Definition of Restructuring Cost
Restructuring cost is the one-time cost or expenses incurred by the company for reorganizing its operations to increase future profitability and efficiency. Restructuring cost is considered as non-operating expenses and is not expected to be incurred again in the near future. But they are included in the income statement as non-recurring operating expenses to calculate the net income for a specified period of time.
Explanation
Restructuring costs are incurred by the company due to different reasons, like when the firm is looking at merger and acquisition with/of other company, when the company is looking for downsizing of the operations or selling a partial business, laying off of the employees or moving of asset in some other location. Restructuring charges include cash cost, asset written off, liabilities accrued, employee severance pay, etc.
Usually, companies that choose to incur the restructuring cost are in significant problems, therefore, to revive their situation and improve the expected profitability in the future, they are ready to pay additional upfront restructuring cost. It does not impact the share price of the company because it is treated as one-time or non-frequent charges. Details of the restructuring charges are also mentioned in the footnote to the financial statements of the company.
Example of Restructuring Cost
XYZ company has decided to make certain changes to its operations. It has incurred the following restructuring expenses:
- Severance checks to employees: $200,000
- Shifting of assets to a different location due to shut-down of plant: $100,000
- Installation of new machinery: $70,000
- Introduction of a new inventory management software: $50,000
Solution:
Total restructuring cost that would be reported in the income statement:
- ($200,000 +$100,000+$70,000+$50,000) = $420,000
Restructuring Cost on Income Statement
Restructuring costis not considered as operating expense but it is still included in the income statement as anon-recurring or onetime operating expense and affects the profit of the period. These charges are not expected to recur in the near future.
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Sometimes restructuring charges are purposely inflated by the creative accountants to create an expense reserve than can be used for offsetting future operating expenses. Therefore, it helps the company to get rid of losses through a one-time charge, clean out the books, and improve future profitability as well.
Restructuring Cost Provision
Restructuring provisions are recognized differently for different scenarios as per IAS 37 (IFRS- international financial reporting standards).
- Sale of Business: In case of sale of operation provision is recognized only after the sale agreement is binding and final.
- Reorganization of the Operation: If only the board decision is formalized, the provision cannot be recognized as it is not enough condition for recognition of restructuring of provision. The restructuring provision is to be recognized only when a detailed plan of reorganization is formulated or implemented or when it is announced to affected people.
- On Acquisition: Restructuring provision for acquisition is only recognized if an obligation exists at the date of the acquisition. No restructuring provision should be recognized for future operating losses. Restructuring provision should only include expenses to be incurred due to the restructuring process, not expenses relating to day to day business of the company. For creating the restructuring provision, restructuring provision account expense line item for P&L is debited and provision liability line item for the balance sheet is credited. The provision should be reviewed at each balance sheet date and adjusted as required.
Advantages of Restructuring Cost
Below are the advantages and disadvantages mentioned below:
Advantages
Advantages are as follows:
- When a company downsizes its business, its overall cost of maintaining the operations is decreased.
- Sometimes restructuring leads to the elimination of layers of management which consequently leads to better communication & decision making, simplified hierarchy and above all increased productivity.
- During restructuring companies introduce new technologies that lead to increased efficiency in its day to day operations.
Disadvantages
Disadvantages are as follows:
- The laying off of skilled employees in the restructuring process may lead to decreased productivity.
- Hiring new employees will increase the training and development expenses of the company.
- The laying off of employees during the restructuring process result can result in low working morale and insecurity of job among workers.
- When companies introduce new technology, the current employees will need to be retrained, and sometimes the complete process of performing the task is changed which hinders the rate of productivity.
Conclusion
All companies incur restructuring cost at one or other point of time, but it should be kept in mind that restructuring also means that the company was not able to support itself or was in a significant problem due to which the company has decided to incur an upfront huge cost to revive the current scenario and improve the future profitability.
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