Financial Accounting and Reporting-CPA Practice Exam

What must occur for an entity to recognize a liability for exit and disposal costs?

1. A commitment to an exit plan must be made

2. An obligating event must have occurred

3. The company must have no intention to exit

4. Investor approval is required

The correct answer is: An obligating event must have occurred

To recognize a liability for exit and disposal costs, an obligating event must have occurred. This concept refers to a situation in which an enterprise has a present duty or responsibility to others that results from past transactions or events. It indicates that the company has little or no discretion to avoid settling the obligation, which is often established when a formal exit plan has been approved and communicated. For an exit or disposal liability to be recognized, the obligation must be both measurable and probable. This generally means there is a clear indication that the company will incur costs associated with exiting a business segment or disposing of assets. When an obligating event occurs, it creates a legal or constructive obligation to either incur future costs related to exiting or to settle the disposal of specific assets. This aligns with the accrual basis of accounting where liabilities and expenses are recognized when incurred rather than when payment is made. The other choices suggest scenarios that do not fulfill the criteria for liability recognition. For example, simply making a commitment to an exit plan does not trigger the recognition of a liability unless it is accompanied by an obligating event. Similarly, having no intention to exit contradicts the concept of recognizing exit costs. Lastly, while investor approval may be a step in the process, it is