Chapter 16 Employee Benefits

Gripping IFRS

Employee benefits

Chapter 16 Employee Benefits Reference: IAS 19; IFRIC 14 Contents:

Page

1. Introduction

486

2. Short-term employee benefits

487

2.1 Overview of short-term benefits

487

2.2 Short-term compensated absences

489 489 489 489

2.2.1 2.2.2

Leave taken Unused leave 2.2.2.1 Non-accumulating leave Example 1: short-term paid leave: non-accumulating: single employee Example 2: short-term paid leave: le ave: non-accumulating: group of  employees 2.2.2.2 Accumulating leave Example 3: short-term paid leave: accumulating and vesting Example 4: short-term paid leave: accumulating and non-vesting Example 5: short-term paid leave: accumulating, vesting and nonvesting 2.3 Profit sharing and bonus plans Example 6: bonuses – raising the bonus provision Example 7: bonuses – paying the bonus Example 8: profit sharing 3. Post-employment benefits

489 490 490 491 491 493 494 495 496 496 497

3.1 Overview of post-employment benefits

497

3.2 Defined contribution plans Example 9: defined contribution plans

497 498

3.3 Defined benefits plans

499

3.3.1

Overview of a defined benefit plan

499

3.3.2

Measurement of a defined benefit plan

499

3.3.2.1 Deficit or surplus 3.3.2.2 Liability or asset 3.3.2.3 Measurement of the plan obligation 3.3.2.3.1 Present value and interest cost Example 10: DBP: effect of the unwinding of the discount 3.3.2.3.2 Current service costs Example 11: DBP: current service costs 3.3.2.3.3 Past service costs Example 12: DBP: past service costs 3.3.2.3.4 Benefits paid Example 13: DBP: benefits paid 3.3.2.3.5 Curtailments and settlements

499 500 500 501 501 502 502 503 504 506 506 507

484

Chapter 16

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Employee benefits

Contents continued …

Page

3.3.2.4 Measurement of the plan assets Example 14: DBP: plan assets

508 508

3.3.2.5 Actuarial assumptions

509

3.3.2.6 Changes to actuarial assumptions Worked example: corridor versus no corridor

509 510

3.3.2.7 Recognising actuarial gains and losses: the amortised corridor approach et al (IAS 19.92, IAS 19.93 and IAS 19.95) Example 15: DBP: using the amortised corridor Example 16: DBP: to use the corridor or not

512

3.3.2.8 Asset balances: the asset ceiling: IAS 19.58 (b) Example 17: DBP: asset ceiling

520 520

3.3.2.9 Asset balances: the recoverability test: IAS 19.58A

521

3.3.2.10Asset 3.3.2.10Asset balances: link between recoverability test and ceiling Flowchart: inter-relationship of IAS 19.58A and IAS 1 9.58(b) Example 18: DBP: 58A and 58(b) Example 19: DBP: 58A and 58(b): loss and PV unchanged Example 20: DBP: 58A and 58(b): loss and PV decreased

522 523 524 524 526

513 517

4. Other long-term benefits

528

5. Termination benefits

529

6. Disclosure 6.1 Short-term employee benefits 6.2 Post-employment benefits 6.2.1 Defined contribution plans 6.2.2 Defined benefit plans Example 21: DBP: disclosure 6.3 Other long-term employee benefits 6.4 Termination benefits

530 530 530 530 530 530 532 533

7. Summary

534

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1

Employee benefits

Introduction

Why do we work? Apart from philosophical reasons (that are unfortunately beyond the scope of this book), we generally work for rewards.

In the mid 1890’s a Russian scientist, by the name of Ivan Pavlov, began investigating the gastric function of dogs. of  dogs. He very importantly noticed that dogs tend to salivate before food was delivered to their mouths. mouths. He called this a ‘psychic ‘psychic secretion’. He became so interested in this phenomena that his research, which began as a scientific study of the chemistry of their saliva, mutated into a psychological study and led to the establishment of what is commonly referred to as ‘conditional reflexes’ or ‘Pavlovian response’. The answer to ‘why do we work’ lies in this Pavlovian theory of conditional reflexes – we work because we expect to receive a benefit – a bit like the dog salivating in expectation of  food. The term ‘employee’ includes all categories: full-time, part-time, permanent, casual, temporary, management and even directors. The benefit we, as employees, expect to receive may be summarised into four categories: benefits in the short-term (benefits payable to us while employed and shortly after we provide the service, e.g. a salary); benefits in the long-term (benefits payable to us while employed but where the benefits may become payable long after we provide the service e.g. a long-service award); benefits   post employment (i.e. after we have retired from employment e.g. a pension); and/ or termination benefits (those that would be receivable if our employment were to be terminated before normal retirement age (e.g. a retrenchment package).

•

•

•

•

The definitions of these four categories of employee benefits are as follows: Employee benefits

Short-term benefits

Long-term benefits

Post-employment benefits

Termination benefits

 Defined in IAS 19 as: Those that fall wholly within 12 months after the end of the period in which the employee renders the service

 Defined in IAS 19 as: Those that do not fall wholly within 12 months after the end of  the period in which the employee renders the service

 Defined in IAS 19 as: Those that are payable after the completion of  employment

Other than termination benefits

Other than postemployment and termination benefits

Other than termination benefits

 Defined in IAS 19 as: Those that are payable as a result of either the: a) entity’s decision to terminate the employment before normal retirement date b) employee’s decision to accept a voluntary redundancy package in exchange for those benefits

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Employee benefits

Employee benefits apply to any type of  settlement  – with the exception of share-based payments. These payments were previously included within this standard (IAS (IAS 19: Employee benefits) but are now covered by its very own standard, IFRS 2: Share based payments. Employee benefits therefore include settlements made by an entity in the form of: cash (e.g. cash salary); goods (e.g. free products); or services (e.g. free medical check-ups). • • •

Post-employment benefits could come in the form of defined contribution plans or defined benefit  plans. Defined benefit plans are relatively complex to account for and require lots of  disclosure. Although defined benefit plans are not as commonly encountered in practice as defined contribution plans, it is still important for you to understand how to account for them. IAS 19 requires a lot of disclosure for post-employment benefits where they are defined benefit  plans whereas there is either little or no disclosure required for the other types of  benefits. There are, however, other disclosure requirements that emanate from other standards such as: IAS 1 Presentation of Financial Statements: - requiring disclosure of the employee benefit e xpense IAS 24 Related Party Disclosures: - requiring disclosure of each type of benefit provided to key management personnel IAS 37 Provisions, Contingent Liabilities and Contingent Assets: - which may require that a contingent liability be disclosed. •

•

•

In addition to other standards requiring disclosure relating to the employee benefit/s, other disclosure may be required by the: Companies Ordinance, 1984 : in respect of directors’ remuneration (see Part III of  Schedule) Code of Corporate Governance.

•

•

2

Short-term employee benefits (IAS 19.8 – 19.23)

2.1 Overview of short-term benefits Short-term employee benefits include benefits that are due within twelve months of the end of  the period during which the employee provided the service. IAS 19.8 lists some of the items included under short-term employee benefits as follows: Wages, salaries and social security contributions; Short-term compensated absences (such as paid annual leave and paid sick leave) where the absences are expected to occur within twelve months after the end of the period in which the employees rendered the related employee service; Profit-sharing and bonuses payable within twelve months after the end of the period in which the employees rendered the related service; and Non-monetary benefits (such as medical care, housing, car and free or subsidised goods or services) for current employees.

• •

•

•

The accrual concept of accounting is applied when recognising a short-term employee benefit: an expense is recognised (debit) ; and a liability is recognised (credit) to the extent that any amount due has not been paid. •

•

This accrual approach is evident in the following journals shown overleaf:

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Employee benefits

Step 1: The employee benefit is raised as a liability when incurred: Employee benefit expense Account payable (e.g. wages payable) (L)  Recognising short-term employee benefits incurred (e.g. wages)

Debit

Credit

XXX XXX

Step 2: When the benefit is paid, the journal entry is: Account payable (e.g. wages payable) (L) Bank Payment of short-term employee benefit (e.g. wages/ company car etc)

XXX XXX

Step 3: If the expense has been underpaid , there will be a credit balance on the account payable. But if the expense has been overpaid , there will be a debit balance on the account payable. If an overpayment cannot be recovered from the employee (e.g. the employee is not not obligated to return the cash or a future payment to the employee may not be reduced by the overpayment) then the overpayment is expensed: e xpensed: Employee benefit expense Account payable (e.g. wages payable) (L) Over-payment of short-term employee benefit (e.g. wages) expensed 

Debit XXX

Credit

XXX

It is also possible that another standard allows or requires that the employee cost be capitalised instead of expensed. This may happen if, for example, example, an employee is used on the construction of another asset asset such as inventory. inventory. In this case, the the benefits payable to this this employee (or group of employees) will be capitalised to inventory (IAS 2) instead of  expensed (see Step 1 above). Inventory (or other asset) Account payable (e.g. wages payable) (L) Capitalisation of short-term employee benefit (e.g. wages)

Debit XXX

Credit

XXX

 Measurement of the short-term employee benefit is relatively simple because: no actuarial assumptions are required to measure either the obligation or the cost; and no discounting is applied to short-term employee benefit obligations – for the simple reason that the time between the receiving of the service and the payment of the benefit is short. • •

As mentioned earlier, IAS 19 does not require any disclosure of a short-term benefit although other standards may require certain limited disclosure. In summary, although we may work in order to earn more than one type of benefit, most of us start working in order to earn basic short-term short-term benefits. These can be summarised as follows: follows: Short-term benefits

Wages, salaries and social security contributions (e.g.

Short-term paid leave

Profit sharing and/  or bonuses

Use of non-monetary benefits (e.g. a company car)

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Employee benefits

Whereas we are all probably capable of processing the journals for wages (or salaries etcetera), the following other types of short-term benefits warrant a bit more attention: short-term compensated absences; profit sharing and bonuses.

• •

2.2 Short-term compensated absences (IAS 19.11 – 19.16) Short-term compensated absences refer to paid leave. In other words, these absences are those when employers pay employees during periods during which no work is done. The leave offered to an employee may be taken or may remain unused at the end of the period.  2.2.1

 Leave taken

The cost of an employee’s short-term absence is recognised as part of his salary expense. For example, if you were to take paid annual leave, your salary would be paid to you while you were on holiday: there would be no extra amount owing to you and therefore the leave that you have taken is simply absorbed into the usual salary expense journal (i.e. there is no extra  journal entry).  2.2.2

Unused leave

not taken by the If there was any leave that was owed to an employee during the year that was not taken employee, a distinction will need to be made between whether the leave was: accumulating: where unused leave can be carried forward to another period; or non-accumulating: where unused leave cannot be carried forward (i.e. falls away if not used in the current period).

• •

2.2.2.1  Non-accumulating leave Non-accumulating leave is recognised, as part of the salary expense, when the leave is taken (i.e. when the absence occurs). If an employee fails to take non-accumulating leave that was owed to him, any unused leave will be simply forfeited (since it is non-accumulating). Since the entity has no obligation to provide the unused leave in future years, (i.e. it is forfeited), no liability for unused leave is raised. Example 1: short-term paid leave: l eave: non-accumulating leave: single employee Mitch Limited has one employee. His name is Guy. Guy is owed 30 days leave per year. Guy is paid C90 000 per year. The year is 365 days and Guy is expected to work 5 days a week. Guy took 20 days leave in 20X1. Guy’s leave is non-accumulating.  Required: Show all related journal entries and calculate any leave pay provision as at the 20X1 yearend. Solution to example 1: short-term paid leave: non-accumulating leave: single employee Comment: Of the 30 days leave that was offered to Guy, 20 days were used and 10 days remained  unused. No provision is made for the 10 days that Guy did not take because the leave is nonaccumulating, which means that Mitch Limited is not obliged to give him this leave. The following  journal would be processed as 12 individual journals over the year (90 000 / 12 1 2 = 7 500 per month): Debit Credit Employee benefit expense 90 000 Total salary processed over the year 

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Employee benefits

Example 2: short-term paid leave: l eave: non-accumulating: group of employees Lee Limited operates a five-day working week. At Lee Limited’s financial year ended 31 December 20X4 (a year with 365 days): there were 50 similarly paid employees each earning an average salary of C50 000 and earning 20 days annual leave per year of service.

• • •

The leave entitlement of 20 days has remained the same for years and will remain the same for years to come. Similarly, the salary of C50 000 has remained unchanged for years and no significant changes are expected in the next few years. The following are the actual average leave statistics to date: end of prior year 20X3: an average of 10 days was used, all earned in 20X3 end of current year 20X4: an average of 12 days was used, all earned in 20X4 • •

The estimated future leave statistics for the year ended 31 December 20X5: an average of 14 days will be taken, all earned in 20X5 •

Ignore public holidays.  Required: Calculate the leave pay provision for Lee Limited’s financial year ended 31 December 20X4 assuming that the annual leave does not accumulate (and therefore does not vest). Solution to example 2: short-term paid leave: non-accumulating: group of employees Comment: this example is similar to example 1, with the difference being that the provision calculated  in this example is for a group of employees whereas the provision in example 1 is calculated for an individual employee. No provision is made at 31 December 20X4 since the leave is non-accumulating. This therefore means that any leave that is not taken is simply forfeited by the employee at the end of the year. The employee therefore lost 10 days in 20X3 (20 – 10 days) and 8 days in 20X4 (20 – 12 days taken). Nonaccumulating leave is recognised as the leave is taken. The leave that was taken was simply recognised as part of the salary of C50 000 (which would have been debited to salaries and credited to bank over the year). The entity does not owe the employee any leave that the employee fails to take. If the company policy was to pay out any unused leave at the end of each year, an accrual would still have to be recognised. In this case, the unused 20X3 leave would have been paid to employees at the end of 20X3. Any unused leave at 31 December 20X4 would, however, be due to the employees on this date. Since the amount owed to the employee would be based on unused leave to 31 December 20X4, it

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Gripping IFRS

Employee benefits

Whether accumulating leave has to be taken in the future or can be converted into cash in the future, an obligation still exists at year end for any unused leave. This must be measured based on the average expected salary per day (on the basis that, even if the leave is not vesting, the entity will effectively be losing this value on the days that the employee stays away from work). Example 3: short-term paid leave: accumulating and vesting Mark Limited has one employee. His name is Jack. Jack is owed 30 days leave per year. Jack  is paid C365 000 per year. The year is 365 days and Jack is expected to work 5 days a week. Jack took 20 days leave in 20X1. Jack’s leave is accumulating. Jack may convert leave that he does not wish to take into cash. The financial year end is 31 December 20X1.  Required: Show all related journal entries and calculate any leave pay provision at 31 December 20X1. Solution to example 3: short-term paid leave: accumulating and vesting Comment: The provision is based on the effective daily cost of employing Jack multiplied by the total number of outstanding days (Jack will either take this leave or will be paid out for it). The cost per day is calculated as follows:  Basic cost per day: C365 000 / 365 days = C1 000  Effective cost per day: C1 000 x 7/ 5 = C1 400 (since he not required to work every day but  rather 5 days out of every 7 days, the effective cost per day is a little higher)

Employee benefit expense Total salary processed over the year  Salaries payable Salary owed to Jack for 20X1 (includes leave taken) *

Debit 365 000

Employee benefit expense (30 – 20 days) x C1 400 per day Provision for leave pay  Leave still owing to Jack at 31 December 20X1

Credit

365 000 14 000 14 000

* this journal would actually be processed as 12 individual journals over the year (365 000 / 12 = 30 416)

Example 4: short-term paid leave: l eave: accumulating and non-vesting William Limited has one employee. His name is Roger. Roger is paid C365 000 per year. Roger is owed 30 days leave per year. He took 20 days leave in 20X1. The year is 365 365 days and Roger is expected to work 5 days a week. His leave is accumulating and he may not  convert leave that he does not wish to take into cash.

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Employee benefits

Solution to example 4A: short-term paid leave: accumulating indefinitely, non-vesting Comment: Even though the 20X1 leave not taken by 31 December 20X1 cannot be converted into cash, a liability must be raised to reflect the cost that the company will incur due d ue to the days of work that will be lost when Roger does take this leave in the future. Since the leave accumulates indefinitely,  all   outstanding days  outstanding days are provided for. The provision is based on the effective daily cost of employing Roger (C365 000 / 365 x 7 / 5 days = C1 400 per day).

Employee benefit expense Total salary processed over the year  Salaries payable Salary owed to Roger for 20X1 (includes leave taken)* Employee benefit expense (30 - 20 days) x C1 400 per day Provision for leave pay  Leave still owing to Roger at 31 December 20X1

Debit 365 000

Credit

365 000 14 000 14 000

* this journal would actually be processed as 12 individual journals over the year (365 000 / 12 = 30 416)

Solution to example 4B: short-term paid leave: accumulating for a period, non-vesting Comment: Even though the 20X1 leave not taken by 31 December 20X1 cannot be converted into cash, a liability must be raised to reflect the cost that the company will incur due d ue to the days of work that will be lost when Roger does take this leave in the future. Since the 20X1 leave not taken by 31 December  20X1 only accumulates for another year, we must base the liability on only the estimated number of   days that Roger will actually take in 20X2 (3 days) – any leave not taken will be forfeited (30 – 20 – 3 = 7 days will be forfeited) and will therefore not cost the company anything. The provision is based on the effective daily cost of employing Roger (C365 000 / 365 x 7 / 5 days = C1 400 per day).

Employee benefit expense Total salary processed over the year  Salaries payable Salary owed to Roger for 20X1 (includes leave taken) * Employee benefit expense 3 days x C1 400 per day Provision for leave pay  Leave still owing to Roger at 31 December 20X1

Debit 365 000

Credit

365 000 4 200 4 200

* this journal would actually be processed as 12 individual journals over the year (365 000 / 12 = 30 416)

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Gripping IFRS

Employee benefits

Example 5: short-term paid leave: l eave: accumulating, vesting and non-vesting Lee Limited operates a five-day working week. At Lee Limited’s financial year ended 31 December 20X4 (a year with 365 days): there were 50 similarly paid employees each earning an average salary of C50 000 and earning 20 days annual leave per year of service.

• • •

The leave entitlement of 20 days has remained the same for years and will remain the same for years to come. Similarly, the salary of C50 000 has remained unchanged for years and no significant changes are expected in the next few years. The following are the actual average leave statistics per employee: end of prior year 20X3: an average of 10 days of the 20X3 leave were unused end of current year 20X4: an average of 12 days was used, and on average this came from: - the 20X3 leave entitlement: 4 days - the 20X4 leave entitlement: 8 days. • •

The estimated future leave statistics per employee for the year ended 31 December 20X5: an average of 14 days will be taken and on average this is expected to come from: - 20X3: 0 days - 20X4: 5 days - 20X5: 9 days •

Ignore public holidays.  Required: Calculate the leave pay provision for Lee Limited’s financial year ended 31 December 20X4 if: A. annual leave is carried forward and available for use in the next financial year (i.e. accumulating) and is paid out in cash at the end of the next financial year if not used (i.e. vested: can be converted into cash). B. annual leave is carried forward to the next financial year (i.e. accumulates) but expires if not used by the end of the next financial year end (i.e. non-vesting: can’t be converted into cash). Solution to example 5A and B: short-term paid leave Comment: Comment: this example involves a calculation for a group of employees rather than for just o ne employee. The average rate per day is:

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Gripping IFRS

Employee benefits

The entity is still obligated in terms of the unused 20X4 leave entitlement at 31 December 20X4 (12 days per employee: 20 days – 8 days), since this leave may still be taken in the future. The provision is: Provision: C191.78 x (20 days – 8 days taken) x 50 employees = C115 068 20X5 leave: No provision: the 20X5 services have not been provided and therefore there is no obligation

Since the 20X5 leave has not yet been earned by the employees (because the services in 20X5 have not yet been provided by the employees), there is no past event that obligates the entity to provide any of the 20X5 leave). If there is no past event, there can be no obligation at 31 December 20X4. Total provision: 20X3 leave: C0 + 20X4 leave: C115 068 + 20X5 leave: C0 = C115 068

Solution to example 5B: short-term paid leave – accumulated and non-vesting 20X3 leave: No provision: unused 20X3 leave will have been forfeited by 31 December 20X4

There were 10 days still due to the employee at end of 20X3: 4 of these days were taken in 20X4 and the remaining 6 days from 20X3 would have been  forfeited  at the end of 20X4. No provision provision is therefore made in respect of 20X3 leave since there is no further obligation with regard to the 20X3 leave. 20X4 leave: Provision to be raised for 5 days leave

The employee is owed 20 days leave per year. Of the 20 days owed to the employee in 20X4, 8 days were taken as leave in 20X4 (P.S. another 4 days were also taken, but these came out of the 20X3 leave entitlement). This means that at 31 December 20X4, the entity owes the employee another 12 days. Since the employee has already rendered the service that entitles him him to this leave, a past event has occurred and there is therefore an obligation at 31 December 20X4. A liability must therefore be recognised for at 31 December 20X4. The liability will, however, be measured based on the number of 20X4 days that the employee will  probably take in 20X5: only 5 days – not the full 12 days (we are therefore expecting that the employees will forfeit an average of 7 days of their 20X4 leave: 20 – 8 – 5 days = 7 days). Compare this to part A where the liability was based on the full 12 days since the terms of part A’s leave entitlement was that the employee would be paid out for every day that he does not take. Although the entity will not be paying the employee out in cash, the cost to the entity is still C191.78 per day since the entity will effectively lose this value on the days that the employee stays at home. Provision: C191.78 x 5 days (20X4 unused leave expected to be used in 20X5) x 50 employees = C47 945 20X5 leave: No provision: the 20X5 services have not been provided and therefore there is no

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Gripping IFRS

Employee benefits

Recognition of these benefits should only occur when: there is a present obligation at year end (i.e. the settlement cannot realistically be avoided); resulting from a past event (the (t he provision of the agreed upon services); and the obligation can be reliably estimated.

•

•

•

The obligation can be either a legal obligation or constructive constructive obligation. For instance: a legal obligation would arise if the employment contract detailed the profit-sharing or bonus arrangement, and if all conditions of service were met; a constructive obligation could arise if the entity created  an obligation for itself through, for instance, a past practice of paying bonuses (or (or sharing in profits). Therefore, even though the employment contract may be silent on such profit-sharing or bonuses (in which case there would be no legal obligation), it is possible for the entity to create a constructive obligation through its past practices, policies, actions or public announcements etc.

•

•

In accordance with IAS19.20, a reliable estimate can only be made if: the terms of the formal plan contains a formula for determining the amount of the benefit; the entity determines the amounts to be paid before the financial statements are authorised for issue; or past practice gives clear evidence of the amount of the entity’s constructive obligation.

• •

•

A characteristic of profit sharing and bonuses are that they often accrue over a period of time, and may end up being only partially earned or even forfeited if an employee leaves before the payment date. This characteristic will impact impact on the measurement measurement of the provision: the probability that the employee/s may leave before they become entitled to the benefit must be factored into the calculation. Example 6: bonuses – raising the bonus provision During 20X2, Luke Limited Limite d created an obligation to pay a bonus of C120 000 to each employee for the year. There were 6 employees at 1 January 20X2, and 2 more employees were hired on 1 April 20X2 (resulting in 8 employees at 31 December 20X2). It was expected

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Gripping IFRS

Employee benefits

Example 7: bonuses – paying the bonus Assume the same information as that in the previous example and that the C120 000 bonus accrued to those employees still employed on 31 December 20X3 (i.e. example 6C). Assume that no employees resigned during 20X3 and that the bonus was paid on 31 December 20X3.  Required: Show the journal entries to be processed by Luke Limited for the year ended 31 December 20X3. Solution to example 7: bonuses – paying the bonus 31 December 20X3 Employee benefit expense 8 x 120 000 – 600 000 Provision for bonuses  Increase in 20X2 bonus provision Provision for bonuses 8 x 120 000; OR Bank  600 000 + 360 000 Payment of bonuses at 31 December 20X3

Debit 360 000

Credit

360 000 960 000 960 000

Example 8: profit sharing John Limited has 5 directors at 31 December 20X2 with whom it has employment contracts that provide for a 20% share of 10% of the profits that exceed a pre-determined target. The target is set at the end of each year for the next year’s profit sharing calculation. At 31 December 20X1 it was decided that the target profit for 20X2 was C1 000 000. The actual profit achieved in 20X2 was C1 200 000. The targeted profit for 20X3, set on 31 December 20X2, is C1 400 000. Before the 20X2 financial statements were authorised for issue it looked probable that this profit target will also be achieved.

•

•

Each of the directors still employed on 31 March of the year after the target is achieved is entitled to their 20% of the total 10% profit share.

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Gripping IFRS

3

Employee benefits

Post-employment Post-employment benefits (IAS 19.24 – 19.125)

3.1 Overview of post-employment benefits If the employee remains employed by the entity until normal retirement age (i.e. does not terminate his employment before this this date) he may be entitled to further benefits. Since these benefits would accrue while he was no longer employed, they would be referred to as ‘postemployment’ benefits. It is important to note that it is the services that he provided whilst employed that entitle him to these benefits after employment. Therefore, there is a past event for which the entity has an obligation. As such, a journal entry to record the obligation and related cost must be recognised as the services are provided :

Employee benefit expense Provision for post-employment benefits (L) Post-employment benefit provided for 

Debit XXX

Credit

XXX

As mentioned in the introduction, post-employment benefits are categorised into two basic types: defined contribution plans; and defined benefit plans. • •

Defined contribution plans are easier to recognise, measure and require almost no disclosure whereas defined benefit plans are more complex to measure and require lots of disclosure. The post-employment plan may be a simple single employer plan or may be a: multi-employer plan: explained in IAS 19.29-32B; group administration plan: explained in IAS 19.33; common control shared-risk plan: explained in IAS 19.34-34B;

• • •

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Employee benefits

The expense is recognised as and when when the employee provides the services. The amount to be recognised is relatively easy to measure: no actuarial assumptions are needed; and it is normally undiscounted (but it will need to be discounted if the contributions become payable after 12 months from the end of the period in which the employee provides the service).

• •

Example 9: defined contribution plans Matthew Limited’s annual salary expense for 20X4 is as follows: gross salary of C4 000 000: 30% is payable to the tax authorities, 7% is payable to a defined contribution plan (provident fund) and the ba lance is payable to the t he employees company contributions to the defined contribution plan: 10% of gross salaries

•

•

 Required: Show the relevant journals (on an a n annual basis despite normally being journalised j ournalised on a monthly basis) and profit before tax note in the financial statements of Matthew Limited for the year ended 31 December 20X4. Solution to example 9: defined contribution plans Employee benefit expense Current tax payable: employees tax (L) Defined contributions payable (L) Employees payable (L): net salary

Given 4 000 000 x 30%

Employee benefit expense Defined contributions payable (L)

4 000 000 x 10%

Debit 4 000 000

Credit

1 200 000 280 000 2 520 000

4 000 000 x 7% Balance (paid to the employee) Gross salaries for the period (including tax and the employees’ contributions to the defined contribution plan)

400 000 400 000

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Gripping IFRS

Employee benefits

3.3 Defined benefit plans (IAS 19.48 - 19.125)  3.3.1

Overview of a defined benefit plan (IAS 19.27)

Where an entity guarantees (promises) that certain benefits will be payable to its employees after employment, the entity has opened itself up to both: an obligation that is potentially much bigger than simply the payment of future contributions to a post-employment plan (e.g. pension payments are often based on the employee’s last salary which may be far greater than originally expected); and the risk that there will not be sufficient assets set aside to settle the obligation (i.e. to pay the benefit owing to the employee).

•

•

Due to the risks involved in a defined benefit plan, there is also far more disclosure required than is required of a defined contribution plan. When accounting for a defined benefit plan we must recognise both: the plan obligation (i.e. the benefits that it owes to its employees); and the plan assets (i.e. those set aside in order to settle the obligation). • •

The initial journal entries (to create the plan obligation and plan assets) are as follows: DBPO

Employee benefit expense xxx

Bank

Defined benefit plan: asset yyy

Defined benefit plan: obligation EB expense

Bank  DBPA

xxx

yyy

As can be seen in these ledger accounts, any contributions made to a defined benefit plan will be recognised as a plan asset (i.e. an investment) instead of an expense (i.e. as in the case of a defined contribution plan). Whereas the measurement of the plan asset is simply its fair value (which is generally its

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Employee benefits

3.3.2.2  Liability or asset 

The liability or asset presented in the statement of financial position is not the same thing as a surplus or deficit. The surplus or deficit is simply simply part of the liability or asset calculation. The liability or asset (which is presented in the statement of financial position) is calculated as follows (IAS 19.54): C

Plan obligation Less plan assets  Deficit/ (surplus)  Adjust for unrecognised items: Add unrecognised actuarial gains Less unrecognised actuarial losses Less unrecognised past service costs  Liability/ (asset) balance

Present value of future obligation Fair value

 IAS 19 .92 & .93 (corridor)  IAS 19 .92 & .93 (corridor)  IAS 19 .96   If it is an asset: consider IAS 19 .58 (ceiling), as well

XXX (XXX) XXX XXX (XXX) (XXX) XXX

as IAS 19.58A if there was also a surplus

If you look at this calculation (i.e. the calculation of the liability (or asset) balance), you will notice that IAS 19 makes the following distinctions: obligations: this is the present value of the plan obligation,

•

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Gripping IFRS

Employee benefits

3.3.2.3.1 Present value and interest cost (IAS 19.63)

A present value is a future amount that has been discounted to a present value using a discount rate that reflects the passage of time. As we get closer to the future date on which the future amount is expected to be paid, the present value will increase until it ultimately equals the future amount. The gradual increase of the present value (until it equals the future amount) is referred to as the unwinding of the discount. The following example explains the workings of a present value calculation and how one records the unwinding of the discount. Example 10: defined benefit plan: effect of the unwinding of the discount Assume that on 1 January 20X1 we owe an amount of C100 000, payable on 31 December 20X5. For simplicity, assume that: this future obligation arose due to services provided by the employee in the first few days of 20X1 and that services thereafter did not result in an increase in the obligation (i.e. the obligation remained static at C100 000); and the discount rate remained unchanged at 10% each year. •

•

 Required: Calculate the present value of the C100 000 and prepare the effective interest rate table. Show the journal entries posted in the ledger accounts. Solution to example 10: defined benefit plan: effect of the unwinding of the discount

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Gripping IFRS

Employee benefits

Bank  20X5

Jnl 7

DBP: Obligation

Jnl 1

Employee benefit expense: Current cost DBP: Obligation 62 092

20X1

Jnl 2

Employee benefit expense: Interest cost DBP: Obligation 6 209

20X2

Jnl 3

DBP: Obligation

6 830

20X3

Jnl 4

DBP: Obligation

7 513

20X4

Jnl 5

DBP: Obligation

8 264

20X5

Jnl 6

DBP: Obligation

9 092

20X1

100 000

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Employee benefits

Step 2: Effective interest rate table (revised for added current costs)

Opening balance Year 20X1 20X2 20X3 20X4 20X5

A 62 092 68 301 90 157 99 173 109 090

Interest A x 10% B 6 209 6 830 9 016 9 917 10 910

Current cost (provided end of year) C 15 026

Closing balance (A + B + C) D 68 301 90 157 99 173 109 090 120 000

42 882 The ledger accounts:

Defined benefit plan: Obligation 20X1 Jnl 1 20X1 Jnl 2 20X1 20X2 Jnl 3 20X2 Jnl 4 20X2

EB Exp: current cost EB Exp: interest cost Closing balance EB Exp: interest cost EB Exp: current cost Closing balance

62 092 6 209 68 301 6 830 15 026 90 157

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Gripping IFRS

Employee benefits

Example 12: defined benefit plan: past service cost A company has a defined benefit plan, agreed to on 1 January 20X1. Details relating to its plan obligation are as follows: Balance on 1 January 20X2: 68 301 (the PV of an estimated future amount of C100 000, payable on 31 December 20X5). Services provided during 20X2 increase the future obligation by C20 000 (PV of  C15 026). On 31 December 20X2, the company changed the terms of the plan such that the future obligation increased by C30 000 (PV C22 539). The condition attaching to this increase in benefit is that the employee must provide 3 years of service. As at 31 December 20X2, of the additional present value: - 20% relates to employees who have already provided 3 years of service; and - 80% relates to employees who have already provided an average of 1 year service. Services provided during 20X3 increase the t he future obligation by C15 000 (PV of  C12 397).

•

•

•

•

The discount rate remained unchanged at 10% each year. All present values have been calculated assuming that the transactions/ services happened at year-end.  Required:

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Gripping IFRS

Employee benefits

The ledger accounts:

Defined benefit plan: Obligation 20X1 Jnl 1 20X1 Jnl 2 20X1 20X2 Jnl 3 20X2 Jnl 4 20X2 Jnl 5

EB Exp: current cost EB Exp: interest cost Closing balance EB Exp: interest cost EB Exp: current cost EB Exp: past cost and DBP: unrecognised

62 092 6 209 68 301 6 830 15 026 22 539

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Gripping IFRS

Employee benefits

Solution to example 12B: defined benefit plan: past service cost – presentation W1: Calculation of the asset or liability balance (statement of financial position):

Plan obligation Less plan assets  Deficit   Adjust for unrecognised items: Add/ (less) unrecognised actuarial gains/ (losses) Less unrecognised past service costs

Present value of future obligation Given (plan asset account)

C

136 363 (111 000) 25 363 0 (9 015)

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Gripping IFRS

Employee benefits

Note 1: Past service costs arose due to a change made to the terms of the plan on 31 December 20X2. The increase in the obligation was valued at C22 539 (20% was vested and 80% was not yet vested but were expected to vest within 2 years). Assume that all transactions occurred at the end of the year.  Required: Show the journal entries in 20X3. Solution to example 13: defined benefit plan: benefits paid 31 December 20X3

Debit

Credit

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Gripping IFRS

Employee benefits

3.3.2.4  Measurement of the plan assets

The plan assets are measured at their fair value. The movement between the opening and closing balance on the plan assets account occurs as follows: Plan assets

Paragraph

Opening balance Expected return on plan assets Contributions by employer Contributions by employee Less benefits/ settlements paid

 Example 14

Fair value value of plan assets assets – beginning of year 

 Example 14

O/ bal x expected rate of return estimated at start of year 

 Example 14

Investments made made into the plan assets during the the year 

 Example 14

Investments made made into the plan assets during the year 

  Example 14

Actual amounts paid to employees

Subtotal

C XXX XXX XXX XXX (XXX) XXX

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Employee benefits

3.3.2.5  Actuarial assumptions (IAS 19.64 – 19.106)

Due to the sometimes very complex calculations needed to measure the plan obligations and plan assets (to a lesser extent), it is advisable to use an actuary. Although IAS 19 does not make the use of an actuary a requirement, IAS 19.64 requires that the entity uses the projected unit credit method to value the obligation. The workings of the projected unit credit method are explained together with an example in IAS 19.64-65 and are not covered further in this chapter. Whether the actuary does the calculations or you do, the measurement requires a number of  assumptions to be made. The actuary (or yourself) will need to assume certain things in order

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Actuarial gains and losses may be recognised:

Employee benefits

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The statement of financial position (barring any other unrecognised gains/ losses etcetera), is therefore:

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There are two basic steps when using the corridor approach. To explain these steps, let us

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Calculation 2: Step 4: Gain/ loss to be recognised in the current year

Employee benefits

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Solution to example 15A: defined benefit plan: using the amortised corridor (20X2)

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