Expensing Termination Benefits for GAAP Purposes

In the normal course of business, employees may be terminated and given a severance package. It is important to know whether the payments are subject to an existing severance plan, which could be either a written employment agreement or a historical pattern of providing severance benefits that results in a substantive on-going plan.

For example, if a company has a history of multiple termination events, in which impacted employees received two weeks of severance for each year of service, then the company likely has established an on-going severance plan for accounting purposes. In those situations, the severance benefits are considered a nonretirement postemployment benefit that is accounted for under ASC 712-10, and a liability is accrued when it becomes probable that a payment will be made and the amount is estimable. Usually, a payment is not deemed probable until the employer makes the decision to terminate the employee. Therefore, the date of the decision to terminate employment is critically important to the determination of when to properly expense termination benefits for GAAP purposes.

The timing of the payments does not affect when the expense is accrued; instead, recognition of the expense occurs for the total amount of the severance package based on the date of the decision to terminate the employee. The date of the decision to terminate is normally evidenced through board meeting minutes, company announcement (in the event of multiple layoffs) and/or severance agreement executed.

Say an employee is terminated on Jan. 15, 2018, and your year-end is Dec. 31, 2017. Per the termination agreement, the employee is to be paid $5,000 monthly over six months (total of $30,000), beginning Jan. 15, 2018.

If the decision to terminate the employee was made prior to Dec. 31, 2017, then the full amount of the termination benefit is accrued as of Dec. 31, 2017. You would record the following entry to accrue for the termination benefits:
Termination Expense  $30,000   
Accrued Termination Benefits   $30,000

You would then record the following entry every time a payment is made to the terminated employee:
Accrued Termination Benefits  $5,000  
Cash   $5,000 

If the decision to terminate the employee was not made until after year-end, no accrual would have been necessary at 2017’s year-end.

Alternatively, if a company has no written severance plan, and has not historically established a substantive on-going plan through multiple prior termination events, the severance benefits to be provided to the impacted employees would be considered a one-time termination benefit accounted for under ASC 420-10. In that scenario, the date management commits to the plan and determines the impacted employees and benefits to be paid is still important, as no severance cost may be recognized prior to that date. However, if the employees are required to continue providing service for a period of time after the decision to terminate is made by management, then the related expense must be recognized over that period. 

Consider the previous example in which the decision was made on Dec. 31, 2017 to terminate an employee on Jan. 15, 2018. Because the employee would be required to continue working between Jan. 1, 2018 and Jan. 15, 2018, the $30,000 would be recognized in January, rather than as of Dec. 31, 2017. In addition, had the employee been required to work for the six months over which the severance payments are being made, then the company would recognize $5,000 each month that the employee is required to continue working. 

Note that in either situation, the termination benefit payments are recognized and deductible when the payments are made for income tax purposes. Payments made in 2018 will be deductible in 2018; payments made in 2019 will be deductible in 2019.

For questions on expensing termination benefits for GAAP purposes, contact Dustin Minton at dminton@bdo.com.

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