06. Employee benefits

Question 1

Why are long term and post employment benefits difficult to estimate?
Give an example of such a benefit

Answer 1

As the obligation depends on factors such as life expectancy, future wage and benefits rates and expected investments returns

E.g. pensions

Question 2

What does IAS 19 Employee benefits cover? (i.e. whats the scope)

Answer 2

Post employment benefits e.g. pensions
Other LT benefits e.g. sabbaticals and long service leave
ST benefits e.g. bonuses & holiday pay
Termination payments e.g. redundancy and severance pay

Question 3

What are the 2 types of pension schemes?

Answer 3

Defined contribution scheme (contribution made is usually % of salary and future pension depends on how fund performs)

Defined benefit schemes - where outcome is guaranteed and typically depends on fill salary and years worked. Contributions therefore vary to achieve the outcome required

Question 4

What is a defined contribution scheme?

Answer 4

Pension - contribution made is usually % of salary and future pension depends on how fund performs

Question 5

What is a defined benefit scheme?

Answer 5

Pension - where outcome is guaranteed and typically depends on fill salary and years worked. Contributions therefore vary to achieve the outcome required

Based on salary at retirement x no. of years worked/ 60 years

Entity has obligation to pay extra funds into the pension plan to meet this promised level of pension benefits.

Question 6

If an entity guarantees a particular level of pension benefit to it’s e’ees on retirement, what is the annual pension income that employees will receive based on?

Answer 6

Salary at retirement x no. of years worked/ 60 years

Question 7

What is the accounting treatment of defined contribution plans?

Answer 7

ACCRUAL BASIS

Contributions into defined contribution plan by e’er are made in return for services provided by e’res during period, therefore:

• Entity should recog contributions payable as an expense in SPL in period which e’er provides services
• Liability should be recog where contributions arise in relation to an e’res service, but remain unpaid at YE

Question 8

What is the accounting treatment for defined benefit plans?

Answer 8

A defined benefit plan provides e’res with promised level of benefits on retirement
They are based upon
- the final benefits promised under the plan
- number of members
- expected age of death
- expected return on investment

An actuary will calc the expected outcome and then this is discounted to PV (known as defined benefit obligation)

Defined benefit obligation is therefore a liability owned by entity, but not shown on as lia on SFP as entity will have been making contributions to scheme, so will have accumulated plan assets

So either have plan deficit and lia on SFP or surplus and an asset is reported on SFP

Question 9

How is the SFP figure calculated for defined benefit plans

Answer 9

Defined benefit obligation is a liability owned by entity, but not shown on as lia on SFP as entity will have been making contributions to scheme, so will have accumulated plan assets

So either have plan deficit and lia on SFP if liability exceeds contributions made or surplus and an asset is reported on SFP

SFP balance is cal’ed as

PV of defined benefit obligation (discounted at the high quality/ AA corporate bond rate) x
Less FB of plan assets (X)

Net pension liability/(asset) X/(X)

Question 10

How is the defined benefit obligation calculated?

(i.e. where you have the net obligation of
Defined plan obligation
Less Fair Value of plan assets )

Answer 10

Opening balance x
Interest cost   X 
Service costs X 
Retirement benefits paid (X) 
= Closing balance  X

Question 11

How is the interest cost calculated on a defined benefit pension scheme?

Answer 11

The liability is 1 year closer to being paid, so need to unwind the discount factor by 1 year
DR Finance cost (net interest cost)
CR Defined benefit obligation

NB: same discount rate is applied to plan assets at start of period(market yield on high quality fixed rate corporate bond at start of year)

So a NET interest component is recog in P&L

Question 12

How is the service costs for defined benefit obligation calculated?

Answer 12

DR Service cost in P&L
CR Defined benefit obligation

Main part of this is the current service cost ( extra pension entitlement arising from e’res service in current period)

But past service cost may also arise

Question 13

What is a past service cost (defined benefit obligation) ?

Answer 13

Past service cost = change in the obligation ‘for e’ee service in prior periods, arising from plan amendment.

Results from a plan amendment (intro/withdrawal of, or changes to, a defined benefit plan) or curtailment (signif reduction by entity to number of e’ees covered by the plan

Question 14

How are retirement benefits paid dealt with in defined benefit obligation?

i.e. what is the journal entry

Answer 14

Employees have retired and taken out cash from the scene so less is owed.

DR Defined benefit obligation
CR Plan assets

Question 15

How is the Fair value of plan assets calculated?
(i.e. where you have the net obligation of
Defined plan obligation
Less Fair Value of plan assets )

Answer 15

FV of plan assets =

Opening balance X 
Interest on assets X 
Contributions paid in X 
Retirement benefits paid (X) 
= Closing balance

Question 16

How is the interest on assets calculated for FV of plan assets (that forms part of the net Defined Benefit scheme calc)

Answer 16

Plan assets will be invested earning an expected return

DR Plan assets
CR profit or loss (net interest cost)

NB: Same rate is applied to the obligation at start of period
A net interest component is recog in P&L

Question 17

How is the contributions paid in a Fair value of plan assets calculated?
i.e. whats the journal?x

Answer 17

Contributions paid = amount of cash actually paid into the scheme (this may/may not be the same as the current service cost)

DR Plan assets
CR Cash

Question 18

How is the Retirement Benefits paid in a Fair value of plan assets calculated?
i.e. whats the journal?x

Answer 18

Employees retire and take cash out of the scheme, so less is owed

DR Defined benefit obligation
CR Plan assets

Question 19

What must be done after all the entries have been posted for defined benefit schemes?

Answer 19

The closing balance on the obligation and on the asset should be equal to closing actuarial valuation, but this is rarely the case

Actuary’s valuation of value of plan assets and obligation is based on assumptions, e.g. life expectancy and final salaries

Actual return is different from amount taken to P&L as part of net interest component

A remeasurement component adjustment is required - which is charged or credits to OCI for year and identified as an item that won’t be reclassified to P&L in future periods

This remeasurement component = usually balancing figure

Question 20

When does settlement occur for defined benefit schemes?

Answer 20

Settlement occurs when an entity eliminates the obligations for part/all of benefits under a plan

Question 21

Give an example of when settlement will occur for defined benefit schemes

Answer 21

An employee may leave for a new job and payment is made from that pension plan to the plan operated by new e’er

Question 22

What arises on the settlement of a defined benefit scheme?

And what is the journal?

Answer 22

A fain/loss arises between amount paid out and reduction in PV of the obligation

This is treated as part of the service cost
DR Plan obligation
CR Plan assets
DR/CR SPL (B)

Question 23

What is an asset ceiling (defined benefit schemes)

Answer 23

This is a threshold to ensure that any defined benefit asset (surplus) is carried at no more than its recoverable amount

Any net asset is restricted to the must of cash saving that will be avail to the entity in the future

= PV of any economic benefits avail int elf form of refunds from plan or reductions in future contributions to the plan

Question 24

How is any write down of net defined benefit asset treated?

Answer 24

Treated as a measurement component in OCI

Question 25

How are other LT employee benefits (i.e. tat doesn’t wholly fall into 12m after period end) accounted for?

Answer 25

Same as for defined benefit pension scheme, but there is less uncertainty, so acc treatment is simplified

Any remeasurement diffs are taken to SPL

Question 26

Give some examples of LY employee benefits

Answer 26

LT disability benefits

Sabbatical leave

Question 27

How are ST benefits (within12m) dealt with in acc?

Answer 27

E.g. holiday pay and bonus schemes

Accruals concept

Question 28

How are termination benefits dealt with?

Answer 28

E.g. any amount payable on the termination of employment (either voluntary redundancy or decision made by e’er)

IAS 37 Provisions, Contingent liabilities & contingent assets are applied
If demonstrably committed to terminating the employment, then recog a provision

Question 29

What kind of standard is IAS 26 Accounting and Reporting by Retirement Benefit Plans?

Answer 29

Mainly presentational and disclosure standard

Question 30

What is a defined contribution plan?

Answer 30

One where the annual pension payable to retired employees is based on accumulated value of the assets in the fund

Question 31

What should the financial statements contain for a defined contribution plans?

Answer 31

• Statement of net assets available to meet the benefits payable
• Description of the funding policy of the plan

Should also typically contain

• Description of any significant activities along with any changes to the plan
• Plan membership, terms and conditions
• FS containing info on perf for period and position at the end of the period
• Description of investment policies

Question 32

What should the financial statements contain for a defined benefit plan?

Answer 32

Same as Defined contribution plan

• Statement of net assets available to meet the benefits payable
• Description of the funding policy of the plan

Should also typically contain

• Description of any significant activities along with any changes to the plan
• Plan membership, terms and conditions
• FS containing info on perf for period and position at the end of the period
• Description of investment policies

PLUS
- Actuarial info (e.g. PV of promised benefits and any assumptions made in making estimates)

Question 33

What are the key audit risks for employee benefits?

Answer 33

• Actuarial assumptions may not be correct
• Valuation of plan assets and liabilities may be incorrect
• Error in calc/posting

Question 34

What audit tests can be done to combat the following audit risk?

• Actuarial assumptions may not be correct

Answer 34

• Ascertain qualifications/ experience and independence of actuaries
• Condiser if appropriate to rely on actuary’s work
• Obtain an understanding of the assumptions and compare to LY
• Enquire about any material changes to the data, assumptions and methods used by actuary
• Obtain written representation from directors to confirm assumptions are consistent with their understanding
• Review correspondence between company and actuary

Question 35

What audit tests can be done to combat the following audit risk?

• Valuation of plan assets and liabilities may be incorrect

Answer 35

• Obtain confirmation of the schemes assets and liabilities
• Review validity and accuracy of the actuarial valuation
• Agree actuary valuation to SOFP figures

Question 36

What audit tests can be done to combat the following audit risk?

• Error in calc/posting

Answer 36

• Agree cash contributions paid into scheme to BS
• Recalc net interest component and compare to P&L
• Check disclosures for IAS 19 E’ee benefits