The Accounting and Tax Treatment of Restructuring Expenses

Corporate restructuring involves a significant change to a company’s business, operations, or financial structure to improve efficiency or adapt to market changes. These actions result in specific costs known as restructuring expenses. Financial reporting for these activities is designed to provide transparency to investors about the financial impact of these corporate changes.

Identifying Restructuring Expenses

Restructuring expenses are one-time costs directly associated with a plan to significantly alter a company’s operations. These are not routine expenditures but are a direct consequence of the restructuring. Primary categories of these expenses include:

• Employee severance and termination benefits: These are payments made to employees who are involuntarily terminated as part of a workforce reduction detailed in the restructuring plan.
• Asset write-downs and impairments: When a company closes a facility or exits a business line, the carrying amount of associated assets is reduced to fair value, resulting in an impairment charge that reflects the asset’s diminished economic benefit.
• Lease and contract termination costs: These can include penalties paid to landlords for breaking a lease on a closed facility or payments to suppliers to exit a long-term purchasing agreement.
• Consulting and legal fees: Payments to external advisors for their services in developing and implementing the restructuring plan are also classified as restructuring expenses.
• Employee relocation costs: When a plan involves consolidating operations, the associated costs for moving employees, such as payments for moving expenses or temporary housing, are included.

Accounting Recognition and Measurement

The accounting for restructuring costs is governed by rules that dictate when these expenses can be recorded in a company’s financial statements. Under U.S. Generally Accepted Accounting Principles (GAAP), specifically Accounting Standards Codification (ASC) 420, a company cannot recognize a liability for restructuring until specific criteria are met.

A central requirement is the existence of a formal, detailed restructuring plan that has been approved by management. The details of this plan must be communicated to the affected parties, such as employees being terminated or the other party in a contract being canceled. This communication event triggers accounting recognition.

Once the criteria for recognition are met, the restructuring liability must be measured at its fair value. Fair value is the price that would be paid to transfer the liability in an orderly transaction. For example, the liability for one-time employee termination benefits is measured based on the expected cash payments; if payments are made over an extended period, their present value is calculated.

It is important to distinguish these costs from others. For instance, costs to dispose of a long-lived asset are accounted for under different rules. Similarly, ongoing employee benefit arrangements are not part of a one-time restructuring plan, as ASC 420 is narrowly focused on obligations from an exit or disposal activity.

Financial Statement Presentation and Disclosure

After restructuring expenses are recognized, they must be properly presented in the financial statements and detailed in the accompanying footnotes. On the income statement, these costs are reported as a component of income from continuing operations. Companies often present restructuring charges as a separate line item to distinguish them from ordinary operating expenses, highlighting their non-recurring nature.

The footnote disclosures provide context behind the numbers on the income statement and balance sheet. Companies are required to provide a detailed narrative description of the restructuring plan. This includes the facts and circumstances leading to the plan, the major types of costs involved, and the expected completion date.

A disclosure requirement is a reconciliation of the restructuring liability. This table shows the activity in the liability account for the period, starting with the beginning balance. It then details the new costs accrued, any cash payments made, and other adjustments, culminating in the ending balance. This reconciliation provides a clear picture of how the restructuring accrual has changed over time.

Tax Implications of Restructuring Costs

The tax treatment of restructuring expenses often differs from the accounting treatment, primarily due to timing. While financial accounting rules focus on recognizing a liability when it is incurred, tax rules are governed by the principle of “economic performance.” For tax purposes, a company can only deduct an expense when the underlying activity has occurred or when the cash payment is actually made.

This creates a temporary difference between the book income reported to shareholders and the taxable income reported to the IRS. For example, a company may recognize a severance expense for accounting purposes in the year a restructuring plan is announced. However, if the severance payments are scheduled to be paid out in the following year, the tax deduction can only be taken in that subsequent year.

This timing difference results in the creation of a deferred tax asset on the company’s balance sheet. The company has recorded an expense for book purposes but has not yet received the tax benefit, creating a future deductible amount. When the costs are eventually paid and deducted for tax purposes, the deferred tax asset is reversed.