As a result of a natural disaster, an entity may decide to sell or abandon certain assets or execute a restructuring plan. A restructuring is a programme that is planned and controlled by management, and materially changes either the scope of a business undertaken by an entity or the manner in which business is conducted. IAS 37 Provisions, Contingent Liabilities and Contingent Assets addresses the accounting for costs associated with exit or disposal activities. Exit activities may include: Natural disasters – Restructuring recognition
- Sale or termination of a line of business
- Closure of a business location in a country or region or relocation of business activities from one country or region to another
- Changes in management structure, for example, eliminating a layer of management
- Fundamental reorganisations that have a material effect on the nature and focus of an entity’s operations
Recognition Natural disasters – Restructuring recognition
Restructuring costs are recognised only when the general recognition criteria in IAS 37 are met, i.e., there is a present obligation (legal or constructive) as a result of a past event, in respect of which a reliable estimate of the probable cost can be made. For constructive obligations to restructure, IAS 37 also requires that the entity has both a detailed formal plan and has raised a valid expectation in the parties affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it. Natural disasters – Restructuring recognition
IAS 37 provides examples of the entity’s actions that may provide evidence that the entity has started to implement a plan, for example, dismantling the plant, selling assets, or making a public announcement of the main features of the plan. However, it also emphasises that the public announcement of a detailed plan to restructure will not automatically create an obligation. The important principle is that the announcement is made in such a way, and in sufficient detail, to give rise to valid expectations in other parties such as customers, suppliers and employees that the restructuring will be carried out.
In order for an announced plan to give rise to a constructive obligation, its implementation needs to be planned to begin as soon as possible and to be completed in a time-frame that makes significant changes to the plan unlikely. Any extended period before commencement of implementation, or if the restructuring will take an unreasonably long time, will mean that recognition of a provision is premature, because the entity is still likely to have an opportunity to change the plan.Natural disasters – Restructuring recognition
If a board’s decision for restructuring is the only relevant event arising before the end of the reporting period, this is not sufficient to create a constructive obligation. The conditions for recognising a restructuring provision require the plan to be detailed and specific, to have gone beyond the directors’ powers of recall, and to be executed without delay or significant alteration.
Measurement Natural disasters – Restructuring recognition
A restructuring provision is measured using the measurement requirements of IAS 37, i.e., the provision is measured at the best estimate of the expenditure required to settle the present obligation, taking into account the risks and uncertainties of the obligation and when the time value of money is material, discounting to present value. A restructuring provision includes only the direct expenditures arising from the restructuring, which are those that are necessarily entailed by the restructuring and not associated with the ongoing activities of the entity. The costs often incurred as part of a restructuring include employee termination benefits under a one-time termination plan, contract termination costs and costs to consolidate or close a facility. Natural disasters – Restructuring recognition
In addition, costs related to the future conduct of the business are recognised as the related services are provided. Future operating losses are not recognised unless they relate to an onerous contract. Careful consideration is needed to distinguish costs of recovering from a natural disaster that relate to future conduct of the business from those related to a restructuring.