A cash charge is typically a one-time item that occurs during an accounting period. Companies must accurately record this item in their financial statements, primarily the balance sheet. This charge involves companies using current cash on hand to pay off an early retirement package, close down or consolidate a business department, or finance another extraordinary item. A cash charge that results in a large expense will go against earnings for the particular accounting period in which the activity occurs.
Extraordinary items — in accounting terms — do not occur frequently and will often require a disclosure or other note in a company’s financial statements. This provides information to the end-users or other stakeholders as to why the event occurred and the methodology used to record the transactions. For publicly held companies, failure to disclose the information surrounding a cash charge can result in an unfavorable audit opinion since the information is crucial to investors.
Companies may decide to make a cash charge in order to improve business operations. For example, large companies with several older, retirees who are receiving a pension may be the target for a cash payoff. Business owners, directors or executives may negotiate with the retirees about taking a one-time cash payoff in order to hire younger workers. If accepted, the cash charge will reduce the company’s cash balance and relieve the pension liability recorded on the company’s books. The capital freed up from the relief of pension payment can then be spent on hiring new workers at a cheaper cost. Although potentially difficult to pay out in the short run, the long run benefits are typically more beneficial.
Consolidating business operations works in a similar fashion. The company may need to pay off leases on land, buildings, or equipment. While some pieces may be sold off legitimately, the company will often need to pay the balance on the unpaid leases. This results in a one-time cash charge written against earnings and removing the asset or liability off the company’s financial statements, depending on how the lease is accounted for, such as operating or capital.
Proper documentation is essential when recording these charges in the company’s accounting ledgers. Failing to accurately document and account for the charge can result in a company overpaying for the pension or lease payoff. Shareholders will not take lightly to companies who simply pay make cash charges to pay items off without properly assessing the long-term value or other related issues, such as the reduction in earnings per share for the current period.
