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Hi Mike,
I don’t quite understand note 4 in this question which is “4 Rose commenced a long-term bonus scheme for employees at 1 May 2010. Under the scheme employees receive a cumulative bonus on the completion of five years service. The bonus is 2% of the total of the annual salary of the employees. The total salary of employees for the year to 30 April 2011 was $40 million and a discount rate of 8% is assumed. Additionally at 30 April 2011, it is assumed that all employees will receive the bonus and that salaries will rise by 5% per year.”
The answer states “Bonus scheme (W9) 0·65
–––––––”and it also states “The cumulative bonus payable will be $4·42 million.
The benefit allocated to each year will be this figure divided by five years. That is $884,000 per year. The current service cost is the present value of this amount at 30 April 2011. That is $884,000 divided by 1·08 for four years, i.e $0·65m”Now, I’m happy with the numbers but what is disturbing me is this “$0.65M is per year so how can it be non current liability amount? The obligation will be settled four years later and so the amount of non current liability should be 0.65*2 = 1.3M. Why is the amount of the non current liability 0.65M? This 0.65M is per year (once discounted) but the liability is further away into the future and is not just one year away so why just recognize 0.65M?
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“so the amount of non current liability should be 0.65*2 = 1.3M”
Why multiply by 2 if it’s 4 years away?
“Why is the amount of the non current liability 0.65M?”
Because only one year has passed. As each year goes by, the obligation will increase
If you were to continue the exercise to determine the obligation at the end of 2012, it would be $1,403,656 (my figures are accurate whereas the figures you have quoted are rounded) and at the end of 2013, the obligation will have risen to $2,273,922
It’s only going to be at the end of 2104 that the obligation becomes a current liability ($3,312,458). Before that, it’s non-current
By the end of 2015, just before the obligation is settled, the amount has risen to $4,461,556 (that corresponds with the rounded figure in your post of $4.42m)
OK?
Ok Mike, I thought it would be paid annually so I suggested multiplying by 2 as four years remain, and the third year, next year, would be classified as current. But all this is just incorrect.
But my major concern is that does the 0.65M represent the TOTAL amount of obligation that we would have to pay in 4 years time, I guess it is expressed in today’s terms. It’s something to do with unwinding too isn’t it so that I got confused why we didn’t recognize the whole 4.42M at once? Argh! This unwinding is getting me in all questions. Please confirm this interpretation of mine as correct.
Because my doubt was why recognize 0.65M (liability for one year as a non current liability) when in reality the whole amount is 4.42M but I suspect it deals with present value and unwinding so we can’t recognize everything in today’s terms.
“Because my doubt was why recognize 0.65M (liability for one year as a non current liability) when in reality the whole amount is 4.42M but I suspect it deals with present value and unwinding so we can’t recognize everything in today’s terms.”
Your suspicions are correct.
$650,000 is the present value of the $884,000 payable in 4 more years’ time
Next year, the current service cost is that same $650,000 but this time multiplied by 1.08% to unwind the discount.
The obligation by the end of 2012 is therefore $1,403,656 and we arrive at that figure (using accurate, not rounded figures) as follows”
$649,841 (your $650,000) obligation outstanding at the end of 2011 now unwound by 8% = $649,841 + $51,987 = $701,828
Now add on the 2012 current service cost which is $884,000 discounted for three years = $701,828! Yes, it’s the same figure as $649,841 unrolled by 1 year!
So, that figure of $1,403,656 is $701,828 unrolled from 2011 + $701,828 current service cost for 2102 = $1,403,656
Are we getting any clearer?
The fact that all these figures are shown as non-current liabilities is because the whole amount is payable at the end on 2015 but the obligation is increasing each year as we get closer to 31 December, 2015
OK?
Just a doubt on what you said “So, that figure of $1,403,656 is $701,828 unrolled from 2011 + $701,828 current service cost for 2102 = $1,403,656”
Why are we double adding 701,828? Why can’t we just take the 2011 figure unroll it and record it as a non current liability but instead of doing this, we are adding so called “service cost for 2012” of the same amount, what are these service costs? And can’t we just keep unrolling the original figure instead of multiplying it by 2 (like in this case). What’s the significance of doubling it?
Thanks,
Gabriel
We’re not multiplying by 2!
650,000 unrolled at 8% = 701,828 and next year we’ll unroll it again by 8% and so on until payment date.
But that only deals with the 2011 service cost
What about the 2012
and the 2013
and the 2014 service costs
Ok, 650,000 is the service cost for 2011 and the figure comes from discounting $884,000 for 4 years at 8%
The service cost for 2012 is 884,000 discounted for 3 years at 8%
Try this on your calculator BEFORE you read any further – do 884,000 discounted for 4 years at 8% and then 884,000 discounted for 3 years at 8% (scroll down when you’ve done that)
Ok! You should have got $649,841 and $701,828
OK so far?
Now, concentrate on the $649,841. That’s the service cost for 2011- it’s therefore the expense in the statement of profit or loss and it’s the obligation (non-current) on the statement of financial position
Now, throughout 2012, that obligation is getting closer and closer to being settled, so we unroll the discount by 1 year at 8%
8% x $649, 842 = $51,987. so that original obligation of $649,841 is now carried at the amount of $649,842 + $51,987 = $701,828
Next year, we’ll unroll it again at the rate of 8% and so on until settlement date.
OK, can we forget the 2011 service cost which started off as $884,000 discounted for 4 years at 8%
The other calculation that you did was $884,000 discounted at 8% for 3 years and you should have arrived at $701,828. Well, of course it is!! If I were to discount that figure by 8% for one more year, I’m back to our friend $649,842 which, when unrolled at 8%, brings me back to $701,828
So you see, we’re not doubling as an exercise the $649,842 that has been unrolled.
This new $701,828 is the service cost for 2012 and has nothing to do with the $701,828 that was the unrolled service cost for 2011
OK so far?
Your last question – what IS this service cost?
It’s the ultimate liability / obligation to pay our employees if they work for us for 5 years divided by the “vesting period” ie divided by 5 (years)
The ultimate obligation was calculated as $4.42m That obligation is earned by our employees over a 5 year period so we need to allocate that amount over the 5 years
$4.42m / 5 = $884,000
But we need the present value of that annual expense so we discount it by 4 years (2011), by 3 years (2012), by 2 years (2013) and by 1 year (2014)
The 2015 figure is only going to be recorded right at the end of 2015 immediately before the obligation is settled
So, in summary, the service cost is the present value for each of the 5 years of the total obligation / 5
OK?
Ok I got it now. Actually, I thought that unwinding the original 2011 figure over 4 years would lead to the full amount of the obligation being realized at 2015 but I now understand that to reach to the full $4.4M at the end of 2015 (actually 30.Apr.2015 as this is the year end date), then we also need to unwind the discount and also factor in the current service costs for each year. Is this a correct interpretation?
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