IAS 37 Restructuring Provisions — Core Rule

Under IAS 37 Restructuring Provisions, an entity may only recognise a restructuring provision when it has a present obligation — specifically a constructive obligation — arising from a formal plan that has raised a valid expectation in those affected that the restructuring will be carried out.

How IAS 37 Restructuring Provisions Works

• Two-limb constructive obligation test (IAS 37.72): A constructive obligation exists only when (a) there is a detailed formal plan identifying the business/operations affected, locations, function and approximate headcount of employees to be compensated, expenditures to be incurred, and when the plan will be implemented; AND (b) the entity has raised a valid expectation in those affected — either by starting to implement the plan or by announcing its main features to those affected.

• "Detailed formal plan" requirement (IAS 37.76): A board decision alone is insufficient. If the plan is announced after the reporting date but before financial statements are authorised, it is a non-adjusting event under IAS 10 — it cannot create a provision at the balance sheet date.

• Measurement — only directly attributable costs (IAS 37.80–81): The provision is measured at the best estimate of expenditure required to settle the obligation. Only costs that are both necessarily entailed by the restructuring and not associated with ongoing activities qualify. This means: redundancy payments, lease termination penalties directly caused by the restructuring, and asset write-downs. Excluded: retraining or relocating continuing staff, marketing costs, investment in new systems, and future operating losses.

• Future operating losses are explicitly prohibited (IAS 37.63): Even if a restructuring will generate significant operating losses before completion, no provision is recognised for those losses unless an onerous contract exists (IAS 37.66–67).

• Onerous contracts within a restructuring (IAS 37.68–69): If the restructuring creates or identifies an onerous contract (where unavoidable costs exceed economic benefits), a separate onerous contract provision must be recognised before any general restructuring provision.

• Disclosure requirements (IAS 37.84–85): The entity must disclose a description of the restructuring, the expected timing of outflows, and any significant uncertainties around amount or timing. A reconciliation of opening to closing carrying amounts is required for each class of provision.

IAS 37 Restructuring Provisions — Practical Example

Scenario: At 31 December 2024, Meridian SA's board approves and publicly announces a plant closure affecting 200 employees. The announcement is made on 20 December 2024, creating a valid expectation. Estimated redundancy costs: €3,200,000. Lease termination penalty on the factory: €450,000. Retraining costs for retained staff: €180,000 (excluded). Future operating losses during wind-down: €600,000 (excluded).

Provision to recognise at 31 December 2024

• Redundancy payments: €3,200,000
• Lease termination penalty: €450,000
• Total restructuring provision: €3,650,000

Journal entry at 31 December 2024

When payments are made in 2025 (e.g., first redundancy tranche of €1,200,000):

IAS 37 Restructuring Provisions — Common Pitfalls

• Board approval without announcement: Practitioners frequently recognise a provision based solely on a board minute dated before year-end. Unless the plan has been communicated externally or implementation has commenced, no constructive obligation exists (IAS 37.72). Auditors routinely test the date and nature of the announcement as the primary recognition trigger.

• Including excluded costs in the provision: Finance teams often bundle retraining, marketing for new product lines, or IT system upgrades into the restructuring provision. IAS 37.81 explicitly prohibits costs related to future conduct of business — each line item must be tested against the "necessarily entailed" criterion.

• Discounting omitted on long-term provisions: Where the restructuring will take more than 12 months to complete — a multi-year plant wind-down, for example — the provision must be discounted at a pre-tax risk-free rate (IAS 37.45–47). Failing to discount a €10m+ multi-year provision is a material error that auditors flag consistently.

IAS 37 Restructuring Provisions — Key Paragraphs

• IAS 37.10 — Definition of a constructive obligation and its distinction from a legal obligation.
• IAS 37.72 — The two conditions that must both be met for a restructuring provision to be recognised.
• IAS 37.76 — Requirement for a detailed formal plan; board decision alone is insufficient.
• IAS 37.80–81 — Measurement: only directly attributable and necessarily entailed costs; explicit exclusion of future operating losses and ongoing business costs.
• IAS 37.45–47 — Discounting provisions where the time value of money effect is material.
• IAS 37.84–85 — Mandatory disclosure: description, timing, uncertainties, and movement reconciliation.