The effect of timing of the creation of a constructive obligation on the recognition of a restructuring provision
Scenario 1: Closure of a division – no implementation before end of the reporting period
On 12 December 2013, the board of Entity A decided to close down a division. No announcement was made before the end of the reporting period (31 December 2013) and no other steps were taken to implement the decision before that date.
In these circumstances, no provision is recognised because management’s actions are insufficient to create a constructive obligation before the end of the reporting period. [IAS 37 Appendix C, Example 5A].
Scenario 2: Closure of a division – communication/implementation before end of the reporting period
In another case, the board of Entity B decides on 12 December 2013 to close down one of its manufacturing divisions. On 20 December 2013 a detailed plan for closure was agreed by the board; letters were sent to customers warning them to seek an alternative source of supply and redundancy notices were sent to the staff of the division.
The communication of management’s decision to customers and employees on 20 December 2013 creates a valid expectation that the division will be closed, thereby giving rise to a constructive obligation from that date. Accordingly a provision is recognised at 31 December 2013 for the best estimate of the costs of closing the division.