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2.3 Disposal activities, exit costs, and restructuring (prebankruptcy)
Publication date: 30 Jun 2021
us PwC Bankruptcy & liquidation guide 2.3
Companies may decide to exit or restructure existing businesses, terminate employees, or restructure or cancel lease agreements in an effort to improve profitability and liquidity. The recognition of costs for employee terminations is affected by the type of termination as well as any future service requirements associated with termination benefits to be paid. For example:
- Employee terminations may be voluntary or involuntary
- Termination benefits may be one-time benefits or provided pursuant to an existing arrangement
- Termination benefits may be individually negotiated or determined for a group
- Termination benefits may be vested or may include a future service requirement as a result of the terminating event
Because different types of termination arrangements may fall within the scope of various sections of the ASC with differing measurement and reporting criteria, it is important to understand the guidance that applies in the specific situation.
Figure BLG 2-2 provides some key considerations when determining the appropriate accounting guidance for termination benefits:
Figure BLG 2-2
Summary of accounting for termination benefits
Summary of accounting for termination benefits
ASC reference
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Termination benefits in scope
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When to record the liability/expense
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Contractual termination benefits
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ASC 712-10-25-2 through ASC 712-10-25-3
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Benefits provided in accordance with an existing plan or agreement that specified termination benefits are due only upon the occurrence of a specific event (e.g., plant closure)
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Recorded when it is probable the employees will be entitled to benefits and the amount can be reasonably estimated
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Special termination benefits
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Benefits where the employer offers termination benefits for a short period of time in exchange for an employee's voluntary termination
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Recorded when an employee irrevocably accepts the offer and the amount can be reasonably estimated
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One-time employee termination benefits
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ASC 420-10-25-4 through ASC 420-10-25-10
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One-time involuntary termination benefits
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Recorded when the conditions specified in ASC 420, Exit or Disposal Cost Obligations, have been met, including management commitment to a plan and communication to employees. A reporting entity should immediately recognize the costs if future services are not required, or ratably over the required future service period if future services are required
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Other post-employment benefits
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ASC 712-10-25-4 through ASC 712-10-25-5
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Benefits provided in accordance with a mutually understood benefit arrangement between the employee and employer or former employee. A mutually understood benefit arrangement could be achieved through either a written plan or through a consistent past practice that would constitute a “substantive plan”
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Recorded when the existing situation or set of circumstances indicates that an obligation has been incurred, it is probable the benefits will be paid, and the amount can be reasonably estimated. Depending on the arrangement, the benefits will be recorded: (a) as the employees provide the services to earn the benefits (for benefits that vest or accumulate), or (b) using a loss contingency model
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Once the recognition conditions for a one-time termination benefit have been met, the pattern of expense recognition is determined by whether future service is required by the employee to receive the benefits. As long as future employee services are not required beyond any minimum retention period, a reporting entity should immediately expense the one-time termination payment. The minimum retention period should not exceed the legal notification period, or in the absence of a legal notification requirement, 60 days. If future services are required beyond the minimum retention period, the reporting entity should recognize expense ratably over the required future service period.
2.3.1 Pensions/other post-employment benefits (pre-bankruptcy)
Companies progressing toward a bankruptcy filing should carefully evaluate whether any significant events have occurred that would require a remeasurement of pension or other post-employment benefit obligations. For instance, restructuring activities, such as those previously described, could result in a plan curtailment, settlement, or significant benefit plan amendment that will typically have accounting consequences. See PEB 4 for further information on pension plan amendments, curtailments, and settlements.
2.3.2 Leases (ASC 842) (pre-bankruptcy)
Entities often cancel lease arrangements as part of restructuring activities, triggering a need to evaluate the appropriate time to recognize the costs associated with any terminations.
ASC 842, Leases, was effective in 2019 for calendar year-end public companies. Certain not-for-profit entities and employee benefit plans that file financial statements with the SEC are also subject to the transition date applicable to public business entities. All other entities are required to apply ASC 842 for annual periods beginning after December 15, 2021.
Restructuring activities could result in a lease modification under ASC 842 for both lessees and lessors. If a lessee terminates a lease in its entirety, there should be no remaining lease liability or right-of-use asset. Any difference between the carrying amounts of the right-of-use asset and the lease liability should be recorded in the income statement as a gain or loss. Upon termination of a sales-type or direct financing lease, a lessor should reclassify the carrying amount of the net investment in the lease to the appropriate asset category. If a sales-type or direct financing lease is terminated prior to the end of the lease term, the lessor should test the net investment in the lease for impairment and recognize any impairment loss identified. See LG 5 for guidance on modification and remeasurement of a lease.
ASC 842-10-35-1 requires a lessee to reassess the lease term or a lessee option to purchase the underlying asset upon the occurrence of certain events. ASC 842-10-55-28 provides examples of those events. An entity should consider whether a lease term needs to be reassessed prior to entering bankruptcy. Restructuring activities (e.g., a completed or announced sale of assets or a business, store closures, exit from a line of business) may meet the criteria for lease term reassessment.
2.3.2A Leases (ASC 840) (pre-bankruptcy)
Entities often cancel lease arrangements as part of restructuring activities, triggering a need to evaluate the appropriate time to recognize the costs associated with any terminations.
Costs to terminate an operating lease include 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. These costs follow the guidance in ASC 420-10-25-11 through ASC 420-10-25-13. If an entity terminates a contract prior to the end of its term, the liability for such costs should be recognized and measured at fair value when the reporting entity terminates the contract in accordance with its terms (e.g., when the reporting entity gives written notice in accordance with the contract terms or has otherwise negotiated a termination with the counterparty). A liability for costs that will continue to be incurred under a noncancelable contract without economic benefit should be recognized and measured at fair value when the reporting entity ceases using the rights conveyed by the contract. For a terminated contract that is an operating lease, the fair value of the liability at the cease-use date would be determined based on the remaining lease rentals, reduced by estimated sublease rentals that could be reasonably obtained for the property, even if the reporting entity does not intend to enter into a sublease.
2.3.3 Other contractual arrangements (pre-bankruptcy)
Entities often cancel contractual arrangements as part of restructuring activities, triggering a need to evaluate the appropriate time to recognize the costs associated with any terminations.
Costs to terminate a contract include 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. These costs follow the guidance in ASC 420-10-25-11 through ASC 420-10-25-13. If an entity terminates a contract prior to the end of its term, the liability for such costs should be recognized and measured at fair value when the reporting entity terminates the contract in accordance with its terms (e.g., when the reporting entity gives written notice in accordance with the contract terms or has otherwise negotiated a termination with the counterparty). A liability for costs that will continue to be incurred under a noncancelable contract without economic benefit should be recognized and measured at fair value when the reporting entity ceases using the rights conveyed by the contract.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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