1. Restructuring (Part of the earnings management bag of tricks)

2. Overview What is restructuring? Why can (did/does) it cause financial reporting problems? The SEC becomes involved Relevant accounting literature Restructuring was/is

3. 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

4. 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

5. 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

6. Restructuring in Practice Annual Sales $19748 Annual Net Income $882 4th Q 1993 Charge $1,800 GTE Communications - Telecommunications ($ in Millions) “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

7. Restructuring in Practice Annual Sales $7,142 Annual Net Income $(439) 3th Q 1993 Charge $642 Borden - Food and Non-Consumer Products ($ in Millions) Charge includes costs to: Unify businesses Modernize and integrate product presentation Remedy problems in under performing businesses and reduce costs

8. Restructuring in Practice Annual Sales $9,622 Annual Net Income $(495) 3th Q 1993 Charge $775 Woolworth - Merchandise Stores ($ in Millions) Charge includes costs of: Termination benefits - 13,000 workforce reduction Redesign or close stores Asset and inventory write downs Leases and occupancy costs

9. Restructuring in Practice Annual Sales $3,970 Annual Net Income $(1720) 3th Q 1993 Charge $225 Flagstar Companies, Inc. - Food Services Enterprises ($ in Millions) Charge includes costs of: Termination benefits Closure of facilities Relocation and training Systems development costs

10. SEC Reactions 1993 - Problem identified: –One-line presentations, net of tax Solution: –SAB 67:SAB 67 Include charges in continuing operations No net-of-tax presentation –Warning and comment letters –Mandatory restatements

11. 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

12. Restatements Mandated by SEC Examples: –Borden –Flagstar –Woolworth

13. 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

14. 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)

15. Restructuring Restatements Woolworth Restated 1993 Quarterly Results Reduced repositioning reserve by $217 million Inventory markdowns Other normal operating costs

16. Relevant Accounting Standards Employee Termination Benefits: –FAS 112; 43; 5; and 88 Other restructuring costs: –APB 30; FAS 5 –EITF 94-3

17. FASB Statement 112: Tests Rights arise from service? Rights vest or accumulate? Payment probable? Payment estimable? Yes to allNo to any Accrue over employee service life Apply Statement 5, Accrue upon loss event

18. FASB Statement 88 Special termination benefits employee accepts Contractual termination benefits

19. 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

20. 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

21. 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)

22. 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

23. Restructuring Was

24. Restructuring Is

25. Restructuring Was/Is