C. REPORTING THE FINANCIAL PERFORMANCE OF A RANGE OF ENTITIES - EMPLOYEE BENEFITS

Question 1

Employee benefits (IAS 19)

Answer 1

Employee benefits (IAS 19) are all forms of consideration given by an entity in exchange for service rendered by employees or for the termination of employment.
IAS 19 sets out rules of accounting and disclosure for:

 Short term employee benefits
 Post-employment benefits
 Other long-term employee benefits
 Termination benefits.

Question 2

Short-term benefits.

Answer 2

Short-term benefits. Employee benefits (other than termination benefits) that are expected to be settles wholly before 12 months after the end of the annual reporting period in which the employees render the related service. Short term benefits include items such as:

 Wages, salaries and social security contributions
 Paid annual leave and paid sick leave
 Profit-sharing and bonuses
 Non-monetary benefits (medical care, housing, cars etc)

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 accrual basis. Short-term benefits are not discounted to present value.

Question 3

Accumulating paid absences

Answer 3

Accumulating paid absences are those that can be carried forward for use in future periods if the current period’s entitlement is not used in full (eg holiday pay). The expected cost of any unused entitlement that can be carried forward or paid in lieu of holidays is recognised as an accrual at the year end.

Question 4

Non-accumulating paid absences

Answer 4

Non-accumulating paid absences cannot be carried forward (eg maternity leave or military service). Therefore, they are only recognized as an expense when the absence occurs.

Question 5

An entity recognizes the expected cost of profit-sharing and bonus payments when and only when:

Answer 5

An entity recognizes the expected cost of profit-sharing and bonus payments 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.

Question 6

Post-employment benefits

Answer 6

Post-employment benefits are employee benefits which are payable after the completion of employment.
 Defined contribution plans – eg annual contribution = 5% salary; future pension depends on the value of the fund
 Defined benefit plans – eg annual pension = Final salary/60 x years worked; future pension depends on final salary and years worked
A pension plan will normally be held in the form of a trust separate from the sponsoring company, so the sponsoring company and the pension plan are separate legal entities that are accounted for separately.

Question 7

Defined contribution plans:

Answer 7

Defined contribution plans: are 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 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.
The obligation for each year is shown as an expense for the period (disclosed in a note) and in the statement of financial position to the extent that it has not been paid.

Question 8

Defined benefit plans:

Answer 8

Defined benefit plans: are 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, it owns the assets and owes the liabilities.

Question 9

Accounting treatment of defined benefit plan.

Answer 9

STEP 1. OPENING FIGURES.  Record opening figures – Obligation and Asset.
STEP 2. NET INTEREST COST. 
STEP 3. CURRENT SERVICE COST.
STEP 4. PAST SERVICE COST. 
STEP 5. CONTRBUTIONS. 
STEP 6. BENEFITS
STEP 7. REMEASUREMENTS
STEP 8. Disclose deficit or surplus in accordance with the standard.

Question 10

Projected unit credit method

Answer 10

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 financial liability (obligation). The accumulated present value of (discounted) future benefits will incur interest over time, and an interest expense should be recognized (the actuary helps to calculate the present value of the plan obligation based on demographic and financial assumptions).

Question 11

STEP 2. NET INTERST COST.

Answer 11

STEP 2. NET INTERST COST. 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 shown as expense in profit and loss. Interest income is applied to the asset and netted against the interest cost on the defined benefit obligation. Resulting net interest cost (or income) on the net defined benefit liability (or asset) is recognized in profit or loss and represents the financing effect of paying for benefits in advance or arrears. Should also reflect any changes in obligation during period (eg past service cost).

DEBIT Net interest cost (P/L) (x% x b/d obligation)
CREDIT PV defined benefit obligation (SOFP)
DEBIT Plan assets (SOFP) (x% x b/d assets)
CREDIT Net interest cost (P/L)

Question 12

STEP 3. CURRENT SERVICE COST.

Answer 12

STEP 3. 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).
DEBIT Current service cost (P/L)
CREDIT PV defined benefit obligation (SOFP)

Question 13

STEP 4. PAST SERVICE COST.

Answer 13

STEP 4. PAST SERVICE COST. It is the increase or decrease in the present value of the defined benefit obligation for employee service in prior periods, resulting from: a plan amendment (introduction or withdrawal or changes) or a curtailment (a significant reduction by the entity in number of employees covered by the plan).
Past service cost is recognized as an adjustment to the obligation and as an expense (or income) at the earlier of:
 When the plan amendment or curtailment occurs or
 When the entity recognizes related restructuring costs (IAS 37) or termination benefits.

Increase in obligation:
DEBIT Past service cost (P/L)
CREDIT PV defined benefit obligation (SOFP)
Decrease in obligation
DEBIT PV defined benefit obligation (SOFP)
CREDIT Past service cost (P/L)

Question 14

STEP 5. CONTRBUTIONS.

STEP 6. BENEFITS

Answer 14

STEP 5. CONTRBUTIONS.
DEBIT Plan assets (SOFP)
CREDIT Company cash
STEP 6. BENEFITS. Actual pension payments made.
DEBIT PV defined benefit obligation (SOFP)
CREDIT Plan assets (SOFP)

Question 15

STEP 7. REMEASUREMENTS

Answer 15

STEP 7. REMEASUREMENTS. Remeasurement (on obligation) gains or losses may arise due to differences between the year-end actuarial valuation of the defined benefit obligation and its accounting value. They are made up of changes in the present value of the obligation resulting from:
 Experience adjustments (difference between previous actuarial assumptions and what has actually occurred) and
 The effects of changes in actuarial assumptions
Remeasurement gains and losses are recognized in other comprehensive income (items that will not be reclassified) in the period in which they occur.

Question 16

Plan assets are:

Answer 16

Plan assets are:
 Assets, such as stocks and shares, held by a fund that is legally separate from the reporting entity, which exists solely to pay employee benefits
 Insurance policies, issued by an insurer that is not a related party, the proceeds of which can only be used to pay employee benefits.

Question 17

Remeasurement of plan assets.

Answer 17

Remeasurement of plan assets. The value of investments will increase over time. This is called return on plan assets and is defined as interest, dividends and other income derived from the plan assets together with realised and unrealised gains and losses on the plan assets, less any costs of managing plan assets and tax payable by the plan itself. The difference between the return on plan assets and the interest income included in net interest on the net defined benefit liability (or asset) is a remeasurement and is recognized in other comprehensive income

Question 18

A settlement

Answer 18

A settlement is a transaction that eliminates all further legal and constructive obligations for part or all of the benefits provided under a defined benefit plan (other than a payment of benefits to, or on behalf of, employees that is set out in the terms of the plan and included in the actuarial assumptions).
The gain or loss on a settlement is recognized in profit and loss when the settlement occurs:
DEBIT PV obligation (as advised by actuary)
CREDIT FV Plan assets (any assets transferred)
CREDIT Cash (paid directly by the entity)
CREDIT/DEBIT Profit or loss (difference)

Question 19

Curtailments

Answer 19

Curtailments - an amendment is made to the plan which improves benefits for plan members. An increase to the obligation (and expense) is recognised when the amendment occurs:
DEBIT Profit or loss X
CREDIT Present value of defined benefit obligation X

Question 20

Pension asset measured at:

Answer 20

Amounts recognized as a net pension asset in the statement of financial position must not be stated at more than their recoverable amount. Consequently, IAS 19 requires any pension asset to be measured at the lower of:
 Net reported asset (in the books) or
 The present value of any refunds/ reduction of future contributions available from the pension plan
Any impairment loss is charged immediately to other comprehensive income

Question 21

IAS 19 Disclosure

Answer 21

Disclosure. IAS 19 requires risk-based disclosures, including detail on investments, future cash requirements and information about risks to which the plan exposes the company. The entity should:
 Explain the characteristics of, and risks associated with, the entity’s defined benefit plans, focusing on unusual, entity-specific or plan-specific risks, or risks that arise from a concentration of investments in one particular area.
 Identify and explain the amounts in the entity’s financial statements arising from its defined benefit plans.
 Explain how the defined benefit plans may affect the entity’s future cash flows, including sensitivity analysis which shows the potential impact of changes in actuarial assumptions. Disclosure is required as to the funding arrangements and commitments from the company to make contributions to the plan.

Question 22

Asset ceiling

Answer 22

Asset ceiling
If a company has an overall pension asset on its statement of financial position then the asset can only be
recognised up to the level of the asset ceiling. The asset ceiling is the present value of any future cash
savings of not having to contribute to the scheme as it is in surplus. If the asset needs to be reduced to the
asset ceiling limit then the reduction in the asset is shown as an expense in profit or loss.