Restructuring

(Part of the earnings management bag

of tricks)

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

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

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

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

Restructuring in Practice
GTE Communications - Telecommunications
($ in Millions)
Annual Sales

4th Q 1993 Charge

Annual Net Income

$19748

$1,800

$882

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

Restructuring in Practice
Borden - Food and Non-Consumer Products
($ in Millions)
Annual Sales

3th Q 1993 Charge

Annual Net Income

$7,142

$642

$(439)

Charge includes costs to:

Unify businesses
Modernize and integrate product presentation
Remedy problems in under performing businesses and reduce
costs

Restructuring in Practice
Woolworth - Merchandise Stores
($ in Millions)
Annual Sales

3th Q 1993 Charge

Annual Net Income

$9,622

$775

$(495)

Charge includes costs of:

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

Restructuring in Practice
Flagstar Companies, Inc. - Food Services Enterprises
($ in Millions)
Annual Sales

3th Q 1993 Charge

Annual Net Income

$3,970

$225

$(1720)

Charge includes costs of:

Termination benefits
Closure of facilities
Relocation and training
Systems development costs

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

SEC Warning Letters:

SEC 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
MD&A
Current an expected effects
future progress and changes

Restatements Mandated by SEC

Examples:
Borden
Flagstar
Woolworth

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

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)

Restructuring Restatements
Woolworth Restated 1993 Quarterly Results
Reduced repositioning reserve by $217 million
Inventory markdowns
Other normal operating costs

Relevant Accounting Standards

Employee Termination Benefits:
FAS 112; 43; 5; and 88

Other restructuring costs:

APB 30; FAS 5
EITF 94-3

FASB Statement 112: Tests

Rights arise from service?
Rights vest or accumulate?
Payment probable?
Payment estimable?

Yes to all

Accrue over employee

service life

No to any

Apply Statement 5, Accrue

upon loss event

FASB Statement 88
Special termination benefits
employee accepts
Contractual termination benefits

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

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

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)

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

Restructuring Was
90
80
70
60
50
Net Income
40
30
20
10
0

Fiscal Quarter

Restructuring Is
90
80
70
60
50
Net Income
40
30
20
10
0

Fiscal Quarter

Restructuring Was/Is

Restructuring Was
90
80
70
60
50
Net Income
40
30
20
10
0

Restructuring Is

Fiscal Quarter