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6.4 Disposal activities, exit costs, and restructuring charges
Publication date: 30 Nov 2023
us PP&E and other assets guide
ASC 420-10, Exit or Disposal Cost Obligations, addresses significant issues related to the recognition, measurement, and reporting of costs associated with exit and disposal activities, including restructuring activities. ASC 420-10 focuses on the recognition of liabilities, specifically requiring that companies only record liabilities when they are incurred.
ASC 360-10, not ASC 420-10, governs the accounting for the impairment of long-lived assets and assets to be disposed of. See PPE 5 for further discussion on identifying, measuring, recording, and classifying impairment charges.
ASC 842 amended the guidance in ASC 420-10 to remove leases from its scope. Refer to LG 4.4 for further details regarding the subsequent recognition and measurement of a lease and LG 5 for further details regarding modification and remeasurement of a lease. See PPE 4.2.4 for details regarding the subsequent accounting for right-of-use assets, PPE 5.2.7 for lease impairment considerations, and PPE 6.3.1.1 for a discussion of lease abandonments. See FSP 11.4.4.1 for a discussion of the presentation and disclosures of exit and disposal cost obligations.
When deliberating ASC 420-10, the FASB discussed whether a definition of restructuring should be developed, but believed an operational definition of restructuring for accounting purposes was not feasible. ASC 420-10 does, however, indicate that an exit activity includes, but is not limited to, a restructuring as defined in International Accounting Standard No. 37 (IAS 37), Provisions, Contingent Liabilities and Contingent Assets. As a result, costs associated with exit or disposal activities under ASC 420-10 include, but are not limited to: (1) involuntary employee termination benefits pursuant to one-time termination plans (i.e., other than pre- existing arrangements or a new plan that is expected to be ongoing, the accounting for which is addressed in ASC 710), (2) costs to terminate a contract that is not a lease, and (3) other exit costs.
IAS 37 defines restructuring as "a programme that is planned and controlled by management, and materially changes either: (a) the scope of a business undertaken by an entity; or (b) the manner in which that business is conducted." A restructuring covered by IAS 37 includes the sale or termination of a line of business, the closure of business activities in a particular location, the relocation of business activities from one location to another, changes in management structure, and a fundamental reorganization that affects the nature and focus of operations.
6.4.1 Costs associated with exit or disposal activities
ASC 420-10 incorporates many of the views of the SEC staff that were previously included in SAB 100. The issuance of SAB 103 in May 2003 resulted in the deletion of SAB 100 guidance previously included under SAB Topic 5.P.1 and SAB Topic 5.P.2. However, there continue to be specific areas and issues included in the previous guidance that provide additional insights beyond that in ASC 420-10 and have been included in the discussion that follows.
Certain costs that may be associated with exit or disposal activities are not included in the scope of ASC 420-10. Examples of these costs include:
- Termination benefits that are provided to employees under the terms of an ongoing benefit arrangement (or enhancements to an ongoing benefit arrangement) or an individual deferred compensation contract covered by other accounting pronouncements. If termination benefits are offered in exchange for an employee’s voluntary termination of service, the liability for such voluntary termination benefits should be recognized in accordance with ASC 712-10.
- Costs to terminate a lease are to be accounted for in accordance with ASC 842-20
- Costs associated with the retirement of a long-lived asset are to be accounted for in accordance with ASC 410-20.
- Impairment of long-lived assets and long-lived asset disposal groups are to be accounted for in accordance with ASC 360-10.
See BCG 2.5.15 for guidance with respect to the recognition of liabilities related to restructurings or exit costs in a business combination.
6.4.1.1 Initial recognition of liabilities for exit/disposal activities
ASC 420-10 incorporates the liability recognition concepts embodied in CON 6 (see Recent standard setting section below for additional information). Accordingly, a liability associated with an exit or disposal activity should be recognized only when an event has occurred that creates a present obligation to transfer assets or provide services in the future that meets the definition of a liability set forth in CON 6. ASC 420-10 emphasizes that the present obligation must be to others and result from the occurrence of a past event. In this regard, ASC 420-10 makes it clear that an entity's commitment to an exit plan, in and of itself, does not create a present obligation to others for the costs expected to be incurred under the plan. Under ASC 420-10, a liability for costs associated with an exit or disposal activity is incurred when the three characteristics of a liability cited in CON 6, par. 36 are present. Specifically, an entity must:
- Have a “present duty or responsibility to one or more entities that entails settlement by probable future transfer, or the use of assets at a specified or determinable date, on occurrence of a specified event, or on demand.” ("Probable" is used with its general meaning and not in the specific technical sense that it is used in ASC 450-10, Contingencies, Overall. Thus, it does not imply the same "high degree of expectation" that its use in ASC 450-10 implies.)
- Have little or no discretion in avoiding a future transfer of assets or providing services
- Determine that an obligating event has already happened
The requirement to recognize costs associated with exit or disposal activities at fair value differs from the probability notion in ASC 450-10. Using that criterion, a liability for costs associated with disposal activities would have been initially recognized when (1) the future transfer of assets or provision of services was probable (as that term is used in ASC 450-10), and (2) the amount could be reasonably estimated. However, as noted above, recognition of exit costs under ASC 420-10 is not based on the probable and reasonably estimable model. ASC 450-10 deals with uncertainty by using a probability threshold for recognition of a loss contingency. In the estimation of the fair value of a liability for exit costs under ASC 420-10, uncertainty in the amount and timing of the future cash flows necessary to settle a liability is addressed by incorporating that uncertainty in the measurement of the fair value of the liability following the principles of CON 7.
Recent standard setting
In December 2021, the FASB issued two new chapters of Concepts Statement No. 8 (CON 8), Conceptual Framework for Financial Reporting. One of the chapters, Elements of Financial Statements, includes revised definitions of certain financial statement elements (e.g., liabilities) and supersedes Concepts Statements No. 6, Elements of Financial Statements (CON 6). Despite this change, ASC 420 continues to reference CON 6. It is unclear when the FASB will make corresponding changes to the language in ASC 420.
6.4.1.2 Fair value of liabilities for exit/disposal activities
ASC 420-10 requires that a liability for a cost that is associated with an exit or disposal activity be recognized at its fair value when incurred. That is, it should be recognized when the cost meets the definition of a liability as set out in CON 6 (see Recent standard setting section below for additional information). See the Fair value measurements guide for additional guidance on measuring the fair value of the liability.
Recent standard setting
In December 2021, the FASB issued two new chapters of Concepts Statement No. 8 (CON 8), Conceptual Framework for Financial Reporting. One of the chapters, Elements of Financial Statements, includes revised definitions of certain financial statement elements (e.g., liabilities) and supersedes Concepts Statements No. 6, Elements of Financial Statements (CON 6). Despite this change, ASC 420 continues to reference CON 6. It is unclear when the FASB will make corresponding changes to the language in ASC 420.
6.4.1.3 Subsequent accounting for exit/disposal activity accruals
ASC 420-10 provides guidance regarding the subsequent accounting for liabilities associated with exit or disposal activities. Companies are required to subsequently adjust accruals established under ASC 420-10 for changes resulting from revisions to either the timing or the amount of estimated cash flows. That change should be measured using the credit-adjusted risk-free rate that was used to initially measure the liability. Accordingly, subsequent measurement of the liability is not at fair value. The adjustment should be recognized in the period of change and reported in the same line item as the original costs were classified at initial recognition.
ASC 420-10 also requires the liability to be adjusted due to the passage of time as an increase in the liability and as an expense (e.g., accretion expense). Interest on the liability would be accreted using the original effective rate and recognized as an operating expense in the income statement (or statement of activities). This guidance is similar to that in ASC 410-20, Asset Retirement and Environmental Obligations, Asset Retirement Obligations.
6.4.2 Employee termination costs
ASC 420-10 addresses the accounting for involuntary employee termination costs that are provided pursuant to a one-time benefit arrangement. A one-time benefit arrangement is an arrangement established by a plan of termination that applies for a specified termination event or for a specified future period. For further details on employee termination costs, including one-time benefit arrangements, refer to PEB 8.5.
6.4.3 Contract termination costs
ASC 842, Leases, amended ASC 420-10 to remove leases from its scope. See the Leases guide and PPE 4.2.4 for further details on the accounting for leases after the adoption of ASC 842.
ASC 420-10 applies to costs to terminate a contract that is not a lease and that existed prior to the entity’s commitment to a plan of disposal. Contract termination costs that may be incurred in connection with an exit or disposal activity are (a) costs to terminate the contract before the end of its term or (b) costs that will continue to be incurred under the contract for its remaining term without economic benefit to the entity.
Costs to terminate a contract before the end of its term should be recognized and measured at their fair value when the entity terminates the contract in accordance with the contract terms. Costs that will continue to be incurred under a noncancelable contract should be recognized and measured at fair value when the entity ceases using the right conveyed by the contract (e.g., the right to receive future goods or services).
Under ASC 842, a lessee may elect an accounting policy, by asset class, to include both the lease and nonlease components as a single component and account for it as a lease. When a lessee has not elected this practical expedient, nonlease components (e.g., common area maintenance, security services) are not accounted for as a lease. Costs to terminate these nonlease components should continue to be accounted for under ASC 420-10.
6.4.4 Recording other costs related to exit/disposal activities
ASC 420-10 also applies to other costs associated with an exit or disposal activity, including costs incurred for (1) protecting and maintaining an asset while held for sale, (2) plant closings, and (3) employee or facility relocations. Typically, these costs are not associated with, and will not be incurred to generate revenues following an entity's commitment to a plan and are incremental to other costs incurred by the entity (i.e., the costs will be incurred as a direct result of that plan).
With respect to other exit costs, irrespective of the direct nature of these costs, ASC 420-10 requires that a liability for such costs only be recognized when they meet the definition of a liability in CON 6 (see Recent standard setting section below for additional information), rather than upon commitment to an exit or disposal plan. The primary basis for recognition lies in the present obligation to others based on a requisite past transaction or event. Accordingly, a company’s intention, which is reflected in the commitment to a plan, does not in and of itself create a present obligation to others.
ASC 420-10 requires that other costs related to exit or disposal activities be accounted for at fair value (see PPE 6.4.1.2). In addition, ASC 420-10 provides guidance for the subsequent accounting for those costs (see PPE 6.4.1.3).
Although ASC 420-10 does not allow for costs associated with exit or disposal activities to be recognized until incurred, we believe that the criteria included in SAB 100 provide guidance in determining which costs are considered exit-related cost and can be presented and disclosed in the financial statements as restructuring costs. (Note that the term "commitment" (used in the SAB) has been replaced with the term "communication" in the list below, to comply with ASC 420-10.)
- The cost is not associated with or is not incurred to generate revenues after the communication date, and either:
- The cost is incremental to other costs incurred by the company prior to the communication date and will be incurred as a direct result of an exit plan; or
- The cost represents amounts to be incurred under a contractual obligation that existed prior to the communication date and will either continue after the exit plan is completed with no economic benefit to the company or be a penalty incurred by the company to cancel the contractual obligation.
For further considerations on the accounting for other exit costs, see Question PPE 6-1 and Question PPE 6-2.
Question PPE 6-1
A company operates 100 retail outlets and has identified the specific location of 60 out of 70 stores that it intends to close pursuant to a store consolidation plan. The exit plan for the 60 stores identifies all significant actions and related costs in budget line item detail. Management believes the average cost to close the additional 10 stores will approximate the average cost of closing the identified 60 stores. Assuming that all other provisions of ASC 420-10 have been met, may the company recognize a liability at the communication date for the exit costs and involuntary termination benefits associated with all 70 stores?
A company operates 100 retail outlets and has identified the specific location of 60 out of 70 stores that it intends to close pursuant to a store consolidation plan. The exit plan for the 60 stores identifies all significant actions and related costs in budget line item detail. Management believes the average cost to close the additional 10 stores will approximate the average cost of closing the identified 60 stores. Assuming that all other provisions of ASC 420-10 have been met, may the company recognize a liability at the communication date for the exit costs and involuntary termination benefits associated with all 70 stores?
PwC response
No. While recognition of estimated exit costs and involuntary termination benefits for the 60 identified stores is appropriate, the requirements of ASC 420-10 have not been met for the remaining 10 stores.
If the company decides not to close one of the 60 stores in a period following it recognizing the liability, the related accrued exit costs and involuntary employee termination benefits for the one store must be reversed; the liability cannot be maintained in anticipation of the costs expected to be incurred when other stores are identified for closing.
Question PPE 6-2
A company enters into a long-term supply contract with a vendor for a component part previously produced internally. In connection with the contract, the company decides to close one of its plants that produced the component, and the vendor agrees to reimburse all plant closing and employee severance costs. The vendor will not purchase any underlying plant assets and the company is not obligated to provide any separate services to or for the vendor such as marketing or advertising services. The vendor simply has agreed to reimburse the company for the costs associated with the closure of the plant as long as the company enters into a supply contract arrangement with the vendor. How should the company account for the vendor's reimbursement of its plant closing and severance costs?
A company enters into a long-term supply contract with a vendor for a component part previously produced internally. In connection with the contract, the company decides to close one of its plants that produced the component, and the vendor agrees to reimburse all plant closing and employee severance costs. The vendor will not purchase any underlying plant assets and the company is not obligated to provide any separate services to or for the vendor such as marketing or advertising services. The vendor simply has agreed to reimburse the company for the costs associated with the closure of the plant as long as the company enters into a supply contract arrangement with the vendor. How should the company account for the vendor's reimbursement of its plant closing and severance costs?
PwC response
The vendor's reimbursement for plant closing and severance cost falls under the scope of ASC 705-20. Cash consideration received by a customer from a vendor is presumed to be a reduction of the prices of the vendor's products or services and should, therefore, be characterized as a reduction of cost of sales when recognized in the customer's income statement, unless the criteria in ASC 705-20 are met. The presumption could not be overcome in this circumstance as the vendor does not receive a distinct benefit (goods or services) in exchange for the consideration. Although there is agreement to reimburse the company for the costs, the reimbursement is for cost associated with the closure of the plant as long as the company enters into a supply contract arrangement with the vendor, not specifically for the sale of the vendor’s products, as contemplated in ASC 705-20-25-1. The last criterion in ASC 705-20 is also not met, as the reimbursement is not for sales incentives offered to customers by manufacturers.
The company should separately assess the accounting for costs associated with the plant closure under applicable literature (e.g., ASC 420, ASC 712, ASC 715, ASC 450) and the vendor's reimbursement under ASC 705-20, and not as an offset to each other. The vendor's reimbursement should be treated as a reduction of cost of sales over the life of the supply contract entered into between the company and the vendor in this arrangement, as the nature of the incentive is for the company to continue in a supply agreement.
Recent standard setting
In December 2021, the FASB issued two new chapters of Concepts Statement No. 8 (CON 8), Conceptual Framework for Financial Reporting. One of the chapters, Elements of Financial Statements, includes revised definitions of certain financial statement elements (e.g., liabilities) and supersedes Concepts Statements No. 6, Elements of Financial Statements (CON 6). Despite this change, ASC 420 continues to reference CON 6. It is unclear when the FASB will make corresponding changes to the language in ASC 420.
6.4.5 Costs that do not qualify as exit costs under ASC 420-10
Similar to costs that are associated with exit or disposal activities, other costs that are not part of these activities are only recognized as liabilities when incurred. Such costs that are not associated with the one-time termination benefits include, among others, repairs and maintenance, software development, moving, relocation, training (which is not part of a termination benefit), and hiring costs. Examples of costs that do not qualify as exit costs include:
- costs to transition customers to a new product line or service;
- franchisee incentive payments for equipment upgrades;
- costs to modify executory contract arrangements (e.g., license and royalty arrangements, purchase or sales commitments, servicing arrangements); and
- asset impairments for facilities that should follow the guidance in ASC 360-10.
These costs generally do not qualify as exit costs because they are generally incurred in order to benefit future periods. Accordingly, these costs should generally not be included in the presentation and disclosure of costs accounted for under ASC 420-10. As described in ASC 420-10-25-14 and ASC 420-10-25-15 and based on conversations with the SEC staff, employee relocation costs that are incremental and a direct result of an exit plan may be included in the presentation and disclosure of exit and other associated costs under ASC 420-10 if the inclusion of such costs is adequately disclosed (such costs must still be expensed as incurred pursuant to ASC 420-10-25-14 and ASC 420-10-25-15).
For further considerations regarding costs that do not qualify as exit costs, see Question PPE 6-3, Question PPE 6-4, and Question PPE 6-5.
Question PPE 6-3
As part of its plan to consolidate manufacturing plants, a company intends to hire 300 individuals for its new facility. The company normally has a good flow of applications to draw from when routinely hiring employees. However, due to time constraints associated with the opening of the new facility, the company has engaged a recruiting firm to assist in the hiring of employees. The company expects that its hiring costs will increase significantly and wants to accrue the incremental amount over its normal hiring costs as part of its restructuring charge. Do such costs qualify as exit costs that can be accrued in accordance with the provisions of ASC 420-10?
As part of its plan to consolidate manufacturing plants, a company intends to hire 300 individuals for its new facility. The company normally has a good flow of applications to draw from when routinely hiring employees. However, due to time constraints associated with the opening of the new facility, the company has engaged a recruiting firm to assist in the hiring of employees. The company expects that its hiring costs will increase significantly and wants to accrue the incremental amount over its normal hiring costs as part of its restructuring charge. Do such costs qualify as exit costs that can be accrued in accordance with the provisions of ASC 420-10?
PwC response
No. Such costs are related to ongoing or future operations and, therefore, would not qualify as exit costs.
Question PPE 6-4
The company expects to hire 40 hourly people to replace employees who left the company for employment elsewhere when they learned that the facility would be shut down as part of a restructuring plan. The new hires will be responsible for the clerical processing of sales, accounts receivable, and accounts payable at the facility for six months until the facility is shut down. Can the payroll costs of the new hourly hires be accrued as part of a restructuring charge?
The company expects to hire 40 hourly people to replace employees who left the company for employment elsewhere when they learned that the facility would be shut down as part of a restructuring plan. The new hires will be responsible for the clerical processing of sales, accounts receivable, and accounts payable at the facility for six months until the facility is shut down. Can the payroll costs of the new hourly hires be accrued as part of a restructuring charge?
PwC response
No. Such costs are associated with the ongoing operations of the company and as such would not be accrued as part of the restructuring charge.
Question PPE 6-5
Company A operates in the on-line photo business. Company A offers a wide-range of services, including the cloud-based storage of digital pictures, printing hard copies of pictures and printing hard copy picture books for customers. Each of the product lines constitutes a separate division within the company. Company A has an agreement with a sole-source provider ("vendor") to provide the materials utilized in the company's business (e.g., paper, ink, cardboard). As an incentive for Company A, under the firmly committed supply agreement, the vendor agreed to provide significant discounts on the price of future purchases of paper and ink if Company A agreed to also purchase a minimum amount of cardboard every month. There is no termination clause that would allow Company A to buy out of the arrangement or reduce the amount of cardboard to be purchased per month (i.e., the agreement is noncancelable).
On January 1, 20X1, the board of directors, along with management, enters into a plan to restructure the business and exit the picture book creation business. The company intends to continue to purchase paper and ink from the vendor but will discontinue the purchase of cardboard. However, according to the agreement, the company is still required to pay for a minimum amount of cardboard per month.
How should Company A account for the remaining contract charges for the minimum required purchases of cardboard?
Company A operates in the on-line photo business. Company A offers a wide-range of services, including the cloud-based storage of digital pictures, printing hard copies of pictures and printing hard copy picture books for customers. Each of the product lines constitutes a separate division within the company. Company A has an agreement with a sole-source provider ("vendor") to provide the materials utilized in the company's business (e.g., paper, ink, cardboard). As an incentive for Company A, under the firmly committed supply agreement, the vendor agreed to provide significant discounts on the price of future purchases of paper and ink if Company A agreed to also purchase a minimum amount of cardboard every month. There is no termination clause that would allow Company A to buy out of the arrangement or reduce the amount of cardboard to be purchased per month (i.e., the agreement is noncancelable).
On January 1, 20X1, the board of directors, along with management, enters into a plan to restructure the business and exit the picture book creation business. The company intends to continue to purchase paper and ink from the vendor but will discontinue the purchase of cardboard. However, according to the agreement, the company is still required to pay for a minimum amount of cardboard per month.
How should Company A account for the remaining contract charges for the minimum required purchases of cardboard?
PwC response
The noncancelable payments for the cardboard under the supply agreement do not constitute exit costs under ASC 420 and, therefore, should be excluded from the restructuring charge. Although Company A will continue to incur the costs of purchasing cardboard without taking delivery (i.e., no future benefit), the company will still receive the discounts on the purchase of paper and ink. The discount constitutes an economic benefit of the contract. As continued economic benefit is derived from the agreement, the costs related to the purchase of the monthly cardboard volumes should be reflected as a component of the costs of purchasing paper and ink on an ongoing basis and reflected in operating profit; if Company A includes a "restructuring" line item in its income statement, it should not include the costs related to the cardboard.
Since the payments to the vendor for the cardboard are made to obtain a discounted price on the paper and ink, a portion of those payments may be allocable to the inventory cost of paper and ink. The guidance in ASC 330 should be considered in determining what would be included as an inventoriable cost.
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