Chapter 6: Termination benefits

Termination benefits result from either:

• an entity’s decision to terminate an employee’s employment (compulsory termination benefits); or
• an employee’s decision to accept an offer of voluntary redundancy in exchange for those benefits (voluntary termination benefits).

Characteristics of termination benefits Termination benefits do not include employee benefits resulting from the termination of employment at the request of the employee without an entity’s offer, or as a result of mandatory retirement requirements, because those benefits are post-employment benefits. In broad terms, termination benefits are amounts payable in return for an employee ceasing to work for an employer. In this context, they are similar to post-employment benefits, such as pensions. However, whereas post-employment benefits are earned throughout an employee’s working life, termination benefits arise as a result of an event, such as a factory closure or a decision to reduce the size of the workforce. The event that gives rise to an obligation is the termination, rather than employee service. Termination benefits are not earned, although their magnitude might be set by reference to an employee’s period of service. The events that give rise to termination benefits might cause the entity to award other benefits that do not represent termination benefits – For example, the awarding of a stay bonus that incentivises the employee to remain in service to the company until the end of the period of termination. The cost of the stay bonus should be accrued over the period of service. Typically, termination benefits comprise lump sum payments, although they could take other forms such as retention of a company car. Termination benefits also include: Pension enhancements. ‘Gardening leave’ (that is, salary until the end of a specified notice period during which the employee renders no further service). Sometimes, it can be difficult to determine whether a particular benefit should be classified as a termination benefit or a post-employment benefit. As a guide, termination benefits generally have three characteristics: The benefits are offered for a clearly defined period. There is no legal or constructive obligation on the employer to extend the closing date, although extensions might be made, at the employer’s discretion. Repeated practice of doing this is likely to establish a constructive obligation. There is no linking of the amount of the benefit to length of future service.

Termination benefits do not include employee benefits resulting from the voluntary departure of the employee without an offer from the entity, or as a result of mandatory retirement requirements. Those benefits are post-employment benefits.

An employee benefit is provided in exchange for services, rather than termination, if the benefit is conditional on future services being provided or the benefit is provided in accordance with the terms of an employee benefit plan.

Treatment of benefits that become payable as a result of the early termination of an employee’s employment by the employer Question: Do past service costs include benefits that become payable as a result of the early termination of an employee’s employment by the employer? Solution: Past service costs exclude benefits that become payable as a result of the early termination of an employee’s employment by the employer. The cost of enhanced pension benefits is, in effect, treated as termination payments rather than past service costs where employees made redundant are granted enhanced pension benefits (say, for early retirement) in lieu of or in addition to redundancy payments. The increase in the defined benefit obligation would be an actuarial loss, if the early retirement benefits were available in the event that the employee had chosen to leave rather than being made redundant.

Employee benefits provided in accordance with the terms of an employee benefit plan are termination benefits if they both result from an entity’s decision to terminate an employee’s employment and are not conditional on future services being provided.

A benefit that is provided regardless of the reason for the employee’s departure, the payment of which is certain but the timing uncertain, is a post-employment benefit rather than a termination benefit.

Statutory payments to employees leaving after five years’ service Entity A operates in country C. Local labour laws require payments to be made to employees leaving the entity for any reason after five years’ service. The amounts payable is determined by reference to final salary and length of service. Benefits will, therefore, be payable to the workforce, but these will not be termination benefits as defined in IAS 19. The benefits are earned during an employee’s working life, and the entity is obliged to pay them, regardless of the reason for the employee’s departure. If the employee works for entity A for at least five years, only the timing of the payment is uncertain. Hence, these benefits are treated as post-employment benefits and accounted for as such.

Voluntary redundancy payments Entity B operates in country C. Local labour laws require payments to be made to employees leaving the entity for any reason after five years’ service. However, in connection with a voluntary redundancy programme, entity B has agreed to make additional payments to those employees who accept the offer of voluntary redundancy. These additional payments will represent termination benefits, as defined in IAS 19, because the entity had no obligation to make the payments until it made the decision to instigate the voluntary redundancy programme.

Redundancies following restructuring The board of an entity has announced two major restructuring plans and, in both cases, has communicated details of the redundancy package to the staff affected: Sale of half of the entity’s global manufacturing business over a two-year period, starting immediately. This will involve the immediate redundancy of 15% of the machine workers in each factory, and 10% of the middle management at each location. Re-organisation of the head office over a one-year period, commencing in two years’ time; 20% of the head office staff will lose their jobs during the restructuring. As regards the sale of the manufacturing business, a provision should be recognised for the estimated costs of the disposal and redundancy. The sites and details of the redundancy and other costs have been identified and communicated. The scale and complexity of the disposal requires it to be completed over an extended period. Disposal activities and recognition of costs for the restructuring will begin immediately. Two years is the time necessary to complete the disposal, and it should not prevent the provision from being recognised. In contrast, the entity should not recognise a provision for the head office’s reorganisation. The re-organisation is not due to start for two years. External parties are unlikely to have a valid expectation that management is committed to the restructuring, because the timeframe allows significant opportunities for management to change the details of the plan or even to withdraw from the offer of benefits under the plan. Additionally, the degree of identification of the staff to lose their jobs is not sufficient to support recognising a redundancy provision. Details of the departments within head office that will be affected should be identified, together with the approximate numbers of staff from each department.

Voluntary redundancy payment with a time limit Entity A restructures its operations in a particular location. It agrees with trade unions, during December 20X3, a plan to reduce staff numbers in that location by 100 by February 20X4. Also, in December 20X3, management communicated an offer of C5,000 for voluntary redundancy to be accepted by the end of January 20X4. The offer for any remaining employees can be withdrawn at any time. If sufficient staff do not accept the offer, management will terminate the employment of additional staff to reach the target of 100. Employees whose employment is terminated involuntarily are entitled to a termination payment of C4,000 each. At 31 December 20X3, 60 employees have accepted the voluntary termination offer, amounting to a liability of C300,000 (60 employees × C5,000). A further C160,000 (40 employees × C4,000) is recognised as an additional liability, because management is demonstrably committed to the plan to terminate 100 staff. A contingent liability of C40,000, for the additional amount that would be payable if the maximum number of employees accepted the termination voluntarily, should also be disclosed.

Termination benefits: recognition

An entity should recognise a liability and expense for termination benefits at the earlier of the following dates:

• when the entity can no longer withdraw the offer of those benefits; and
• when the entity recognises costs for a restructuring that is within the scope of IAS 37 and involves the payment of termination benefits.

Termination benefits can be either voluntary, where the employer offers benefits to encourage employees to choose to leave, or compulsory, where the employer determines which employees will be terminated.

For voluntary termination benefits, the point in time when an entity can no longer withdraw the offer of termination benefits is the earlier of:

• when the employee accepts the offer; and
• when a restriction (for example, a legal, regulatory or contractual requirement or other restriction) on the entity’s ability to withdraw the offer takes effect. This would be when the offer is made, if the restriction existed at the time of the offer.

For compulsory termination benefits, the entity can no longer withdraw the offer of termination benefits once it has communicated to the affected employees a plan of termination that meets all of the following criteria:

• Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made.
• The plan identifies the number of employees whose employment is to be terminated, their job classifications or functions and their locations (but the plan need not identify each individual employee) and the expected completion date.
• The plan establishes the termination benefits that employee will receive in sufficient detail that employees can determine the type and amount of benefits that they will receive when their employment is terminated.

An entity that recognises termination benefits should consider whether it also has a plan amendment or a curtailment of other employee benefits to account for.

Termination benefits: measurement

An entity should measure termination benefits on initial recognition, and it should measure and recognise subsequent changes, in accordance with the nature of the employee benefit. Termination benefits that are an enhancement to post-employment benefits are accounted for as post-employment benefits. Otherwise:

• If the termination benefits are expected to be settled wholly before 12 months after the end of the annual reporting period in which the termination benefit is recognised, the entity should apply the requirements for short-term employee benefits.
• If the termination benefits are not expected to be settled wholly before 12 months after the end of the annual reporting period, the entity should apply the requirements for other long-term employee benefits. The amounts recognised as a provision should be measured at the expected amounts to be paid, and they should be discounted where they are long term. Because termination benefits are not provided in exchange for service, IAS 19 relating to the attribution of the benefit to periods of service are not relevant.

Use of discount rate in computing provision for redundancy Entity A’s management has decided to make 250 staff redundant within the next year. However, the costs of the redundancy will arise over a longer period and are expected to be C20 million, payable as C8 million in one year’s time and C12 million in two years’ time. The market yield for high-quality corporate bonds of both a one-year and a two-year duration at 31 December 20X1 is 5.5%. Management should recognise the cost of the redundancy provision at the present value of the future cash flows of C18,364,360: Year 1 Year 2 Total Cash flows C8,000,000 C12,000,000 C20,000,000 Discount factor (5.5%) 0.94787 0.89845 Present value of cash flows C7,582,960 C10,781,400 C18,364,360 Interest expense C1,635,640 The difference between the undiscounted cash flows and their present value of C1,635,640 will be recognised in the income statement over years 1 and 2 as the discount accretes.

Accounting for termination benefits IAS 19 provides an example illustrating the requirements for accounting for termination benefits, as summarised below. Management is committed to close a factory in 10 months and, at that time, it will terminate the employment of all of the remaining employees at the factory. Management needs the expertise of the employees at the factory to complete existing contracts, and it announces the following plan. Each employee that renders service until the factory closure will receive, on the termination date, a cash payment of C30,000. Employees leaving before the factory closure will receive C10,000. There are 120 employees at the factory. Management expects 20 employees to leave before closure. The total expected cash outflows under the plan are C3,200,000 (20 × C10,000 + 100 × C30,000). The entity accounts for benefits provided in exchange for termination of employment as termination benefits; and it accounts for benefits provided in exchange for services as short-term employee benefits. Termination benefits The benefit provided in exchange for termination of employment is C10,000, which the entity would have to pay for terminating the employment without any future service. The entity recognises a liability of C1,200,000 (120 employees × C10,000) for the termination benefits at the earlier of when the plan of termination is communicated to the affected employees and when the entity recognises the restructuring costs associated with the factory closure. Benefits provided in exchange for services The incremental benefits that employees will receive if they provide services for the 10-month period are given in exchange for services provided over that period. They are accounted for as short-term employee benefits, because the entity expects to settle them within 12 months after the end of the annual reporting period. In this example, discounting is not required, so an expense of C200,000 (100 employees × C20,000 ÷ 10) is recognised in each month during the service period of 10 months, with a corresponding increase in the carrying amount of the liability.