If a company lays off an employee and the employee signs a severance agreement that allows him to receive his salary for another six months. Does the company have to recognize the expense immediately, or can the expense be recognized in the periods when the payments are made?
Accounting treatment of Severance Payments
Answers
I have always recorded the expense at the time the severance commitment is made unless the payments have some linkage to future performance or other contingencies. If there is no further performance linked to the employee you have a commitment with no future value and should expense at the time of the commitment.
Generally recording the expense up front has been a desired outcome regardless of the correct
I agree with Lyle, Principle of Conservatism is always good when in doubt. I would just recognize the liability and expense it immediately since there is no "revenue"/or service to match it to.
It has to do with materiality, resources,
If I book the pre-paid expense, then every "month" I need to "amortize" that transaction when I enter my payroll transactions.
At the end of the day, what is the impact on the overall picture of financial health.
2
There would be no prepaid expense in this scenario, where payments are made over a period of time.
Jeff -
You need to learn not to be so literal. You'll notice that I had quote marks around two of the three major terms. Maybe I left off that set of quote marks.
By the way, many of the severance agreements I've been involved with have severance distributed over the normal course of payroll periods. So the proper term should have been liability, maybe we make another useless general account (just like you were taught in college, where by the time you finished Acct III, the g/l was larger than GM's COA) just for severance liability. mea culpa.
Booked when the termination exercise is firmed and employees are identified. We used to accrue the full severance package (including garden leaves) when the employees are notified. We changed this when the former removed accounting for tardiness in
I agree with Lyle and Emerson -- accrue in full at the time of severance.
Thanks Everyone. Your comments confirmed the position we took. However, we were wondering if anyone may have taken a different approach. Many thanks for your contributions
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Andre, there is a FASB Statement (No. 146) that directly addresses this topic. If the employees are required to provide services over the 6-month period, then the expenses is recognized over the period of service. If no service is required, then the expense is recognized at the point in time that a liability is incurred.
Personally, I've expensed as everyone above mentioned. Wayne mentioned materiality. I have known companies to merely expense it as they go as ongoing payroll when it is immaterial. I've also known companies to require a departing employee to agree to certain terms in a severance agreement including confidentiality, non-compete, non-solicitation, etc. They use those terms to substantiate value to be received in exchange for the payment and thus expensed over the severance period.
1
Actually, the FASB has clarified that non-compete arrangements do not qualify as "service" under Statement 146. Even in that scenario, you should expense the payment when the liability is incurred.
Expense once, when payment is made. It's the most rational, ethical, and defensible transaction (and why create unnecessary work?).
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