Accounting for unusual or infrequently occurring events

 MATERIAL GAINS AND LOSSES - UNUSUAL OR INFREQUENTLY OCCURRING, NOT EXTRAORDINARY

A material event or transaction that is either unusual or infrequently occurring, but not both, is by definition not an extraordinary item. Material gains or losses of this nature should be shown separately on the face of the income statement as a component of income from continuing operations. These items are not shown net of tax, nor is per share disclosure permitted on the face of the income statement. However, note disclosure may be given that presents the item net of tax and discloses the per share effects. The discussion that follows covers four special items and their reporting: disposal of part of a segment, restructuring charges, takeover defense, and sale of stock by a subsidiary.

(a) DISPOSAL OF PART OF A SEGMENT OF A BUSINESS. 

The gain or loss on the disposal of part of a segment of a business is not an extraordinary item or a discontinued operation. Thus it may be reported as a separate component of continuing operations. The measurement principles used to calculate gain or loss on disposal are described in paragraph 15 of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” Unlike the disposal of a segment, a company is not permitted to accrue expected operating losses when a commitment date is reached to dispose of part of a segment. The results of operations prior to the measurement date should not, however, be shown separately on the income statement. This information may be disclosed in the notes to financial statements along with per share data.

Some examples of situations not qualifying as discontinued operations that were also given in the interpretations of APB Opinion No. 30 are:

• Sale of a major subsidiary in one country by an entity that has other activities in the same industry in other countries

• Sale of an interest in an equity investee in the same line of business as the investor

• Sale of assets related to the manufacture of wool suits when the entity manufactures suits from synthetic products elsewhere (considered only product line disposal)

(b) RESTRUCTURING CHARGES. 

During the middle to late 1980s, enterprises began to restructure their operations. These corporate restructurings involved sales of equipment or facilities, severance of employees, and relocation of operations. The EITF considered the income statement presentation (ordinary or extraordinary) of such restructurings but was unable to reach a consensus in EITF Issue No. 86-22, “Display of Business Restructuring Provisions in the Income Statement.” It only stated that entities should use their own judgment. The SEC subsequently addressed this issue in SAB No. 67, “Income Statement Presentation of Restructuring Charges,” issued in December 1986. The SEC position stated that restructuring charges should be shown as a component of continuing operations and separately disclosed if material. Since Staff Accounting Bulletins (SABs) do not apply to nonpublic companies, the EITF considered in Issue No. 87-4, “Restructuring of Operations: Implications of SEC Staff Accounting Bulletin No. 67,” whether the SEC position was GAAP for nonpublic companies. The Task Force indicated that following the SAB provisions is not required for nonpublic enterprises to be in accordance with GAAP. The Task Force agreed that consistent with its views expressed in Issue No. 86-22, nonpublic companies should exercise judgment in selecting the most meaningful income statement presentation.

The SEC observer later provided clarification of the extent of SAB No. 67, such as:

• SAB No. 67 was not intended to address the presentation of a simple sale of assets or a portion of a line of business.

• The SAB restates the position of the SEC observer that showing “earnings from operations before provisions for restructuring of operations,” which is acceptable under EITF Issue No. 86-22, is not acceptable for SEC registrants.

In the early 1990s, companies were reporting restructuring charges on an increasing basis. Restructuring charges as reported comprised various broad types of expenses. Restructuring charges included costs of severance and termination, costs to eliminate or consolidate product lines, costs to close or relocate operations or plants, costs to restrain employees to use newly developed systems, and losses on impairment or disposal of assets. In EITF Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity Including Certain Costs Incurred in a Restructuring,” the Task Force reached the following tentative conclusions.

a. A liability for employee termination benefits should be recognized when management approves the plan if all the following conditions exist:

1. Prior to the date of the financial statements, management with the appropriate authority to involuntarily terminate employees approves and commits the company to the plan (termination plan) that establishes the benefits to be received upon termination.

2. Prior to the date of the financial statements, the plan and benefit arrangements are communicated to employees in sufficient detail to enable affected employees to calculate their benefits.

3. The plan specifies the number of employees, job classification, or function and their location.

4. The period of time to complete the plan of termination indicates that significant changes are not likely. The foregoing provisions do not apply to termination benefits paid as part of the disposal of a segment, pursuant to an ongoing benefit plan, or under the terms of a defined compensation contract.

b. Costs that have no future economic benefit should be accrued on the commitment date. The commitment date is the date when all the following conditions are met.

1. Management with the appropriate authority commits the company to the exit plan.

2. The plan identifies all actions to be taken (i.e., activities to be continued or closed/sold, including method of disposition and expected date of plan completion).

3. Actions required to implement the plan begin as soon as possible after the commitment date, and the period of time to complete the plan indicates that changes to the plan are not likely.

The costs to be recognized under the exit plan can have no future benefit to continued operations. Costs meeting this requirement should be recognized at the commitment date if they are not associated with or are not incurred to generate revenues after the commitment date of the exit plan and meet either criterion (1) or (2) below.

1. The cost is incremental to other costs incurred prior to the commitment date and is incurred as a direct result of the exit plan.

2. The costs will be incurred under a contractual commitment existing prior to the commitment date and will not economically benefit the company. Costs should be recorded when they are reasonably estimable. Any unrecognized costs should be recorded when they can be reasonably estimated. Results of operations after the commitment date are not exit costs. Costs to sell assets under the exit plan are also not exit costs. Costs not qualifying as exit costs should not be recognized at the commitment date but when an obligation is actually incurred. The EITF Issue 94-3 has significant disclosure requirements and also provides many examples to illustrate applications of its provisions.

(c) TAKEOVER DEFENSE. 

A question created by the takeover surge is the appropriate presentation of takeover defense expenses on the income statement. The FASB issued Financial Technical Bulletin (FTB) No. 85-6, which makes the following two statements:

1. A company should not classify the cost to defend itself from a takeover or the costs attributable to a “standstill” agreement as an extraordinary item.

2. If a company repurchases shares for a price significantly in excess of current market from an unwanted suitor, it must include stated or unstated rights. Accordingly, only the amount representing fair value should be accounted for as the cost of Treasury shares, any excess should be accounted for according to its substance, presumably charged to expense. The SEC has stated that in applying FTB No. 85-6 quoted market represents fair value; use of appraised values that differ from public market values is not acceptable.

(d) SALES OF STOCK BY A SUBSIDIARY.
 

Prior to the issuance in 1983 of SAB No. 51, “Accounting for Sales of Stock by a Subsidiary,” most parent companies had accounted for the effects on its equity in the subsidiary of a sale of additional stock by a subsidiary as a capital transaction. In SAB No. 51, the SEC indicated that it had reconsidered this position where the sale of such shares by the subsidiary is not part of a broader corporate reorganization. The SEC, in its reconsideration, stated that it accepts the advisory conclusions of the AICPA issues paper “Accounting in Consolidation for Issuances of a Subsidiary’s Stock,” which indicates that profit or loss should be recognized in these situations. The SEC concluded that if gains (losses) are recognized from issuances of a subsidiary’s stock as income statement items, they should be shown as a separate line item (without regard for materiality) and clearly designated as nonoperating. Subsequently SAB No. 81, “Gain Recognition on the Sale of a Business or Operating Assets to a Highly Leveraged Entity,” was issued in 1989, indicating that gain recognition may not be appropriate where a subsidiary is sold to a highly leveraged entity. Further, SAB No. 84, “Accounting for Sales of Stock by a Subsidiary,” which was also issued in 1989, gives additional guidance on recognizing a sale of stock by a subsidiary as a gain.

The income statement treatment in consolidation of gains or losses for the sale of stock by a subsidiary represents a choice among acceptable accounting methods and, once chosen, should be applied consistently to all stock transactions for any subsidiary that meet the conditions for income statement treatment. In SAB 84, the staff also deals with other interpretation matters, such as what constitutes a broader corporate reorganization.

The Financial Accounting Standards Board has exposure drafts under consideration that will affect accounting for guarantees and consolidation of special purpose entities. On final approval, the proposed exposure drafts will affect the accounting and income statement presentation for these areas.