How a Restructuring Accrual Affects the Income Statement

How a Restructuring Accrual Affects the Income Statement
The U.S. accounting system is based on accruals.

Restructuring

Restructuring costs involve either the costs in writing down the cost of assets because the assets have lost value, or the costs of closing a business and letting people go. These costs are usually not part of the normal operations of a business, and analysts exclude them from their earnings number because of that. Companies know that analysts exclude restructuring costs from earnings; they sometimes take advantage of this and try to fit more costs into restructuring that are really just part of normal operations to make their earnings look better.

Accrual Accounting

The U.S. Generally Accepted Accounting Principles fall under an accrual system. This basically means that revenues are recognized when the company fulfills its obligation of the sale, while expenses are recognized when they occur. Therefore, you don't need to have a cash outlay to have an expense, and you don't need to have a cash inflow to record revenue. Because of the timing difference between recognition of expenses and revenues and the inflow and outflow of cash, accruals occur and fall on the balance sheet.

Restructuring Accrual

A restructuring accrual occurs when the restructuring is actually incurred. However, there doesn't have to be a cash outlay for the expense. For example, if a company lays off a group of people and gives them 12 months of severance pay due at the end of each month, the company incurs the expense when the people are laid off and recognizes it on the income statement then. However, the cash outlay occurs for the next 12 months.

Analyzing Restructuring Accruals

One way to look at restructuring accruals is averaging them out over a few years to smooth out the fluctuations. That way, you're able to get a better picture of the company's long-term earnings power. You then won't have either too high or too low of an earnings figure for the company and will be more likely to value the company properly.