Financial Accounting and Reporting-CPA Practice Exam

Which of the following describes an example of exit and disposal costs?

1. Costs to upgrade machinery

2. Severance pay for involuntary terminations

3. Inventory write-offs

4. Marketing expenses related to a new product

The correct answer is: Severance pay for involuntary terminations

The identification of severance pay for involuntary terminations as an example of exit and disposal costs is accurate. Exit and disposal costs refer to expenses incurred when a company decides to discontinue a segment of its operations, which may include employee-related costs resulting from layoffs or terminations. Severance pay is a direct cost associated with this process, as it is compensation provided to affected employees, reflecting the financial obligations that arise when a company downsizes or restructures. In contrast, the other options provided do not fit the definition of exit and disposal costs. Costs to upgrade machinery involve capital expenditures aimed at improving operational efficiency rather than costs associated with exiting a market or segment. Inventory write-offs pertain to losses recognized on unsold or obsolete inventory, which do not directly relate to exit strategies or disposal strategies but rather to asset valuation. Marketing expenses related to a new product are incurred to promote new offerings and do not involve costs associated with exiting or disposing of current operations. Thus, recognizing severance pay as exit and disposal costs aligns with the underlying principle of managing the financial impacts of discontinuing operations or reducing workforce size.