best estimate of those costs also requires judgment and supportable cost projections.
Comparison to US GAAP
Read more in our publication: IFRS Compared to US GAAP.
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