Restructuring provisions and future losses
When IAS 37 lets a client provide for restructuring costs, why a board decision alone is not enough, and why future operating losses never qualify.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
In the last month of the financial year, a client's board decides to close its loss-making branch in another city. The minutes record the decision, the managing director has a spreadsheet of expected costs, and the finance manager would like to provide for all of it this year: the retrenchment packages, the lease exit costs, the losses the branch will make until it shuts, and the cost of retraining the staff who will move to head office. The year would then absorb the pain, and next year would look clean.
IAS 37 allows some of that and firmly rules out the rest. This article covers when a restructuring provision may be recognised, which costs belong in it, why future operating losses never do, and what evidence the file needs.
A board decision is not enough
A provision under IAS 37 is a liability of uncertain timing or amount, arising from either a legal obligation or a constructive one. IAS 37 explains that a constructive obligation arises from the entity's own actions, through which it has indicated to others that it will accept certain responsibilities and so created an expectation that it will discharge them.
A board decision taken in private does not do that. Until the people affected know, nobody outside the boardroom has any expectation the company must meet, and the board could change its mind at the next meeting without breaking a promise to anyone. At that stage there is no obligation, and so no provision, however firm the directors feel about the decision.
The announced detailed plan as the constructive obligation
Under IAS 37, a provision for restructuring costs is recognised only when the entity has a constructive obligation because the main features of the detailed restructuring plan have been announced to those affected by it.
Each part of that sentence is a test:
- A detailed plan. Not an intention, but a plan setting out what is being closed or changed, which staff are affected and roughly when.
- Its main features. The announcement need not include every detail, but the essentials must be communicated.
- Announced to those affected. The staff whose jobs go, the landlord whose lease will be ended, the customers and suppliers of the branch where they are affected.
For the client in the example, if the branch staff were told at a meeting before year end about the closure, the timetable and the retrenchment terms, a constructive obligation may exist at year end. If the announcement is planned for the first week of the new year, it does not, and the restructuring is a matter for disclosure rather than provision this year. Local labour law sets its own consultation and notice steps for retrenchments; those are legal questions for the client's advisers, but the letters and meeting records they produce are often the best evidence of when the plan was announced.
Costs that qualify and costs that do not
Once a provision is justified, the next question is what goes in it. IAS 37 has its own requirements on which restructuring costs qualify, and the standard should be read before finalising the figure. Two principles from the facts above guide the working.
First, the provision exists because of the obligation to restructure. Costs that the restructuring itself necessarily causes are candidates: retrenchment packages for the staff being let go, and penalties for ending the branch lease early, for example.
Second, costs of the business that will continue are not part of an obligation that exists at year end. Retraining staff who move to head office, marketing the business's new structure and investing in new systems all relate to the future business. They are recognised when incurred.
Retrenchment packages have their own recognition rule as well. Under IAS 19, a liability for termination benefits is recognised at the earlier of when the entity can no longer withdraw the offer of those benefits and when it recognises costs for a restructuring within the scope of IAS 37 that involves paying termination benefits. So a valid restructuring provision that includes retrenchments brings the termination benefits with it; the interaction is covered in retrenchment and termination benefits.
No provision for future operating losses
The losses the branch will make between year end and closure do not belong in the provision. IAS 37 states that a provision cannot be recognised for future operating losses, because there is no obligation at the end of the reporting period. The company could avoid those losses by closing sooner, and in any case they arise from trading that has not happened yet.
That rule disappoints directors who want to take the whole hit in one year, but it protects the next year's readers. Losses that are provided for in advance and then quietly released make next year's results look better than the business really performed.
If a contract linked to the branch, such as a supply agreement, will cost more to fulfil than it brings in, that may be an onerous contract, which IAS 37 treats separately; check it on its own terms.
Evidence and disclosure
The file for a restructuring provision should hold:
- The board minute approving the plan.
- The detailed plan itself.
- Evidence of announcement to those affected before year end: letters to staff, meeting records, notices to the landlord.
- The calculation of each cost included, with the reason it qualifies.
- The list of costs excluded, with the reason.
In Achekam's Studio, the provision is posted as a year-end adjusting entry against the client's trial balance; an entry that later proves wrong is reversed with a record of who did it and why, never deleted. The Studio's standard policy wording is based on IFRS for SMEs and is labelled for review before issue, and staff can write the client's own. Notes take their figures from the mapped trial balance, and facts the trial balance does not hold, such as the nature of the restructuring and its expected timing, are left as "[to be completed]" for a person to write. The general recognition questions are covered in provisions and contingent liabilities.
The IFRS Foundation's IAS 37 page summarises how provisions are defined and accounted for, and what must be disclosed. When a client mentions a restructuring at the planning meeting, ask first when, and how, the people affected were told.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
