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Restructuring

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					         Restructuring

(Part of the earnings management bag
               of tricks)
                Overview
• What is restructuring?
• Why can (did/does) it cause financial
  reporting problems?
• The SEC becomes involved
• Relevant accounting literature
• Restructuring was/is
      Restructuring Activities
• In the 1980’s and 90’s the term
  “Restructuring” became one of the major
  buzzwords, also known as
• “getting lean and mean”
• Purpose: to improve efficiency, restore
  international competitiveness, pay for
  leveraged buy-outs
    Restructuring consists of all or
       some of the following:
•   Closing plants
•   laying off employees
•   moving operations
•   reorganization of operations (very popular)
•   cost cutting, cost cutting, cost cutting
    Why can (did/does) it cause
   financial reporting problems?
• Restructuring is perceived to be good
• All costs even remotely (or sometimes not
  at all) associated with restructuring were
  reported as a separate line item (net of tax)
  on the income statement
  – (making it look like an extraordinary event)
• In some cases “restructuring” occurred year
  after year
                  Restructuring in Practice
GTE Communications - Telecommunications
($ in Millions)


   Annual Sales            4th Q 1993 Charge       Annual Net Income
       $19748                    $1,800                  $882



                     “Re-Engineering Plan” - 3 Years
   • Termination benefits - 17,000 workforce reduction
   •Consolidation of facilities
   •Upgrading/replacing customer service and admin. Systems
   •Enhance network software
   •Training
                  Restructuring in Practice
Borden - Food and Non-Consumer Products
($ in Millions)


   Annual Sales           3th Q 1993 Charge        Annual Net Income
       $7,142                    $642                   $(439)




                       Charge includes costs to:
    • Unify businesses
    • Modernize and integrate product presentation
    • Remedy problems in under performing businesses and reduce
    costs
                  Restructuring in Practice
Woolworth - Merchandise Stores
($ in Millions)


   Annual Sales             3th Q 1993 Charge       Annual Net Income
       $9,622                      $775                   $(495)




                          Charge includes costs of:
    • Termination benefits - 13,000 workforce reduction
    • Redesign or close stores
    • Asset and inventory write downs
    • Leases and occupancy costs
                  Restructuring in Practice
Flagstar Companies, Inc. - Food Services Enterprises
($ in Millions)


   Annual Sales              3th Q 1993 Charge          Annual Net Income
       $3,970                       $225                     $(1720)




                            Charge includes costs of:
    • Termination benefits
    • Closure of facilities
    • Relocation and training
    • Systems development costs
              SEC Reactions
• 1993 - Problem identified:
  – One-line presentations, net of tax
• Solution:
  – SAB 67:
     • Include charges in continuing operations
     • No net-of-tax presentation
  – Warning and comment letters
  – Mandatory restatements
           SEC Warning Letters:
“SEC wants explanation from firms planning
 to post restructuring losses” (WSJ, 2/25/94)
 Sent to 84 registrants that announced restructurings

• “Reminder” of specific 10K requirements:
   – Footnotes
      • Circumstances; material elements;
      • asset write-offs vs future cash outflows
   – MD&A
      • Current an expected effects
      • future progress and changes
Restatements Mandated by SEC
• Examples:

  – Borden
  – Flagstar
  – Woolworth
         Restructuring Restatements
“Borden to Reverse, Reclassify 40% of 1992 Charge”


 • Reversed $119 million
     • Canceled projects
     • Promotion accruals
 • Reclassified $145 million as marketing expense
 •Borden spokesman: “Truly incremental and related to one-time
 advertising and promotional program not occurring in the normal
 course of business
         Restructuring Restatements
Flagstar Cos. Restated 1993 Financial Results


 • Reduced reserve by $33 million
     • Training
     • Systems development
     •Future costs to improve image
 • Costs to be taken as incurred (normal operating expenses)
         Restructuring Restatements
Woolworth Restated 1993 Quarterly Results


 • Reduced repositioning reserve by $217 million
     • Inventory markdowns
     • Other normal operating costs
 Relevant Accounting Standards
• Employee Termination Benefits:
  – FAS 112; 43; 5; and 88
• Other restructuring costs:
  – APB 30; FAS 5
  – EITF 94-3
FASB Statement 112: Tests

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




           Yes to all                      No to any



Accrue over employee                      Apply Statement 5, Accrue
     service life                              upon loss event
FASB Statement 88

    •Special termination benefits
       •employee accepts
    •Contractual termination benefits
EITF 94-3

    •Only costs to exit existing activities
    •Involuntary employee termination benefits
    only if they are not under pre-existing or
    ongoing plan
    •Relocation costs
EITF 94-3

    •Provisions only appropriate for costs that:
       •are not associated with future revenue
       generations and have no future economic
       benefits
            •I.e., cannot include items such as
            advertising, training or system
            development
       •Have an incremental cost of obligation that
       existed prior to consummation date
EITF 94-3/Purchase Accounting

   •Criteria for Recognition:
   •Consummation date - beginning to assess and
   formulate restructuring plan
   •Plan is finalized - one year
   •Plan is specific
   •Period of time to complete plan indicates significant
   changes are not likely
      •(this is to ensure that so-called “restructuring” will
      not be a regular, annual event)
EITF 94-3/Purchase Accounting

   •Required Disclosures:
      •Major actions
      •Type and amount of exit costs accrued
      • Type and amount of exit cost charged to accrual
      •Adjustments
      •If exit plan is not finalized
          •Description of unresolved issues and types of
          potential liabilities
Restructuring Was

            90
            80
            70
            60
            50
 Net Income
            40
            30
            20
            10
             0
                 1   2     3       4      5   6
                         Fiscal Quarter
Restructuring Is

            90
            80
            70
            60
            50
 Net Income
            40
            30
            20
            10
             0
                 1   2     3       4      5   6
                         Fiscal Quarter
Restructuring Was/Is


                Restructuring Was    Restructuring Is
           90
           80
           70
           60
           50
Net Income
           40
           30
           20
           10
            0
                   1       2          3       4         5   6
                                    Fiscal Quarter

				
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