When a company reorganizes its
operations to attain greater efficiency, it often incurs significant
associated costs.
For instance, let’s consider Burlington Industries . A disclosure note accompanying
the company’s financial statements indicates a 1999 reorganization
related to its apparel fabrics business and various moves in 2000 to
strengthen its interior furnishing products business. In both cases, facility closings
and asset write-downs were important components of the
restructurings. Facility
closings and related employee layoffs translate into costs incurred for
severance pay and relocation costs. For example, a portion of the
disclosure note related to the 2000 restructuring follows:
Restructuring and
Impairment Charges (in part)
The closings and overhead reductions outlined above will result
in the elimination of approximately 2,450 jobs in the United States and
950 jobs in Mexico, with severance benefit payments to be paid over
periods of up to 12 months from the termination date depending on the
employee’s length of service.
Notice that the severance benefit payments are “to be paid
over periods of up to 12 months from the termination date …” This means
that a portion of the restructuring activities and related cash outflows
will occur during the following fiscal year. When a company restructures
its operations, it estimates the future costs associated with the
restructuring and expenses the costs in the period in which the decision
to restructure is made. An
offset liability is recorded and actual expenditures are charged against
this liability. The purpose
of this accrual is to match the restructuring costs with the decision to
restructure and not with the period or periods in which the actual
activities take place or when the benefits (if any) are realized.
What if the estimates turn out to be incorrect?
LSI Logic Corporation is a leader in the design,
development, and manufacture of high-performance integrated circuits and
storage systems. The company’s income statements for 1999 and 1998
reported restructuring costs of $75.4 million in 1998 and
negative $2 million in 1999 as part of operating expenses.
Why the negative expense in 1999? A review of the
disclosure note that accompanied LSI’s financial statements reveals that
in 1998 the company recorded restructuring costs that included estimated
employee-related expenses
and estimated facilities expenses associated with a plan to
streamline operations. In 1999, LSI lowered its estimate of the total
costs associated with the restructuring and recorded an adjustment that
increased income. When an estimate is changed in a reporting period
after the period the estimate was made, the company should record the
effect of the change in the current period rather than restate prior
years’ financial statements to correct the estimate.
The appearance of restructuring costs on corporate income
statements increased significantly in the 1980s and 1990s. Many U.S. companies reacted to
increased competition by streamlining their operations. The popular term heard often is
downsizing. Mr. Robert Willens, an
accounting analyst at Lehman Brothers, a large brokerage firm,
attributes the increase in corporate restructurings to increased foreign
competition, but there certainly are other motivations as well.
The SEC became concerned about the frequency with which
companies were accruing restructuring costs in the manner described
above. One of the chief concerns was that some companies were purposely
expensing large costs currently in an effort to manipulate future
income.For example, employee relocation costs incurred in
conjunction with a restructuring may produce future benefits to the
company through greater operating efficiency. If so, accrual prior to
any action may result in premature expense recognition of these
costs.
The FASB’s Emerging Issues Task Force responded to the
SEC’s concern with EITF Issue No. 94-3, “Liability Recognition for Costs
to Exit an Activity (including Certain Costs Incurred in a
Restructuring).” The Issue discusses the various types of costs related
to restructurings and establishes criteria that limit which costs can be
accrued in the period management approves a restructuring plan. In
general, costs that have no future economic benefit that are incurred as
a result of a commitment by a company’s management to execute a
restructuring plan should be accrued at the commitment date. A
commitment date occurs when a number of specified conditions are met.
The Issue also increases the disclosure requirements for certain types
of restructuring costs.
However, even this new standard does not eliminate the
possibility that restructuring costs could be used as a method to
manipulate earnings.
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