Employees Benefit – IAS 19Presented By: Mr. Qanit Khalil, FCA

Post Retirement / Long TermEmployee Benefits - Pensions

Defined Contribution Schemes

• dkkdkEmployer pays fixed contribution to an external fund (usually % of salary).

• Employer’s obligation is discharged upon payment of the contribution.

• Members benefits depend uponperformance of the fund over time.

• Investment risk is with the employee.

DC Schemes – Impact on the financial statements

Income statement:Record contribution as expensein Income Statement

Balance sheet:No impact on balance sheet otherthan outstanding contributions payable to the investment funds.

Defined Contribution (DC)

Examples:• A Company agrees to pay 5% of an

employee’s salary into a third party fund.• The company pays Rs10,000 pa for each

employee into a third party fund following each year of service.

Key criteria:• Fixed amount of contribution.• Employer’s obligation ceases upon payment of

contribution.

Defined Benefit Schemes

• May be pension or lump-sum.

• Usually based on salary and years of service.

• The calculation of pension benefits is based on Final pay or Average pay.

• Liability calculated by actuary.

• The company is making a promise and therefore bears the risk of meeting the future obligation.

• Risk remains with Employer

Defined Benefit (DB) cont…

Examples:• The company agrees to provide employees

with a pension of x% of their final salary for each year of service.

• The company agrees to provide a lump sum of 5 times the employee’s final salary.

If the plan rules do not meet the definition of DC, the plan must be treated as DB.

Comparison of DC & DB Plans

EMPLOYEES COMPANY

• Cost certainty • Less attractive to employees

• Benefit certainty• No investment

risk

• Subject to Financial viability of employer

• Retention • Exposed to financial risks and increasing life expectancy

DCDC

DBDB

• Portability • Not subject

toFinancial viability of employer

• Risk of insufficient funds to cover retirement (investment risk, longer life)

Pros Cons ConsPros

Funding

Pension plans can be:• Funded Retirement Benefits (FRB)• Unfunded Retirement Benefits (URB)

Funding decisions are usually based on factors such as:• Cash position of the company • Local tax regulations• Local legal requirements• Suitable investments available• Market norms

Funded Retirement Benefits (FRBs)

Funded Plans:• Assets have been contributed into a separate

legal entity to the employer• Is usually a trust, governed by trustees.• The value of the assets may be less or more

than the value of the liability• Assets> Liabilities = Funded plan in Surplus• Liabilities> Assets = Funded plan in Deficit

Unfunded Retirement Benefits (URBs)

Unfunded Plans:• No assets have been put aside by the

employer to meet pension obligations.• Benefits are paid from company funds• Viewed by employees as being less secure.

Question

If you have a Funded scheme in deficit, this means that:

(A) Company has no specific assets put aside to meet it’s pension liability

(B) Liabilities exceed Assets

(C) Assets exceed Liabilities

(D) The actuaries are doing a terrible job

If you have a Funded scheme in deficit, this means that:

(A) Company has no specific assets put aside to meet it’s pension liability

(B) Liabilities exceed Assets

(C) Assets exceed Liabilities

(D) The actuaries are doing a terrible job

Question

Definitions Of DB Components

Pension Obligation

Pension Assets (if any)

Exclude: Unrecognised gains /losses

Related Deferred Tax

Balance Sheet - Defined Benefit Plan

Define DBO

– The expected future payments required to settle the benefits resulting from employee service in the current and prior periods.

– The obligation is discounted using the interest rate of high quality corporate bonds.

– The obligation is calculated by the actuary.

Key Drivers:– Actuarial assumptions– Business decisions

Measures of Defined Benefit Obligation

Accrued Benefit Obligations : The Pension Liability based on service to date and current salary levels.

Vested Benefit Obligation :The portion of the benefit obligation that does not depend on future employee service. Alternatively, it is vested portion of ABO

This assumes the employee leaves service immediately.

Projected Benefit Obligations

The Pension Liability based on service to date but taking into account future expected salary levels.

This recognises that the liability for benefits earned by service to date will increase as salaries rise in the future. PBO is the liability recognised in the Balance Sheet.

Measures of Defined Benefit Obligation

1311191089889Current service cost

Benefit Attributed to:

196

8.9

89

262

131

131

2

131131131131- Current year (1%)

5243932620- Prior year

655524393131Current and prior year

65547632489Closing obligation

47.833.419.60Interest @ 10%4763241960Opening obligation

5431Year

Data for Illustration: Salary in Year 1 = 10,000; Assumed annual increase 7%Discount Rate: 10%

Calculation of DBO

Pension Fund Assets

• Specific assets to meet future pension obligations.

• Held in legal entities (eg trusts) separate to Unilever.

• Assets measured at fair value• May be equities, bonds, property etc.• If market price not available, at fair value (e.g.

using a discount rate that reflects the associated risk and the maturity)

Profit and loss - Defined Benefit Plan

• Gross Service Cost

• Past Service Costs

• Settlements

• Curtailments

• Interest Cost

• Expected Return on Plan assets

Gross Service Cost

Increase in the present value of a defined benefit obligation resulting form employee service in the current period

The Net Present Value of the extra future benefits earned through the current period of service

The actuary will calculate this as part of the valuation report and normally express this as a percentage of payroll.

ExamplePayroll cost Rs1,000,000 x 15% = €150,000

Accounting EntryDr Operating Profit Dr Operating Profit –– Gross Service CostGross Service CostCr Pension LiabilityCr Pension Liability

AssetLiability

Past Service Costs /Plan amendments

Occur when plan benefits are improved beyond the current terms and effect past service.

The amount recognised is the cost (ieadditional liability created) as a result of the improved benefits .

Recognise cost immediately when irrevocable decision is made and benefit is vested. Unvested benefits are recognised on a straight line method over the average vesting period

Accounting EntryDr Operating Profit Dr Operating Profit –– Past Service CostPast Service CostCr Pension LiabilityCr Pension Liability

Example: Retirees receive a pension of 50% of their final salary. The company then increases this to 60%, resulting in a PSC.

AssetLiability

Settlements

Arise where the liability is settled by some action eg business disposal or transferring the DB liability to an insurance company.

Amount to record is the difference between the liability disposed of and the assets given in settlement.

Usually result in a cost to P&L Amount will be calculated in conjunction

with the actuary.

Accounting EntryDr Pension LiabilityDr Pension LiabilityCr Pension AssetsCr Pension AssetsDr Operating Profit Dr Operating Profit –– Settlement Cost Settlement Cost

AssetLiability

Curtailments

Result from significant reductions in employees and thus liability.

Examples are factory closures, large restructuring programmes

No fixed recognition criteria for what constitutes a Curtailment.

Record the reduction in the present value of the pensions liability.

Amount calculated by actuary. Usually results in a credit to P&L (TR)

Accounting EntryDr Pension LiabilityDr Pension LiabilityCr Operating Profit Cr Operating Profit –– Curtailment Cost Curtailment Cost

AssetLiability

Interest on Liability

Interest cost – is the unwinding of the discount of the pensions liability for the current period.

The discount rate is agreed at the last valuation based on the appropriate bond yields for that country.

Calculation is:Average liability X % discount = Interest

for the period rate on Liability

Accounting EntryDr InterestCr Pension Liability

AssetLiability

Expected Return on Assets

The credit taken in the Profit and Loss Account for the return on plan assets based on the actual value of the plan assets and the long term expected return on those assets

Calculation is:

Accounting EntryDr Pension AssetsCr Operating Profit

Variance from the expected return is taken in the Actuarial gain/loss or SORIE.

Average assets X % rate of = Expected Returnfor the period return on Assets

X

AssetLiability

Cash Movements - Defined Benefit Plan

• Company contributions• Benefit Payments

Company Contributions

Payments from Employer to funded plans to increase plan assets.

Only applies to Funded plans. Must record only the company

contribution, not any employee contributions

Any refunds (where applicable) from a surplus in the pension fund, should be recorded here as a negative value

Accounting EntryDr Pension AssetsCr Cash

AssetLiability

Benefit Payments

Records the amounts of payments paid to pensioners.

Relates to both:

• Funded schemes - benefits paid from pension fund assets;• Unfunded schemes – benefits paid from Company funds.

Accounting EntryDr Pension LiabilityCr Pension Assets

AssetLiability

Actuarial Assumptions

Actuarial Assumptions

Main AssumptionsDiscount rateRate of salary increaseExpected rate of return on plan assetsDemographic variables (e.g. staffturnover, mortality etc.)

Can lead to volatile results Can result in unexpected funding shortfalls Actuarial assumptions should be unbiased & mutually compatible

Actuarial Gains and losses

• Actual less Expected Return• Experience Gains/ Losses• Changes in Actuarial Assumptions

Actual less Expected Return

This entry records the difference between the actual return and the expected return on assets.

All assets must be recorded at fair value at year end.

This entry posts the difference so that the closing asset values are at fair value.

Accounting EntryDr/Cr Pension Assets (for fair valuation of assets)Dr/Cr Reserves OR Un-recognizedActuarial gain / loss

AssetLiability

Experience Gains & Losses

Records effect on liability caused by differences between actual experience and the latest assumptions.

Latest assumptions vs what actually happened

Entry performed when new actuarial valuation performed

Amount calculated by actuary

Accounting EntryDr/Cr Pension liability (to record difference

on the basis of latest assumptions)Dr/Cr Reserves OR Un-recognisedactuarial gain/loss

AssetLiability

Changes in Actuarial Assumptions

Records effect on liability caused by changes in discount rates, inflation, salary increases, mortality rates etc.

Different variables = different liability.

Entry performed when new actuarial valuation performed

Amount calculated by actuary

AssetLiability

Actuarial Assumptions

What are the key drivers in the actuarial assumptions impacting a company’s pension plans?

1. Inflation 2. Discount rate3. Salary growth4. Life expectancy5. The mix of equity and bonds held in the plan

QUESTION: Which of the items above are correct?A) All of the aboveB) 1 and 2 onlyC) 1,3 and 5D) 1,2,3 and 4

Actuarial Assumptions

What are the key drivers in the actuarial assumptions impacting a company’s pension plans?

1. Inflation 2. Discount rate3. Salary growth4. Life expectancy5. The mix of equity and bonds held in the plan

QUESTION: Which of the items above are correct?A) All of the aboveB) 1 and 2 onlyC) 1,3 and 5D) 1,2,3 and 4

Elements of Defined Benefit Plan Liability

The defined benefit obligation (DBO) recognised in the balance sheet is:

Present value of DBOPlus actuarial gains not yet recognizedLess actuarial losses not yet recognizedLess past services costs not yest recognizedLess fair value of plan assets

Present value of DB

O

Plan assets

at fair

value

Unrecognised actuarial

losses

Unrecognised past

service cost

Net liability in the B/S

Amortization of Actuarial Gains and LossesPresent value of D

BO

Plan assets

at fair

value

Unrecognised actuarial

losses

Unrecognised past

service cost

Net liability in the B/S

10% corridor

Amortise: Corridor is the higher of

10% of PV DBO10% of plan assets

Limit is separate for each plan Amortize actuarial gains/ loss

existing at the beginning of the periodover remaining average working lives of employees

Faster recognition method if consistently applied to both gains & losses

41

BRecognize loss

> 50 (10% of 500)

A<50

A<50

BRecognize gain

> 50 (10% of 500)

Losses Gains-10% +10%

CorridorA Spread excess greater than 50 over employees’ service lives

B

On 1 January 20X5 PV of the defined benefit obligation was 500 and fair value of plan assets was 400

Amortization of Actuarial Gains and Losses - !0% Corridor Approach

Actuarial gains/losses may also be recognised through ‘SORIE”

Profit or Loss:Corridor Approachany faster recognition method

Statement of recognized income & expense:Immediate recognitionfor all plans

Section 6 – Further Info

Disclosure Requirements

IAS 19 requires company to disclose:• Closing positions of liabilities and assets• Key assumptions used to calculate these

figures.• Explanations for the movement in balances• P&L expense recognised in the period• Material “one-off” transactions• Analysis of funded/ unfunded balances• Sensitivity information about medical cost

trend rates• Five year history of experience adjustments

on DBO and on plan assets

Amendments to IAS 19: Multi-employer Plans

DB accounting for the proportional share of assets and defined benefit obligation

Defined contribution accounting if insufficiant information

Recognize an asset or liability resulting from contractual sharing for surpluses / deficits

Amendments to IAS 19: Entities Under Common Control

Measure the plan as a whole as required by IAS 19

Recognise net defined benefit cost charged if there is contract or policy to charge it

If no contract or policy exists, DB accounting by

sponsoring employer

Other entities expense their contributions payable

Related party disclosures

Net asset is subject to an asset ceiling test

PV of DB

O Plan assets

at fair

value

Unrecognised actuarial

losses

Unrecognised past

service cost

Asset ceiling

Surplus available as

refund

Improve employee

benefits etc.

Asset Ceiling Test

Limit the net asset to:

Amount available in form of refunds or reductions in contributions Plus unrecognized actuarial losses (net) Plus unrecognized past service costs

Asset Ceiling Concept

– The objective of the asset ceiling is to prevent gains being recognised solely as a result of the deferred recognition of past service cost and actuarial losses

– The problem arises when an entity defers recognition of actuarial losses or past service cost in determining the amount specified in paragraph 54 but is required to measure the defined benefit asset at the net total specified in paragraph 58(b). Recognising asset equal to unrecognised past service cost and actuarial losses could result in the entity recognising an increased asset

Thank You