daimler benz in 1993 under german gaap reported a profit of 168 million dm but under us gaap for the...
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AS-15EMPLOYEE BENEFITS
Daimler Benz in 1993 under German GAAP reported a profit of 168 million DM but under US GAAP for the same period, the company reported a loss of almost a billion DM, largely caused by pension blues. It highlighted problems relating to pension accounting & funding.
Note: Pension payments are quite insignificant in comparison to global enterprises but as Indian companies are going global this becomes a critical issue.
Why AS for employee benefits
To prescribe the accounting and disclosure for employee benefits.Entity must recognize: A liability when an employee has provided
service in exchange for benefits to be paid in future.
An expense when the entity consumes the service provided by an employee.
OBJECTIVE
Employee benefits
Short term benefits
Post employment
benefits
Defined contributio
n plans
Defined benefit plans
Other long term
benefits
Termination benefits
SCOPE
1 Employee benefits are all forms of consideration given in exchange for service rendered by employees.
2 Short term employee benefits are employee benefits which fall due wholly within twelve months after the end of the period in which the employees render the related service.
3 Termination benefits are payable as a result of the entity’s decision to terminate employment before the normal retirement date or an employee’s decision to accept voluntary redundancy.
Definitions
4 Post-employment benefits are those which are payable after the completion of employment.
5 Defined contribution plans are post employment benefit plans under which an enterprise pays fixed contributions into a separate entity (a fund) & will have no obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in current or prior periods.
6 Defined benefit plans are the plans other than defined contribution plans.
Definitions
When an employee has rendered service to an entity during an accounting period, the entity should recognize the undiscounted amount to be paid in exchange for that service as:
A liability after deducting any amount already paid. If amount already paid > undiscounted amount recognize the prepaid expense to the extent prepayment will lead to refund.
An expense (unless another AS permits the inclusion of the benefits in the cost of an asset)
Accounting for short term employee benefits
Post employment benefit plans are either defined contribution plans or defined benefit plans based on the terms and conditions.
Post -employment benefit plan
Defined contribution plans
Amount contributed is fixed but benefit
is not fixed
Post employment benefit plans
Fixed amount of contribution to a separate fund. No constructive or legal obligation to pay
further contribution Post employment benefit = Contribution made
& Investment returns Investment risk doesn’t rest with the employer.
Employee takes this risk Annual cost to the employer is reasonably
predictable The expense in the period is normally the same
as the amount of the contribution paid.
Defined Contribution plan
The entity is obliged to provide the agreed benefits to the current & former employees.
Employer has ongoing obligation to make sufficient contribution to the plan.
Liability is not fixed. Actuarial valuation based on various
estimates & assumptions. Actuarial risks & Investment risk rest with
employer.
Defined benefit plans
Post -employment benefit plan
Advantages for employees
Advantages to employer
Disadvantages to employees
Disadvantages to employer
Defined contribution plan
1 Flexibility2 Independent of financial viability of employer
1 Fixed contribution2 Risks with employees
Bear Investment risk
Less attractive to employees as upside is restricted
Defined Benefit plan
1 Benefits are fixed2 No investment risk
Attractive to employee so easy to retain them
Must be financially viable for the employer
Exposed to Actuarial risks (Financial, increasing life expectancy, etc) & Investment risks
Comparison of Defined Contribution & Defined Benefit
1 Use of Actuarial techniques for Determination of benefits attributable to
current & prior periods. Making estimates about demographic &
financial variables.2 Present value of defined benefit
obligation & current service cost3 Determination of fair value of plan assets
Accounting for defined benefit plans
4 Determination of Actuarial gains & losses Amount of actuarial gains & losses to be
recognized in financial statements.5 Determination of past service cost where
plan has been introduced/modified6 Determination of resulting gains/losses
where the plan has been curtailed/settled
Accounting for defined benefit plans
1 Current service cost is the increase in actuarial liability resulting from employee service in the current period.
2 Past service cost is the increase in the actuarial liability relating to employee service in the previous period but only arising in current period.
3Curtailments and settlements are the gains & losses arising when major reductions are made to the no. of employees in the plan.
Definitions
4 Interest cost is the increase in the liability arising because the benefits are one year closer to settlement (unwinding of discount).
5 Actuarial gains & losses are the increases & decreases in the planned asset or defined benefit obligation that occur either because the actuarial assumptions have changed or because of differences between the previous actuarial assumptions and the actual outcome.
Definitions
Actuarial assumptions are an entity’s best estimates of the variables that will determine the ultimate cost of providing post-employment benefits.Factors that need to be considered to make an appropriate estimate: Demographic assumptions relate to,
rates of employee turnover, early retirement , mortality, claim rates under medical plans.
Making estimations about demographic & financial variables
Financial assumptions relate to, the discount rate, future salary &benefits level, expected rate of return on plan assets.
Actuarial assumptions should be unbiased and mutually compatible.
Actuarial assumptions need to reflect the economic relationships between factors such as inflation, rates of salary increase, return on plan assets and discount rates.
The whole defined benefit obligation need to be discounted , even if part of obligation falls due within 12 months of Balance sheet date.
A lump sum benefit is payable of termination of service and equal to 1% of final salary for each year of service. The salary in year 1 is 10,000 and is assumed to increase at 7% (compound) each year. The discount rate used is 10% per year. The following table shows how the obligation build up for an employee who is expected to leave at the end of the year 5, assuming that there are no changes in actuarial assumptions . For simplicity, this example ignores the additional adjustment needed to reflect the probability that the employee may leave the entity at an earlier or later date.
Actuarial Valuation Method
Year 1 2 3 4 5Benefits attributedto prior years 0 131 262 393
524 Current years 131 131 131 131
131 (1% of final salary)Current & Prior years 131 262 393 524
655
Actuarial Valuation method - solution
Opening obligation 89 196 324 476 Interest @ 10 9 20 33 48 Current 89 98 108 119 131service cost Closing ___ ___ ___ ___ ___
Obligation 89 196 324 476 655
Actuarial Valuation method - solution
Note:1. The opening obligation is the present value
of benefit attributed to prior years.2. The current service cost is the present
value of benefit attributed to the current year.
3. The closing obligation is the present value of benefit attributed to current and prior years.
Plan assets comprises Assets held by long-term employer benefits fund.
Assets held by a long-term employee benefit fund are assets that
Are held by an entity (a fund) that is legally separate from the reporting entity and exists solely to pay of fund employee benefits;
Are available to be used only to pay or fund employee benefits, are not available to the reporting entity’s own creditors (even in the bankruptcy) and can not be returned to the reporting entity.
Recognition of Plan Asset
Plan assets do not include: Unpaid contributions due from reporting
entity to the fund. As obvious, plan assets are to be measured
at the fair value.
Actuarial gains and losses may result from increase or decreases in either:
o The Present value of a defined benefit obligation;
Oro The fair value plan assets.
Actuarial Gains & Losses
Causes include:o Unexpectedly high or low rates or employee
turnover, early retirement or mortality;o Increase in salaries, benefits etc;o The effect of changes in the discount rate;
ando Differences between the actual return on
plan assets and expected return on plan assets.
Actuarial Gains & Losses
Plan AssetsParticulars AmountFV at the start of the year XContribution paid to plan XBenefits paid (X)Expected return (%) XActuarial gain/ loss (bal fig.)XFV at the end of the year X
Actuarial Gains & Losses
Planned ObligationParticulars AmountPV at the start of the year XInterest Cost (%) XCurrent service cost (%) (X)Benefits paid XActuarial gain/ loss (bal fig.) XPV at the end of the year X
Actuarial Gains & Losses
According to AS 15 actuarial Gains & Losses should be immediately recognized actuarial gains and losses in the period in which it arises.
Method for determination of Actuarial Gains & Losses
Past service costs occurs either due to an introduction or a change to a post-employment benefits plan.
It is the change in the present value of the defined benefits obligation for employee service in prior periods.
May be positive or negative
Past Service Cost
Yes
No
Employee have right to receive benefits
immediately
“Vested” recognize immediately to Profit &
Loss Account
Become “vested” at later date, Spread on a straight-line basis
over the average period
An entity operates a pension plan that provides a pension of 3% of final salary for each year of service. The benefits become vested after five years of service. On 1 January 2005 the entity improves the pension to 3.5% of final salary for each year of service starting from 1 January 2001 At the date of the improvement, the present value of the additional benefits for service from 1 January 2001 to 1 January 2005 is as follows:
Past Service Cost
Employee with more than five200
Years’ service at 1/1/05Employees with less than fiveYears’ service at 1/1/05 150(average period until vesting: three years)
Total 350The entity recognizes 200 immediately because those benefits are already vested. The entity recognizes 150 on a straight-line basis over three years from 1 January 2005.
Past Service Cost
A curtailment occurs when an entity: Is demonstrably committed to making a
material reduction in the number of employees covered by a plan.
Amend the terms of a plan such that a material element of future service by current employees will qualify for no or reduced benefits.
Curtailments & Settlements
For Example, an entity closes a plant and makes those employees redundant.
A settlement occurs when an entity enters into a transaction to eliminate the obligation for part or all of the benefits under a plan.
Gain or Loss arising on curtailment or settlement should be recognized when the curtailment or settlement occurs.
Curtailments & Settlements
An enterprise discontinues a business segment and employees of the discontinued segment will earn no further benefits. This is a curtailment without a settlement. Using current actuarial assumptions (including current market interest rates and other current market prices) immediately before the curtailment , the enterprise has a defined benefit obligation with a net present value of Rs 1,000 and plan assets with a fair value of Rs 820 and unrecognized past service cost of Rs 50.
Curtailment- Problem
The curtailment reduces the net present value of the obligation by Rs100 to Rs900.
Of the previously unrecognized past service cost, 10% (Rs. 100/ Rs 1000) relates to the part of the obligation that was eliminated through the curtailment. Therefore, the effect of the curtailment is as follows:
(Amount in Rs) Before curtailment Gain After curtailment
Present Value of obligation 1,000 (100) 900Fair value of Plan Assets (820) Nil (820)
Unrecognized past service cost (50) 5 (45)
Net liability recognized inBalance Sheet 130 (95) 35
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