Employee benefits (IAS 19)
1 Pensions
1.1 Jargon buster
When a company sets up a pension plan it will make contributions to the plan in line with the guidance of an actuary.
When the employees retire the plan will pay out benefits in accordance with the rules of the plan.
There are two types of plan: defined contribution and defined benefit.
In a defined contribution plan, the company promises a level of contribution (e.g. 5% of salary), but no guarantee is given of what benefits may ultimately be paid out by the plan. The employee takes all the risk.
In a defined benefit plan, the company promises a level of benefit (based on years of service and salary while in service). In this case the company faces uncertainty over the level of contributions that will be required to fund the benefits. Thus the company takes all the risk.
Important. You are not sitting an actuarial exam, so don’t worry too much about the terminology. All that matters is that you recognise the term (e.g. service cost) and know where it should be shown in the financial statements.
1.2 Defined contribution scheme
Contributions are accrued in the financial statements with an expense recognised in profit or loss.
1.3 Defined benefit scheme
Statement of financial position (extract)
$m | |
Fair value of scheme assets | X |
Fair value of scheme liabilities | (X) |
Net pension asset/(liability) | X/(X) |
Statement of profit or loss and other comprehensive income (extract)
$m | |
Profit or loss | |
Operating costs | |
Current service costs | (X) |
Past service costs | (X) |
Financing costs | |
Interest expense | (X) |
Return on investment | X |
Other comprehensive income | |
Re-measurement gain/(loss) (W) | X/(X) |
Workings
Assets | $m | Liabilities | $m |
Opening | X | Opening | X |
Return on investment | X | Interest | X |
Contributions paid in | X | Service costs | X |
Benefits paid out | (X) | Benefits paid out | (X) |
Expected | X | Expected | X |
Re-measurement component (β) | X/(X) | Re-measurement component (β) | X/(X) |
Closing (per actuary) | X | Closing (per actuary) | X |
Base net interest on the opening net deficit or surplus, at the rate applying to that part of the year, and let the remeasurement fall out as the balancing figure in other comprehensive income, where it stays — it is never reclassified to profit or loss. Explain each adjustment; a table of figures alone leaves marks behind.
1.4 Curtailment
A curtailment occurs when there are a significant number of employees who leave the scheme, commonly seen if there is a re-organisation of the business or change in scheme from defined benefit to defined contribution.
The asset and liability are re-measured to fair value and any change is taken to profit or loss.
1.5 Asset ceiling
If a company has an overall pension asset on its statement of financial position then the asset can only be recognised up to the level of the asset ceiling. The asset ceiling is the present value of any future cash savings of not having to contribute to the scheme as it is in surplus. If the asset needs to be reduced to the asset ceiling limit then the reduction in the asset is shown as an expense in other comprehensive income.
2 Other employment benefits
2.1 Short-term benefits
An example of a short-term benefit is holiday pay. If an employee does not take all of their annual leave, then the employer may allow them to carry some days forward to the next year. In this case, the employee is working additional days in the current year and fewer days in the subsequent year.
The accruals concept would require that an extra wage expense should be charged in the current year, and a lower charge in the subsequent year. Thus the wage expense will match the work done.
The entry for this adjustment would be Dr Wage expense Cr Accrual.
2.2 Long-term benefits
Examples of long-term benefits are bonuses payable more than 12 months after the balance sheet date and long-term disability payments made to staff. The accounting is similar to defined benefit pension plans except that remeasurement differences are recognised in the profit and loss account (instead of other comprehensive income).