ASC 420-10: Accounting for Exit or Disposal Activities

Accounting Standards Codification (ASC) 420-10 provides guidance for the financial accounting and reporting of costs related to exit or disposal activities. The standard ensures that liabilities for these costs are recognized in the correct period and measured accurately. A company’s internal decision to commit to a plan is not sufficient to create a liability. Financial statements must reflect these obligations only when an actual, present obligation to an external party has been incurred.

Scope of Exit or Disposal Activities

This guidance applies to costs incurred as part of a plan to cease or alter a portion of a company’s operations, such as closing a facility or discontinuing a product line. The standard addresses costs that are a direct consequence of the exit or disposal plan and are not associated with generating future revenues.

One primary category of costs is one-time employee termination benefits. These are payments, such as severance, offered to employees involuntarily terminated as part of the exit activity. The benefits are provided under a unique arrangement for the exit event, not a pre-existing company policy. If a company has a history of providing similar benefits, the arrangement is considered an ongoing plan and falls under different accounting guidance.

Another area involves costs to terminate a contract, which includes penalties for ending an agreement prematurely. These costs can be a one-time payment to exit the contract or the ongoing expense of a contract that no longer provides any economic benefit to the company.

The standard also covers other direct costs, such as expenses for consolidating facilities and relocating employees or equipment. These costs must be incremental and result directly from the exit plan. Costs of maintaining an idle property, for example, are recognized as they are incurred over time, not upfront.

Criteria for Liability Recognition

A liability for an exit or disposal cost is recorded only when it has been incurred, meaning a present obligation to others exists. The timing of recognition is not based on management’s commitment to a plan but on specific events that create an unavoidable obligation. The criteria for recognizing these liabilities differ depending on the cost’s nature.

For one-time employee termination benefits, a liability is recognized when the exit plan is finalized and communicated to the affected employees. This communication creates a legitimate expectation of payment, leaving the company little discretion to avoid the obligation. The plan must specify the employees to be terminated, their benefits, and the timeline.

When dealing with costs to terminate a contract, the liability is recognized when the company officially terminates the agreement according to its terms. This often occurs when the company provides written notice or takes another action specified in the contract. For a contract that will continue without providing any economic benefit, the liability is recognized when the company ceases to use the benefits of the contract.

Other associated costs, like those for relocating equipment or consolidating facilities, are recognized in the period they are incurred. This means the liability is recorded when the related goods or services are received. For example, the expense for moving equipment is recorded when the moving company performs the service, not when the decision to move is made.

Initial and Subsequent Measurement

Once recognition criteria are met, the liability for an exit or disposal cost is measured at its fair value. Fair value is the price paid to transfer a liability in an orderly transaction between market participants. When a quoted market price is not available for costs like future severance payments, companies use a present value technique to estimate fair value.

To calculate the present value, a company estimates the future cash payments it expects to make and applies a discount rate to bring those amounts to their value in today’s dollars. For example, if a company promises severance payments over two years, it would not record the full undiscounted amount. Instead, it would calculate the present value of that stream of payments, reflecting the time value of money.

After the initial measurement, the liability must be re-evaluated at the end of each reporting period. If the estimated amount or timing of future cash outflows changes, the liability is adjusted. Any changes to the liability are recognized in the current period’s income statement, in the same line item as the original expense, ensuring the balance sheet reflects the best estimate of the obligation.

Presentation and Disclosure Requirements

Exit and disposal costs are reported as a separate line item on the income statement within income from continuing operations. This presentation helps users of financial statements understand the impact of the restructuring on the company’s core profitability. The corresponding liability is presented on the balance sheet.

Detailed disclosures in the footnotes are required from the period the activity is initiated until it is completed. The company must provide a description of the exit plan, including the facts and circumstances leading to the decision and the expected completion date.

A reconciliation of the liability balance from the beginning to the end of the period is required. This shows the initial liability, new costs incurred, cash payments made, and any adjustments to estimates.

The company must also disclose the income statement line items where the exit costs are aggregated. For each major type of cost, such as termination benefits or contract fees, the total amount expected to be incurred must be reported.