Termination benefits and furloughs: IFRS® Standards vs. US GAAP

From the IFRS Institute – August 28, 2020

The current global environment and economic slowdown is forcing many companies to resize their workforce either temporarily or permanently. IAS 19¹ has a single accounting approach for all termination benefits, unlike US GAAP, which has several recognition models depending on whether the benefits are voluntary, involuntary, contractual, one-off, etc. Here we provide an overview of what we consider to be the top 10 differences between IFRS Standards and US GAAP related to termination benefit and furlough arrangements.

Understanding cost-saving employment actions

Termination benefits relate to permanently ceasing an employment relationship and can take various forms, including lump-sum payments and/or periodic future payments. Those benefits can be offered as part of a larger restructuring event or separately. An important distinction in accounting for employee termination benefits is whether those measures are voluntary or involuntary.

• Voluntary termination benefits are typically offered by employers for a short period in exchange for an employee’s voluntary termination of employment, including early retirement.
• Involuntary termination benefits are provided by employers to employees in connection with their termination of employment. These benefits are not contingent on employees’ acceptance of the termination benefit arrangement.

In contrast, a furlough is a mandatory temporary leave of absence from which the employee is expected to return to work or be restored from a reduced work schedule. Furloughs typically consist of no or reduced pay to employees and/or a continuation of certain fringe benefits. They may or may not be for a specified period of time. These arrangements allow a company to save costs but ultimately retain their workforce until some or all of those employees can return to work. Accounting for furlough arrangements depends on various factors – e.g. whether the related employees are considered active or inactive and whether the furlough is voluntary or involuntary. As such, accounting for furloughs has similarities to termination benefit accounting.

Our top 10 differences

These are what we consider to be the top 10 accounting differences for termination and furlough arrangements between IFRS Standards and US GAAP.

1.   IFRS Standards apply a single accounting approach; US GAAP does not

IAS 19 makes no distinction between different types of termination benefits and a single accounting approach is applied. A company recognizes a liability for termination benefits at the earlier of:

• when it recognizes the costs for a restructuring (in the scope of IAS 37) that includes the payment of termination benefits; and
• when it can no longer withdraw the offer of those benefits.

US GAAP addresses different categories of termination benefits (e.g. contractual, special, postemployment/retirement, one-time termination benefits) in multiple Accounting Standards Codification® Topics. For voluntary and involuntary benefits, including furloughs, depending on the type of benefit, one of the following applies:

• ASC 710, Compensation—General
• ASC 712, Compensation—Nonretirement Postemployment Benefits
• ASC 715, Compensation—Retirement Benefits
• ASC 420, Exit or Disposal Cost Obligations.

2.   Termination benefits offered in a larger restructuring event – timing of recognition

Under IAS 19, timing of recognition for termination benefits may depend on whether they are part of a larger restructuring event (e.g. if it occurred earlier than the termination).

Under US GAAP, there is generally no linkage between the recognition of a larger restructuring event (or other exit activities as defined in ASC 420) and the recognition of termination benefits offered.

For example, voluntary termination benefits are often offered as part of a larger restructuring event. If they have been communicated with the specificity required by IAS 37 to be recognized as a provision, the expense is recognized under IFRS Standards before it is known who will accept the offer. Under US GAAP, acceptance is required before recognizing the liability.

3.   Involuntary termination benefits – timing of recognition

Under IAS 19, the recognition of involuntary termination benefits that are not part of a larger restructuring requires communication to the affected employees, with the specificity required by IAS 19.

Under US GAAP, involuntary termination benefit recognition criteria differ depending on the category of termination benefit, and in many cases recognition will be earlier than under IAS 19 (see difference #4).

4.   Involuntary contractual termination benefits – communication to employees

Under IAS 19, the recognition of involuntary termination benefits that are not part of a larger restructuring requires communication to the affected employees, with the specificity required by IAS 19.

Under US GAAP, a liability is recognized when the amounts are probable and estimable (i.e. communication to affected employees is not required) if:

• there is a pre-existing (contractual) termination benefit arrangement such that the employer and employees have a mutual understanding of the benefits the employee will receive if involuntarily terminated; or
• there is a past practice of providing ‘similar benefits’ as those currently contemplated (e.g. following a similar formula).

Because it is common for termination benefits to fall into this category, this could result in a significant acceleration of the recognition of the cost / liability under US GAAP compared to IFRS Standards.

5.   Involuntary one-time termination benefits – accounting for service requirements

Under IAS 19, benefits that require future services (even until the end of the legal notice period) are not considered termination benefits and are accounted for as normal compensation expense as and when the services are provided. However, payments to an employee during the legal notice period, when the employee is no longer required to perform services for the company to receive the payment, are in the scope of the termination benefits guidance.

Under US GAAP, one-time termination benefits may require future services. For example, one-time payments that require services through the legal notice period (or in its absence 60 days) are accrued when there is a present obligation, which arises as of the communication date, unlike IAS 19.

However, for both IAS 19 and US GAAP, the liability for one-time termination benefits requiring services beyond the legal notice period is initially measured at the communication date and recognized ratably over the service period; the measurement of the liability is reassessed at each reporting date.

6.   Enhancements to existing plans – timing of recognition

Companies may decide to provide additional or enhanced termination benefits along with the employee’s base termination benefits. Under IAS 19, a single accounting approach is applied to the total set of benefits, and therefore the benefit enhancement is recognized in the same period as the base benefit.

Under US GAAP, any one-time enhancement made to an existing arrangement, or a one-time termination benefit paid in connection with an exit activity, is accounted for under ASC 420. In contrast, enhancements that are revisions to the ongoing arrangement are accounted for under other Topics. Judgment is often required in making this distinction and will depend on the relevant facts and circumstances. Under US GAAP, enhanced termination benefits may or may not be recognized in the same period as the base termination benefits (see #4), resulting in differences from IFRS Standards.

7.   Measurement under IAS 19 depends on whether termination benefits are short- or long-term; measurement under US GAAP does not

IAS 19’s measurement criteria for termination benefits are based on the nature of the employee benefit provided.

• Termination benefits expected to be settled wholly within 12 months are measured like short-term employee benefits.
• Termination benefits expected to be settled wholly beyond 12 months are measured like long-term employee benefits – i.e. the accounting depends on whether those benefits are akin to defined contribution or defined benefit arrangements. Either may require discounting if the effect is material.
• Termination benefits that are enhancements to postemployment benefits are measured like postemployment benefits (e.g. as defined benefit or contribution plans).

Under US GAAP, the measurement of termination benefits depends on the categories of benefits (e.g. contractual, special, postemployment/retirement, one-time termination benefits) and is not based on whether they are short- or long-term benefits.

Read our IFRS Perspectives article, Defined Benefit Plans: IFRS Standards vs. US GAAP, for more insights on the differences between IFRS Standards and US GAAP for defined benefit plans.

8.   One-time termination benefits – accounting for changes in interest rates for long-term benefits

Under IAS 19, provisions for long-term termination benefits are remeasured at each reporting date based on the current estimate of the expenditure to be incurred, and for changes in interest rates.

Under US GAAP, subsequent measurements under ASC 420 use the initial credit-adjusted risk-free rate –prohibiting adjustments to one-time termination benefits for changes in interest rates – which could lead to a difference in the amounts recognized.

9.   Nonretirement post-employment benefits – accounting for contractual severance benefits

Under US GAAP, severance benefits that are part of a contractual arrangement (e.g. required by the terms of the severance plan due to a plant closure) are considered contractual termination benefits and within the guidance on other post-employment benefits. Contractual severance benefits are recognized when it is probable the employee is entitled to the benefit and the amount is reasonably estimable. IAS 19 does not specifically address contractual severance benefits.

As a result, differences may exist between US GAAP and IFRS Standards for the recognition timing and the measurement of contractual severance benefits.

10.  Furlough arrangements

For both US GAAP and IFRS Standards, the accounting for furlough arrangements depends on a number of factors.

Under IFRS Standards, the accounting follows the general IAS 19 guidance. If there are benefits paid, and the employee is furloughed, there is specific guidance on non-accumulating paid absences. A company recognizes no liability or expense until the time of the absence, because employee service does not increase the amount of the benefit; therefore, furlough benefits are usually recognized as they occur over the period of inactivity.

However, under US GAAP, if a company determines that furloughed employees are inactive, furlough benefit costs are generally accrued when they are probable (e.g. when communicated to the employee) and reasonably estimable. Determining whether an employee is active or inactive during the furlough period requires judgment, and the outcome under US GAAP may not always be the same as under IFRS Standards. Our Coronavirus Hot Topic, Compensation and benefit arrangements and related accounting implications, provides indicators that are helpful in making this determination, and also provides a flow chart to assist in determining the appropriate accounting for furlough arrangements under US GAAP.

The takeaway

Accounting for termination benefits and furlough arrangements can be complex, because the classification criteria are generalized under IFRS Standards, but specific under US GAAP. Further complexity arises because of the multiple standards that address the accounting and reporting under US GAAP. Careful judgment is required to appropriately classify benefits based on the nature and terms of the underlying arrangements.

Dual reporters will need to carefully assess the accounting under both sets of standards and be mindful of these key differences in recognizing and measuring termination benefit and furlough arrangements.

Footnotes

1. IAS 19, Employee Benefits

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