IAS 19-EMPLOYEE BENEFITS

Defined contribution plans and defined benefit plans

With defined contribution plans, the employer (and possibly, as here, current employees too) pay
regular contributions into the plan of a given or 'defined' amount each year. The contributions are
invested, and the size of the post-employment benefits paid to former employees depends on how
well or how badly the plan's investments perform. If the investments perform well, the plan will be
able to afford higher benefits than if the investments performed less well.

Accounting for payments into defined contribution plans is straightforward.

(a) The obligation is measured by the amounts to be contributed for that period.
(b) There are no actuarial assumptions to make.
(c) If the obligation is settled in the current period (or at least no later than 12 months after the end of
the current period) there is no requirement for discounting.

IAS 19 requires the following.

(a) Contributions to a defined contribution plan should be recognised as an expense in the period they
are payable (except to the extent that labour costs may be included within the cost of assets).
(b) Any liability for unpaid contributions that are due as at the end of the period should be recognised
as a liability (accrued expense).
(c) Any excess contributions paid should be recognised as an asset (prepaid expense), but only to the
extent that the prepayment will lead to, eg a reduction in future payments or a cash refund.
In the (unusual) situation where contributions to a defined contribution plan do not fall due entirely within
12 months after the end of the period in which the employees performed the related service, then these
should be discounted.

Disclosure requirements
(a) A description of the plan
(b) The amount recognised as an expense in the period

With defined benefit plans, the size of the post-employment benefits is determined in advance, ie the
benefits are 'defined'. The employer (and possibly, as here, current employees too) pay contributions
into the plan, and the contributions are invested. The size of the contributions is set at an amount that
is expected to earn enough investment returns to meet the obligation to pay the post-employment
benefits. If, however, it becomes apparent that the assets in the fund are insufficient, the employer
will be required to make additional contributions into the plan to make up the expected shortfall. On
the other hand, if the fund's assets appear to be larger than they need to be, and in excess of what is
required to pay the post-employment benefits, the employer may be allowed to take a 'contribution
holiday' (ie stop paying in contributions for a while).

Accounting for defined benefit plans is much more complex. The complexity of accounting for defined
benefit plans arises from the following factors.
(a) The future benefits (arising from employee service in the current or prior years) cannot be
measured exactly, but whatever they are, the employer will have to pay them, and the liability
should therefore be recognised now. To measure these future obligations, it is necessary to use
actuarial assumptions.

(b) The obligations payable in future years should be valued, by discounting, on a present value basis.
This is because the obligations may be settled in many years' time.

(c) If actuarial assumptions change, the amount of required contributions to the fund will change, and
there may be actuarial gains or losses. A contribution into a fund in any period will not equal the
expense for that period, due to actuarial gains or losses.

The main categories of actuarial assumptions are as follows:

(a) Demographic assumptions are about mortality rates before and after retirement, the rate of
employee turnover, early retirement, claim rates under medical plans for former employees, and so
on.
(b) Financial assumptions include future salary levels (allowing for seniority and promotion as well as
inflation) and the future rate of increase in medical costs (not just inflationary cost rises, but also
cost rises specific to medical treatments and to medical treatments required given the expectations of
longer average life expectancy).

The statement of profit or loss and other comprehensive income

The components of defined benefit cost must be recognised as follows in the statement of profit or
loss and other comprehensive income:

Component Recognised in

(a) Service cost Profit or loss

(b) Net interest on the net defined benefit liability Profit or loss
(c) Re-measurements of the net defined benefit liability Other comprehensive income (not
reclassified to P/L)

On Statement of Financial position, an entity offsets its pension obligation and its plan assets and
reports its net position:

If the obligation exceeds the assets, there is a plan deficit (the usual situation) and a liability is
reported in the statement of financial position.

If the assets exceed the obligation, there is a surplus and an asset is reported in the statement of
financial position.

Measuring plan assets and liabilities:

An actuary measures the plan assets and liabilities by applying carefully developed estimates and
assumptions relevant to the defined benefit pension plan.

• The plan liability is measured at the present value of the defined benefit obligation, using the
Projected Unit Credit Method. This is an actuarial valuation method.

• Discounting is necessary because the liability will be settled many years in the future and,
therefore, the effect of the time value of money is material. The discount rate used should be
determined by market yields on high quality corporate bonds at the start of the reporting period,
and applied to the net liability or asset at the start of the reporting period.

• Plan assets are measured at fair value. IFRS 13 Fair Value Measurement provides a framework for
determining how fair value should be established.
IAS 19 does not prescribe a maximum time interval between valuations. However, valuations should
be carried out with sufficient regularity to ensure that the amounts recognised in the financial
statements do not differ materially from actual fair values at the reporting date.

• Where there are unpaid contributions at the reporting date, these are not included in the plan
assets. Unpaid contributions are treated as a liability owed by the entity/employer to the plan.

Components of cost

The net interest component: this is charged (or credited) to profit or loss and represents the
change in the net pension liability (or asset) due to the passage in time. It is computed by applying
the discount rate at the start of the year to the net defined benefit liability (or asset).

The service cost component: this is charged to profit or loss and is comprised of three elements:

• 'Current service cost, which is the increase in the present value of the obligation arising from
employee service in the current period. period.

• Past service cost, which is the change in the present value of the obligation for employee
service in prior periods, resulting from a plan amendment or curtailment

Contributions into the plan: these are the cash payments paid into the plan during the reporting
period by the employer. This has no impact on the statement of profit or loss and other
comprehensive income.

Benefits paid: these are the amounts paid out of the plan assets to retired employees during the
period. These payments reduce both the plan obligation and the plan assets. Therefore, this has no
overall impact on the net pension deficit (or asset).

the net pension deficit will differ from the amount calculated by the actuary as at the current year
end. This is for a number of reasons, that include the following:

An adjustment, known as the remeasurement component, must therefore be posted. This is

charged or credited to other comprehensive income for the year and identified as an item that will
not be reclassified to profit or loss in future periods.

• Any gain or loss on settlement' . • The actuary's calculation of the value of the plan obligation
and assets is based on assumptions, such as life expectancy and final salaries, and these will have
changed year-on-year.

• The actual return on plan assets is different from the amount taken to profit or loss as part of the
net interest component.
An adjustment, known as the remeasurement component, is charged or credited to other
comprehensive income for the year and identified as an item that will not be reclassified to profit or
loss in future periods.

A past service cost is the 'change in the present value of the defined benefit obligation for
employee service in prior periods, resulting from a plan amendment or a curtailment'

• Past service costs could arise when there has been an improvement in the benefits to be
provided under the plan. This will apply whether or not the benefits have vested (i.e. whether or
not employees are immediately entitled to those enhanced benefits), or whether they are obliged
to provide additional work and service to become eligible for those enhanced benefits.

• Past service costs are included within the service cost component for the year.

• Past service costs are recognised at the earlier of: – 'when the plan amendment or curtailment
occurs – when the entity recognises related restructuring costs or termination benefit'

A curtailment is a significant reduction in the number of employees covered by a pension plan. This
may be a consequence of an individual event such as plant closure or discontinuance of an
operation, which will typically result in employees being made 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. For example, an employee may leave the entity for a new job
elsewhere, and a payment is made from that pension plan to the pension plan operated by the new
employer.

• The gain or loss on settlement comprises the difference between the fair value of the plan assets
paid out and the reduction in the present value of the defined benefit obligation and is included as
part of the service cost component.

• The gain or loss on settlement is recognised on the date when the entity eliminates the obligation
for all or part of the benefits provided under the defined benefit plan.

Accounting for short-term employee benefits is quite straightforward, because there are no actuarial
assumptions to be made, and there is no requirement to discount future benefits.

Recognition and measurement

(a) Unpaid short-term employee benefits as at the end of an accounting period should be recognised
as an accrued expense. Any short-term benefits paid in advance should be recognised as a
prepayment (to the extent that it will lead to, eg a reduction in future payments or a cash refund).

(b) The cost of short-term employee benefits should be recognised as an expense in the period when
the economic benefit is given, as employment costs (except insofar as employment costs may be
included within the cost of an asset, eg property, plant and equipment).