Appendix 2 – Supplementary reading

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 Employee benefits
Supplementary reading

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 Appendix 2 – Supplementary reading

1 Concepts and principles

1.1 The conceptual nature of employee benefit costs
When a company or other entity employs a new worker, that worker will be offered a package of
pay and benefits. Some of these will be short-term and the employee will receive the benefit at
about the same time as they earn it; for example basic pay, overtime and so on. Other employee
benefits are deferred, however, the main example being retirement benefits (ie a pension).
The cost of these deferred employee benefits to the employer can be viewed in various ways. They
could be described as deferred salary to the employee. Alternatively, they are a deduction from
the employee's true gross salary, used as a tax-efficient means of saving. In some countries, tax
efficiency arises on retirement benefit contributions because they are not taxed on the employee, but
they are allowed as a deduction from taxable profits of the employer.

1.2 Accounting for employee benefit costs

Accounting for short-term employee benefit costs tends to be quite straightforward, because
they are simply recognised as an expense in the employer's financial statements of the current
period.
Accounting for the cost of deferred employee benefits is much more difficult. This is because of
the large amounts involved, as well as the long time scale, complicated estimates and uncertainties.
In the past, entities accounted for these benefits simply by charging profit or loss (the income
statements) of the employing entity on the basis of actual payments made. This led to substantial
variations in reported profits of these entities and disclosure of information on these costs was usually
sparse.

2 Defined benefit, defined contribution and multi-employer

plans
2.1 Defined benefit and defined contribution plans
IAS 19 para. 8 sets out the following definitions relating to classification of plans.

Defined contribution plans: post-employment benefit plans under which an entity pays fixed
contributions into a separate entity (a fund) and will have no legal or constructive obligation to pay
Key term
further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to
employee service in the current and prior periods.
Defined benefit plans: post-employment benefit plans other than defined contribution plans.

There are two types or categories of post-employment benefit plan, as given in the definitions above
(IAS 19: paras. 26–30).
(a) Defined contribution plans. With such plans, the employer (and possibly current
employees too) pay regular contributions into the plan of a given or 'defined' amount each
year. The contributions are invested, and the size of the post-employment benefits paid to
former employees depends on how well or how badly the plan's investments perform. If the
investments perform well, the plan will be able to afford higher benefits than if the investments
performed less well.
(b) Defined benefit plans. With these plans, the size of the post-employment benefits is
determined in advance; ie the benefits are 'defined'. The employer (and possibly current
employees too) pay contributions into the plan, and the contributions are invested. The size of
the contributions is set at an amount that is expected to earn enough investment returns to meet
the obligation to pay the post-employment benefits. If, however, it becomes apparent that the
assets in the fund are insufficient, the employer will be required to make additional

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contributions into the plan to make up the expected shortfall. On the other hand, if the fund's
assets appear to be larger than they need to be, and in excess of what is required to pay the
post-employment benefits, the employer may be allowed to take a 'contribution holiday' (ie
stop paying in contributions for a while).
It is important to make a clear distinction between the following.
 Funding a defined benefit plan, ie paying contributions into the plan
 Accounting for the cost of funding a defined benefit plan
The key difference between the two types of plan is the nature of the 'promise' made by the entity to
the employees in the plan:
(a) Under a defined contribution plan, the 'promise' is to pay the agreed amount of
contributions. Once this is done, the entity has no further liability and no exposure to risks
related to the performance of the assets held in the plan.
(b) Under a defined benefit plan, the 'promise' is to pay the amount of benefits agreed under
the plan. The entity is taking on a far more uncertain liability that may change in the future as
a result of many variables and has continuing exposure to risks related to the performance of
assets held in the plan. In simple terms, if the plan assets are insufficient to meet the plan
liabilities to pay pensions in future, the entity will have to make up any deficit.

2.2 Multi-employer plans

Multi-employer plans are defined contribution plans (other than State plans) or defined benefit
plans (other than State plans) that:
Key term
(a) Pool the assets contributed by various entities that are not under common control; and
(b) Use those assets to provide benefits to employees of more than one entity, on the basis that
contribution and benefit levels are determined without regard to the identity of the entity that
employs the employees concerned.
(IAS 19: para. 8)

IAS 19 (IAS 19: paras. 32–39) requires an entity to classify such a plan as a defined contribution
plan or a defined benefit plan, depending on its terms (including any constructive obligation beyond
those terms).
For a multi-employer plan that is a defined benefit plan, the entity should account for its
proportionate share of the defined benefit obligation, plan assets and cost associated with the plan
in the same way as for any other defined benefit plan and make full disclosure.
When there is insufficient information to use defined benefit accounting, then the multi-employer
plan should be accounted for as a defined contribution plan and additional disclosures made (that
the plan is in fact a defined benefit plan and information about any known surplus or deficit).

3 'Asset Ceiling' test

The following illustration shows how the 'Asset Ceiling' test is performed.

Illustration 1
Defined benefit plan calculations
Clement operates a defined benefit pension scheme for its employees. At 1 January 20X1 the present
value of the defined benefit obligation was $5 million and the fair value of the plan assets was
$5.7 million. Equivalent values at 31 December 20X1 were $5.94 million and $7.1 million.

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 Appendix 2 – Supplementary reading

For the year ended 31 December 20X1:

 Current service cost was $1.5 million
 The interest rate applicable to the net defined benefit asset was 3%
 Contributions of $2 million were made to the plan
 $800,000 was paid out to former employees of Clement
The present value of future economic benefits in relation to the plan is $1.1 million.
Required
Calculate the amount of remeasurement to be recognised in other comprehensive income in the year
ended 31 December 20X1.
Solution
Net defined
Obligation Assets benefit asset
$'000 $'000 $'000
At 1 January 20X1 5,000 5,700 700
Current service cost 1,500
Contributions 2,000
Payments (800) (800)
Interest (3%  5m)/(3%  5.7m) 150 171
5,850 7,071
Remeasurements (β) 90 29
At 31 December 20X1 5,940 7,100 1,160
Remeasurement due to asset ceiling (60)
Asset ceiling 1,100

Therefore, the total remeasurement amount recognised in other comprehensive income is:
$'000
Remeasurement loss on obligation 90
Remeasurement gain on assets (29)
Remeasurement loss due to asset ceiling 60
Net remeasurement loss 121

4 Contributions and benefits paid other than at the end of

the period
In most exam questions you will be told that contributions and benefits will be paid at the end of the
accounting period. Occasionally this may not be the case. The following illustration shows how to
deal with a situation where the payments are made at different times.

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Illustration 2
Contributions and benefits paid other than at the end of the period
Jett Co has a defined benefit pension plan.
Required
Using the information below, prepare extracts from the statement of financial position and the
statement of comprehensive income of Jett Co, together with a reconciliation of plan movements for
the year ended 31 January 20X8. Ignore taxation.
(a) The plan assets were $4.1m on 1 February 20X7 and plan liabilities at this date were
$4.8m.
(b) The company paid a contribution of $680,000 in a lump sum on 1 February 20X7.
(c) Benefits paid to former employees, which amounted to $440,000, were paid in two equal
amounts on 31 July 20X7 and 31 January 20X8.
(d) The yield on high quality corporate bonds was 6% and the actual return on plan assets was
$282,000.
(e) Current service cost can be calculated as 4.2% of wages and salaries in the current year.
The wages and salaries expense is $5,900,000.
(f) The actuary valued the plan liabilities at 31 January 20X8 as $4.95.
(6 marks)
Solution
STATEMENT OF FINANCIAL POSITION (Extract)
$'000
Non-current liabilities
Defined benefit pension obligations (4,950 – 4,622) 328

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME (Extract)

$'000
Charged to profit or loss
Current service cost 248
Net interest on net defined benefit liability (281 – 280) 11
249
Other comprehensive income
Loss on remeasurement of obligation (61)
Gain on remeasurement of plan assets (excluding amounts in net 2
interest)

$'000
Reconciliation of pension plan movement
Plan deficit at 1 Feb 20X7 (4,100 – 4,800) (700)
Company contributions 680
Profit or loss total (249)
Other comprehensive income total (61 – 2) (59)
Plan deficit at 31 Jan 20X8 (4,950 – 4,622) (328)

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$'000

Changes in the present value of the defined benefit obligation

Defined benefit obligation at 1 Feb 20X7 4,800
Interest cost (4,800 × 6% × 6/12) + ((4,800 – 220) × 6% × 6/12) 281
Pensions paid (440)
Current service cost ($5,900 × 4.2%) 248
Remeasurement loss through OCI (bal. fig.) 61
Defined benefit obligation at 31 Jan 20X8 4,950

Tutorial note: Interest cost

As benefits are paid in two equal payments, we must pro-rate the interest cost calculation
to take account of the timing of the payment on 31 July 20X7. (The benefits paid on the
last day of the year do not impact on the interest cost)

$'000
Changes in the fair value of plan assets
Fair value of plan assets at 1 Feb 20X7 4,100
Contributions 680
Pensions paid (440)
Interest income on plan assets ((4,100 + 680) × 6% × 6/12) + 280
(4,100 + 680 – 220) × 6% × 6/12)
Remeasurement gain through OCI (282 – 280) 2
Fair value of plan assets at 31 Jan 20X8 (bal. fig.) 4,622

Tutorial note: Interest income

Interest income on plan assets must be adjusted for:
Contributions – paid at the beginning of the year so added to the opening asset balance
Benefits – paid in equal instalments, so we must pro-rate to take account of the timing of
the payment on 31 July 20X7

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Provisions, contingencies
and events after the
reporting period
Supplementary Reading

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