Financial Reporting for Employee Termination Events

Types of employee terminations

Termination benefits can generally be categorized as voluntary or involuntary, with the latter taking different forms depending on whether the arrangement is considered ongoing or a one-time benefit. Each of these arrangements comes with its own specific accounting considerations and requirements governed by ASC 712, Compensation — Nonretirement Postemployment Benefits, or ASC 420, Exit or Disposal Cost Obligations.

Voluntary termination

Voluntary, or “special,” termination benefits are offered by an employer for a short period of time in exchange for an employee’s voluntary termination, including early retirement (e.g., an employee buyout for cash or pension credits). In order for the termination offer to be binding, both the employer and the employee must agree to the details of the termination.

A liability and an expense equal to the amount of benefits expected to be paid to a terminated employee are recorded when both the amount can be reasonably estimated, and the employee irrevocably accepts the termination offer and any revision period associated with the arrangement has lapsed. In certain cases, a termination arrangement can extend beyond the end of a reporting period; if a portion of the employee acceptances runs into the subsequent period, the corresponding benefit accrual will be present in each period.

Involuntary termination

• Contractual termination benefits: These benefits are those required by the terms of a preexisting plan upon the occurrence of a specified event (e.g., the closing of a factory location due to downsizing). An employer is legally obligated to pay termination benefits to employees once the event occurs; thus, a liability and an expense are recorded once it is probable that the terminated employees will be entitled to benefits (e.g., when it is probable that the specified event will occur, or benefits will be paid) and the amount can be reasonably estimated.
• Other postemployment benefits: These benefits (e.g., severance benefits or the continuation of insurance coverage) are provided through an ongoing termination plan, either in written form or based on an employer’s consistent history of termination benefits offered, in exchange for an employee’s service. If the other postemployment benefits vest or accumulate, the benefits are recognized as services are provided. However, if the benefits do not vest or accumulate, a liability should be accrued when the benefit payment is probable and can be reasonably estimated.
• One-time termination benefits: As the name suggests, these benefits are pursuant to a one-time benefit arrangement that is not ongoing and would not be applicable for future events. This type of benefit applies to companies without a preexisting plan that decide to lay off employees, either immediately or within a certain timeframe. Similarly, if a company has a preexisting plan in place but does something outside of that plan to enhance the benefit, the component outside of the preexisting plan would qualify as a one-time involuntary termination benefit.In order to accrue the liability for a one-time termination benefit, management must commit to a plan in which significant changes are unlikely, and which identifies the number of employees to be terminated, job title, office location, and completion date. In addition, termination details and benefits must be communicated to affected employees before any liability can be recorded.Once all such requirements are met, the timing of recognition depends on whether employees are required to perform additional services in order to receive the termination benefits. The associated expense and liability are recognized immediately if future services are not required; however, if future services are required, the expense and liability are recognized ratably over the period of future service.

Future employee termination events

The near-term economic environment is surrounded with uncertainty, and many companies are only beginning to understand the impacts to their business. This uncertainty could lead to additional termination events in the coming months, which some may already be anticipating. As previously mentioned, companies generally may not accrue for future termination benefits under US GAAP unless a preexisting termination plan is in place.

Termination benefit plan including elements of more than one type

Termination benefit plans sometimes have characteristics of more than one benefit type. In these cases, employers should account for the termination benefits using a hybrid of the accounting guidelines applicable to each portion of the benefit. For example, if a retail company already had a preexisting termination plan, but also offered its terminated employees an additional, one-time termination benefit, the company would record an expense and liability for the standard termination benefits when it became probable they would be paid and the amount was reasonably estimable. Only once the details of the one-time termination benefit are finalized and affected employees are notified of the additional benefit (e.g., a present obligation is created) can an accrual be recorded for this portion of the plan.