IAS19 – Employee benefits – ACCA Past exams of March 2019

Dear Sir,

Could you please explain the answer from ACCA regarding basic settlement and an additional pension contribution as below.

Questions:

Hudson has a year end of 31 December 20X2 and operates a defined benefit scheme for all employees. In addition, the directors of Hudson are paid an annual bonus depending upon the earnings before interest, tax, depreciation and amortisation (EBITDA) of Hudson.

Hudson has been experiencing losses for a number of years and its draft financial statements reflect a small loss for the current year of $10 million. On 1 May 20X2, Hudson announced that it was restructuring and that it was going to close
down division Wye. A number of redundancies were confirmed as part of this closure with some staff being reallocated to other divisions within Hudson. The directors have approved the restructuring in a formal directors meeting. Hudson is highly geared and much of its debt is secured on covenants which stipulate that a minimum level of net assets should be maintained. The directors are concerned that compliance with International Financial Reporting Standards (IFRS® Standards) could have significant implications for their bonus and debt covenants.

<b>Redundancy and settlement costs</b>

Hudson still requires a number of staff to operate division Wye until its final expected closure in early 20X3. As a consequence, Hudson offered its staff two settlement packages in relation to the curtailment of the defined benefit scheme. A basic settlement was offered for all staff who leave before the final closure of division Wye. An additional pension contribution was offered for staff who remained in employment until the final closure of division Wye.

The directors of Hudson have only included an adjustment in the financial statements for those staff who left prior to 31 December 20X2. The directors have included this adjustment within the remeasurement component of the defined benefit scheme. They do not wish to provide for any other settlement contributions until employment is finally terminated, arguing that an obligation would only arise once the staff were made redundant. On final termination, the directors intend to include the remaining basic settlement and the additional pension contribution within the remeasurement component. The directors and accountant are aware that the proposed treatment does not conform to IFRS Standards. The directors believe that the proposed treatment is justified as it will help Hudson maintain its debt covenant obligations and will therefore be in the best interests of their shareholders who are the primary stakeholder.
The directors have indicated that, should the accountant not agree with their accounting treatment, then he will be replaced.

Answer:

A distinction needs to be made between the basic settlement and the additional pension contribution. The basic settlement is an obligation which Hudson has to pay as compensation for terminating the employee’s services regardless of when the
employee leaves the entity. IAS 19 Employee Benefits requires such payments to be recognised at the earlier of when the plan of termination is announced and when the entity recognises the associated restructuring costs associated with the closure of
Wye.
Hudson should therefore have provided in full for the cost of the basic settlement regardless of whether the staff have left or not. This should be recognised as part of the past service cost in the profit or loss of Hudson for the year ended 31 December
20X2.

The additional pension contribution is only paid to employees who complete service up to the closure of division Wye. Since
this is expected in early 20X3, these should be accounted for as a short-term benefit. In effect, the contributions are in exchange for the period of service until redundancy. Hudson should estimate the number of employees who will remain with
Hudson until the closure of Wye. The cost of this payment should then be spread over the period of service. Since this should be included within the current service cost, this will have an adverse effect on the profit or loss in both 20X2 and 20X3.

I don’t understand why basic settlement is classified as part of past service cost and why the addition pension contribution is classified as short-term benefits. I think it should be included in current service cost of defined benefits plan.