IAS 19

IAS 19 Employee Benefits covers four distinct types of employee benefit. However, the examiner has confirmed that he will only examine post-employment benefits. Post-employment benefits are employee benefits which are payable after the completion of employment. These can be in the form of: (a) Defined contribution schemes: y e.g. annual contribution = 5% salary y future pension depends on the value of the fund. (b) Defined benefit schemes: y e.g. annual pension = Final salary x years worked 60 y future pension depends on final salary and years worked. The accountings for the two different types of schemes are very different. It is important that you decide on the nature of the scheme before attempting to account for it. A pension scheme will normally be held in a form of trust separate from the sponsoring employer. Although the directors of the sponsoring company may also be trustees of the pension scheme, the sponsoring company and the pension scheme are separate legal entities that are accounted for separately.

Defined contribution schemes

The company's obligation is to pay an agreed amount into a plan on behalf of its employees.

Accounting treatment
The obligation for each year is shown as an expense for the period (disclosed in a note) and in the balance sheet to the extent that it has not been paid. These are easy to account for, as the cost of the pension contribution is always made under the control of the sponsoring employer.

Lecture example 1
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.

Required Calculate the total income statement expense for post-employment benefits for the year and the accrual which will appear in the balance sheet at 31 December 20X9.

Defined benefit schemes

Introduction
A separate plan is established into which the company makes regular payments, as advised by an actuary. This fund needs to ensure that it has enough assets to pay future pensions to pensioners.

Measurement of plan obligation

Projected unit credit method IAS 19 requires the use of the projected unit credit method which sees each period of service as giving rise to an additional unit of benefit entitlement and measures each unit separately to build up the final liability (obligation). Discounting current service cost The benefits earned must be discounted to arrive at the present value of the defined benefit obligation. The increase during the year in this obligation is called the current service cost which is shown as an expense in the income statement. In effect, the current service cost is the increase in total pensions payable as a result of continuing to employ your staff for another year. The discount rate used should be related to market yields on high quality fixed-rate corporate debt, (or government debt if no market in corporate debt exists). Compounding interest cost The obligation must be compounded back up each year reflecting the fact that the benefits are one period closer to settlement. This increase in the obligation is called interest cost and is also shown as an expense in the income statement.

Measurement of plan assets

The sponsoring employer needs to set aside investments during the accounting period to cover the pension liability. To meet the IAS 19 criteria (and protect the pensioners!) they must be held by an entity legally separate from the reporting entity. The value of the investments will increase over time. This is called the return on plan assets and 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 itself. The expected return on plan assets is shown as income in the income statement. Any difference between that and the actual return is an actuarial gain or loss.

The role of the actuary

The actuary provides: y the income statement charge for the year (current service cost) y the rate for expected return on plan assets y the discount factor for liabilities (interest cost) y the contributions required, and y a valuation of the assets and liabilities of the scheme on an annual basis. Actuarial assumptions The actuarial assumptions must be: y unbiased neither imprudent not excessively conservative. y mutually compatible reflecting relationships between inflation, rates of salary increase and returns on plan assets. Actuarial gains and losses Differences between the actuarial values of the asset and liability and the accounting values are called actuarial gains or losses. They are made up of: y experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred), and y the effects of changes in actuarial assumptions. IAS 19 allows a choice of accounting policy regarding recognition of actuarial gains and losses: y y in profit or loss either in the period in which they occur or deferred on a systematic basis directly in retained earnings in the period in which they occur (and shown in the statement of recognised income and expense which becomes compulsory for entities that adopt this policy).

In the former case, IAS 19 requires (as a minimum) that the following actuarial gains and losses are recognised in profit or loss for the period: Net actuarial gains or losses brought forward outside 10% corridor Average remaining working lives of participating employees The '10% corridor' limit is defined as the higher of 10% of b/d: (a) 10% b/d present value of benefit obligations (b) 10% b/d fair value of plan assets.

Approach
The suggested approach to defined benefit schemes is to deal with the change in the obligation and asset in the following order: 1. Record opening figures: y asset y obligation y any unrecognised gains and losses 2. Interest cost y Based on discount rate and PV obligation at start of period. y Should also reflect any changes in obligation during period, e.g. past service cost Dr Interest cost (I/S) (x% x b/d obligation) Cr PV defined benefit obligation (B/S) 3. Expected return on plan assets y Based on long-term expectations as advised by actuary and asset value at start of period. y Technically, the expected return is also time apportioned on contributions less benefits paid in the period. Dr Plan assets (B/S) Cr Expected return on plan assets (I/S) (y% x b/d assets) 4. Current service cost y Increase in the present value of the obligation resulting from employee service in the current period. Dr Current service cost (I/S) Cr PV defined benefit obligation (B/S)

5. Contributions y Into the plan by the company y As advised by actuary. Dr Plan assets (B/S) Cr Company cash 6. Benefits y Actual pension payments made. Dr PV defined benefit obligation (B/S) Cr Plan assets (B/S) 7. Past service cost y Increase in PV obligation as a result of the introduction or improvement of benefits. y Past service cost is vested when any minimum employment period has been completed. Vested benefits: Dr Past service cost (I/S) Cr PV defined benefit obligation (B/S) Non-vested benefits: Dr Unrecognised past service cost (B/S) Cr PV defined benefit obligation (B/S) The unrecognised past service cost is amortised through profit or loss on a straight line basis over the average period until the minimum employment period is completed. 8. Actuarial gains and losses y Arising from annual valuations of obligation and assets. y On obligation, differences between actuarial assumptions and actual experience during the period, or changes in actuarial assumptions. y On assets, differences between expected and actual return.

(a) (only If using corridor approach): recognise unrecognised gains/losses b/d outside 10% corridor in profit or loss over average remaining working lives of employees. (b) Calculate carried down actuarial gains/losses from balance sheet workings. Recognise in: unrecognised gains/losses, or profit or loss directly, or retained earnings directly according to accounting policy.

Lecture example 2
Lewis Co has a defined benefit plan for its employees. The present value of the future benefit obligations at 1 January 20X7 was $890m and fair value of the plan assets was $1,000 million. There were unrecognised actuarial gains of $120m at the same date (Lewis Co's accounting policy is to use the 10% corridor approach to recognition of actuarial gains and losses). Further data concerning the year ended 31 December 20X7 is as follows: $millions Current service cost 127 Benefits paid to former employees 150 Contributions paid to plan 104 Present value of benefit obligations at 31 December 1,100 Fair value of plan assets at 31 December 1,230 Interest cost (gross yield on 'blue chip' corporate bonds) 10% Expected return on plan assets 12% Existing employees participating in the plan have an average remaining working life of 10 years. This tends to remain static as employees leave and join the plan. On 1 January 20X7 the plan was amended to provide additional benefits with effect from that date subject to a minimum employment period of eight years. The present value of the additional benefits was calculated by actuaries at $10 million with respect to employees who had already completed the minimum service requirements and $20 million for employees who on average had worked for the company for three years.

Lecture example 3
A company has a defined benefit pension plan. At 1 January 20X1 the following values relate to the plan: The fair value of the plan assets is $30m. The present value of the defined benefit obligation is $25m. There are cumulative unrecognised actuarial gains of $4m. The average remaining working lives of employees is 10 years.

At the end of the period, at 31 December 20X1, the following values relate to the pension scheme: The fair value of the plan assets has risen to $35m. The present value of the defined benefit obligation has risen to $28m. The actuarial gain is $5m. The average remaining working lives of employees is 10 years. Required Show the ways in which actuarial gain could be treated for the period ending 31 December 20X1 (the asset ceiling test is ignored in this example).

Settlements and curtailments

A settlement occurs when an entity enters into a transaction that eliminates all further legal or constructive obligations for part or all of the benefits provided under a defined benefit plan. Example: a lump-sum cash payment made in exchange for rights to receive postemployment benefits. A curtailment occurs when an entity either: (a) is demonstrably committed to make a material reduction in the number of employees covered by the plan; or (b) amends the terms of a defined benefit plan such that a material element of future service by current employees will no longer qualify for benefits, or will qualify only for reduced benefits. Examples: y Discontinuance of an operation, so that employees' services are terminated earlier than expected. y A change to the plan rules where future service by current employees will qualify for less benefits.

The gain/loss on a settlement or curtailment is recognised in profit or loss. e.g. Dr PV obligation X Cr FV plan assets X Cr Unrecognised actuarial losses X Cr Cash (for a settlement) X Cr Income statement (difference) X

Lecture example 4
A company closes down its subsidiary, and the employees of that subsidiary no longer earn further pension benefits. The company has a defined benefit obligation with a net present value of $60m. The plan assets have a fair value of $48m. There are net cumulative and actuarial unrecognised gains of $4m. The curtailment reduces the net present value of the obligation by $6m. Requirement Calculate the curtailment gain and the net liability recognised in the balance sheet after the curtailment.

The 'Asset ceiling' test

Amounts recognised as a net pension asset in the balance sheet should not be stated at more than their recoverable amount. Consequently, IAS 19 requires any net pension asset to be measured at the lower of: y net reported asset, and y any cumulative unrecognised net actuarial losses and past service cost + present value of any refunds/reduction of future contributions available from the pension plan The amount is charged immediately to profit or loss or to retained earnings depending on the entity's accounting policy for actuarial differences.

Lecture example 5
The fair value of the plan assets is $130m The present value of the defined benefit obligation is $105m There are cumulative unrecognised actuarial losses of $4m Present value of refunds from the plan, and reductions in future contributions, is $23m.

Answer Example 2 Income statement note Defined benefit expense recognised in profit or loss Current service cost $m 127

Interest cost [(890 10%) + (30 10%)] Expected return on plan assets (1,000 12%) Past service cost - vested benefits - non-vested benefits (20/(8 3 years)) Net actuarial (gains)/losses recognised in the year (Working) Balance sheet notes Net defined benefit liability recognised in the balance sheet Present value of defined benefit obligation Fair value of plan assets Unrecognised actuarial gains/(losses) (Working) Unrecognised past service cost [20 (20/(8 3 years)] Net liability Changes in the present value of the defined benefit obligation Opening defined benefit obligation Interest cost [(890 10%) + (30 10%)] Current service cost Benefits paid Past service cost - vested - non-vested Actuarial (gain)/loss (balancing figure) Closing defined benefit obligation Changes in the fair value of plan assets Opening fair value of plan assets Expected return on plan assets (1,000 12%) Contributions Benefits paid Actuarial gain/(loss) (balancing figure) Closing fair value of plan assets Working Recognised/unrecognised gains and losses $m Corridor limits, higher of: 10% b/d obligation 10% b/d assets Corridor limit Unrecognised gains/(losses) b/d Gain recognised [(120100)/10] Gain/(loss) on obligation in the year Gain/(loss) on assets in the year Unrecognised gains/(losses) c/d 89 100 100 120 (2) (111) 156 163 $m 1,000 120 104 (150) 156 1,230

92 (120) 10 4 (2) 111 $m 1,100 (1,230) (130) 163 (16) 17 $m 890 92 127 (150) 10 20 111 1,100