IAS 19 Employee Benefits: should be applied by all entities in accounting for the provision of all employee benefits, except

those benefits which are equity-based.

- In this case IFRS 2 Share-based Payment applies Short-term employee benefits Post-employment benefits Other long-term employee benefits Termination benefits

Profit-sharing and bonus plan: An entity should recognise an expense and a corresponding liability for the cost of providing profit-sharing arrangements and bonus payments when: The entity has a present legal or constructive obligation. A reliable estimate of the obligation can be made. - when payment is part of an employees employment contract

- past performance has led to the expectation that benefits will be payable in the current period IAS 19 sets out that a reliable estimate for bonus or profit-sharing arrangements can be made only when: there are formal terms setting out determination of the amount of benefits the amount payable is determined by the entity before the financial statements are authorised for issue; or Past practice provides clear evidence of the amount of a constructive obligation

Illustration 01 Post-employment benefits: Post-employment benefits include retirement benefits such as: Pensions Continued private medical care Post-employment life insurance

Two main types of post-employment benefit schemes: Defined contribution schemes (money purchase schemes) Defined benefit schemes (final salary schemes)

Defined contribution plans: Characteristics: Contributions into the plan are fixed, normally at a percentage of an employees salary Contributions are usually paid by into the plan by both the employer and the employee The amount of pension paid to retirees is not guaranteed and will depend upon the size of the plan, which in turns depends upon the performance of the pension fund investments The expectation is that the investments made will grow through capital appreciation and the reinvestment of returns; and on a members retirement, the plan should have grown sufficient enough to provide the anticipated benefits
Time Variables returns on investments Defined contributions (therefore) variable benefits

Risks associated with defined contribution schemes: Investment risk: If the investments not perform as anticipated, the size of the plan will be smaller than initially anticipated and therefore there will be insufficient assets to meet the expected benefits. This risk is carried by the employees.

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Actuarial risk: This is the risk that the actuarial assumptions such as those on employee turnover, life expectancy or future salaries vary significantly form what actually happens. This risk is also carried by the employees in the cased of defined contribution plans.

Recognition and measurement: Contributions into a defined contribution plan by an employer are made in return for services provided by an employee during the period. The employer has no further obligation for the value of the assets of the plan or the benefits payable. o The entity should recognise contributions payable as an expense in the period in which the employee provides services A liability should be recognised where contributions arise in relation to an employees service, but remain unpaid at the period end Any excess contributions paid should be recognised as an asset (prepaid expense) but only to the extent that the prepayment will lead to a reduction in future payments or a cash refund In the unusual situation where contributions are not payable during the period (or within 12 months of the end of the period) in which the employee provides his or her services on which they accrue, the amount recognised should be discounted, to reflect the time value of money Illustration: 02 Disclosure requirement: Where an entity operates a defined contribution plan during the period, it should disclose: The amount that has been recognised as an expense during the period in relation to the plan A description of the plan

Defined benefit plans: These are defined by IAS 19 as all plans other than defined contributions plans. Characteristics: The amount of pension paid to retirees is defined by reference to factors such as length of service and salary levels (i.e. the benefit is guaranteed) Contributions into the plan are therefore variable depending upon how the plan is performing in relation to the expected future obligation (i.e. if there is a shortfall, contributions will increase and vice versa)
Time Variables returns on investments, mortality rate, etc (therefore) variable contributions Defined benefits

Contribution levels: The actuary advises the company on contributions necessary to produce the defined benefits (the funding plan) Formal actuarial valuations will be performed (e.g. every three years) to reveal any surplus or deficit on the scheme at a given date. Contributions may be varied as a result; for example, the actuary may recommend a contribution holiday to eliminate a surplus or increase the contribution level in case of shortfall.
A period during which no contributions are made

Risk associated with defined benefit plan; As the employer is obliged to make up any shortfall in the plan thus, in a defined benefit plan, the employer carries both the investment risk and actuarial risk. Types of defined benefit plans: two types:
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Funded plans: these plans are set up as separate legal entities and are managed independently, often by trustees contributions paid by the employer and employee are paid into the separate legal entity the assets held within the separate legal entities are effectively ring-fenced for the payments of benefits

Unfunded plans: these plans are held within employer legal entities and are managed by the employers management teams assets are not ring-fenced for the payment of benefits and remain the assets of the employer entity Common in UK and US public sector and normal method of pension provision in many European countries and Japan

Where defined benefit plans can appear as defined contribution plans: IAS 19 examples: Where the employee benefits from the upside potential on the investment but has a level of protection from downside risk Where a plans level of benefits is not linked solely to the amount of contributions made into the plan Where informal practice have led to the entity having a constructive obligation to provide additional benefits under a plan (example: increasing the benefit to compensate the inflation or etc) even if the entity has no legal requirement to increase the benefits. Accounting for the movement in defined benefit plans:

Present value of defined benefit obligations

Fair value of plan assets

B/f at start of year (advised by actuary) Retirement benefits paid out (DR PV of defined benefit obligation; CR FV of plan assets) Contributions paid into plan (DR FV of plan assets; CR Cash) Expected return on plan assets (DR FV of plan assets; CR P&L) Unwinding of interest (DR Interest cost; CR PV of defined benefit obligation) Current service cost (DR Expense; CR PV of defined benefit obligation) Past service cost (DR Past service cost expense; CR PV of defined benefit obligation) Actuarial gains / (losses) (balancing figure) (number of accounting treatments available) C/f at end of year (advised by actuary) (X) X (X) (X) (X) (X) X/(X) (X)

X (X) X X X

X/(X) X

Net actuarial gain or (loss)

IAS 19 encourages the use of a qualified actuary to measure the defined benefit obligation. This is not, however, a requirement. Valuations are not required at each reporting date; however they should be carried out sufficiently regularly to ensure that amounts recognised are not materially different from those which would be recognised if they were valued at the reporting date.

In Statement of Financial Position the pension plan is measured as: Present value of defined benefit obligations Fair value of plan assets (X) X X/(X)
(where 10% corridor method is applied Unrecognised actuarial gains/(losses) to dateand not actuarial differences are X/(X) recognised) see 10% corridor from page 5

Unrecognised past service cost Plan (deficit) / surplus

X (X)/X

Where the plan is in surplus, IAS 19 requires that the net asset is restricted to the lower of: The amount determined from the above calculation The total of: Any cumulative unrecognised net actuarial gains or losses Unrecognised past service costs, and The PV of any economic benefits available in the form of refunds from the plan or reduction in future mezbah.ahmed@bimsedu.com contributions to the plan Page 3 of 7

Illustration: 03

Present value of defined benefit obligations: is the present value of all expected future payments required to settle the obligation resulting from employee service in the current and prior period.
Discount rate can be determined by reference to: Market yields on high quality corporate bonds at the reporting date, or where there is no market for such bonds Market yields on government bonds The corporate or government bonds should be denominated in the same currency as the defined benefit obligation, and be for similar term. Expected future payments are based upon a number of assumptions and estimates, such as: The final benefits payable under the plan (often dependent on future salaries as benefits are often quoted as a percentage of the employee s final salary), and The number of members who will draw benefits (this will in turn depend on employee turnover and mortality rates)

Plan assets: are defined as those assets held by a long-term benefit fund and those insurance polices which are held by an entity, where the fund/entity is legally separate from the employer and assets/policies can only be used to fund employee benefits. Fair value: is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arms length transaction. IAS 19 provides no further explanation or guidance on fair value, and therefore it may be established by reference to any of the following: Market price Present value of future cash flows (using discount rate which reflects the risks associated with the plan assets and their maturity date) Prices achieved in recent transactions between willing and unrelated parties Option pricing model Investments owned by the employer which have been earmarked for employee benefits but which the employer could use for different purposes are not plan assets.

Return on plan assets: is defined as interest, dividends and other revenue derived from plan assets together with realised and unrealised gains or losses on the plan assets, less any costs of administering the plan and less any tax payable by the plan assets. The expected return on plan assets is a forward looking estimate based on market expectations at the beginning of the period for returns over the life of the pension scheme. It is generally expressed as a percentage, which should be applied to the fair value of the plan assets (normally on the brought forward amount). Note that the difference between the expected and actual return on plan assets forms part of the actuarial gain or loss

Illustration 04 Unwinding of interest: The defined benefit obligation is measured at present value; therefore the liability increases with the unwinding of the discount, as the liability is one year closer to being settled. Illustration 05 Current service cost: is the increase in the present value of the defined benefit obligation resulting from employee service in the current period. Past service cost: An entity will sometimes change a pension plan to increase benefits payable. Past service cost is in effect the extra liability arising because of the increase in benefits. The amount is calculated as: Defined benefit obligation immediately after additional benefits introduced Defined benefit obligation immediately before additional benefits introduced Past service cost X (X) X
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This amount should be recognised in profit or loss on a straight line basis over the period from the additional benefits being introduced to the vesting date (i.e. the date on which the employees become entitled to the additional benefit). If vesting is immediate, the past service cost is recognised in profit or loss immediately.

Actuarial differences (gain or loss): Accounting treatment: IAS 19 allows a number of methods of dealing with actuarial gains or losses, including: Immediate recognition in profit or loss (for gain: DR Net pension liability; CR Profit or loss) Immediate recognition as other comprehensive income (for gain: DR Net pension liability; CR Other comprehensive income) Deferral where they fall within certain size limits

Deferral of actuarial differences: IAS 19 provides the option to defer actuarial differences where they do not exceed a certain size limit, known as the 10% corridor. The 10% corridor is calculated as the greater of: 10% of the PV of the defined benefit obligation at the start of the accounting period 10% of the FV of the plan assets at the start of the accounting period

The actuarial difference which is considered in relation to this size limit is the net cumulative unrecognised actuarial gain or loss at the start of the accounting period.

Where the net cumulative unrecognised actuarial gain or loss exceeds the 10% corridor, the excess is amortised (i.e. recognised as Actuarial loss in profit or loss) over a maximum period of the expected average remaining working lives of the members of the plan. A shorter amortisation period may be adopted, but an entity must apply this consistently from year to year.

Illustration 06 Multiple plans and offsetting: Where a sponsoring employer runs more than one defined benefit scheme, each must be accounted for separately and a plan deficit in one cannot be set off against a plan surplus in another unless there is a legal right. Termination benefits: are employee benefit payables on the termination of employment, through voluntary redundancy or as a result of a decision made by the employer to terminate employment before the normal retirement date. Termination benefits are recognised as an expense when the entity is committed to either: Terminate the employment before normal retirement date, or Provide termination benefits in order to encourage voluntary redundancy

Where termination benefits fall due more than twelve months after the reporting date they should be discounted.

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Illustration 01: Annual bonus: (CR text: page 259): An entity with a 30 June year end has a past practice of paying an annual bonus to employees, although it has no contractual obligation to do so. Its practice is to appropriate 4% of its pre-tax profits, before charging the bonus, to a bonus pool and pay it those employees who remain in employment on the following 30 September. The total bonus is allocated to employees in proportion to their 30 June salaries, and amounts due to those leaving over the next three months are retrieved from the bonus pool for the benefit of the entity. Past experience is that employees with salaries representing 8% of annual salaries leave employment by 30 September. The entitys pre-tax profits for the year ended 30 June 20X5 were 4 million. Requirement: How should the bonus be recognised in the financial statements?

Illustration 02: Defined contribution plan: (CR text: page 263): Mouse Co agrees to contribute 5% of employees total remuneration into a post-employment plan each period. In the year ended 31 December 20X9, the company paid total salaries of 10.5 million. A bonus of 3 million based on the income for the period was paid to the employees in March 20Y0. The company had paid 510,000 into the plan by 31 December 20X9. Requirement: Calculate the total expense for post-employment benefits for the year and the accrual which will appear in the statement of financial position at 31 December 20X9. Illustration 03: Defined benefit plan: Presentaiton: (CR text: Page: 280) The defined benefit pension plan of Leadworth plc was formed on 1 January 20X3. The following details related to the scheme at 31 December 20X3. m Present value of obligation Fair value of plan assets Current service cost for the year Contributions paid Interest cost on scheme liabilities for the year Expected return on scheme assets for the year 208 200 176 160 32 16

The directors are aware that the plan could have a significant impact on the profit or loss of the company and wish to recognise any acturial gain immediately, provided that this is allowed under IFRS. Requirement: Show how the defined benefit pension plan should be dealt with in the financial statements for the year ended 31 December 20X3. Illustration 04: Return from plan assets: (CR text: page: 267): At 1 January 20X2 the fair value of assets of a defined benefit plan were valued at 1m. On 1 July 20X2 the plan received contributions from the employer of 490,000 and on the same date it paid out benefits of 190,000. After these transactions, the fair value of the plans assets at 31 December 20X2 was 1.5m. The reporting entity made the following estimates at 1 January 20X2, based on market prices at that date. % Dividend/interest income (after tax payable by fund) Realised and unrealised gains (after tax) on plan assets Administration costs Requirement: Calculate the expected and actual return on plan assets. mezbah.ahmed@bimsedu.com Page 6 of 7 9.25 2.00 (1.00) 10.25

Illustration 05: Unwinding of interest: (CR text: page: 267): In 20X8, an employee leaves a company after working there for 24 years. The employee chooses to leave his accrued benefits in the pension scheme until he retires in seven years time (he now works for another company). At the time of his departure, the actuary calculates that it is necessary at that date to have a fund of 296,000 to pay the expected pensions to the exemployee when he reties. At the start of the year, the yield on high quality corporate debt was 8%, and remained the same throughout the year and the following year. Requirement: Calculate the interest cost to be debited to profit or loss in Years 1 and 2. Illustration 06: 10% Corridor: CR text: page 272 ACM provides the following information about a defined benefit pension scheme which started on 1 January 20X5: 20X5 PV of obligation at 31 December FV of plan assets at 31 December Amounts paid out to retirees ACM contributions to the plan Expected rate of return at start of year Current service cost Discount rate at start of year 4,000 3,000 3,500 10% 3,500 7% 20X6 7,800 6,400 3,200 9.5% 3,300 8% 20X7 10,200 8,700 780 2,500 8.2% 2,400 9%

ACM defers actuarial gains or losses in excess of a 10% corridor, spreading them over the average remaining service lige of employees, whihch, for each of the years considered is assessed as 20 years. Requirement: Calculate amounts to be disclosed in ACMs financial statements in each of the three years.

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