Question

The board of directors of KLM Pte Ltd (“KLM”) has decided on 18 December 20X1 to close its factory in Malaysia and move it to Vietnam. The decision was based on a detailed formal plan of re-structuring as required by FRS 37 “Provisions, Contingent Liabilities and Contingent Assets”. The decision was conveyed to the management personnel at the headquarters in Germany. The cost of restructuring the operation in Malaysia as per the plan was $700,000.

Illustrate and explain how KLM should treat this re-structuring in its financial statements for the year ended 31 December 20X1.

Answer 1

Financial Reporting Standard 37 "Provisions, Contingent Liabilities and Contingent Assets"

The objective of this Standard is to ensure that appropriate recognition criteria and measurement
bases are applied to provisions, contingent liabilities and contingent assets and that sufficient
information is disclosed in the notes to enable users to understand their nature, timing and amount.

1 This Standard shall be applied by all entities in accounting for provisions, contingent
liabilities and contingent assets, except:
(a) those resulting from executory contracts, except where the contract is onerous;
and
(b) [deleted]
(c) those covered by another Standard.
2 This Standard does not apply to financial instruments (including guarantees) that are within
the scope of SB-FRS 109 Financial Instruments.
3 Executory contracts are contracts under which neither party has performed any of its
obligations or both parties have partially performed their obligations to an equal extent. This
Standard does not apply to executory contracts unless they are onerous.
4 [Deleted]
5 When another Standard deals with a specific type of provision, contingent liability or
contingent asset, an entity applies that Standard instead of this Standard. For example, some
types of provisions are addressed in Standards on:
(a) [deleted]
(b) income taxes (see SB-FRS 12 Income Taxes);
(c) leases (see SB-FRS 116 Leases). However, this Standard applies to any lease that
becomes onerous before the commencement date of the lease as defined in SB-FRS
116. This Standard also applies to short-term leases and leases for which the
underlying asset is of low value accounted for in accordance with paragraph 6 of SBFRS 116 and that have become onerous;
(d) employee benefits (see SB-FRS 19 Employee Benefits);
(e) insurance contracts (see SB-FRS 104 Insurance Contracts). However, this Standard
applies to provisions, contingent liabilities and contingent assets of an insurer, other
than those arising from its contractual obligations and rights under insurance
contracts within the scope of SB-FRS 104;

(f) contingent consideration of an acquirer in a business combination (see SB-FRS 103
Business Combinations); and
(g) revenue from contracts with customers (see SB-FRS 115 Revenue from Contracts
with Customers). However, as SB-FRS 115 contains no specific requirements to
address contracts with customers that are, or have become, onerous, this Standard
applies to such cases.
SB-FRS 37
5
6 [Deleted]
7 This Standard defines provisions as liabilities of uncertain timing or amount. In some
countries the term ‘provision’ is also used in the context of items such as depreciation,
impairment of assets and doubtful debts: these are adjustments to the carrying amounts of
assets and are not addressed in this Standard.
8 Other Standards specify whether expenditures are treated as assets or as expenses. These
issues are not addressed in this Standard. Accordingly, this Standard neither prohibits nor
requires capitalisation of the costs recognised when a provision is made.
9 This Standard applies to provisions for restructurings (including discontinued operations).
When a restructuring meets the definition of a discontinued operation, additional disclosures
may be required by SB-FRS 105 Non-current Assets Held for Sale and Discontinued
Operations.

Restructuring

70 The following are examples of events that may fall under the definition of restructuring:

(a) sale or termination of a line of business;
(b) the closure of business locations in a country or region or the relocation of business
activities from one country or region to another;
(c) changes in management structure, for example, eliminating a layer of management;
and
(d) fundamental reorganisations that have a material effect on the nature and focus of the
entity’s operations.

71 A provision for restructuring costs is recognised only when the general recognition criteria for

provisions set out in paragraph 14 are met. Paragraphs 72–83 set out how the general
recognition criteria apply to restructurings.

72 A constructive obligation to restructure arises only when an entity:

(a) has a detailed formal plan for the restructuring identifying at least:
(i) the business or part of a business concerned;
(ii) the principal locations affected;
(iii) the location, function, and approximate number of employees who will be
compensated for terminating their services;
(iv) the expenditures that will be undertaken; and
(v) when the plan will be implemented; and

(b) has raised a valid expectation in those affected that it will carry out the
restructuring by starting to implement that plan or announcing its main features
to those affected by it.

73. Evidence that an entity has started to implement a restructuring plan would be provided, for
example, by dismantling plant or selling assets or by the public announcement of the main
features of the plan. A public announcement of a detailed plan to restructure constitutes a
constructive obligation to restructure only if it is made in such a way and in sufficient detail (ie
setting out the main features of the plan) that it gives rise to valid expectations in other parties
such as customers, suppliers and employees (or their representatives) that the entity will carry
out the restructuring.

74. For a plan to be sufficient to give rise to a constructive obligation when communicated to
those affected by it, its implementation needs to be planned to begin as soon as possible and
to be completed in a timeframe that makes significant changes to the plan unlikely. If it is
expected that there will be a long delay before the restructuring begins or that the
restructuring will take an unreasonably long time, it is unlikely that the plan will raise a valid
expectation on the part of others that the entity is at present committed to restructuring,
because the timeframe allows opportunities for the entity to change its plans.

75. A management or board decision to restructure taken before the end of the reporting period
does not give rise to a constructive obligation at the end of the reporting period unless the
entity has, before the end of the reporting period:
(a) started to implement the restructuring plan; or
(b) announced the main features of the restructuring plan to those affected by it in a
sufficiently specific manner to raise a valid expectation in them that the entity will
carry out the restructuring.
If an entity starts to implement a restructuring plan, or announces its main features to those
affected, only after the reporting period, disclosure is required under SB-FRS 10 Events after
the Reporting Period, if the restructuring is material and non-disclosure could influence the
economic decisions that users make on the basis of the financial statements.

76. Although a constructive obligation is not created solely by a management decision, an
obligation may result from other earlier events together with such a decision. For example,
negotiations with employee representatives for termination payments, or with purchasers for
the sale of an operation, may have been concluded subject only to board approval. Once that
approval has been obtained and communicated to the other parties, the entity has a
constructive obligation to restructure, if the conditions of paragraph 72 are met.

77. In some countries, the ultimate authority is vested in a board whose membership includes
representatives of interests other than those of management (eg employees) or notification
to such representatives may be necessary before the board decision is taken. Because a
decision by such a board involves communication to these representatives, it may result in a
constructive obligation to restructure.

78. No obligation arises for the sale of an operation until the entity is committed to the
sale, ie there is a binding sale agreement.

79. Even when an entity has taken a decision to sell an operation and announced that decision
publicly, it cannot be committed to the sale until a purchaser has been identified and there is a
binding sale agreement. Until there is a binding sale agreement, the entity will be able to
change its mind and indeed will have to take another course of action if a purchaser cannot
be found on acceptable terms. When the sale of an operation is envisaged as part of a
restructuring, the assets of the operation are reviewed for impairment, under SB-FRS 36.
When a sale is only part of a restructuring, a constructive obligation can arise for the other
parts of the restructuring before a binding sale agreement exists.

80. A restructuring provision shall include only the direct expenditures arising from the
restructuring, which are those that are both:
(a) necessarily entailed by the restructuring; and
(b) not associated with the ongoing activities of the entity.

81. A restructuring provision does not include such costs as:
(a) retraining or relocating continuing staff;
(b) marketing; or
(c) investment in new systems and distribution networks.
These expenditures relate to the future conduct of the business and are not liabilities for
restructuring at the end of the reporting period. Such expenditures are recognised on the
same basis as if they arose independently of a restructuring.

82. Identifiable future operating losses up to the date of a restructuring are not included in a
provision, unless they relate to an onerous contract as defined in paragraph 10.

83. As required by paragraph 51, gains on the expected disposal of assets are not taken into
account in measuring a restructuring provision, even if the sale of assets is envisaged as part
of the restructuring.