made of the probable cost. [IAS 37.71]. The standard’s specific requirements for the
recognition of a provision for restructuring costs seek to define the circumstances that
give rise to a constructive obligation and thereby restrict the recognition of a provision
to cases when an entity:
(a) has a detailed formal plan for the restructuring identifying at least:
(i) the business or part of a business concerned;
(ii) the principal locations affected;
(iii) the location, function, and approximate number of employees who will be
compensated for terminating their services;
(iv) the expenditures that will be undertaken; and
(v) when the plan will be implemented; and
(b) has raised a valid expectation in those affected that it will carry out the
restructuring by starting to implement that plan or announcing its main features to
those affected by it. [IAS 37.72].
The standard gives examples of the entity’s actions that may provide evidence that the
entity has started to implement a plan, quoting the dismantling of plant or selling of
assets, or the 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. [IAS 37.73].
Provisions, contingent liabilities and contingent assets 1907
The standard also suggests that 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 timeframe 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 a chance of changing the plan. [IAS 37.74].
In summary, these conditions require the plan to be detailed and specific, to have gone
beyond the directors’ powers of recall and to be put into operation without delay or
significant alteration.
The criteria set out above for the recognition of provisions mean that a board decision,
if it is the only relevant event arising before the end of the reporting period, is not
sufficient. This message is reinforced specifically in the standard, the argument being
made that a constructive obligation is not created by a management decision. There will
only be a constructive obligation where the entity has, before the end of the reporting
period:
(a) started to implement the restructuring plan; or
(b) announced the main features of the restructuring plan to those affected by it in a
sufficiently specific manner to raise a valid expectation in them that the entity will
carry out the restructuring. [IAS 37.75].
If the restructuring is not started or announced in detail until after the end of the
reporting period, no provision is recognised. Instead, the entity discloses a non-
adjusting event after the reporting period. [IAS 37.75, IAS 10.22(e)].
The following examples in IAS 37 illustrate how a constructive obligation for a
restructuring may or may not be created.
Example 27.13: The effect of timing of the creation of a constructive obligation on
the recognition of a restructuring provision
Scenario 1: Closure of a division – no implementation before end of the reporting period
On 12 December 2019, the board of Entity A decided to close down a division. No announcement was made
before the end of the reporting period (31 December 2019) and no other steps were taken to implement the
decision before that date.
In these circumstances, no provision is recognised because management’s actions are insufficient to create a
constructive obligation before the end of the reporting period. [IAS 37 IE Example 5A].
Scenario 2: Closure of a division – communication/implementation before end of the reporting period
In another case, the board of Entity B decides on 12 December 2019 to close down one of its manufacturing
divisions. On 20 December 2019 a detailed plan for closure was agreed by the board; letters were sent to
customers warning them to seek an alternative source of supply and redundancy notices were sent to the staff
of the division.
The communication of management’s decision to customers and employees on 20 December 2019 creates a
valid expectation that the division will be closed, thereby giving rise to a constructive obligation from that
date. Accordingly, a provision is recognised at 31 December 2019 for the best estimate of the costs of closing
the division. [IAS 37 IE Example 5B].
The standard acknowledges that there will be circumstances where a board decision
could trigger recognition, but not on its own. Only if earlier events, such as negotiations
with employee representatives for termination payments or with purchasers for the sale
1908 Chapter 27
of an operation, have been concluded subject only to board approval would the decision
of the board create an obligation. In such circumstances, it is reasoned that when board
approval has been obtained and communicated to the other parties, the entity is
committed to restructure, assuming all other conditions are met. [IAS 37.76].
There is also discussion in the standard of the situation that may arise in some countries
where, for example, employee representatives may sit on the board, so that a board
decision effectively communicates the decision to them, which may result in a
constructive obligation to restructure. [IAS 37.77].
In practice it can be very difficult to determine whether it is appropriate to recognise a
provision for the future costs of a restructuring programme. The determination of
whether an organisational change is fundamental, material or just part of a process of
continuous improvement is a subjective judgement. Once it has been established that
the activities in question constitute a restructuring rather than an ongoing operating
cost, it can be difficult to determine whether management’s actions before the reporting
date have been sufficient to have ‘raised a valid expectation in those affected’. [IAS 37.72].
Even if a trigger point is easily identifiable, such as the date of an appropriately detailed
public announcement, it might not necessarily commit management to the whole
restructuring, but only to specific items of expenditure such as redundancy costs. When
the announcement is less clear, referring for example to consultations, negotiations or
voluntary arrangements, particularly with employees, judgement is required.
Furthermore, taken on its own, the ‘valid expectation’ test is at least as open to
manipulation as one based on the timing of a board decision. Entities anxious to
accelerate or postpone recognition of a liability could do so by advancing or deferring
an event that signals such a commitment, such as a public announcement, without any
change to the substance of their position.
In these situations it is important to consider all the relat
ed facts and circumstances and
not to ‘home in’ on a single recognition criterion. The objective of the analysis is to
determine whether there is a past obligating event at the reporting date. The guidance
in the standard about restructuring, referring as it does to constructive obligations and
valid expectations is ultimately aimed at properly applying the principle in IAS 37 that
only those obligations arising from past events and existing independently of an entity’s
future actions are recognised as provisions. [IAS 37.19]. In essence, a restructuring
provision qualifies for recognition if, as at the reporting date, it relates to a detailed plan
of action from which management cannot realistically withdraw.
6.1.3
Recognition of obligations arising from the sale of an operation
IAS 37 has some further specific rules governing when to recognise an obligation arising
on the sale of an operation, stating that no obligation arises for the sale of an operation
until the entity is committed to the sale, i.e. there is a binding sale agreement. [IAS 37.78].
Thus a provision cannot be made for a loss on sale unless there is a binding sale
agreement by the end of the reporting period. The standard says that this applies even
when an entity has taken a decision to sell an operation and announced that decision
publicly, it cannot be committed to the sale until a purchaser has been identified and
there is a binding sale agreement. Until there is such an agreement, the entity will be
Provisions, contingent liabilities and contingent assets 1909
able to change its mind and indeed will have to take another course of action if a
purchaser cannot be found on acceptable terms. [IAS 37.79].
Even in cases where it is part of a larger restructuring that qualifies for recognition under
IAS 37, an obligation arising from the sale is not recognised until there is a binding sale
agreement. Instead, the assets of the operation must be reviewed for impairment under
IAS 36. This may therefore mean that an expense is recorded in the income statement;
it is just that the expense gives rise to a reduction of the carrying amount of assets rather
than the recognition of a liability. The standard also recognises that where a sale is only
part of a restructuring, the entity could be committed to the other parts of restructuring
before a binding sale agreement is in place. [IAS 37.79]. Hence, the costs of the
restructuring will be recognised over different reporting periods.
6.1.4
Costs that can (and cannot) be included in a restructuring provision
Having met the specific tests in the standard for the recognition of a restructuring
provision at the end of the reporting period, IAS 37 imposes further criteria to restrict
the types of cost that can be provided for. Presumably these additional restrictions are
intended to ensure that the entity does not contravene the general prohibition in IAS 37
against provision for future operating losses. [IAS 37.63].
A restructuring provision should include only the direct expenditures arising from the
restructuring, which are those that are both:
(a) necessarily entailed by the restructuring; and
(b) not associated with the ongoing activities of the entity. [IAS 37.80].
The standard gives specific examples of costs that may not be included within the
provision, because they relate to the future conduct of the business. Such costs include:
(a) retraining
or
relocating continuing staff;
(b) marketing;
or
(c) investment in new systems and distribution networks. [IAS 37.81].
Because these costs relate to the future conduct of the business, they are recognised on
the same basis as if they arose independently of a restructuring. [IAS 37.81]. In most cases,
this means that the costs are recognised as the related services are provided.
Example 27.14: Distinguishing restructuring costs from ongoing expenses
On 15 November 2019, management announced its intention to close down its operation in the North of the
country and relocate to a new site in the South, primarily to be closer to its key customers. Before the end of
the reporting period (31 December 2019), the principal elements of the plan were agreed with employee
representatives, a lease signed for a building at the new location, and a decision was made to market the
existing facility for sale; all on the basis that production would start at the new location on 31 March 2020
and the existing site would be vacated on 30 April 2020. Production would cease at the existing site on
28 February 2020 to allow plant and equipment to be relocated. Inventory levels would be increased up to
that date so that customers could be supplied with goods sent from the Northern facility until 31 March.
Whilst the majority of the 600 existing staff was expected to take redundancy on 28 February 2020, 50 had
agreed to accept the entity’s offer of relocation, including an incentive of €3,000 each towards relocation
costs. Of those employees taking redundancy, 20 had agreed to continue to work for the entity until 30 June
2020, to dismantle plant and equipment at the Northern site; install it at the new facility in the South; and
train new staff on its operation. A bonus of €4,500 per employee would be payable if they remained until
30 June. A further 60 had agreed to stay with the entity until 31 March 2020, to ensure that inventory was
1910 Chapter 27
sent out to customers before the new site was operational, of which 10 would remain until 30 April 2020 to
complete the decommissioning of the Northern facility. These employees would also receive a bonus for
staying until the promised date.
The announcement of management’s decision on 15 November 2019 and the fact that the key elements of the
plan were understood by employees and customers of the Northern site before the end of the reporting period
give rise to a constructive obligation that requires a provision to be recognised at 31 December 2019 for the
best estimate of the costs of the reorganisation.
However, only those direct costs of the restructuring not associated with ongoing activities can be included
in the provision. For example, as follows:
Associated
Direct cost of
with ongoing
Type of expense
restructuring
activities
Redundancy payments to 550 staff
•
Payroll costs to 28 February 2020 (all 600 staff)
•
Relocation incentive of €3,000 per employee (50 staff)
•
Payroll costs – to 31 March 2020 (60 staff dispatching goods)
•
Payroll costs – March to June 2020 (20 staff relocating plant) Note 1 •
•
Payroll costs – April 2020 (10 staff decommissioning site)
•
Costs of dismantling plant and equipment Note 1 •
•
Cost of transporting PP&E and inventory to the new site
•
Costs of recruiting and training staff for the Southern site
•
Rent of new site to 31 March 2020 (pre-production)
•
Cost of invoices, forms and stationery showing new address
•
Note 1: Costs relating to dismantling plant and equipment that is no longer inten
ded for use in the business could be regarded as a direct cost of restructuring. However, costs relating to the dismantling and installation of equipment at the new site and training staff to operate it are costs associated with ongoing operations and, therefore, ineligible for inclusion in the restructuring provision.
The entity will need to consider whether the existing facility should be classified as a non-current asset held
for sale. On the basis that management had decided to market the facility for sale, but had not yet actively
begun to do so, it is unlikely that the criteria in IFRS 5 would be met as at 31 December 2019. Classification
of non-current assets held for sale is discussed in Chapter 4 at 2.
This example shows that individual classes of expenditure should be disaggregated into
components that distinguish those elements associated with ongoing activities. Even if
expenditure would not have been incurred without the restructuring activity, its
association with ongoing activities means that it is ineligible for inclusion in a provision.
IAS 37 requires the cost to be both necessarily entailed by the restructuring and not
associated with the ongoing activities of the entity. [IAS 37.80].
For that reason, whilst the cost of making employees redundant is an eligible
restructuring cost, any incremental amounts paid to retain staff to ensure a smooth
transition of operations from one location to another are not eligible because they are
incurred to facilitate ongoing activities. IAS 19 requires these to be treated as short-term
employee benefits to the extent that they are expected to be settled within 12 months
Provisions, contingent liabilities and contingent assets 1911
after the end of the reporting period.14 Similarly, whilst the costs of dismantling plant
and equipment intended to be scrapped is an eligible restructuring cost, the costs of
dismantling plant and equipment intended to be relocated and installed at the new site
is ineligible, because it is associated with ongoing activities.
A further rule in IAS 37 is that the provision should not include identifiable future
operating losses up to the date of the restructuring, unless they relate to an onerous
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 376
