Employee Benefits

IAS - 19
Employee Benefits
Employee benefits: All forms of consideration given by an entity in exchange for service
rendered by employees or for the termination of employment.
Why IAS 19?
The main objective of IAS 19 is to prescribe the accounting and disclosure for employee
benefits. IAS 19 requires and entity to recognize:
◦ a liability when an employee has provided service in exchange for employee benefits to be paid in
the future; and
◦ an expense when the entity consumes the economic benefit arising from service provided by an
employee in exchange for employee benefits.

That’s the clear demonstration of matching principle—to recognize an expense in the

period when matching revenue is recognized.
Employee Benefits
Short-term Benefits
◦ wages, salaries and social security contributions;
◦ paid annual leave and paid sick leave;
◦ profit-sharing and bonuses; and
◦ non-monetary benefits (such as medical care, housing, cars and free or subsidised goods or services) for
current employees;
Post-Employment Benefits
◦ retirement benefits (e.g. pensions and lump sum payments on retirement); and
◦ other post-employment benefits, such as post-employment life insurance and post-employment medical
care;
Other Long-term benefits
◦ long-term paid absences such as long-service leave or sabbatical leave;
◦ jubilee or other long-service benefits; and
◦ long-term disability benefits; and
Termination Benefits
◦ terminate an employee’s employment before the normal retirement date
Short-term benefits
Short-term benefits: Employee benefits (other than termination benefits) that are expected
to be settled wholly before 12 months after the end of the annual reporting period in which
the employees render the related service.
Short-term employee benefits are recognised as a liability and an expense when an
employee has rendered service during an accounting period, ie on an accruals basis.
Short-term benefits are not discounted to present value.
Short-term paid absences
Sometimes an entity may pay employees for absence for various reasons. These include
holidays, sickness and maternity leave. Entitlement to paid absences falls into two
categories:
Accumulating
◦ carried forward for use in future periods if the current period’s entitlement is not used in full;
◦ expense and liability is recognised when employees render service that increases their entitlement
to future paid absences
◦ measured at the additional amount expected to be paid as a result of the unused entitlement that
has accumulated at the end of the reporting period.

Non-accumulating
◦ unused amounts cannot be carried forward;
◦ expense and liability is recognised when the absences occur.
◦ This may arise, for example, where an employee continues to receive their normal remuneration
whilst being absent due to illness or other permitted reason.
Example 1 – Short term Benefits
The salaried employees of an entity are entitled to 20 days' paid leave each year. The
entitlement accrues evenly over the year and unused leave may be carried forward for one
year. The holiday year is the same as the financial year. At 31 December 20X4, the entity had
2,200 salaried employees and the average unused holiday entitlement was 4 days per
employee. Approximately 6% of employees leave without taking their entitlement and there
is no cash payment when an employee leaves in respect of holiday entitlement. There are
255 working days in the year and the total annual salary cost is $42 million. No adjustment
has been made in the financial statements for the above and there was no opening accrual
required for holiday entitlement.
Required:
◦ Discuss, with suitable computations, how the leave that may be carried forward is treated in the
financial statements for the year ended 31 December 20X4.
Solution – Example 1
An accrual should be made under IAS 19 Employee Benefits for the holiday entitlement that
can be carried forward to the following year. This is because the employees have worked
additional days in the current period (generating additional economic benefits for the
company), but will work fewer days in the following period when the salary for those days is
paid. An accrual is therefore required to match costs and revenues and apply the accruals
concept.

Debit P/L ($42m * 94% * 4 days/255 days) $619,294

Credit Accruals $619,294
Profit-sharing and bonus plans
The expected cost of profit-sharing and bonus payments must be recognised when, and
only when:
◦ the entity has a present legal or constructive obligation to make such payments as a result of past
events; and
◦ a reliable estimate of the obligation can be made.

A reliable estimate of its legal or constructive obligation under a profit-sharing or bonus

plan can be made when, and only when:
◦ the formal terms of the plan contain a formula for determining the amount of the benefit;
◦ the entity determines the amounts to be paid before the financial statements are authorised for
issue; or
◦ past practice gives clear evidence of the amount of the entity’s constructive obligation.
Example 2 – Profit Sharing
Mooro Co runs a profit sharing plan under which it pays 3% of its net profit for the year to
its employees if none have left during the year. Mooro Co estimates that this will be
reduced by staff turnover to 2.5% in 20X9.
Required:
◦ Which costs should be recognised by Mooro Co for the profit share?

Solution:
Mooro Co should recognise a liability and an expense of 2.5% of net profit.
Post-employment benefit plans
A pension plan (sometimes called a post-employment benefit plan or scheme) consists of a
pool of assets, together with a liability for pensions owed. Pension plan assets normally
consist of investments, cash and (sometimes) properties. The return earned on the assets is
used to pay pensions.
There are two main types of pension plan:
◦ defined contribution plans
◦ defined benefit plans.
Post-employment benefit plans
A defined contribution plan
◦ An entity pays fixed contributions of 5% of employee salaries into a pension plan each month. The
entity has no obligation outside of its fixed contributions.
◦ The lack of any obligation to contribute further assets into the fund means that this is a defined
contribution plan.

A defined benefit plan

◦ An entity guarantees a particular level of pension benefit to its employees upon retirement. The
annual pension income that employees will receive is based on the following formula:
◦ Salary at retirement × (no. of years worked/60 years)
◦ The entity has an obligation to pay extra funds into the pension plan to meet this promised level of
pension benefits. This is therefore a defined benefit plan.
Test you understanding - 1
Deller has a defined contribution pension scheme. However, during the year, it introduced a
new post-employment plan (the Fund) for its employees as a way of enhancing the benefits
they will receive when they retire. Deller makes monthly contributions into the Fund that
are equal to a set percentage of the salary cost.
Upon retirement, employees will receive annual payments from the Fund based on their
number of years of service and their final salary.
The Fund is voluntary and Deller can cancel it at any point.
Deller has a history of paying employees benefits that are substantially above the national
average, with annual increases in excess of inflation. Deller has won many accolades as a
‘top employer’ and received positive coverage from the national press when the Fund was
announced. The leadership team are well trusted by the employees.
Required:
◦ Advise Deller on whether the Fund is a defined benefit plan or a defined contribution plan.
Solution
It is possible that there will be insufficient assets in the Fund to pay the benefits due to
retired employees, particularly if final salaries or life expectancy rise substantially. Deller
therefore bears actuarial and investment risk because, if it continues with the Fund, it
would need to make up for any shortfall.
Although the Fund is voluntary and can be cancelled, Deller has a history of remunerating
its employees above the national average as well as a strong reputation as a good and
honest employer. Deller therefore has a constructive obligation to continue with the Fund
and to ensure that its level of assets is sufficient.
As a result of the above, the Fund should be accounted for as a defined benefit plan.
Accounting for defined contribution plans
The entity should charge the agreed pension contribution to profit or loss as an employment
expense in each period.
The expense of providing pensions in the period is often the same as the amount of
contributions paid. However, an accrual or prepayment arises if the cash paid does not equal the
value of contributions due for the period.
Example 3 – Defined Contribution
An entity makes contributions to the pension fund of employees at a rate of 5% of gross
salaries. For convenience, the entity pays $10,000 per month into the pension scheme with
any balance being paid in the first month of the following accounting year. The wages and
salaries for 20X6 are $2.7 million.
Required:
◦ Calculate the pension expense for 20X6, and the accrual/ prepayment at the end of the year.

Solution:
This appears to be a defined contribution scheme.
The charge to profit or loss should be: $2.7m × 5% = $135,000
The statement of financial position will therefore show an accrual of $15,000, being the
difference between the $135,000 expense and the $120,000 ($10,000 × 12 months) cash
paid in the year.
Example 4 – Defined Contribution
Mouse, a public limited company, 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 profit or loss expense for post-employment benefits for the
year and the accrual which will appear in the statement of financial position at 31
December 20X9.
Solution:
Salaries $10,500,000 Debit P/L $675,000
Bonus $ 3,000,000 Credit Cash $510,000
$13,500,000 * 5% = $675,000 Credit Accruals $165,000
Defined benefit plans
Defined benefit plans: post-employment benefit plans other than defined contribution
plans.
Typically, 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. The entity records the pension plan assets (at fair value) and
liabilities (at present value) in its own books as it bears the pension plan's risks and benefits,
so in substance, if not in legal form, it owns the assets and owes the liabilities.
Complexity
Accounting for defined benefit plans is much more complex than for defined contribution
plans because:
◦ The future benefits (arising from employee service in the current or prior years) cannot be
measured exactly, but whatever they are, the employer will have to pay them, and the liability
should therefore be recognised now. To measure these future obligations, it is necessary to use
actuarial assumptions.
◦ The obligations payable in future years should be valued, by discounting, on a present value basis.
This is because the obligations may be settled in many years' time.
◦ If actuarial assumptions change, the amount of required contributions to the fund will change, and
there may be actuarial (remeasurement) gains or losses. A contribution into a fund in any period
will not equal the expense for that period, due to remeasurement gains or losses.
Projected unit credit method &
Actuarial assumptions
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). The accumulated present value of
(discounted) future benefits will incur interest over time, and an interest expense should be
recognised.
Actuarial assumptions are needed to estimate the size of the future (post-employment)
benefits that will be payable under a defined benefits scheme. The main categories of
actuarial assumptions are:
◦ Demographic assumptions, eg mortality rates before and after retirement, the rate of employee
turnover, early retirement
◦ Financial assumptions, eg future salary rises

Actuarial assumptions made should be unbiased and based on market expectations.

Accounting for defined benefit plans - SFP
Under a defined benefit plan, an entity has an obligation to its employees. The entity
therefore has a long-term liability that must be measured at present value.
The entity will also be making regular contributions into the pension plan. These
contributions will be invested and the investments will generate returns. This means that
the entity has assets held within the pension plan, which IAS 19 states must be measured at
fair value.
On the statement of financial position, an entity offsets its pension obligation and its plan
assets and reports the net position:
◦ If the obligation exceeds the assets, there is a plan deficit (the usual situation) and a liability is
reported in the statement of financial position.
◦ If the assets exceed the obligation, there is a surplus and an asset is reported in the statement of
financial position.
Working
$000
Net deficit/(asset) brought forward (Obligation bfd – assets bfd) X/(X)
Net interest component (bfd * %) X/(X)
Service cost component X
Contributions into plan (X)
Benefits paid -
X/(X)
Remeasurement component (bal. fig) X/(X)
Net deficit/(asset) carried forward (Obligation cfd – assets cfd) X/(X)
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 profit or loss.
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 is determined by reference to market yields at the end of the
reporting period on high quality corporate bonds (or government bonds for currencies for
which no deep market in high quality corporate bonds exists). The term of the bonds should
be consistent with that of the post-employment benefit obligations.
Past service Cost
Past service cost is the increase or decrease in the present value of the defined benefit
obligation for employee service in prior periods, resulting from:
a) A plan amendment (the introduction or withdrawal of, or changes to, a defined benefit
plan); or
b) A curtailment (a significant reduction by the entity in the number of employees covered by
the plan).

Past service cost is recognised as an adjustment to the obligation and as an expense (or
income) at the earlier of the following dates:
a) When the plan amendment or curtailment occurs; or
b) When the entity recognises related restructuring costs (in accordance with IAS 37) or
termination benefits.

Debit Profit or Loss X

Credit Present value of defined benefit obligation X
Interest
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 profit or loss.
Interest income is applied to the asset and netted against the interest cost on the defined
benefit obligation. The resulting net interest cost (or income) on the net defined benefit
liability (or asset) is recognised in profit or loss and represents the financing effect of paying
for benefits in advance or in arrears.
Contributions into the plan
These are the cash payments paid into the plan during the reporting period by the
employer. This has no impact on the statement of profit or loss and other comprehensive
income.
Benefits paid
These are the amounts paid out of the plan assets to retired employees during the period.
These payments reduce both the plan obligation and the plan assets. Therefore, this has no
overall impact on the net pension deficit (or asset).
Remeasurement component
After accounting for the above, the net pension deficit will differ from the amount
calculated by the actuary as at the current year end. This is for a number of reasons, that
include the following:
◦ The actuary's calculation of the value of the plan obligation and assets is based on assumptions,
such as life expectancy and final salaries, and these will have changed year-on-year.
◦ The actual return on plan assets is different from the amount taken to profit or loss as part of the
net interest component.

An adjustment, known as the remeasurement component, must therefore be posted. This is

charged or credited to other comprehensive income for the year and identified as an item
that will not be reclassified to profit or loss in future periods.
Summary of the amounts recognised in
the financial statements
• Service Cost • Remeasurement • Plan Obligation
• Net Interest Component • Plan Assets
component • Asset Ceiling

Profit or
OCI SFP
Loss
Example
The following information is provided in relation to a defined benefit plan operated by
Celine. At 1 January 20X4, the present value of the obligation was $140 million and the fair
value of the plan assets amounted to $80 million.
20X4 20X5
Discount rate at start of year 4% 3%
Current and past service cost ($m) 30 32
Benefits paid ($m) 20 22
Contributions into plan ($m) 25 30
Present value of obligation at 31 December ($m) 200 230
Fair value of plan assets at 31 December ($m) 120 140
Required:
Determine the net plan obligation or asset at 31 December 20X4 and 20X5 and the amounts
to be taken to profit or loss and other comprehensive income for both financial years.
Solution
20X4 20X5
$m $m
Obligation bal b/fwd 1 January 140.0 200.0
Asset bal b/fwd at 1 January (80.0) (120.0)
Net obligation b/fwd at 1 January 60.0 80.0
Service cost component 30.0 32.0
Net interest component
4% × $60m 2.4
3% × $80m 2.4
Contributions into plan (25.0) (30.0)
Benefits paid - -
Remeasurement component (bal. fig.) 12.6 5.6
Net obligation c/fwd at 31 December 80.0 90.0
Curtailment
A curtailment arises when there is a significant reduction in the number of employees
covered by a plan, which will typically result in employees being made redundant. Any gain
or loss on curtailment is part of the service cost component.
Example
Angus operates a defined benefit scheme for its employees but has yet to record anything
for the current year except to expense the cash contributions which were $18 million. The
opening position was a net liability of $45 million which is included in the non-current
liabilities of Angus in its draft financial statements. Current service costs for the year were
$15 million and interest rates on good quality corporate bonds fell from 8% at the start of
the year to 6% by 31 March 20X8. In addition, a payment of $9 million was made out of the
cash of the pension scheme in relation to employees who left the scheme. The reduction in
the pension scheme liability as a result of the curtailment was $12 million. The actuary has
assessed that the scheme is in deficit by $51 million as at 31 March 20X8.
Required
◦ Calculate the gain/loss on remeasurement of the defined benefit pension net liability of Angus as
at 31 March 20X8, and state how this should be treated.
Solution
$m

Opening net liability 45.0

Net interest cost ($45m × 8%) 3.6

Current service cost 15.0

Gain on curtailment ($12m – $9m) (3.0)

Cash contributions into the scheme (18.0)

42.6

Loss on remeasurement (B) 8.4

Closing net liability 51.0

Example
AB decides to close a business segment. The segment’s employees will be made redundant
and will earn no further pension benefits after being made redundant. Their plan assets will
remain in the scheme so that the employees will be paid a pension when they reach
retirement age (i.e. this is a curtailment without settlement).
Before the curtailment, the scheme assets had a fair value of $500,000, and the defined
benefit obligation had a present value of $600,000. It is estimated that the curtailment will
reduce the present value of the future obligation by 10%, which reflects the fact that
employees will not benefit from future salary increases and therefore will be entitled to a
smaller pension than previously estimated.
Required:
◦ What is net gain or loss on curtailment and how will this be treated in the financial statements?
Solution
The obligation is to be reduced by 10% × $600,000 = $60,000, with no change in the fair
value of the assets as they remain in the plan. The reduction in the obligation represents a
gain on curtailment which should be included as part of the service cost component and
taken to profit or loss for the year. The net position of the plan following curtailment will be:

Before On After
curtailment
$000 $000 $000
Present value of obligation 600 (60) 540
Fair value of plan assets (500) - (500)
Net obligation in SOFP 100 (60) 40

The gain on curtailment is $60,000 and this will be included as part of the service cost
component in profit or loss for the year.
Settlement
A settlement occurs when an entity enters into a transaction to eliminate the obligation for
part or all of the benefits under a plan. For example, an employee may leave the entity for a
new job elsewhere, and a payment is made from that pension plan to the pension plan
operated by the new employer.
The gain or loss on settlement comprises the difference between the fair value of the plan
assets paid out and the reduction in the present value of the defined benefit obligation and
is included as part of the service cost component.
The asset ceiling
Most defined benefit pension plans are in deficit (i.e. the obligation exceeds the plan
assets). However, some defined benefit pension plans do show a surplus.
If a defined benefit plan is in surplus, IAS 19 states that the surplus must be measured at the
lower of:
◦ the amount calculated as normal (per earlier examples and illustrations)
◦ the total of the present value of any economic benefits available in the form of refunds from the
plan or reductions in future contributions to the plan.

This is known as applying the ‘asset ceiling’. It means that a surplus can only be recognised
to the extent that it will be recoverable in the form of refunds or reduced contributions in
the future. In other words, it ensures that the surplus recognised in the financial statements
meets the definition of an 'asset' (a resource controlled by the entity that will lead to a
probable inflow of economic benefits).
Example
The following information relates to a defined benefit plan:
$000
Fair value of plan assets 950
Present value of pension liability 800
Present value of future refunds and reductions in future 70
contributions

Required:
◦ What is the value of the asset that recognised in the financial statements?
Solution
The amount that can be recognised is the lower of:

$000
Present value of plan obligation 800
Fair value of plan assets (950)
(150)

$000
PV of future refunds and/or reductions in future contributions (70)
Therefore the asset that can be recognised is restricted to $70,000.
Termination benefits
Termination benefits may be defined as benefits payable as a result of employment being
terminated, either by the employer, or by the employee accepting voluntary redundancy.
Such payments are normally in the form of a lump sum; entitlement to such payments is not
accrued over time, and only become available in a relatively short period prior to any such
payment being agreed and paid to the employee.
The obligation to pay such benefits is recognised either when the employer can no longer
withdraw the offer of such benefits (i.e. they are committed to paying them), or when it
recognises related restructuring costs (normally in accordance with IAS 37). Payments which
are due to be paid more than twelve months after the reporting date should be discounted
to their present value.
Other long-term employee benefits
This comprises other items not within the above classifications and will include long-service
leave, long-term disability benefits and other longservice benefits. These employee benefits
are accounted for in a similar manner to accounting for post-employment benefits, as
benefits are payable more than twelve months after the period in which services are
provided by an employee.
Disclosure requirements
IAS 19 has extensive disclosure requirements. An entity should disclose the following
information about defined benefit plans:
◦ Significant actuarial assumptions used to determine the net defined benefit obligation or assets.
◦ a general description of the type of plan operated
◦ a reconciliation of the assets and liabilities recognised in the statement of financial position
◦ the charge to total comprehensive income for the year, separated into the appropriate
components
◦ analysis of the remeasurement component to identify returns on plan assets, together with
actuarial gains and losses arising on the net plan obligation
◦ sensitivity analysis and narrative description of how the defined benefit plan may affect the nature,
timing and uncertainty of the entity’s future cash flows.