[Federal Register Volume 64, Number 230 (Wednesday, December 1, 1999)]
[Rules and Regulations]
[Pages 67154-67163]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-31160]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 211

[Release No. SAB 100]


Staff Accounting Bulletin No. 100

AGENCY: Securities and Exchange Commission.

ACTION: Publication of staff accounting bulletin.

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SUMMARY: This staff accounting bulletin expresses views of the staff 
regarding the accounting for and disclosure of certain expenses 
commonly reported in connection with exit activities and business 
combinations. This includes accrual of exit and employee termination 
costs pursuant to Emerging Issues Task Force (EITF) Issues No. 94-3, 
Liability Recognition for Certain Employee Termination Benefits and 
Other Costs to Exit an Activity (Including Certain Costs Incurred in a 
Restructuring), and No. 95-3, Recognition of Liabilities in Connection 
with a Purchase Business Combination, and the recognition of impairment 
charges pursuant to Accounting Principles Board (APB) Opinion No. 17, 
Intangible Assets, and Statement of Financial Accounting Standards 
(SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and 
for Long-Lived Assets to be Disposed Of.

DATES: Effective November 24, 1999.

FOR FURTHER INFORMATION CONTACT: Eric Jacobsen, Paul Kepple, or Eric 
Casey, Office of the Chief Accountant (202-942-4400), Robert Bayless, 
Division of Corporation Finance (202-942-2960), Securities and Exchange 
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549; electronic 
addresses: [email protected]; [email protected]; [email protected]; 
[email protected].

SUPPLEMENTARY INFORMATION: The statements in staff accounting bulletins 
are not rules or interpretations of the Commission, nor are they 
published as bearing the Commission's official approval. They represent 
interpretations and practices followed by the Division of Corporation 
Finance and the Office of the Chief Accountant in administering the 
disclosure requirements of the Federal securities laws.

    Dated: November 24, 1999.
Margaret H. McFarland,
Deputy Secretary.

PART 211--[AMENDED]

    Accordingly, Part 211 of Title 17 of the Code of Federal 
Regulations is amended by adding Staff Accounting Bulletin No. 100 to 
the table found in Subpart B.
STAFF ACCOUNTING BULLETIN NO. 100
    1. Amend Section A of Topic 2 of the Staff Accounting Bulletin 
Series to add new subsection 9. Liabilities Assumed in a Purchase 
Business Combination. Revise the title of Section P of Topic 5 to 
Restructuring Charges, designate the current section P as subsection 3 
of Section P of Topic 5, Income Statement Presentation of Restructuring 
Charges, deleting the first paragraph under that subsection, and 
renumbering Questions 1, 2, and 3 in that subsection to be Questions 
13, 14, and 15. Add new subsection 1. Characteristics of an Exit Plan 
to Section P of Topic 5. Add new subsection 2. Characteristics of an 
Exit Cost to Section P of Topic 5. Add new subsection 4. Disclosures. 
to Section P of Topic 5. Furthermore, add new Sections BB. Inventory 
Valuation Allowances and CC. Impairments to Topic 5.

TOPIC 2: BUSINESS COMBINATIONS

A. Purchase Method
* * * * *
8. Business Combinations Prior to an Initial Public Offering
* * * * *
9. Liabilities Assumed in a Purchase Business Combination
    Facts: Company A acquires Company Z in a business combination 
accounted for as a purchase. Company Z has recorded liabilities for 
contingencies such as product warranties and environmental costs.
    Question: Are there circumstances in which it is appropriate for 
Company A to adjust Company Z's carrying value for these liabilities in 
the purchase price allocation?
    Interpretive Response: Yes. Accounting Principles Board Opinion No. 
16, Business Combinations, requires that receivables, liabilities, and 
accruals be recorded in the purchase price allocation at their fair 
value, typically the present value of amounts to be received or paid, 
determined using appropriate current market interest rates. In some 
cases, fair value is readily determinable from contemporaneous arms-
length transactions involving substantially identical assets or 
liabilities, or from amounts quoted by a third party to purchase the 
assets or assume the liabilities. More frequently, fair values are 
based on estimations of the underlying cash flows to be received or 
paid, discounted to their present value using appropriate current 
market interest rates.
    The historical accounting by Company Z for receivables or 
liabilities may often be premised on estimates of the amounts to be 
received or paid. Amounts recorded by Company A in its purchase price 
allocation may be expected to differ from Company Z's historical 
carrying values due, at least, to the effects of the acquirer's 
discounting, including differences in interest rates. Estimation of 
probable losses and future cash flows involves judgment, and companies 
A and Z may

[[Page 67155]]

differ in their systematic approaches to such estimation. Nevertheless, 
assuming that both companies employ a methodology that appropriately 
considers all relevant facts and circumstances affecting cash flows, 
the staff believes that the two estimates of undiscounted cash inflows 
and outflows should not differ by an amount that is material to the 
financial statements of Company Z, unless Company A will settle the 
liability in a manner demonstrably different from the manner in which 
Company Z had planned to do so (for example, settlement of the warranty 
obligation through outsourcing versus an internal service department). 
But the source of other differences in the estimates of the 
undiscounted cash flows to be received or paid should be investigated 
and reconciled. If those estimates of undiscounted cash flows are 
materially different, an accounting error in Company Z's historical 
financial statements may be present, or Company A may be unaware of 
important information underlying Company Z's estimates that also is 
relevant to an estimate of fair value.
    The staff is not suggesting that an acquiring company should record 
assumed liabilities at amounts that reflect an unreasonable estimate. 
If Company Z's financial statements as of the acquisition date are not 
fairly stated in accordance with generally accepted accounting 
principles (GAAP) because of an improperly recorded liability, that 
liability should not serve as a basis for recording assumed amounts. 
That is, the correction of a seller's erroneous application of GAAP 
should not occur through the purchase price allocation. Rather, Company 
Z's financial statements should be restated to reflect an appropriate 
amount, with the resultant adjustment being applied to the historical 
income statement of Company Z for the period(s) in which the trends, 
events, or changes in operations and conditions that gave rise to the 
needed change in the liability occurred. It would also be inappropriate 
for Company Z to report the amount of any necessary adjustment in the 
period just prior to the acquisition, unless that is the period in 
which the trends, events, or changes in operations and conditions 
occurred. The staff would expect that such trends, events, and changes 
would be disclosed in Management's Discussion and Analysis in the 
appropriate period(s) if their effect was material to a company's 
financial position, results of operations or cash flows.
    In summary, the staff believes that purchase price adjustments 
necessary to record liabilities and loss accruals at fair value 
typically are required, while merely adding an additional ``cushion'' 
of 10 or 20 or 30 percent to such account balances is not appropriate. 
To arrive at those fair values, the undiscounted cash flows must be 
projected, period by period, based on historical experience and 
discounted at the appropriate current market discount rate.
* * * * *

TOPIC 5: MISCELLANEOUS ACCOUNTING

* * * * *
P. Restructuring Charges
    The term ``restructuring charge'' is not defined in the existing 
authoritative literature. While the events or transactions triggering 
the recognition \1\ of what are often identified as restructuring 
charges vary, these charges typically result from the consolidation 
and/or relocation of operations, or the disposition or abandonment of 
operations or productive assets. Restructuring charges may be incurred 
in connection with a business combination, a change in an enterprise's 
strategic plan, or a managerial response to declines in demand, 
increasing costs, or other environmental factors.
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    \1\ The Financial Accounting Standards Board (FASB) has on its 
agenda currently three projects which are expected to improve 
existing financial reporting with regard to certain aspects of 
liability recognition and presentation, including the recognition or 
nonrecognition of constructive obligations. In the interim, pending 
completion of the FASB's efforts to improve financial reporting in 
this area, the staff is providing interpretive guidance regarding 
the existing accounting requirements for exit costs. The staff will 
reconsider the guidance provided herein upon completion of the 
FASB's projects.
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    Some types of restructuring charges, such as ``exit costs,'' as 
defined in Emerging Issues Task Force \2\ (EITF) Issue No. 94-3, 
Liability Recognition for Certain Employee Termination Benefits and 
Other Costs to Exit an Activity (including Certain Costs Incurred in a 
Restructuring) (EITF 94-3), are recognized as liabilities and charged 
to operations when management commits to a restructuring plan, while 
other types of restructuring charges contemplated by the plan may not 
be recognized until they are actually incurred. The circumstances in 
which the intended actions of management result in the recognition of a 
liability are identified in either EITF 94-3 or EITF Issue No. 95-3, 
Recognition of Liabilities in Connection with a Purchase Business 
Combination (EITF 95-3), collectively referred to as the 
``Consensuses.''
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    \2\ The Emerging Issues Task Force is a private sector body 
established by the FASB. The Commission's Chief Accountant 
participates in the body's deliberations.
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1. Characteristics of an Exit Plan
    Accrual of certain involuntary employee termination benefits and 
exit costs under the Consensuses requires a commitment by the company 
to a termination or exit plan (hereinafter collectively referred to as 
an exit plan) that specifically identifies all significant actions to 
be taken.\3\ Not all plans qualify under the Consensuses as a basis for 
recognizing a liability for exit costs or involuntary employee 
termination benefits.
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    \3\ Registrants should refer to the Consensuses for their 
specific requirements. Registrants are reminded that they are 
required at the commitment date to account for those types of costs 
(exit, termination, etc.) falling within the scope of the 
Consensuses that are incurred in connection with a qualifying exit 
plan in accordance with the Consensuses. That is, applying the 
Consensuses (being Level C GAAP per AU411.16) is not optional.
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    Facts: Prior to year end, senior management of a company approves a 
plan to exit certain activities and terminate employees involuntarily. 
Approval by the board of directors is required by the Company's 
policies to implement the exit plan, but is not obtained until after 
year end.
    Question 1: Would it be appropriate for the company to accrue exit 
costs and involuntary employee termination benefits as of year end 
pursuant to the Consensuses?
    Interpretive Response: No. The Consensuses do not permit accrual of 
exit costs or involuntary employee termination benefits prior to the 
date the company is committed to an exit plan by management having the 
appropriate level of authority (the commitment date). The staff 
believes that if the Company's policies require board of directors' 
approval, or management elects to seek board of directors' approval, 
the appropriate level of authority needed to commit the company under 
the Consensuses would be that of the board of directors. If board of 
directors' approval is neither required nor sought, the appropriate 
level of authority would be at a level below the board of directors 
(e.g., chief executive officer). The appropriate level of authority 
would be a division or branch manager if that manager can and will 
commit the enterprise to incur particular exit costs or involuntary 
employee termination benefits without additional ratification or budget 
authorization.
    Facts: Corporate management is developing an exit plan which will 
include involuntary employee terminations, plant shutdowns, and

[[Page 67156]]

asset dispositions associated with the consolidation and reduction of 
operations in several of its business units. Senior management of the 
company has set a target of reducing its North American distribution 
costs by 50 percent within two years. However, the exit plan is in the 
development stage, with only initial cost estimates having been 
developed. The corporate management team currently is developing the 
more detailed plans, significant actions, and related budgets for which 
individual business units and plant managers will be held accountable 
and be required to execute. The more detailed plans will set forth how, 
when, and by whom the cost reductions will be achieved.
    Question 2: Does the staff believe that exit costs may be accrued 
prior to the completion of a more detailed exit plan?
    Interpretive Response: No. The EITF set restrictive standards for 
plan specificity when it stated in EITF 94-3, ``The exit plan 
specifically identifies all significant actions to be taken to complete 
the exit plan . . . and the period of time to complete the exit plan 
indicates that significant changes to the exit plan are not likely 
(emphasis added).'' Consistent with the intent of the EITF, and to 
minimize the opportunities for earnings management, the staff believes 
that a liability for exit costs arising from a discretionary management 
action should be accrued only if the discretionary action is part of a 
comprehensive plan that has been rigorously developed and thoroughly 
supported.
    In assessing whether an exit plan has sufficient detail, the staff 
would expect generally that a company's exit plan would be at least 
comparable in terms of the level of detail and precision of estimation 
to other operating and capital budgets the company prepares, such as 
annual business unit budgets. The absence of controls and procedures to 
detect, explain and, if necessary, correct variances or adjust 
accounting accruals would indicate that the plan lacked the 
authenticity and management commitment necessary for it to serve as a 
basis for recognizing a liability for exit costs.
    The staff also believes that as a prerequisite to accruing exit 
costs at the commitment date, the company must be able to estimate 
reliably \4\ the nature, timing, and amount of the exit costs 
associated with the significant actions it has specifically identified. 
Factors the staff believes should be considered when determining 
whether exit costs can be estimated reliably include whether:
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    \4\ See FASB Concept Statement No. 2, Qualitative 
Characterisitics of Accounting Information and FASB Concept 
Statement No. 5, Recognition and Measurement in Financial Statements 
of Business Enterprises, paragraph 63.
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     The estimate reflects the most likely expected outcome 
given all the information currently available to management;
     The exit plan identifies all significant actions expected 
to be taken;
     The exit plan includes an expected timetable for 
completing those actions;
     The plan is the one that will be used to evaluate the 
performance of those responsible for executing the plan and for making 
periodic comparisons of planned versus actual results and variances;
     All significant actions are documented in the plan in 
sufficient detail, including but not limited to details such as, 
geographic locations, estimated costs, expected cash flows, etc.;
     The components used in making the detailed calculation in 
the plan and arriving at the estimated liability (for example, per 
person costs, number of people, etc.) have a reasonably supportable 
basis; and
     The key assumptions used in developing the plan have a 
reasonably supportable basis.
    Repeated material changes in the nature, timing, or amount of the 
estimated exit costs and involuntary termination benefits subsequent to 
the commitment date may also indicate an inability to make reliable 
estimates.
    Facts: Company A operates five hundred retail outlets and has 
identified the specific location of 80 out of 100 stores which it 
intends to close pursuant to a store consolidation plan. The exit plan 
for the 80 stores identifies all significant actions and related costs 
in budget line item detail, such as lease termination costs, 
involuntary employee termination costs, store closure costs, 
subcontractor costs (where appropriate), etc. for each facility, as 
well as all other information specifically enumerated by the 
Consensuses. Management believes that the average cost to close the 
additional 20 stores will approximate the average cost of closing the 
80 identified stores.
    Question 3: Assuming that all other provisions of EITF 94-3 have 
been met, may Company A recognize a liability at the commitment date 
for the exit costs and involuntary termination benefits associated with 
all 100 stores?
    Interpretive Response: No. While recognition of estimated exit 
costs and involuntary termination benefits for the 80 identified stores 
is appropriate, the staff believes that Company A has not met the 
requirements in EITF 94-3 for the 20 stores yet to be identified. The 
staff believes that all exit costs and involuntary termination benefits 
should be identified by specific property location and that no higher 
level of identification or aggregation (e.g., country, region, state, 
county, etc.) is appropriate under the guidance in EITF 94-3. If and 
when Company A identifies the specific locations of other stores, the 
involuntary termination benefits, the exit costs, and the exit plan 
associated with those stores should be evaluated and accounted for as a 
new exit plan under the Consensuses rather than a revision of the exit 
plan for the 80 stores.
    Although Company A may be unable to specifically identify 
significant actions to be taken to complete some parts of the exit plan 
(and so recognizing a liability currently under the Consensuses is not 
appropriate), management should consider its disclosure obligations 
under the Commission's rules and regulations regarding its future 
plans, including those obligations relating to Management's Discussion 
and Analysis (MD&A).
    Question 4: If Company A decides not to close one of the stores in 
a period following the quarter in which it recognized a liability for 
exit costs and involuntary employee termination benefits for the 80 
identified stores, may Company A leave the accrued exit costs and 
involuntary employee termination benefits for that store on its balance 
sheet in anticipation of costs expected to be incurred when other 
stores are identified for closing?
    Interpretive Response: No. Exit costs and involuntary employee 
termination benefits accrued for the store should be reversed. At each 
balance sheet date (annual or interim), exit cost and involuntary 
employee termination benefits accruals should be evaluated to ensure 
that any accrued amount no longer needed for its originally intended 
purpose is reversed in a timely manner. When an exit, termination, or 
other loss accrual is no longer appropriate, reversal of the liability 
should be recorded through the same income statement line item that was 
used when the liability was initially recorded. Generally accepted 
accounting principles (GAAP) do not permit unused or excess liability 
accruals to be retained as general accruals, used for purposes other 
than that for which the liability was established initially, or 
returned to earnings over time and in small amounts. Furthermore, costs 
actually incurred in connection with an exit plan should be charged to 
the exit accrual only to the extent those costs

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were specifically included in the original estimation of the accrual. 
Costs incurred in connection with an exit plan but not specifically 
contemplated in the original estimate of the liability for exit costs 
and involuntary employee termination benefits should be charged to 
operating expense in the period incurred, or the period that the exit 
cost or involuntary termination benefit qualifies for accrual under 
EITF 94-3, with appropriate explanation in MD&A.
    Companies should have appropriate internal accounting controls with 
respect to exit, termination, or other loss accruals and the related 
expenses. These controls must ensure the company is in compliance with 
Section 13(b) of the Securities Exchange Act of 1934 and provide a 
reasonable basis for ensuring adjustments required by GAAP (increases 
or decreases) with respect to such liabilities are made on a timely 
basis.
    Question 5: The Consensuses require that the exit plan begin as 
soon as possible after the commitment date and that the time needed to 
complete it indicates that significant changes in the plan (due to 
changing market conditions or other external factors, for example) are 
unlikely. What factors may indicate that an exit plan will not begin or 
be executed within a period of time that significant changes in the 
plan are unlikely?
    Interpretive Response: Based on the staff's experience, a number of 
factors may indicate that an exit plan might not begin or be executed 
within a period of time that is short enough to allow a company to 
appropriately conclude that significant changes in the exit plan are 
unlikely (and consequently, that recognizing a liability pursuant to 
the Consensuses would not be appropriate), including:
    1. Where all significant actions to be undertaken pursuant to the 
plan have not been identified with sufficient specificity or are not 
reasonably estimable,
    2. Where it is likely that execution of the plan will be delayed 
due to events or circumstances that are reasonably likely to occur, or
    3. Where a company lacks the internal controls or information 
needed to monitor effectively the activities being performed, compare 
the costs incurred to the plan, and make adjustments to the plan on a 
timely basis.
    Facts: In the first quarter of 2000, a company develops a strategic 
plan to restructure four divisions during the next three years. The 
exit plan will be implemented one division at a time.
    Question 6: May the company recognize a liability for the exit 
costs and involuntary employee termination benefits for all four 
divisions in the first quarter of 2000?
    Interpretive Response: The Consensuses contemplate completion of an 
exit plan within a time period that indicates that significant changes 
in the exit plan are unlikely. In order to satisfy that condition, the 
staff believes that management must be able to make reasonable 
estimates of the exit costs and involuntary employee termination 
benefits, and that those estimates would not be likely to change 
materially within that time period. Today's dynamic and constantly 
changing business environment often affects a company's ability to 
identify exit activities to be undertaken and estimate exit costs and 
involuntary employee termination benefits to be incurred after the 
commitment date with sufficient precision and specificity to permit the 
accrual of those costs at the commitment date \5\ under the 
Consensuses. Thus, the staff generally believes that the further out an 
exit activity is from the commitment date, the greater the risk that 
either all or part of the exit plan will be materially revised in 
response to events or circumstances that are reasonably likely to 
occur. Furthermore, the staff also observes that many of the 
illustrative examples in EITF 94-3 assume completion of significant 
actions within one year of the commitment date.\6\ Therefore, the staff 
believes that a rebuttable presumption exists that the exit plan should 
be completed and the exit costs and involuntary employee termination 
benefits incurred within one year from the commitment date.
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    \5\ For purposes of EITF 95-3, the date the plan is finalized, 
not to exceed one year from consummation.
    \6\ A one-year period is also consistent with Accounting 
Principles Board Opinion (APB) No. 30, Reporting the Results of 
Operations--Reporting the Effects of Disposal of a Segment of a 
Business, and Extraordinary, Unusual and Infrequently Occurring 
Events and Transactions (APB 30), SAB No. 93, Accounting and 
Disclosures Regarding Discontinued Operations, FASB Statement of 
Financial Accounting Standards No. 38, Accounting for Preacquisition 
Contingencies of Purchased Enterprises, EITF Issue No. 87-11, 
Allocation of Purchase Price to Assets to Be Sold and Statement on 
Auditing Standards No. 59, The Auditor's Consideration of an 
Entity's Ability to Continue as a Going Concern.
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    The staff recognizes, however, that an exit plan might not be 
completed within one year of the commitment date due to circumstances 
outside the company's control. Circumstances outside the company's 
control would include, for example, legal or contractual restrictions 
on the company's ability to complete the exit plan, such as existing 
union contracts or enacted legal restrictions concerning the length of 
notice required to involuntarily terminate employees. In such 
circumstances, management should have appropriate evidence and support 
for concluding that execution of its plan will not be materially 
affected by intervening developments and that reasonable estimates of 
the nature, timing, and amount of exit costs and involuntary employee 
termination benefits can be made so far in advance.
    Facts: As of the balance sheet date, Company A's exit plan provides 
only that it will terminate involuntarily a certain number of employees 
within certain grades and classes of employees in connection with 
consolidation of 10 facilities in Europe. The specific grades of 
employees to be terminated involuntarily have not been identified at 
the balance sheet date. Company A has not made any announcement 
regarding its exit or termination plans. The involuntary termination 
benefits are expected to vary based on the grade and class of employee 
as well as the country in which the worker is employed.
    Question 7: Assuming that the board of directors of Company A 
approves the exit and termination plans in the condition described 
above by year end, in the staff's view, may Company A recognize a 
liability at the balance sheet date for the costs it expects to incur 
to terminate involuntarily certain grades of employees within certain 
classes of employees pursuant to the Consensuses?
    Interpretive Response: No. In order to recognize a liability for 
the cost to terminate employees involuntarily, the Consensuses require 
that the exit plan must specifically identify (a) the benefit formula 
to be used for determining individual employee involuntary termination 
payments, (b) the number of employees to be involuntarily terminated, 
and (c) the employees' job classifications or functions and locations.
    Furthermore, the EITF considered notification to be an essential 
element obligating the employer to fulfill its commitment, giving rise 
to a liability. Therefore, the employees within the classifications or 
functions at risk of being involuntarily terminated must also be 
notified of the pending involuntary termination prior to the balance 
sheet date. The notification must include the provisions of the 
involuntary termination benefit formula in sufficient detail such that 
each employee would be able to calculate the severance benefit to be 
received if terminated involuntarily.
    In this example, Company A has not met the notification 
requirements of the

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Consensuses, nor does it appear that Company A has finalized the 
information called for under (a), (b), or (c) referred to above.\7\
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    \7\ While recognizing a liability at the commitment date 
pursuant to the Consensuses would not be appropriate, registrants 
are reminded to consider the requirements of FASB Statement of 
Financial Accounting Standards No. 88, Employers Accounting for 
Settlements and Curtailments of Defined Pension Plans and for 
Termination Benefits and FASB Statement of Financial Accounting 
Standards No. 112, Employer's Accounting for Postemployment Benefits 
for those involuntary termination benefits that may be payable 
pursuant to pre-existing contractual arrangements (e.g., union 
contracts) or regulatory requirements (e.g., national labor laws).
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2. Characteristics of Exit Costs
    Under the Consensuses, an exit cost is a cost that results from a 
plan to exit an activity pursuant to a qualified exit plan and that 
meets all of the following conditions:
    1. The cost is not associated with or does not benefit activities 
that will be continued.
    2. The cost is not associated with or is not incurred to generate 
revenues after the commitment date.
    3. The cost meets one of the following criteria:
    a. It is incremental to other costs incurred in the company's 
conduct of its activities prior to the commitment date and will be 
incurred as a direct result of the exit plan; or
    b. The cost will be incurred under a contractual obligation that 
existed prior to the commitment date and will either continue after the 
exit plan is completed with no economic benefit to the company or be a 
penalty to cancel the contractual obligation.
    FASB Concept Statement No. 6, Elements of Financial Statements 
(SFAC 6), paragraphs 35 to 43 and FASB Statement of Financial 
Accounting Standards No. 5, Accounting for Contingencies (SFAS 5) 
provide guidance for when to recognize liabilities in general and loss 
contingencies in particular. Registrants should not analogize to the 
Consensuses for costs that are outside the scope of the Consensuses. 
Moreover, to fall within the scope of the Consensuses, a cost cannot be 
associated with or benefit continuing activities.
    Facts: For existing customers of a product line or service that is 
to be discontinued, a company is developing a plan to transition the 
customers over the next year to a new product line or service.
    Question 8: May the costs the company expects to incur to complete 
this transition be recognized as a liability for exit costs pursuant to 
the Consensuses as of the date the company commits to a plan to 
transition these existing customers?
    Interpretive Response: No. The costs are being incurred in order to 
benefit future periods through the retention of customers, and with the 
expectation of generating future revenues. The staff believes that the 
costs to transition the customers may not be recognized as a liability 
for exit costs under the Consensuses and should be recognized and 
expensed as incurred in operating income.
    Facts: A franchiser announces a franchisee cash incentive program 
in order to induce its franchisees to upgrade their equipment over the 
next year. The franchiser is not contractually obligated to make any 
payments to individual franchisees until the franchisees accept the 
offer and incur ``qualifying'' costs to upgrade their equipment, which 
costs are reimbursable by the franchiser.
    Question 9: May the franchiser accrue the estimated cost of the 
incentive program at the date it announces the plan pursuant to the 
Consensuses?
    Interpretive Response: No. The franchiser is incurring the cost in 
order to benefit continuing activities and with the expectation of 
indirect future economic benefit. Therefore, the staff believes that 
these are not exit costs. Furthermore, considering the definition and 
characteristics of a liability as provided in paragraphs 35 through 43 
of SFAC 6 and SFAS 5, costs such as the above should not be accrued 
until the franchiser becomes contractually obligated to make such 
payments.
    Facts: Company A licenses technology from Company B on a perpetual, 
exclusive basis, paying an annual royalty of 10 percent of sales. Prior 
to the balance sheet date, the board of directors of Company A approves 
a plan to renegotiate terms of the royalty arrangement. In exchange for 
reducing the annual royalty rate from 10 percent of all sales to 5 
percent of the first $20 million in annual sales, Company A will 
propose to pay Company B a nonrecurring, lump-sum payment of $5 
million. Although internally committed to the plan, as of the balance 
sheet date, Company A has not yet approached Company B regarding 
renegotiating the royalty terms of the technology license.
    Question 10: May Company A recognize a liability at the balance 
sheet date pursuant to the Consensuses for its estimate of the cost to 
modify the royalty arrangement as well as the estimated nonrecurring, 
lump-sum payment by the company?
    Interpretive Response: No. The lump-sum payment is outside the 
scope of exit costs contemplated by the Consensuses because it is being 
incurred to modify terms of an existing and continuing relationship. 
The staff does not believe that the modification of an executory 
contract (for example, license and royalty, purchase or sales 
commitments, servicing, etc.) represents the ``exiting'' of one 
contract and the initiation of a new, unrelated contract.\8\ In 
addition, the staff notes that, although the board of directors of 
Company A has committed to a plan, Company B has not agreed to the 
terms under which it would accept modification of the royalty 
arrangement. Under these facts and circumstances, it does not appear to 
the staff that Company A would have a basis upon which to reasonably 
estimate the costs of changing the arrangement.
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    \8\ The staff observes that not all contract terminations are 
exit activities within the scope of the Consensuses. The 
applicability of the Consensuses depends on the particular facts and 
circumstances surrounding the termination.
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    Under these facts and circumstances, the staff believes that any 
costs to modify the contract would not fall within the scope of the 
Consensuses. Furthermore, GAAP would not permit recognition of 
liabilities for costs associated with modifying the contract prior to 
their being incurred.
    Facts: A company, in responding to significant staffing shortages, 
hires an executive search firm, agreeing to pay the firm a fixed fee 
for each successful recruitment. In addition, the company commits to 
pay the relocation costs of future employees recruited by the executive 
search firm.
    Question 11: May the company accrue the estimated fees to be paid 
to the executive search firm as well as the estimated cost to relocate 
new employees at the date the company engages the firm and commits to 
the plan to pay relocation costs?
    Interpretive Response: No. Such costs are being incurred to benefit 
continuing activities, are not necessarily incremental to other costs 
incurred by the company in the normal course of business, and do not 
represent obligations of the company at the date the company engages 
the executive search firm. That is, the staff believes that these costs 
are neither exit nor integration costs that will be incurred as a 
result of a purchase business combination and thus, they do not fall 
within the scope of the Consensuses.\9\

[[Page 67159]]

Rather, the fees to be paid to the executive search firm and the 
relocation costs should be recognized as liabilities as and when the 
services are provided.
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    \9\ For employee relocation costs incurred relative to employees 
of a company acquired in a business combination accounted for under 
the purchase method, registrants are reminded to consider the 
requirements of EITF 95-3.
---------------------------------------------------------------------------

    Question 12: May the company accrue as an exit cost at the balance 
sheet date an asset impairment in accordance with the Consensuses for 
facilities it expects to close or dispose of?
    Interpretive Response: No. The Consensuses address recognition of 
liabilities associated with exit plans and not recognition of losses 
associated with asset impairments. That is, the recognition of losses 
on asset impairments, even in connection with exit plans, does not fall 
within the scope of the Consensuses. The closure and disposition or 
abandonment of a registrant's own long-lived assets, such as 
manufacturing plants, not constituting a business segment in accordance 
with APB 30, would be accounted for in accordance with SFAS 121, with 
any losses on asset impairment being charged to operating income.\10\
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    \10\ Where an acquirer intends, at the consummation date, to 
dispose of certain of an acquiree's long-lived assets, registrants 
are reminded to consider the requirements of APB 16, EITF Issue No. 
87-11, and EITF Issue No. 90-6 in allocating the purchase price to 
and subsequently accounting for such assets held for disposal.
---------------------------------------------------------------------------

3. Income Statement Presentation of Restructuring Charges
    Facts: Because restructuring charges typically do not relate to ``a 
single separate major line of business or class of customer,'' \11\ 
they do not qualify for presentation as losses on the disposal of a 
discontinued operation. Additionally, since the charges are not both 
unusual and infrequent \12\ they are not presented in the income 
statement as extraordinary items.
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    \11\ See APB 30, paragraph 13.
    \12\ See APB 30, paragraph 20.
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    Question 13. * * *
    Question 14. * * *
    Question 15. * * *
4. Disclosures
    Beginning with the period in which the exit plan is committed to, 
the Consensuses require disclosure, in all periods, including interim 
periods, until the exit plan is completed, of the following:
    1. The amount of involuntary termination benefits accrued and 
charged to expense and their income statement classification.
    2. The number of employees to be terminated.
    3. A description of the employee group(s) to be terminated.
    4. The actual amount of involuntary termination benefits paid and 
charged against the liability and the number of employees actually 
terminated pursuant to the exit plan.
    5. Where the activities that will not be continued are significant 
to the enterprise's revenue or operating results or if the exit costs 
recognized at the commitment date are material:
    a. A description of the major actions comprising the exit plan, 
activities that will not be continued, including the method of 
disposition, and the anticipated date of completion.
    b. A description of the type and amount of exit costs recognized as 
liabilities and their income statement classification.\13\
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    \13\ Registrants should refer to EITF Issue No. 96-9, 
Classification of Inventory Markdowns and Other Costs Associated 
with a Restructuring for additional comments as to income statement 
presentation. For example, the staff believes that inventory 
writedowns should be classified in the income statement as a 
component of cost of goods sold.
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    c. A description of the type and amount of exit costs paid and 
charged against the liability.
    d. The revenue and net operating income or losses from activities 
that will not be continued if those activities have separately 
identifiable operations for all periods presented.
    6. The amount of any adjustment(s) to the liability account and 
whether the corresponding entry was recorded as an adjustment of the 
cost of an acquiree or included in the determination of net income for 
the period.
    7. Where an acquirer has not finalized the plan to exit an activity 
or involuntarily terminate (relocate) employees of the acquiree as of 
the balance sheet date, a description of any unresolved issues, the 
types of additional liabilities that may result in a change to the 
purchase price allocation, and how any adjustments will be 
reported.\14\
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    \14\ Registrants are reminded of the requirements in FASB 
Statement No. 38, paragraph 4(b) and SAB Topic 2-A (7). The staff 
believes that the allocation period should not extend beyond the 
minimum reasonable period necessary to gather the information that 
the registrant has arranged to obtain for purposes of the estimate, 
and in any event usually should not exceed one year.
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    Question 16: What specific disclosures about restructuring charges 
has the staff requested to fulfill the disclosure requirements of the 
Consensuses and Management's Discussion and Analysis (MD&A)?
    Interpretive Response: The staff often has requested greater 
disaggregation and more precise labeling when exit and involuntary 
termination costs are grouped in a note or income statement line item 
with items unrelated to the exit plan.\15\ For the reader's 
understanding, the staff has requested that discretionary, or decision-
dependent, costs of a period, such as exit costs, be disclosed and 
explained in MD&A separately. Also to improve transparency, the staff 
has requested disclosure of the nature and amounts of additional types 
of exit costs and other types of restructuring charges \16\ that appear 
quantitatively or qualitatively material, and requested that losses 
relating to asset impairments be identified separately from charges 
based on estimates of future cash expenditures.
---------------------------------------------------------------------------

    \15\ EITF 94-3 requires that the effect of recognizing a 
liability for exit costs should be presented in income from 
continuing operations and not net of taxes. Refer to EITF 94-3 for 
additional guidance regarding the income statement presentation.
    \16\ Examples of common components of exit costs and other types 
of restructuring charges which should be considered for separate 
disclosure include, but are not limited to, involuntary employee 
terminations and related costs, changes in valuation of current 
assets such as inventory writedowns, long term asset disposals, 
adjustments for warranties and product returns, leasehold 
termination payments, and other facility exit costs, among others.
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    The staff frequently reminds registrants that in periods subsequent 
to the commitment date that material changes and activity in the 
liability balances of each significant type of exit cost and 
involuntary employee termination benefits (either as a result of 
expenditures or changes in/reversals of estimates) should be disclosed 
in the footnotes to the interim and annual financial statements and 
discussed in MD&A. In the event a company recognized liabilities for 
exit costs and involuntary employee termination benefits relating to 
multiple exit plans, the staff believes presentation of separate 
information for each individual exit plan that has a material effect on 
the balance sheet, results of operations or cash flows generally is 
appropriate.
    For material exit or involuntary employee termination costs related 
to an acquired business, the staff has requested disclosure in either 
MD&A or the financial statements of--
    a. When the registrant began formulating exit plans for which 
accrual may be necessary,
    b. The types and amounts of liabilities recognized for exit costs 
and involuntary employee termination benefits and included in the 
acquisition cost allocation, and
    c. Any unresolved contingencies or purchase price allocation issues 
and the types of additional liabilities that may result in an 
adjustment of the acquisition cost allocation.
    The staff has noted that the economic or other events that cause a 
registrant to consider and/or adopt an exit plan or

[[Page 67160]]

that impair the carrying amount of assets, generally occur over time. 
Accordingly, the staff believes that as those events and the resulting 
trends and uncertainties evolve, they often will meet the requirement 
for disclosure pursuant to the Commission's MD&A rules prior to the 
period in which the exit costs and liabilities are recorded pursuant to 
GAAP. Whether or not currently recognizable in the financial 
statements, material exit or involuntary termination costs that affect 
a known trend, demand, commitment, event, or uncertainty to management, 
should be disclosed in MD&A. The staff believes that MD&A should 
include discussion of the events and decisions which gave rise to the 
exit costs and exit plan, and the likely effects of management's plans 
on financial position, future operating results and liquidity unless it 
is determined that a material effect is not reasonably likely to occur. 
Registrants should identify the periods in which material cash outlays 
are anticipated and the expected source of their funding. Registrants 
should also discuss material revisions to exit plans, exit costs, or 
the timing of the plan's execution, including the nature and reasons 
for the revisions.
    The staff believes that the expected effects on future earnings and 
cash flows resulting from the exit plan (for example, reduced 
depreciation, reduced employee expense, etc.) should be quantified and 
disclosed, along with the initial period in which those effects are 
expected to be realized. This includes whether the cost savings are 
expected to be offset by anticipated increases in other expenses or 
reduced revenues. This discussion should clearly identify the income 
statement line items to be impacted (for example, cost of sales; 
marketing; selling, general and administrative expenses; etc.). In 
later periods if actual savings anticipated by the exit plan are not 
achieved as expected or are achieved in periods other than as expected, 
MD&A should discuss that outcome, its reasons, and its likely effects 
on future operating results and liquidity.
    The staff often finds that, because of the discretionary nature of 
exit plans and the components thereof, presenting and analyzing 
material exit and involuntary termination charges in tabular form, with 
the related liability balances and activity (e.g., beginning balance, 
new charges, cash payments, other adjustments with explanations, and 
ending balances) from balance sheet date to balance sheet date, is 
necessary to explain fully the components and effects of significant 
restructuring charges. The staff believes that such a tabular analysis 
aids a financial statement user's ability to disaggregate the 
restructuring charge by income statement line item in which the costs 
would have otherwise been recognized, absent the restructuring plan 
(for example, cost of sales; selling, general, and administrative; 
etc.).
* * * * *
A.A. * * *
B.B. Inventory Valuation Allowances
    Facts: Accounting Research Bulletin No. 43 (ARB 43), Chapter 4, 
Statement 5, specifies that: ``A departure from the cost basis of 
pricing the inventory is required when the utility of the goods is no 
longer as great as its cost. Where there is evidence that the utility 
of goods, in their disposal in the ordinary course of business, will be 
less than cost, whether due to physical obsolescence, changes in price 
levels, or other causes, the difference should be recognized as a loss 
of the current period. This is generally accomplished by stating such 
goods at a lower level commonly designated as market.''
    Footnote 2 to that same chapter indicates that ``In the case of 
goods which have been written down below cost at the close of a fiscal 
period, such reduced amount is to be considered the cost for subsequent 
accounting purposes.''
    Lastly, Accounting Principles Board Opinion No. 20, Accounting 
Changes, provides ``inventory obsolescence'' as one of the items 
subject to estimation and changes in estimates under the guidance in 
paragraphs 10-11 and 31-33 of that standard.
    Question: Does the write-down of inventory to the lower of cost or 
market, as required by ARB 43, create a new cost basis for the 
inventory or may a subsequent change in facts and circumstances allow 
for restoration of inventory value, not to exceed original historical 
cost?
    Interpretive Response: Based on ARB 43, footnote 2, the staff 
believes that a write-down of inventory to the lower of cost or market 
at the close of a fiscal period creates a new cost basis that 
subsequently cannot be marked up based on changes in underlying facts 
and circumstances.\17\
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    \17\ See also disclosure requirements for inventory balances in 
Rule 5-02-6 of Regulation S-X.
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C.C. Impairments
    Standards for recognizing and measuring impairment of the carrying 
amount of long-lived assets, certain identifiable intangibles, and 
goodwill related to those assets to be held and used are found in 
Statement of Financial Accounting Standards No. 121, Accounting for the 
Impairment of Long-Lived Assets and for Long-Lived Assets to Be 
Disposed Of (SFAS 121). Additional guidance related to goodwill 
impairment is also provided in Accounting Principles Board (APB) 
Opinion No. 17, Intangible Assets (APB 17). The FASB currently has 
active projects addressing both SFAS 121 and APB 17 issues. The staff 
will reconsider the guidance provided below upon completion of those 
projects.
    Facts: Company X has mainframe computers that are to be abandoned 
in six to nine months as replacement computers are put in place. The 
mainframe computers were placed in service in January 19X0 and were 
being depreciated on a straight-line basis over seven years. No salvage 
value had been projected at the end of seven years and the original 
cost of the computers was $8,400. The board of directors, with the 
appropriate authority, approved the abandonment of the computers in 
March 19X3 when the computers had a remaining carrying value of $4,600. 
No proceeds are expected upon abandonment. Abandonment cannot occur 
prior to the receipt and installation of replacement computers, which 
is expected prior to the end of 19X3. Management had begun reevaluating 
its mainframe computer capabilities in January 19X2 and had included in 
its 19X3 capital expenditures budget an estimated amount for new 
mainframe computers. The 19X3 capital expenditures budget had been 
prepared by management in August 19X2, had been discussed with the 
company's board of directors in September 19X2 and was formally 
approved by the board of directors in March 19X3. Management had also 
begun soliciting bids for new mainframe computers beginning in the fall 
of 19X2. The mainframe computers, when grouped with assets at the 
lowest level of identifiable cash flows, were not impaired on a ``held 
and used'' basis throughout this time period. Management had not 
adjusted the original estimated useful life of the computers (seven 
years) since 19X0.
    Question 1: Company X proposes to recognize an impairment charge 
under SFAS 121 for the carrying value of the mainframe computers of 
$4,600 in March 19X3. Does Company X meet the requirements in SFAS 121 
to classify the mainframe computer assets as ``to be disposed of?''
    Interpretive Response: No. SFAS 121, paragraph 15, provides that 
when management, having the authority to approve the action, has 
committed to a plan to dispose of the assets, whether by

[[Page 67161]]

sale or abandonment, the assets to be disposed of should be reported at 
the lower of carrying amount or fair value less cost to sell. The staff 
believes that registrants must also consider the criteria in APB 
Opinion No. 30, Reporting the Results of Operations--Reporting the 
Effects of Disposal of a Segment of a Business, and Extraordinary, 
Unusual and Infrequently Occurring Events and Transactions (APB 30), 
paragraph 14, and Emerging Issues Task Force Issue No. 94-3, Liability 
Recognition for Certain Employee Termination Benefits and Other Costs 
to Exit an Activity (Including Certain Costs Incurred in a 
Restructuring) (EITF 94-3) to determine whether a plan is sufficiently 
robust to designate the assets as assets to be disposed of. APB 30 and 
EITF 94-3 require a plan to have the following characteristics:
     Prior to the date of the financial statements, management 
having the appropriate level of authority approves and commits the 
enterprise to a formal plan of disposal, whether by sale or 
abandonment;
     The plan specifically identifies all major assets to be 
disposed of, significant actions to be taken to complete the plan, 
including the method of disposition and location of those activities, 
and the expected date of completion;
     There is an active program to find a buyer if disposal is 
to be by sale;
     Management can estimate proceeds to be realized on 
disposal;
     Actions required by the plan will begin as soon as 
possible after the commitment date; and
     The period of time to complete the plan indicates that 
significant changes to the plan are not likely.
    The staff believes that a necessary condition of a plan to dispose 
of assets in use is that management have the current ability to remove 
the assets from operations. For example, the staff believes that the 
above fact pattern would not qualify as a plan of disposal under SFAS 
121 in March 19X3 because the mainframe computer assets cannot be taken 
out of service and abandoned prior to installing the new, but not yet 
available, mainframe computers. The operational requirement to continue 
to use the assets is indicative that the assets are still held for use. 
The staff does not intend this guidance to mean that assets to be sold 
must be removed from service in order to be designated as assets held 
for disposal. Rather, the company must be able to remove the assets 
from service upon identification of a buyer or receipt of an acceptable 
bid, but the assets can otherwise remain in service provided the 
criterion in SFAS 121 has been met. If a buyer is found and an 
acceptable offer is received, but the assets must be retained by the 
seller for some period due to ongoing operational needs, the criterion 
for ``to be disposed of'' treatment has not been met.
    The staff also believes that an active program to find a buyer 
exists only if the marketing effort commenced promptly after the 
commitment date and continued unabated until the sale was accomplished.
    Question 2: Would the staff accept an adjustment to write down the 
carrying value of the computers to reflect a ``normalized 
depreciation'' rate for the period from March 19X3 through actual 
abandonment (e.g., December 19X3)? Normalized depreciation would 
represent the amount of depreciation otherwise expected to be 
recognized during that period without adjustment of the asset's useful 
life, or $1,000 ($100/month for ten months) in the example fact 
pattern.
    Interpretive Response: No. Whether the mainframe computers are 
viewed as ``to be disposed of'' or ``held and used'' at March 19X3, 
there is no basis under SFAS 121 to write down an asset to an amount 
that would subsequently result in a ``normalized depreciation'' charge 
through the disposal date. For an asset that meets the requirements to 
be classified as ``to be disposed of'' under SFAS 121, paragraph 15 of 
that standard requires the asset to be valued at the lower of carrying 
amount or fair value less cost to sell. For assets that are classified 
as ``held and used'' under SFAS 121, an assessment must first be made 
as to whether the asset is impaired. Paragraph 6 of SFAS 121 indicates 
that an impairment loss should be recognized only if the sum of the 
expected future cash flows (undiscounted and without interest charges) 
is less than the carrying amount of the asset(s) grouped at the lowest 
level of identifiable cash flows. If an impairment loss is to be 
recognized for an asset to be ``held and used,'' it is measured as the 
amount by which the carrying amount of the asset exceeds the fair value 
of the asset. The staff would object to a write down of long-lived 
assets to a ``normalized depreciation'' value as representing an 
acceptable alternative to the approaches required in SFAS 121.
    The staff also believes that registrants must continually evaluate 
the appropriateness of useful lives assigned to long-lived assets, 
including identifiable intangible assets and goodwill.\18\ In the above 
fact pattern, management had contemplated removal of the mainframe 
computers beginning in January 19X2 and, more formally, in August 19X2 
as part of compiling the 19X3 capital expenditures budget. At those 
times, at a minimum, management should have reevaluated the original 
useful life assigned to the computers to determine whether a seven year 
amortization period remained appropriate given the company's current 
facts and circumstances, including ongoing technological changes in the 
market place. This reevaluation process should have continued at the 
time of the September 19X2 board of directors' meeting to discuss 
capital expenditure plans and, further, as the company pursued 
mainframe computer bids. Given the contemporaneous evidence that 
management's best estimate during much of 19X2 was that the current 
mainframe computers would be removed from service in 19X3, the 
depreciable life of the computers should have been adjusted prior to 
19X3 to reflect this new estimate. The staff does not view the 
recognition of an impairment charge to be an acceptable substitute for 
choosing the appropriate initial amortization or depreciation period or 
subsequently adjusting this period as company or industry conditions 
change. The staff's view applies also to selection of, and changes to, 
estimated residual values. Consequently, the staff may challenge 
impairment charges for which the timely evaluation of useful life and 
residual value cannot be demonstrated.
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    \18\ See APB 17, paragraph 31, and SFAS 121, paragraph 6 and 
footnote 1.
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    Question 3: Although the carrying amount of goodwill related to 
assets to be held and used must be assessed for impairment in 
conformity with SFAS 121, paragraph 107 of that standard observes that 
cost of goodwill that is not identified with impaired assets (i.e., 
``enterprise level'') continues to be accounted for under APB 17. 
Companies are required by paragraph 31 of APB 17 to evaluate 
continually whether events and circumstances warrant revised estimates 
of useful lives or recognition of a charge-off of carrying amounts. APB 
17 does not specify a particular quantitative methodology for measuring 
the existence or extent of an impairment. What methodologies are 
acceptable for determining impairment of ``enterprise level'' goodwill 
under APB 17?
    Interpretive Response: Several methodologies have evolved for 
measuring impairment of enterprise level goodwill under APB 17. These

[[Page 67162]]

methodologies appear to fall within three general categories: market 
value method, undiscounted cash flows methods, and discounted cash 
flows methods. A market value method compares the enterprise's net book 
value to the value indicated by the market price of its equity 
securities; if net book value exceeds market capitalization, the excess 
carrying amount of goodwill is written off. Cash flow methods employ 
forecasts of the enterprise's future cash flows, with comparison of the 
enterprise's net book value to (a) aggregate cash flow, or (b) the 
present value of those cash flows. The staff has observed variations in 
practice with respect to when a registrant will recognize an impairment 
of the carrying amount of enterprise goodwill depending on which of 
these methods is applied, how an enterprise's capitalization will be 
considered in cash flow forecasts, and how the discount rate is 
selected.
    Regardless of the method used and the diversity in application of 
some of those methods, the staff believes that the evaluation of 
enterprise level goodwill cannot occur at a level which does not 
include all of the operations which benefit directly from that acquired 
intangible. If an acquired business has been managed as a separate 
business unit, the business unit may be the appropriate level to 
evaluate the related goodwill. In contrast, if the acquired business 
has been fully integrated into the registrant's operations, evaluation 
of the purchased goodwill would be appropriate only at the level of the 
registrant as a whole.
    Question 4: A registrant's method of assessing and measuring the 
impairment of enterprise level goodwill under APB 17 is an accounting 
policy subject to APB Opinion No. 22, Disclosure of Accounting Policies 
(APB 22).\19\ What disclosures would the staff expect regarding the 
method selected?
---------------------------------------------------------------------------

    \19\ See also APB Opinion No. 12, Omnibus Opinion--1967, 
regarding disclosure requirements for depreciable assets.
---------------------------------------------------------------------------

    Interpretive Response: Until diversity in practice is reduced, a 
company that reports material amounts of unamortized cost of goodwill 
or that recognizes material amounts of goodwill amortization should 
describe the manner in which the carrying amount of enterprise level 
goodwill is assessed for recoverability and how and when any impairment 
would be measured. Materiality is to be assessed based on the 
relationship of the unamortized asset balance to other financial 
position measurements (including shareholders' equity) or of the 
relationship of the amortization expense to income statement 
measurements.
    The staff believes that the policy adopted by the company, and the 
description of that policy included in the financial statements, should 
be explicit and refer to objective, rather than discretionary, factors. 
The staff would expect the following to be addressed:
     What conditions would trigger an impairment assessment of 
the carrying amount of enterprise level goodwill;
     What method--market value, discounted or undiscounted cash 
flows--would be used to measure an impairment;
     How the method would be implemented, including how 
interest charges would be considered in the assessment, how the 
discount rate would be selected, and other significant aspects of the 
policy.
    When there is a change in the method used to assess the carrying 
value of goodwill, the Commission's rules \20\ require a preferability 
letter from the company's auditors. The staff does not believe that it 
would be appropriate to rely on the guidance in SFAS 121 concerning 
impairments of long-lived assets to justify preferability of changes in 
the method of evaluating impairment of the carrying amount of 
enterprise level goodwill. For example, a company that previously 
changed from an undiscounted cash flow method to assess recoverability 
of enterprise level goodwill to a method that uses discounted cash flow 
could not justify a change back to an undiscounted cash flow method by 
reference to SFAS 121. The staff believes that, generally, a discounted 
cash flows approach is preferable to an undiscounted cash flows 
approach and a market value approach is preferable to using a 
discounted cash flows approach, assuming that market value is reliably 
determinable.
---------------------------------------------------------------------------

    \20\ See Rule 10-01(b)(6) of Regulation S-X.
---------------------------------------------------------------------------

    The staff believes that an impairment triggered by a change in 
accounting policy should be treated as a change in accounting principle 
inseparable from a change in estimate.\21\ The impairment charge should 
be presented as a change in estimate within operating income (or loss) 
and not as the cumulative effect of a change in accounting principle.
---------------------------------------------------------------------------

    \21\ See paragraph 32 of APB Opinion No. 20, Accounting Changes.
---------------------------------------------------------------------------

    Facts: Company A acquires 100 percent of Company B in a purchase 
business combination, with Company B becoming a wholly owned subsidiary 
of Company A. The acquisition cost of $1,000 is pushed down to Company 
B's financial records, resulting in an allocation of $300 to fixed 
assets, $600 to goodwill, and $100 to other net assets. The fixed 
assets are composed entirely of four manufacturing facilities.
    Two years after the acquisition, Company A commits to a 
reorganization plan that calls for the relocation of Company B's 
manufacturing operations to facilities separately owned and operated by 
Company A. Company B's line of products will continue to be marketed. 
There will be no reduction in the level of output of Company B's 
products as a result of the relocation, nor will there be any 
diminution in expected profitability in future years. That level of 
profitability is expected to recover the remaining cost of the 
unamortized goodwill. Company A has committed to dispose of the 
manufacturing facilities of Company B and has met all of the criteria 
necessary to classify those assets as ``to be disposed of'' under SFAS 
121. Company A expects to realize $200 in net proceeds from the sale of 
the four manufacturing facilities. The current carrying amounts for the 
facilities and goodwill are $280 and $480, respectively, which are not 
impaired on a ``held and used'' basis.
    Question 5: Is it appropriate to recognize an impairment loss of 
$560 ($280+$480-$200) based on the excess of the carrying amount of 
goodwill and fixed assets over net sales proceeds?
    Interpretive Response: No. An impairment loss can be recognized 
only for the $80 loss ($280-$200) on the sale of the facilities. 
Paragraph 123 of SFAS 121 indicates that goodwill related to assets to 
be disposed of by an entity should be accounted for under the 
provisions of APB 17, paragraph 32, which states:
    ``Ordinarily goodwill and similar intangible assets cannot be 
disposed of apart from the enterprise as a whole. However, a large 
segment or separable group of assets of an acquired company or the 
entire acquired company may be sold or otherwise liquidated, and all or 
a portion of the unamortized cost of the goodwill recognized in the 
acquisition should be included in the cost of the assets sold.''
    In the above fact pattern, the staff believes that the operations 
and business of Company B, which supported the initial premium 
resulting in the recognition of goodwill, were not diminished by the 
disposition of solely physical facilities. The underlying operations, 
customer relationships, future revenue streams, and business outlook 
remained intact and, as a result, the staff believes that it is 
inappropriate to treat the disposition of manufacturing

[[Page 67163]]

facilities as if the business itself had been disposed of. The staff 
would object to the allocation of goodwill to the disposed 
manufacturing facilities.
    Paragraph 19 of SFAS 121 requires disclosure of the results of 
operations of assets held for disposal. If revenues attributable to 
assets to be disposed of, that remain in operation for some period of 
time prior to their disposal, cannot be segregated because 
substantially the same revenues will continue after the assets are 
disposed of, the amount of the benefit from suspending depreciation, in 
accordance with SFAS 121, paragraph 16, should be disclosed. The effect 
associated with assets held for disposal should be discussed in 
Management's Discussion and Analysis (MD&A), if material.
    Facts: Assume the same fact pattern as for Question 5, except that 
the four manufacturing facilities will be shut down, but not disposed 
of or abandoned. The four manufacturing facilities do not meet the 
criteria necessary to be classified as ``to be disposed of'' under SFAS 
121 but are impaired on a ``held and used'' basis under SFAS 121. 
Company A intends to retain the four facilities in case the need arises 
in the future for further manufacturing capacity.
    Question 6: Would the staff object to the company's proposal to 
recognize an impairment loss based on the excess of the carrying amount 
of goodwill and fixed assets over fair value?
    Interpretive Response: Yes. Paragraph 12 of SFAS 121 specifies: 
    ``If an asset being tested for recoverability was acquired in a 
business combination accounted for using the purchase method, the 
goodwill that arose in that transaction shall be accounted for as part 
of the asset grouping * * * in determining recoverability. If some but 
not all of the assets acquired in that transaction are being tested, 
goodwill shall be allocated to the assets being tested for 
recoverability on a pro rata basis using the relative fair values of 
the long-lived assets and identifiable intangibles acquired at the 
acquisition date unless there is evidence to suggest that some other 
method of associating the goodwill with those assets is more 
appropriate.''
    In the above fact pattern, the staff believes that it is 
inappropriate to allocate the carrying amount of the goodwill balance 
to the four facilities being evaluated for impairment. In this 
instance, the goodwill that existed at the time Company B was acquired 
principally was the result of a customer base, marketing activities, 
existing product lines and new products being developed. It did not 
relate to the fixed assets but, rather, the ongoing operations of the 
business, which have not been reduced in any way. The goodwill 
represents the inherent value of the going concern element of Company B 
and the ability of the entity to generate a return in excess of the 
return that could be generated on the acquired assets individually, all 
of which are still in place. The staff contrasts this scenario with one 
where facilities are eliminated in conjunction with a subsequent 
decision to abandon the product or business line housed in those 
facilitites. If the revenue producing activity and the facilities had 
been acquired in a business combination giving rise to recognition of 
goodwill, a portion of goodwill should be allocated to the facilities 
based on their relative fair value, unless another allocation method is 
more appropriate.
    Question 7: Has the staff expressed any views with respect to 
company-determined estimates of cash flows used for assessing and 
measuring impairment of assets under SFAS 121?
    Interpretive Response: In providing guidance on the development of 
cash flows for purposes of applying the provisions of SFAS 121, 
paragraph 9 of that standard indicates that estimates of expected 
future cash flows should be the best estimate based on reasonable and 
supportable assumptions and projections. Additionally, paragraph 9 
indicates that all available evidence should be considered in 
developing estimates of expected future cash flows and that the weight 
given to the evidence should be commensurate with the extent to which 
the evidence can be verified objectively.
    The staff recognizes that various factors, including management's 
judgments and assumptions about the business plans and strategies, 
affect the development of future cash flow projections for purposes of 
applying SFAS 121. The staff, however, cautions registrants that the 
judgments and assumptions made for purposes of applying SFAS 121 must 
be consistent with other financial statement calculations and 
disclosures and disclosures in MD&A. The staff also expects that 
forecasts made for purposes of applying SFAS 121 be consistent with 
other forward-looking information prepared by the company, such as that 
used for internal budgets, incentive compensation plans, discussions 
with lenders or third parties, and/or reporting to management or the 
board of directors.
    For example, the staff has reviewed a fact pattern where a 
registrant developed cash flow projections for purposes of applying the 
provisions of SFAS 121 using one set of assumptions and utilized a 
second, more conservative set of assumptions for purposes of 
determining whether deferred tax valuation allowances were necessary 
when applying the provisions of Statement of Financial Accounting 
Standards No. 109, Accounting for Income Taxes. In this case, the staff 
objected to the use of inconsistent assumptions.
    In addition to disclosure of key assumptions used in the 
development of cash flow projections, the staff also has required 
discussion in MD&A of the implications of assumptions. For example, do 
the projections indicate that a company is likely to violate debt 
covenants in the future? What are the ramifications to the cash flow 
projections used in the impairment analysis? If growth rates used in 
the impairment analysis are lower than those used by outside analysts, 
has the company had discussions with the analysts regarding their 
overly optimistic projections? Has the company appropriately informed 
the market and its shareholders of its reduced expectations for the 
future that are sufficient to cause an impairment charge? The staff 
believes that cash flow projections used in the impairment analysis 
must be both internally consistent with the company's other projections 
and externally consistent with financial statement and other public 
disclosures.
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[FR Doc. 99-31160 Filed 11-30-99; 8:45 am]
BILLING CODE 8010-01-P