1. Employee Benefits: Pensions Flashcards
What accounting standard governs employee benefits?
IAS 19 - Employee Benefits
Which type of employee is not subject to IAS 19
Those which are equity-based and to which IFRS 2 applies
Explain the difference between accumulating and non-accumulating absences and give an example of each. Which is more likely to be the subject of a calculation and what will this look like?
Accumulating absences accrue over the employees period of service and can be carried forward. Examples include holidays.
Non-accumulating absences are entitlements and are not capable of being carried forward. Examples include maternity leave or sick leave.
Accumulating absences are more likely to involve a calculation because there will be a year end accrual for unused, carried forward elements.
This calculation is relatively simple: just multiply the affected number of employees by their unused holiday and then multiply the result by the monetary value given in the question for each day of holiday
When should an expense and corresponding liability be recognised in relation to profit-sharing and bonus payment schemes? (2)
If:
- The entity has a legal or constructive obligation, and,
- A reliable estimate of the obligation can be made
IAS 19 provides 3 scenarios under which a reliable estimate can be made. State them
(1) Formal terms setting out the determination of the amount
(2) Amount payable is determined before financial statements authorised for issue
(3) Past practice provides evidence of amount
What is the normal adjustment required when finding the bonus/profit amount which has accrued?
Always adjust downwards based on the best estimate of the number of employees who will leave
Briefly define a defined contribution pension scheme and a defined benefit scheme. Which has the more difficult accounting?
Defined contribution (money purchase) - employees pay a fixed amount in and this is invested. The final salary is not known and depends on the performance of the investment. More formally, the employee is said to bear the ‘actuarial risk’
Defined benefit (final salary) - employees pay a varying amount in. The company guarantees a particular level of salary. Therefore the company bears the ‘actuarial risk’.
The defined benefit plan has the more complicated accounting.
Explain the accounting for a defined contribution pension plan.
Relatively simple - this is just a normal expense, with a possible year end liability if not paid in cash (or, less likely, a year end asset if there has been an overpayment). There is no complicated pro-forma.
Example:
An employer pays 5% of employee remuneration into a defined contribution benefit plan. Employee remuneration in the year was $1m and $20,000 had been physically paid in at the year end.
Dr Staff Costs (5% x $1m) 50,000
Cr Cash (actually paid) 20,000
Cr Accruals 30,000
What 2 items of information must be disclosed in relation to a defined contribution plan?
(1) Amount recognised as an expense in relation to the plan in the period
(2) Description of the plan
Assume you have set up a pension pro-forma in which the PV of the defined benefit obligation is presented as a positive figure (this is easier to work with).
State whether the following lines increase or reduce that figure.
(1) Retirement benefits paid out
(2) Contributions paid into the plan
(3) Interest cost on obligation
(4) Current service cost
(1) Reduce figure - when the benefits have been paid out, there is no longer a liability for them so if we are presenting the PV of defined benefit obligation as a positive figure then we need to reduce it
(2) Trick question - this affects the asset side
(3) Adds to figure - unwinding the interest updates and increases the liability to its current value
(4) Adds to figure - this is the additional liability incurred during the year
In the pension pro-forma, what is unusual / specific regarding the “Retirement benefits paid out” line?
This is the only entry which should hit both columns i.e. both the PV of defined benefit obligation and the FV of plan assets. (Of course, there will be opening and closing figures in both columns and a gain / loss for both - what we mean here is that the “retirement benefits paid out” line is the only row before the carried forward amounts which hits both columns).
If you are using the easier presentation of the PV of defined benefit as a positive figure, then the Retirement benefits paid out line will be a negative entry in both columns
In a standard, uncomplicated pension pro-forma, which line entries should be taken into the income statement?
(1) Net interest on the net defined benefit liability / asset
(2) Current service cost
Do not include contributions paid into the plan in the income statement - this is a cash issue only. Note that this is the typical error made by a company accountant in the exam question and which you are expected to correct and explain.
The net interest line is the net of the interest return on plan assets and the interest cost on the obligation
What are past service costs? How are they recognised?
Past service costs mean changes to the pension plan to increase the benefits payable. They increase (credit) the PV of the defined benefit obligation.
Under the revised IAS 19, past service costs are recognised in the period of plan amendment (rather than being split into vested and unvested elements as under the old rules)
A company reduces the value of some benefits but increases others at the same time. Explain the treatment
Treat this on a net basis
IAS 19 requires a qualified actuary to measure the defined benefit obligation. True or False?
False - this is encouraged but it is not required
Summarise the basic requirements of IFRS 13 regarding the correct methodology to determine fair value (6)
(1) Use market-based measurement and not entity-specific measurement
(2) Apply exit / selling prices
(3) Take into account market conditions at the measurement date
(4) Use methods which are appropriate and sufficient to the data available
(5) Maximise use of observable inputs
(6) Minimise use of unobservable inputs
A company operates a pension plan with the following qualification criteria:
- Pension benefit for employees who leave before 5 years of service = nil
- Pension benefit for employees who leave after completing 5 years of service but before completing 20 years of service = 10%
- Pension benefit for employees who leave after completing 20 years of service = 40%
it is estimated that 30% of staff leave before completing 5 years of service and a further 50% before completing 20 years of service.
Explain how the benefit should be calculated in the yearly calculation of profits
Find a weighted average. If 30% leave before completing 5 years and another 50% before completing 20 years, this leaves a balance of 20% who will gain the maximum entitlement
Weighted average is (30% serving less than 5 years x 0% benefit awarded) + (50% x 10%) + (20% x 40%) = 13%
State the 3 entries we might see in the IS in relation to a defined benefit pension plan
(1) Current service cost = expense
(2) Net interest = expense or income
(3) Past service costs = expense
Again, note that the contributions into the scheme do NOT go into the IS - this is a common error that you are expected to note and correct in the exam
State the one entry we expect to see in OCI regarding a pension scheme
Re-measurement of the net defined benefit liability or asset
State some disclosures required under IAS 19 as revised
Main disclosures:
(1) Description of the plan
(2) Accounting policy applied to actuarial gains and losses
(3) Reconciliation of the PV of the defined benefit obligation and FV of plan assets from opening to closing amounts, including analysis of each element within this
(4) Actual return on plan assets
(5) Analysis of total expenses recognised in profit or loss
(6) Principal actuarial assumptions made
State 2 examples of long-term employee benefits other than pensions and explain the accounting in each case
(1) Long-term disability benefits
(2) Paid sabbatical leave
In each case, the accounting is a simplified version of teh defined benefit plan
State the accounting considerations in relation to the following termination benefits:
(1) Firm commitment via a detailed formal plan and cannot realistically withdraw
(2) Voluntary redundancy with uncertainty as to the number of employees who will accept
(3) Termination benefits falling due more than 12 months after the reporting date
(1) Recognise a provision and related expense
(2) Contingent liability rather than the provision because cannot be measured reliably. This is disclosed rather than recognised under IAS 37
(3) Discount to present value
What is the interest rate used to discount the defined benefit obligation? Why is this rate used?
The rate on high quality cor, porate bonds
This will give the lowest possible interest rate and therefore the discounting will be by the smallest possible amount i.e. discounting at 5% gives a higher liability than discounting at 20%.
This leaves the PV of the defined benefit obligation at its highest possible amount, reflecting prudence
What 3 types of risk should the discount rate chosen NOT reflect?
(1) Investment risk
(2) Actuarial risk
(3) Specific risk relating to the entity’s business
Considering the final risk above, do not confuse pension discounting with the appropriate discounting approach to a project in a business analysis (SBM) question where it is of course appropriate to look at the specifics of the scenario
