Restructuring

1
Restructuring

• (Part of the earnings management bag of tricks)

2
Overview

• What is restructuring?
• Why can (did/does) it cause financial reporting
  problems?
• The SEC becomes involved
• Relevant accounting literature
• Restructuring was/is

3
Restructuring Activities

• In the 1980s and 90s the term Restructuring
  became one of the major buzzwords, also known as
• getting lean and mean
• Purpose to improve efficiency, restore
  international competitiveness, pay for leveraged
  buy-outs

4
Restructuring consists of all or some of the
following

• Closing plants
• laying off employees
• moving operations
• reorganization of operations (very popular)
• cost cutting, cost cutting, cost cutting

5
Why can (did/does) it cause financial reporting
problems?

• Restructuring is perceived to be good
• All costs even remotely (or sometimes not at all)
  associated with restructuring were reported as a
  separate line item (net of tax) on the income
  statement
• (making it look like an extraordinary event)
• In some cases restructuring occurred year after
  year

6
Restructuring in Practice
GTE Communications - Telecommunications ( in
Millions)
Annual Sales 19748
Annual Net Income 882
4th Q 1993 Charge 1,800

• Re-Engineering Plan - 3 Years
• Termination benefits - 17,000 workforce
  reduction
• Consolidation of facilities
• Upgrading/replacing customer service and admin.
  Systems
• Enhance network software
• Training

7
Restructuring in Practice
Borden - Food and Non-Consumer Products ( in
Millions)
Annual Sales 7,142
Annual Net Income (439)
3th Q 1993 Charge 642

• Charge includes costs to
• Unify businesses
• Modernize and integrate product presentation
• Remedy problems in under performing businesses
  and reduce costs

8
Restructuring in Practice
Woolworth - Merchandise Stores ( in Millions)
Annual Sales 9,622
Annual Net Income (495)
3th Q 1993 Charge 775

• Charge includes costs of
• Termination benefits - 13,000 workforce
  reduction
• Redesign or close stores
• Asset and inventory write downs
• Leases and occupancy costs

9
Restructuring in Practice
Flagstar Companies, Inc. - Food Services
Enterprises ( in Millions)
Annual Sales 3,970
Annual Net Income (1720)
3th Q 1993 Charge 225

• Charge includes costs of
• Termination benefits
• Closure of facilities
• Relocation and training
• Systems development costs

10
SEC Reactions

• 1993 - Problem identified
• One-line presentations, net of tax
• Solution
• SAB 67
• Include charges in continuing operations
• No net-of-tax presentation
• Warning and comment letters
• Mandatory restatements

11
SEC Warning LettersSEC wants explanation from
firms planning to post restructuring losses
(WSJ, 2/25/94) Sent to 84 registrants that
announced restructurings

• Reminder of specific 10K requirements
• Footnotes
• Circumstances material elements
• asset write-offs vs future cash outflows
• MDA
• Current an expected effects
• future progress and changes

12
Restatements Mandated by SEC

• Examples
• Borden
• Flagstar
• Woolworth

13
Restructuring Restatements
Borden to Reverse, Reclassify 40 of 1992 Charge

• Reversed 119 million
• Canceled projects
• Promotion accruals
• Reclassified 145 million as marketing expense
• Borden spokesman Truly incremental and related
  to one-time advertising and promotional program
  not occurring in the normal course of business

14
Restructuring Restatements
Flagstar Cos. Restated 1993 Financial Results

• Reduced reserve by 33 million
• Training
• Systems development
• Future costs to improve image
• Costs to be taken as incurred (normal operating
  expenses)

15
Restructuring Restatements
Woolworth Restated 1993 Quarterly Results

• Reduced repositioning reserve by 217 million
• Inventory markdowns
• Other normal operating costs

16
Relevant Accounting Standards

• Employee Termination Benefits
• FAS 112 43 5 and 88
• Other restructuring costs
• APB 30 FAS 5
• EITF 94-3

17
FASB Statement 112 Tests
Rights arise from service? Rights vest or
accumulate? Payment probable? Payment estimable?
Yes to all
No to any
Accrue over employee service life
Apply Statement 5, Accrue upon loss event
18
FASB Statement 88

• Special termination benefits
• employee accepts
• Contractual termination benefits

19
EITF 94-3

• Only costs to exit existing activities
• Involuntary employee termination benefits only if
  they are not under pre-existing or ongoing plan
• Relocation costs

20
EITF 94-3

• Provisions only appropriate for costs that
• are not associated with future revenue
  generations and have no future economic benefits
• I.e., cannot include items such as advertising,
  training or system development
• Have an incremental cost of obligation that
  existed prior to consummation date

21
EITF 94-3/Purchase Accounting

• Criteria for Recognition
• Consummation date - beginning to assess and
  formulate restructuring plan
• Plan is finalized - one year
• Plan is specific
• Period of time to complete plan indicates
  significant changes are not likely
• (this is to ensure that so-called restructuring
  will not be a regular, annual event)

22
EITF 94-3/Purchase Accounting

• Required Disclosures
• Major actions
• Type and amount of exit costs accrued
• Type and amount of exit cost charged to accrual
• Adjustments
• If exit plan is not finalized
• Description of unresolved issues and types of
  potential liabilities

23
Restructuring Was
24
Restructuring Is
25
Restructuring Was/Is