IAS 19 EMPLOYEE BENEFITS

IAS 19 Employee benefits is a long and complex standard covering both short-term and long-
term (post- employment) benefits.

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 he or she earns it, for example basic pay, overtime and so on. Other
employee benefits are deferred, however, the main example being retirement benefits (i.e a
pension).

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
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.

IAS 19 is intended to prescribe the following.

(a) When the cost of employee benefits should be recognised as a liability or an expense

(b) The amount of the liability or expense that should be recognised.

As a basic rule, the standard states the following.

(a) A liability should be recognised when an employee has provided a service in exchange
for benefits to be received by the employee at some time in the future.

(b) An expense should be recognised when the entity consumes the economic benefits

from a service provided by an employee in exchange for employee benefits.

Categories of employee benefits

The standard recognises four categories of employee benefits, proposes a different accounting
treatment for each. These four categories are as follows.

1
 1. Short-term benefits including, if expected to be settled wholly before twelve months
after the end of the annual reporting period in which the employees render the
related services:
- Wages and salaries
- Social security contributions
- Paid annual leave
- Paid sick leave
- Paid maternity/paternity leave
- Profit shares and bonuses
- Paid jury service
- Paid military service
- Non-monetary benefits, eg medical care, housing, cars, free or subsidized goods.
2. Post- employment benefits, eg pensions and post- employment medical care and post-
employment insurance.
3. Other long-term benefits, eg profit shares, bonuses or deferred compensation payable
later than 12 months after the year end, sabbatical leave, long- service benefits and
long-term disability benefits.
4. Termination benefits, eg early retirement payments and redundancy payments

Short-term employee benefits

Accounting for short-term employee benefits is fairly straightforward, because there are no
actuarial assumptions to be made, and there is no requirement to discount future benefits
(because they are all, by definition, payable no later than 12 months after the end of the
accounting period).

RECOGNITION AND MEASUREMENT

The rules for short-term benefits are essentially an application of basic accounting principles
and practice.

(a) Unpaid short-term employee benefits as at the end of an accounting period should be
recognised as an accrued expense. Any short-term benefits paid in advance should be
recognised as a prepayment (to the extent that it will lead to, a reduction in future
payments or a cash refund).

(b) The cost of short-term employee benefits should be recognised as an expense in the
period when the economic benefit is given, as employment costs (except insofar as
employment costs may be included within the cost of an asset, eg property, plant and
equipment.

2
(c) SHORT-TERM PAID ABSENCES

There may be short-term accumulating paid absences. These are absences for which an
employee is paid, and if the employee’s entitlement has not been used up at the end of
the period, they are carried forward to the next period. An example is paid holiday
leave, where any unused holidays in one year are carried forward to the next year. The
cost of the benefits of such absences should be charged as an expense as the employees
render service that increases their entitlement to future compensated absences.

There may be short-term non-accumulating paid absences. These are absences for
which an employee is paid when they occur, but an entitlement to the absences does
not accumulate.

DISCLOSURE

There are no specific disclosure requirements for short-term employee benefits in the standard.

POST-EMPLOYMENT BENEFITS

Many employers provide post-employment benefits for their employees after they have
stopped working. Pension schemes are the most obvious example, but an employer might
provide post-employment death benefits to the dependants to former employees, or post-
employment medical care.

Post-employment benefit schemes are often referred to as plans. The plan receives regular
contributions from the employer (and sometimes from current employee as well) and the
money is invested in assets, such as stocks and shares and other investments. The post-
employment benefits are paid out of the income from the plan assets (dividends, interest) or
from the sale of some plan assets.

There are two types or categories of post-employment benefit plan as shown below:

(a) Defined contribution plans.

With such plans, the employer (and possibly current employee 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.

3
(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 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).

The key difference between the two types of plan is the nature of the promise made by the
entity to the employees in the scheme:

(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 the benefits agreed
under the plan. The entity is taking a far more uncertain liability that may change in
future as a result of many variables and has continuing exposure to risks related to the
performance of assets held in the plan.

Defined contribution plans

Accounting for payments into defined contribution plans is straightforward.

(a) The obligation is measured by the amounts to be contributed for that period.

(b) There are no actuarial assumptions to make.

(c) If the obligation is settled in the current period (or at least no later than 12 months after
the end of the current period) there is no requirement for discounting.

IAS 19 requires the following:

(a) Contributions to a defined contribution plan should be recognised as an expense in the

period they are payable.

4
(b) Any liability for unpaid contributions that are due as at the end of the period should be
recognised as a liability (accrued expense).

(c) Any excess contributions paid should be recognised as an asset (prepaid expense), but
only to the extent that the prepayment will lead to, eg a reduction in future payments
or cash refund.

Disclosure requirements

(a) A description of the plan

(b) The amount recognised as an expense in the period.

Defined benefit plans: recognition and measurement

Accounting for defined benefit plans is much more complex. The complexity of accounting for
defined benefit plans stems largely from the following factors.

(a) The future benefits 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.

(b) 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.

(c) If actuarial assumptions change, the amount of required contributions to the fund will
change, and there may be actuarial gains or losses.

IAS 19 defines the following key terms to do with defined benefit plans.

The net defined benefit liability (asset) is the deficit or surplus, adjusted for any effect of
limiting a net defined benefit asset to the asset ceiling.

The deficit or surplus is:

(a) The present value of the defined benefit obligation less

(b) The fair value of plan assets (if any).

The asset ceiling is the present value of any economic benefits available in the form of refunds
from the plan or reductions in future contributions to the plan.

The present value of a defined benefit obligation is the present value, without deducting any
plan assets, of expected future payments required to settle the obligations resulting from
employee service in the current and prior periods.
5
Outline of the method
There is a four- step method for recognizing and measuring the expenses and liability of a
defined benefit pension plan.

An outline of the method used by an employer to account for expenses and obligation of a
defined benefit plan is given below.

Step 1 Measure the deficit or surplus

(a) An actuarial technique (the Projected Unit Credit Method), should be used to
make a reliable estimate of the amount of future benefits employees
have earned from service in relation to the current and prior years. The entity
must determine how much benefit should be attributed to service performed
by employees in the current period, and in prior periods. Assumptions
include, for example, assumptions about employee turnover, mortality rates,
future increases in salaries.

(b) The benefit should be discounted to arrive at the present value of the defined
benefit obligation and the current service cost.

(c) The fair value of any plan assets should be deducted from the present value of
the defined benefit obligation.

Step 2 The surplus or deficit measured in Step 1 may have to be adjusted if a net
benefit asset has to be restricted by the asset ceiling.

Step 3 Determine the amounts to be recognised in profit or loss:

(a) Current service cost

(b) Any past service cost and gain or loss on settlement

(c) Net interest on the net defined benefit liability (asset)

Step 4 Determine the re-measurements of the defined benefit liability (asset), to be

recognised in other comprehensive income (items that will not be reclassified to
profit or loss):

(a) Actuarial gains and losses

(b) Return on plan assets (excluding amounts included in net interest on the net
defined benefit liability (asset)

6
 (c) Any change in the effect of the asset ceiling (excluding amounts included in net
interest on the net defined benefit liability (asset)

Actuarial Assumptions
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 as follows.

(a) Demographic assumptions are about mortality rates before and after retirement, the
rate of employee turnover, early retirement, claim rates under medical plans for former
employees, and so on.

(b) Financial assumptions include future salary levels (allowing for seniority and promotion
as well as inflation) and the future rate of increase in medical costs.

The statement of financial position

In the statement of financial position, the amount recognised as a defined benefit liability
(which may be a negative amount, ie an asset) should be the following.

(a) The present value of the defined obligation at the year end, minus

(b) The fair value of the assets of the plan as at the year-end (if there are any) out of which
the future obligations to current and past employees will be directly settled.

The statement of profit or loss and other comprehensive income

All the gains and losses that affect the plan obligation and plan asset must be recognised. The
components of defined benefit cost must be recognised as follows in the statement of profit or
loss and other comprehensive income:

Component Recognised in

(a) Service cost Profit or loss

(b) Net interest on the net defined benefit liability Profit or loss

(c) Re- measurements of the net defined benefit liability Other comprehensive

income (not reclassified to P/L)

7
Service costs
These comprise:

(a) Current service cost, this is the increase in the present value of the defined benefit
obligation resulting from employee services during the period.

(b) Past service cost, which is the change in the obligation relating to service in prior
periods. This results from amendments or curtailments to the pension plan.

A plan amendment arises when an entity either introduces a defined benefits plan or
changes in the benefits payable under an existing plan. As a result, the entity has
taken on additional obligations that it has not hitherto provided for. For example,
an employer might decide to introduce a medical benefits scheme for former
employees.

A curtailment occurs when an entity significantly reduces the number of employees

covered by a plan. This could result from an isolated event, such as closing a plant,
discontinuing an operation or the termination or suspension of a plan.

(c) Any gain or loss on settlement

A settlement occurs either when an employer enters into a transaction to eliminate part
or all of its post-employment benefit obligations (other than a payment of benefits to or
on behalf of employees under the terms of the plan and included in the actuarial
assumptions)

Actuarial gains and losses

An end of each accounting period, a new valuation, using updated assumptions, should be
carried out on the obligation. Actuarial gains or losses arise because of the following.

(a) Actual events (eg employee turnover, salary increases) differ from the actuarial
assumptions that were made to estimate the defined benefit obligations.

(b) The effect of changes to assumptions concerning benefit payment options.

(c) Estimates are revised (eg different assumptions are made about future employee
turnover, salary rises, mortality rates, and so on)

(d) The effect of changes to the discount rate

8
Actuarial gains and losses are recognised in other comprehensive income. They are not
reclassified to profit or loss.

Return on plan assets

A new valuation of the plan assets is carried out at each period end, using current fair values.
Any difference between the new value, and what has been recognised up to that date (normally
the opening balance, interest, and any cash payments into or out of the plan) is treated as a re-
measurement and recognised in other comprehensive income.

Example
At 1 January 20X2 the fair value of the assets of a defined benefit plan were valued at
K1,100,000 and the present value of the defined benefit obligation was K1,250,000. On 31
December 20X2, the plan received contributions from the employer of K490,000 and paid out
benefits of K190,000.

The current service cost for the year was K360,000 and a discount rate of 6% is to be applied to
the net liability/(assets).

After these transactions, the fair value of the plan’s assets at 31 December 20X2 was
K1,500,000. The present value of the defined benefit obligation was K1,553,600.

Required

Calculate the gains or losses on re-measurement through OCI and the return on plan assets and
illustrate how this pension plan will be treated in the statement of profit or loss and other
comprehensive income and statement of financial position for the year ended 31 December
20X2.

Solution
It is always useful to setup a working reconciling the assets and obligation:

Assets Obligation

9
 K K

Fair value/present value at 1 January 20X2 1,100,000 1,250,000

Interest (1,100,000 x 6%)/(1,250,000 x 6%) 66,000 75,000

Current service cost 360,000

Contributions received 490,000

Benefits paid (190,000) (190,000)

Return on plan assets (balancing figure) (OCI) 34,000 -

Loss on re-measurement (balancing figure) (OCI) -_ 58,600

1,500,000 1,553,600

The following accounting treatment is required.

(a) In the statement of profit or loss and other comprehensive income, the following
amounts will be recognised:

In profit or loss:

Current service cost 360,000

Net interest on net defined benefit liability (75,000 – 66,000) 9,000

In other comprehensive income (34,000 – 58,600) 24,600

(b) In the statement of financial position, the net defined benefit liability of K53,600
(1,553,600 – K1,500,000) will be recognised.

Asset ceiling test

The term relates to a threshold established by IAS 19 to ensure that any defined benefit asset
(ie a pension surplus) is carried at no more than its recoverable amount. In simple terms, this

10
means that any net asset is restricted to the amount of cash savings that will be available to the
entity in future.

The asset ceiling is the present value of those future benefits. The discount rate used is the
same as that used to calculate the net interest on the net defined benefit liability/(asset). The
net benefit asset would be reduced to the asset ceiling threshold. Any related rite down would
be treated as a re-measurement and recognised in other comprehensive income.

11
12
13
14
15