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ASC 420 addresses the accounting for involuntary termination benefits that are provided pursuant to a one-time benefit arrangement, and not part of an ongoing written or substantive plan. The distinction is important as it can have a significant effect on the timing of recognition of the cost of those benefits. As a general rule, severance benefits provided pursuant to an ongoing plan will be accrued when probable and reasonably estimable, whereas one-time termination benefits cannot be accrued until the terms of the benefit arrangement have been communicated to the affected employees and may need to be spread over a future service period through the termination date.

8.5.1 Requirements for recognition of one-time termination benefits

For one-time termination benefits, a liability is required to be recognized when all of the conditions in ASC 420-10-25-4 are met and the benefit arrangement has been communicated to employees.

ASC 420-10-25-4

An arrangement for one-time employee termination benefits exists at the date the plan of termination meets all of the following criteria and has been communicated to employees (referred to as the communication date):

  1. Management, having the authority to approve the action, commits to a plan of termination.
  2. The plan identifies the number of employees to be terminated, their job classifications or functions and their locations, and the expected completion date.
  3. The plan establishes the terms of the benefit arrangement, including the benefits that employees will receive upon termination (including but not limited to cash payments), in sufficient detail to enable employees to determine the type and amount of benefits they will receive if they are involuntarily terminated.
  4. Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.

The FASB specifically observed that the basis for recognizing a liability is because the communication of a promise to provide one-time termination benefits if employees are terminated creates a constructive obligation at the date of communication.

8.5.1.1 Management approval of one-time termination benefits

ASC 420 requires both approval of the plan by management having the appropriate level of authority and announcement of the benefits in sufficient detail in order to recognize the liability. If a company’s ordinary decision-making process requires approval by the board of directors for a plan of termination, a liability cannot be established until board approval has been obtained. Even if a plan did not require board approval, but management nonetheless elects to seek such approval, the approval must be obtained before an accrual can be established.

8.5.1.2 Affected employee groups of one-time termination benefits

ASC 420 does not require the employer to give individual employees notice of termination prior to the accrual of involuntary postemployment benefits. Rather, it is the overall benefit arrangement that must be communicated to employees. The notification must include the provisions of the involuntary termination benefit formula in sufficient detail that each employee would be able to calculate the severance benefit that he or she would receive if terminated involuntarily. If the employees are not informed in sufficient detail, no accrual can be recorded.
As noted above, ASC 420 requires that management must have an approved plan, which provides detailed information about the employees that are to be terminated, including identification of not only the number of employees to be terminated, but also specific job classifications or functions and locations, prior to the accrual of involuntary termination benefits. Because notification is an essential element obligating the employer to fulfill its commitment, notification of benefits to be received pending involuntary terminations must be made specifically to employees within the classifications or functions at risk of being involuntarily terminated prior to the balance sheet date in order to accrue the liability.

8.5.1.3 Terms and actions of one-time termination benefits

The third and fourth conditions described in PEB 8.5.1 are intended to ensure that the plan is sufficiently detailed as to give rise to a liability. In general, we would expect the plan to be comparable in terms of the level of detail and the precision of its estimation with other operating and capital budgets that the company prepares, such as annual business unit budgets.

8.5.2 One-time termination benefits versus an ongoing plan

ASC 420 includes a rebuttable presumption that, absent evidence to the contrary, if a reporting entity has a past practice of providing similar termination benefits, the benefit arrangement is presumed to be an ongoing benefit arrangement that should be accounted for under other accounting standards, such as ASC 712 (see PEB 8.4). Additionally, under ASC 420, any termination benefits that are deemed to be enhancements to an ongoing benefit arrangement (i.e., the enhancement would result in a benefit that would be in addition to the benefit provided under the current arrangement) should be accounted for under other accounting standards, such as ASC 712. ASC 420-10-55-1 notes that, in order to be considered an enhancement to an ongoing benefit arrangement, the additional termination benefits must represent a revision to the ongoing arrangement that is not limited to a specified termination event or a specified future period. Otherwise, the additional termination benefits should be considered one-time termination benefits and accounted for under ASC 420.
Judgment will be necessary in determining if the relevant facts and circumstances indicate that the benefits represent one-time termination benefits that should be accounted for under ASC 420 or represent benefits pursuant to an ongoing benefit arrangement that is subject to other accounting standards. Additionally, entities will need to distinguish whether the relevant benefits to be accounted for under an ongoing benefit arrangement under ASC 712 relate to past service and vest/accumulate (ASC 710 model) or result from "an existing condition, situation, or set of circumstances" that results in a probable liability (ASC 450 model).
For many companies, a written postemployment benefit plan exists that evidences an employer’s promise to provide termination benefits to involuntarily terminated employees. An employer with such a plan has a mutual understanding with its employees regarding the benefit arrangement and has therefore obligated itself to pay the benefits in the event employees are involuntary terminated. Accordingly, the requirement to pay benefits for prior service is met and a liability for the cost of the benefits would be recognized under ASC 712 when payment is probable and reasonably estimable. See PEB 8.4.2.2.
For other companies, although no written plan exists, a history of paying severance benefits may exist. In such a case, the history of severance payments should be analyzed. A benefit arrangement that is mutually understood by an employer and its employees because of a consistent past practice of paying benefits would constitute a postemployment benefit plan that would be within the scope of ASC 712. We believe the guidance in ASC 715 on what constitutes a “substantive” plan when a written plan does not exist would generally be applicable to determine whether a benefit plan exists and is within the scope of ASC 712. See PEB 1.11.
ASC 420-10-55-17 through ASC 420-10-55-19 includes an example to illustrate the application of the guidance in the context of a typical involuntary termination benefit plan subject to the provisions of ASC 712.
Question PEB 8-16
PEB Corporation does not have a written severance plan and does not have a history of significant involuntary terminations of employees. On December 15, 20X1, PEB Corporation makes a general announcement that cost-cutting measures are underway and an involuntary work force reduction will occur in the near future. As of December 15, 20X1, PEB Corporation has identified affected employees, but has not notified them and does not plan to do so until January 20X2. Management has approved a plan to provide terminated employees with a benefit equal to 5% of their annual base salary upon termination, which is communicated to potentially affected employees in January 20X2. Upon termination, no future services will be required of the employees.

What model for termination benefits should be used?
PwC response
Because PEB Corporation does not have a mutually understood benefit arrangement with its employees—neither an existing plan nor past practice that would constitute a substantive plan—the involuntary termination benefits in connection with the proposed reduction in force would be considered a one-time benefit under ASC 420.
Question PEB 8-17
What constitutes a past practice of providing termination benefits for purposes of assessing whether a benefit is a one-time termination benefit?
PwC response
The term "past practice" is not defined in either ASC 420 or ASC 712. ASC 715-60-35-51 provides some guidance, indicating that a past practice would be indicated when the nature of the change and duration of the past practice are sufficient to warrant a presumption that it is understood by the plan participants. Judgment will be necessary in determining if the relevant facts indicate that a reporting entity has a past practice of providing termination benefits.
Question PEB 8-18
An employer does not have a written plan regarding payment of involuntary termination benefits. The employer determines that it will initiate a reduction in force (RIF) during its fiscal fourth quarter and has decided that it will pay termination benefits to employees who are involuntarily terminated as part of the RIF. The employer has had one RIF in its history. Employees affected by that RIF were provided termination benefits.

How should the employer determine if it has a past practice of providing benefits?
PwC response
The employer should evaluate the facts surrounding the payment of benefits for the previous RIF to determine whether the previous action, including the related communication of the decision to pay benefits, was sufficient to establish a mutual understanding between the employer and the remaining employees such that the employees would expect to be entitled to receive termination benefits if they were ever terminated. Each situation should be evaluated based on its facts and circumstances.
Although it is unlikely that benefits paid as a result of a single RIF would constitute a past practice, management’s communications at that time or subsequently could have established a mutual understanding.
Question PEB 8-19
What factors should be considered when evaluating whether the current benefit arrangement is "similar" to prior termination benefit arrangements?
PwC response
Determining whether the current benefit arrangement is similar to prior termination benefit arrangements will depend on the facts and circumstances. Factors to consider include (a) whether the arrangements were based upon the same benefit formula, (b) the employees’ understanding of the nature and amount of the benefits to be provided, and (c) the events and decisions giving rise to the payment of the benefits.
Question PEB 8-20
An employer does not have a written plan regarding payment of involuntary termination benefits. However, it has provided such benefits as part of a reduction in force (RIF) in each of the last several years. It intends to initiate a RIF during its fiscal fourth quarter and pay termination benefits to employees who are terminated as part of that RIF. The employer believes it has a mutual understanding with its employees that the employees will receive some level of termination benefits if they are terminated as a result of the RIF (i.e., the past practice threshold has been met).

How should the employer evaluate whether the benefits to be provided in the current RIF are "similar" to those in previous RIFs?
PwC response
The employer should evaluate both the terms and amount of the current benefit arrangement relative to prior arrangements to evaluate whether there is reasonable similarity, including, but not limited to, evaluating the accumulating and vesting provisions of the benefit arrangement and the basis for the amount. Each situation should be evaluated based on its facts and circumstances.
If there is a trivial difference between the current arrangement and prior arrangements (e.g., the current arrangement includes two weeks plus one day of severance pay for every year of service and the prior arrangements included two weeks of severance pay for every year of service), we believe the benefits would be similar. Conversely, if there is a substantive difference between the current arrangement and prior arrangements (e.g., the current arrangement includes six weeks of pay for every year of service per employee and the prior arrangements included two weeks of pay for every year of service), the benefits would generally not be similar.
Question PEB 8-21
An employer has a written involuntary termination benefit plan that provides, upon involuntary termination, one week of severance pay for every year of service (i.e., the benefits accumulate). The employer has not previously determined that involuntary terminations were probable, thus no liability has been recognized. During its fiscal fourth quarter, the company determines that it will initiate a reduction in force (RIF) and determines that payment of benefits is probable and reasonably estimable.

Additionally, the employer decides it will provide a one-time benefit (additional week of severance for each year of service) to the employees who are to be involuntarily terminated as part of this RIF. The additional benefit is not part of the written plan and will not apply to employees affected by any future RIFs. Management communicated the increased one-time benefit to its employees in its fiscal fourth quarter.

Would the additional benefit be considered an enhancement to an ongoing benefit arrangement?
PwC response
No. Since the additional benefit relates only to a specified termination event and is not intended to be available for future employee terminations, it is not an enhancement that would be accounted for under ASC 712, but a one-time termination benefit that would be accounted for under ASC 420. The benefit was communicated to all employees in a manner such that employees understand that the benefit represented a one-time benefit. Accordingly, since the employees will not receive the additional one-time benefit until the termination date (six months after the fiscal year end), the liability for the one-time benefit should be measured initially at the communication date (fiscal fourth quarter) based on the fair value of the liability as of the termination date. The liability would then be recognized ratably during the first and second quarters of the next fiscal year (the future service period). The benefits payable under the written plan would be recognized under ASC 712 when the amounts payable under the plan become probable and estimable, in the manner described in Example PEB 8-1 in PEB 8.4.2.2.
Question PEB 8-22
As part of involuntarily terminating employees in a certain non-US country, companies are required to negotiate with the local works council and agree on the terms of the involuntary termination, including the total amount of severance benefits that will be paid to the terminated employees. Severance benefits include a minimum benefit pursuant to statutory requirements, the amount of which is based upon years of service. They may also include an additional benefit that is agreed upon between the works council and the company, which may be based on the same benefit formula prescribed by statute.

An employer is initiating a reduction in force (RIF) and intends to pay an additional amount of severance benefit (i.e., over and above the statutory requirement) to the involuntarily terminated employees. Past negotiations have not always resulted in the payment of an additional benefit. However, the employer has a history of negotiating with the works council for additional benefits and will likely do so under future RIFs.

Would the statutory benefit be subject to ASC 712? Would the additional negotiated benefit be subject to ASC 712?
PwC response
The statutory arrangement would, in substance, be the equivalent of a severance benefit plan and thus subject to ASC 712 because the employer and its employees have a mutual understanding of the benefits that employees will receive if they are terminated. The determination of whether the additional negotiated benefit would be subject to ASC 712 or considered a one-time termination benefit that would be accounted for under ASC 420, would hinge on whether there is a similar mutual understanding regarding that benefit and whether that additional benefit would be applicable to future RIFs.
If the negotiation with the works council regarding non-statutory benefits is perfunctory, a mutual understanding regarding the additional benefit arrangement could exist based on the employer’s past practice or when it is communicated to the affected employees. However, if the negotiation with the works council regarding non-statutory benefits is not perfunctory or the outcome cannot be reasonably predicted, there generally would be no mutual understanding of the additional benefits employees would be entitled to receive until the negotiation is finalized and becomes binding on the employer.

8.5.3 Recognition and measurement of one-time termination benefits

Under ASC 420, a commitment to an exit plan does not, by itself, result in a liability for the costs of a planned exit or disposal activity. The timing of recognition of the liability for one-time termination benefits under ASC 420 is dependent upon whether employees are required to render services until they are terminated in order to receive the termination benefits and, if so, whether the employee will be retained to render service beyond a minimum retention period.
As described in ASC 420-10-25-7, the minimum retention period should not exceed the legal notification period (defined in ASC 420-10-20 as “[t]he 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”) or, in the absence of a legal notification requirement, 60 days. For example, certain actions may fall under the Worker Adjustment and Retraining Notification Act of 1988 (WARN Act), which requires employers with 100 or more employees to notify affected employees 60 days in advance of a plant closing or mass layoff. Also, under the WARN Act, all employees are legally employed and paid by the employer until the end of the 60-day notification period, even if the terminated employees will cease providing services immediately. Collective bargaining or other labor contracts, or statutory requirements in foreign countries, may require different notification periods.
If employees are not required to render service until they are terminated in order to receive the termination benefits (that is, 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, a liability for the termination benefits would be measured at fair value and recognized at the communication date (see PEB 8.5.1).
If future service is required beyond a minimum retention period for employees to receive the one-time termination benefit, entities must initially (at the communication date) measure the liability at its fair value as of the termination date. That liability must then be recognized (accrued) ratably over the future service period, effectively as a stay bonus.
The retention period should be determined from the communication date (as described in PEB 8.5.1) through the date employees must work to receive the termination benefits. The period begins when the plan has been committed to and communicated to the affected employee groups, not when individual employees are notified of their pending termination. Based on the plan of termination, it is possible that certain affected employees may be retained to render service beyond the minimum retention period and others may not. In such a case, the recognition of the liability for the termination benefits should be bifurcated.
The fair value of the termination benefits reflects the cost that the company would need to pay a market participant to transfer the liability for the benefit payments. While ASC 420-10-30-2 notes that quoted market prices are the best representation of fair value, it goes on to state that quoted market prices will typically not be available and other valuation techniques, such as a present value technique, will typically be used to estimate the fair value of the benefit liability. Where discounting is required (and in some cases, the standard notes that the period of time until payment occurs may be so short that the effect of discounting may not be material), ASC 420-10-35-1 provides for the use of the credit-adjusted risk-free rate. Changes to the liability due to the passage of time are recognized as an expense; this expense is not considered “interest cost” for purposes of applying ASC 835-20 on the capitalization of interest.
Changes to the liability due to changes in the amount or timing of estimated cash flows are measured using the credit-adjusted risk-free rate that was used to measure the liability initially, and reflected in the income statement in the period of change.
If a plan of termination changes and employees that originally were not expected to provide services beyond the minimum retention period (and therefore the full amount of the liability for their one-time termination benefits was recognized at the communication date) are now expected to be retained beyond the minimum retention period, it may be acceptable to recognize the liability for any incremental benefits prospectively over the remaining (new) required service period. Alternatively, the liability previously recognized could be adjusted (reduced) to the amount that would have been recognized to date if the liability had been recognized ratably over the remaining future service period from the original communication date to the updated termination date. See ASC 420-10-55-2 through ASC 420-10-55-10 for several examples of the valuation and attribution of one-time termination benefits.
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