The end is in FASB's sights: new FASB statements clarify accounting practices for debt extinguishment, severance costs, and pension disclosure

Healthcare Financial Management, Sept, 2004 by Alan Reinstein, Cathleen L. Miller

The FASB recently issued three standards that focus on accounting treatments for various types of "endings":

* Extinguishments of debt and capital leases (SFAS No. 145)

* Employee termination and restructuring costs (SFAS No. 146)

* Accounting for pensions and other post retirement benefit disclosures (SFAS No. 132, revised)

These new provisions guide preparation of more meaningful and credible financial statements, but also present new disclosure requirements and balance-sheet effects that financial managers need to navigate.

Extinguishment of Debt-SFAS No. 145

In Apri1 2002, the FASB issued a statement designed to provide more consistent and credible accounting for the extinguishment of debt, certain capital leases, and other items. Statement of Financial Accounting Standards (SFAS) No. 145 (Rescission of FASB Statements Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections) calls for all entities, including healthcare organizations, to recognize fewer extinguishments of debt transactions as extraordinary and recognize more consistently modified capital leases as sale-leaseback contracts. Healthcare financial managers should recognize that these new provisions could impair certain financial ratios, causing violations of certain loan covenants, which could require obtaining waivers or modifications from their bankers or other lenders.

Previously, SFAS No. 4 (Reporting Gains and Losses from Extinguishment of Debt) and SFAS No. 64 (Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements) required that all gains and losses from extinguishments of debt be classified as extraordinary gains and losses. In a recent four-year period, the FASB found that 11 percent of companies reported extraordinary items, and more than 90 percent of those reports related to debt extinguishments (Accounting Trends and Techniques--2001, New York: AICPA).

Under the former guidelines, for example, a hospital that had committed to a long-term lease of an obsolete MRI machine could "buy off" its present payments at a penalty rate to repurchase a new machine and classify the extinguishment of debt as an extraordinary loss. However, such events represent normal management operating strategies, not unusual or infrequent events. Therefore, the new FASB standard requires entities to report such effects as part of "normal" operating income (or loss).

However, SFAS No. 145 still allows entities to classify as extraordinary items gains and losses from extinguishment of debt that meet the "unusual and infrequent" criteria in APB Opinion No. 30. An example would be one-time refinancings related to newly enacted laws or other major catastrophes, such as earthquakes.

APB Opinion No. 30 also requires disclosures about material gains and losses associated with debt extinguishments that are unusual or infrequent in nature--but not both. Thus, SFAS No. 145 and APB Opinion No. 30 should help distinguish debt extinguishment transactions that are part of a healthcare organization's recurring operations from those that are unusual or infrequent or both (transactions that meet the criteria of extraordinary items).

SFAS No. 145 also removes inconsistencies in accounting for certain lease modifications by focusing on the substance rather than the form of these transactions. Amending SFAS No. 13, Accounting for Leases, SFAS No. 145 requires that accounting for modifications to capital leases that result in classifying the lease as an operating lease use the same accounting treatment as sale-lease-back transactions. In such situations, the lessee should adhere to the guidance of FASB Statement No. 98, Accounting for Leases: Sale-Leaseback Transactions Involving Real Estate; Sales-Type Leases of Real Estate; Definition of the Lease Term.

Employee Termination--SFAS No. 146

In late 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, to address a wide range of costs, such as one-time employee termination benefits, termination of noncapital lease contracts, and other costs that are associated with restructuring or other exit or disposal activities. However, its provisions do not affect costs of terminating capital leases, restructuring costs associated with assets acquired as part of a business combination, or employee benefits under ongoing arrangements, such as pensions or post retirement healthcare plans.

SFAS No. 146 prevents the reporting of many so called "big bath" charges, improves the matching of expenses with related benefits, and aligns the recognition of a liability with the conceptual definition of a liability in Concepts No. 6 (FASB Concepts Statements).

Superseding EITF No. 94-3 (Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity Including Certain Costs Incurred in a Restructuring), all for-profit and not for profit entities must now recognize costs associated with exit or disposal activities only when they incur liabilities for such costs rather than when they commit to exit or disposal plans. Healthcare organizations must now initially measure liabilities for exit and disposal activities at fair value, evaluate the liability for costs associated with exit and disposal activities each reporting period, and measure subsequent changes in the fair value of the liability. In subsequent periods, their income statements should recognize accretion expense and their balance sheets should recognize increases in the liability due to the passage of time.