New on the Horizon: Defined benefit plans. International Financial Reporting Standards May 2010

Transcription

1 New on the Horizon: Defined benefit plans International Financial Reporting Standards

2 Foreword In 2006 the International Accounting Standards Board (IASB) added to its agenda a project for a fundamental review of all aspects of post-employment benefit accounting. Since then the IASB has been on a rollercoaster ride of post-employment benefit accounting considerations, including a discussion paper Preliminary Views on Amendments to IAS 19 Employee Benefits (the DP) issued in March 2008 with proposals for employee benefits to be based on promises, for the liability related to certain employee benefit promises to be measured at fair value and a new approach to accounting for cash-balance plans. Following the DP, the IASB also discussed proposals to put the full impact of defined benefit plan accounting in profit or loss. However, the recent exposure draft ED/2010/3 Defined Benefit Plans Proposed Amendments to IAS 19 (the ED) which is the subject of this publication, does not include any of these proposals. Instead the ED focuses mostly on recurring costs, i.e. service costs and net interest income or expense, being recognised in profit or loss, and remeasurements being recognised in other comprehensive income. One of the most significant proposals in the ED is for the elimination of the corridor method, which we expect to have a significant impact on those applying this method given that such entities would need to recognise all actuarial gains and losses immediately in other comprehensive income. However, even if an entity does not apply the corridor method, the ED proposals still should be given serious attention. This is because the ED also proposes a new approach to calculating and presenting the net interest income or expense on the net defined benefit asset (liability), which, if the proposals are finalised as drafted, would result in such amount being calculated as a single net interest figure, based on the discount rate that is used to measure the defined benefit obligation. As a consequence, an entity would no longer recognise the long-term expected return on plan assets in profit or loss and there would therefore be a reduction in net profit from that reported under current IAS 19 Employee Benefits. The difference between actual asset returns and the amount included in net interest, together with actuarial gains and losses on the defined benefit obligation, would be reported in other comprehensive income, leaving profit or loss unaffected by these volatile amounts. When considering the proposals in the ED, the wider practical impact that they might have, for example on compliance with debt covenant requirements and key performance measures, also may be a focus for entities. The ED s proposals would alter both the timing and location of recognition of the changes in the net benefit asset (liability) and each entity should evaluate the impact from its own perspective. The ED proposals may result in entities needing to reconsider the way in which they monitor their position and performance via key performance measures or could even result in needing to renegotiate existing debt covenants and terms. As a result, while the ED provides a comment period of four months, we believe that it includes some critical proposals that entities should consider sooner rather than later. This publication will help you obtain a better understanding of these proposals. Lynn Pearcy (Leader) Annie Mersereau (Deputy leader) Regina Croucher Bruce Darton Mary Tokar KPMG s global IFRS Employee Benefits leadership team KPMG International Standards Group

3 About this publication This publication has been produced by the KPMG International Standards Group (part of KPMG IFRG Limited). We would like to acknowledge the efforts of the principal authors of this publication. Those authors include Regina Croucher, Hagit Keren and Lynn Pearcy of the KPMG International Standards Group. Content Our New on the Horizon publications are prepared upon the release of a new proposed IFRS or proposed amendment(s) to the requirements of existing IFRSs. They include a discussion of the key elements of the new proposals and highlight areas that may result in a change of practice. This edition of New on the Horizon considers the proposed requirements of ED/2010/3 Defined Benefit Plans Proposed Amendments to IAS 19, which was published on 29 April The text of this publication is referenced to the ED and to selected other current IFRSs in issue at 30 April References in the left-hand margin identify the relevant paragraphs. Further analysis and interpretation will be needed in order for an entity to consider the potential impact of the ED in light of its own facts, circumstances and individual transactions. The information contained in this publication is based on initial observations developed by the KPMG International Standards Group, and these observations may change. Other ways KPMG member firms professionals can help A more detailed discussion of the general accounting issues that arise from the application of IFRSs can be found in our publication Insights into IFRS. In addition to Insights into IFRS, we have a range of publications that can assist you further, including: IFRS compared to US GAAP Illustrative financial statements for interim and annual periods IFRS Handbooks, which include extensive interpretative guidance and illustrative examples to elaborate or clarify the practical application of a standard New on the Horizon publications, which discuss consultation papers Newsletters, which highlight recent developments IFRS Practice Issue publications, which discuss specific requirements and pronouncements First Impressions publications, which discuss new pronouncements Disclosure checklist. IFRS-related technical information also is available at For access to an extensive range of accounting, auditing and financial reporting guidance and literature, visit KPMG s Accounting Research Online. This web-based subscription service can be a valuable tool for anyone who wants to stay informed in today s dynamic environment. For a free 15-day trial, go to and register today.

4 Contents 1. Executive summary 4 2. Introduction and background Drivers for the project Project to be done in stages The FASB parallel project The IASB ED 6 3. Principle proposals Summary of proposed changes Scope Short-term vs long-term employee benefits Post-employment benefits vs other long-term benefits Recognition, including elimination of the corridor method Actuarial gains and losses Past service cost Other implications Summary Measurement The projected unit credit method Actuarial assumptions Presentation Service costs Finance costs Remeasurements The effect of settlements or curtailments Illustrative examples of presentation under the ED s proposals Disclosure Multi-employer plans Settlements and curtailments Other matters Multi-employer plans Incorporation of IFRIC Proposed amendment to IFRS Effective date and transition 32

5 New on the Horizon: Defined benefit plans 4 1. Executive summary The exposure draft ED/2010/3 Defined Benefit Plans Proposed Amendments to IAS 19 (the ED) is part of the International Accounting Standards Board s (IASB or Board) broader employee benefits project. It proposes significant changes to the recognition, presentation and disclosure of defined benefit plans; it also proposes some measurement changes. The ED proposes one category of long-term employee benefits that would combine post-employment benefits and other long-term benefits. The ED proposes to recognise all changes in the value of the defined benefit obligation and in the value of plan assets in the financial statements in the period in which they occur. The ED proposes that the changes in the net defined benefit liability (asset) would be split into the following components: service costs to be recognised in profit or loss; net interest income or expense to be recognised in profit or loss as part of finance costs; and remeasurements of the net defined benefit liability (asset), including actuarial gains and losses to be recognised in other comprehensive income. The ED proposes that in determining whether the benefit formula is back-end loaded an entity would consider estimates of all factors that affect the level of benefits, including expected future salary increases and the best estimate of benefits that are contingent on performance hurdles. The ED proposes additional guidance on administrative costs and taxes payable by the plan and whether those should be included in the measurement of the defined benefit liability or deducted from the return on plan assets. The ED proposes that the net interest income or expense component would be determined by applying the discount rate that is used to discount the defined benefit obligation to the net defined benefit liability (asset). The ED proposes that the effect of settlements would be recognised in other comprehensive income as remeasurements. The ED proposes further disclosures about defined benefit plans, focused on specified objectives.

6 5 New on the Horizon: Defined benefit plans 2. Introduction and background The overall objective of the IASB in its employee benefits project is to conduct a fundamental review of all aspects of long-term benefit accounting and in particular post-employment benefit accounting. It issued a discussion paper Preliminary Views on Amendments to IAS 19 Employee Benefits (the DP) in 2008 and has now issued the ED discussed in this publication. The project forms part of the Memorandum of Understanding between the IASB and the US Financial Accounting Standards Board (FASB) which sets up a roadmap of convergence between IFRSs and US Generally Accepted Accounting Principles (US GAAP). However, currently the FASB is not working actively on its employee benefits project but is monitoring the work of the IASB to determine its next steps. 2.1 Drivers for the project The employee benefits project is driven in part by a widespread concern about the adequacy of the accounting for post-employment benefit plans and evidence of difficulty in understanding the information entities provide about post-employment benefit plans. These factors were reinforced by the US Securities and Exchange Commission in its Recommendations pursuant to the Sarbanes- Oxley Act of 2002 that the FASB address off-balance sheet accounting, including accounting for defined benefit post-employment benefit plans. In its response to these Recommendations, the FASB noted that this was one of the subjects to be addressed jointly by the FASB and IASB. 2.2 Project to be done in stages The IASB split the project initially into two stages: a relatively short-term element and a longer-term fundamental review. As part of the first stage, in March 2008 it published the DP. The DP proposed to amend the way in which so-called contribution-based promises are accounted for and also to introduce more general recognition, presentation and disclosure changes. Contribution-based promises are, in summary, those in which the benefit promised to the employee is made up of contributions and, potentially, a promised level of return on those contributions; the DP proposed that they should be accounted for, broadly, at fair value. Comments on the DP showed that such promises are widespread and concern was expressed that this was too fundamental a change to be introduced as part of a short-term project. As a result, the IASB now proposes to take forward the first stage of its IAS 19 Employee Benefits project in two steps. The first step is the issuance of an amended standard, the objective of which is to introduce improvements primarily to the recognition, presentation and disclosure of an entity s post-employment benefit obligations. Some measurement changes also are proposed. With these changes, which are the subject of this publication, the IASB aims to provide users of financial statements with better information about those plans. The second step is intended to be a further exposure draft with respect to contribution-based promises, potentially as part of the comprehensive review of post-employment benefit accounting that will form the second stage of the IASB s work. The IASB is not likely to discuss the future steps of its employee benefits project in detail until after mid The FASB parallel project As noted above, post-employment benefit accounting forms part of the Memorandum of Understanding between the IASB and the FASB (the Boards). At present, however, the two Boards are running parallel projects and the FASB has made changes to its post-employment benefit standards as the result of the first phase of its project. Under the proposals of the ED the statement of financial position would be aligned more closely between US GAAP and IFRS but significant differences would remain at this stage from the perspective of the statement of comprehensive income.

7 New on the Horizon: Defined benefit plans 6 In running these parallel projects, each Board monitors the progress of the other Board s postemployment benefits project but as yet there are no active joint discussions around the project. However, both Boards hope to benefit from comment letters received on the other s consultation documents. The Boards plan to discuss how to achieve a common post-employment benefits standard once the IASB has completed the first step of its project. 2.4 The IASB ED The IASB believes that the proposals in the ED, if approved, should improve the ability of users to understand entities post-employment benefit obligations through increased transparency, improved comparability and improved disclosures. The IASB s objective is to finalise these shortterm, targeted improvements to the accounting for defined benefit plans by the middle of The purpose of this publication is to summarise the key features of the proposals in the ED, and highlight potential impacts and conceptual and application issues identified to date so as to facilitate informed debate of, and comment on, the proposals.

8 7 New on the Horizon: Defined benefit plans 3. Principle proposals 3.1 Summary of proposed changes The table below provides an overview of the amendments proposed in the ED with respect to defined benefit plans. Sections 3.2 to 3.8 discuss the proposed amendments in detail. Current requirements Proposed amendments Classification The accounting for defined benefit post-employment benefits differs from the accounting for other long-term benefits, mainly in respect of the timing of recognition of actuarial gains and losses and past service costs; the disclosures also differ. One category of long-term employee benefits that would combine defined benefit postemployment benefits and other long-term employee benefits, with the same accounting treatment and disclosure requirements for both. See 3.4 Recognition For post-employment defined benefit plans, the deferral of actuarial gains and losses (the corridor method) is permitted and deferred recognition of unvested past service costs is required. Recognition of all changes in the value of the defined benefit obligation and in the value of plan assets would be required in the period in which they occur. See 3.5 Measurement General guidance on the accounting for benefit plans with a back-end loaded benefit formula. In determining whether the benefit formula is back-end loaded an entity would consider estimates of all factors that affect the level of benefits, including expected future increase in salaries and the best estimate of benefits that are contingent on performance hurdles. See Guidance and examples are provided in respect of actuarial assumptions to be made when measuring the defined benefit liability and limited guidance on how to treat administrative costs and taxes payable by the plan. Additional examples would be provided of actuarial assumptions that should be reflected in the measurement of a defined benefit obligation; there are detailed proposals on the split of administrative costs and taxes payable by the plan between return on plan assets and the defined benefit obligation. See 3.6.2

9 New on the Horizon: Defined benefit plans 8 Current requirements Proposed amendments Presentation Service costs, interest expense on the defined benefit obligation and expected return on plan assets are presented in profit or loss for all entities; it is a policy choice in which line items they are presented. The presentation of actuarial gains and losses depends on the policy choice adopted by the entity. The choices currently available for recognition and presentation of actuarial gains and losses in respect of postemployment defined benefit plans are: The periodic change in the net defined benefit liability for all long-term employee benefits would be separated into the following components: service costs to be recognised in profit or loss; net interest income or expense to be recognised in profit or loss as part of finance costs; and remeasurements to be recognised in other comprehensive income. See 3.7 immediate recognition in other comprehensive income; deferred or loss under the corridor method; and a method that results in faster or loss e.g. immediate recognition. Expected long-term return on plan assets is presented in profit or loss, while the difference between the expected return and the actual return is an actuarial gain or loss recognised in accordance with the entity s policy choice. The net interest income or expense component would be determined by applying the discount rate that is used to discount the defined benefit obligation to the net defined benefit liability (asset). It therefore would include interest income on plan assets based on this discount rate, while the difference between that amount and the actual return is a remeasurement recognised in other comprehensive income. See Settlements and curtailments are recognised in profit or loss. Settlements would be recognised in other comprehensive income as remeasurements. Curtailments would continue to be recognised in profit or loss. See Disclosure Detailed disclosure requirements. Further disclosures about defined benefit plans, focused on specified objectives. See 3.8

10 9 New on the Horizon: Defined benefit plans 3.2 Scope IAS 19.1 IAS 19 currently applies to an employer s accounting for all employee benefits, except those to which IFRS 2 Share-based Payment applies. The ED does not propose any amendments to the scope of the current version of IAS Short-term vs long-term employee benefits ED 4, 7, 8, BC79 The IASB is proposing to amend the definitions of short-term employee benefits and long-term employee benefits so that the distinction between the two depends on when the entity expects the benefit to become due to be settled. According to the proposed definitions, short-term employee benefits would be those that the entity expects to become due to be settled within 12 months after the end of the reporting period in which the employees render the related service and long-term employee benefits those that it expects to become due to be settled 12 months or more after that time (in both cases excluding termination benefits). All benefits that the entity expects to become due to be settled after the completion of employment would be long-term benefits. ED BC79 The ED provides the following example: an employee of Company A is entitled to a long-service leave benefit, which is vested at the reporting date. A s management does not expect that the employee will require settlement of the benefit by taking the leave within 12 months of the reporting date. On that basis, the ED concludes that this benefit meets the definition of a long-term employee benefit. In another example, Company B has a cumulative vacation programme in which employees C and D have accrued but not taken 30 and 45 vacation days respectively during the reporting period. B does not expect C to take any of the vacation in the following twelve months and D is expected to take all of the vacation within that period. Based on the proposed definitions, it appears that C s benefit would be a long-term employee benefit while D s benefit would be a short-term employee benefit. Observations The distinction between short-term and long-term employee benefits, which affects the measurement of the obligation and not just its classification in the statement of financial position, is a difficult area and this is the IASB s second proposed change. The definitions were amended in the annual improvement project (issued May 2008) and are now re-opened in the ED. Two changes are proposed: first to insert expects to become before due to be settled and second to change period to reporting period. There may be a continuing lack of clarity in certain areas, however. For instance, the example given in the ED and set out above does not consider the classification of the benefit in the reporting periods prior to it becoming vested. The proposal inserts reporting before period, implying that it is the 12 months after the end of the reporting period that should be considered, rather than the end of the period during which the benefit as a whole is earned, when determining short-term vs long-term classification. This proposal may resolve some of the practice issues around the meaning of period of service noted in our publication Insights into IFRS ( ), although clarification may be required where benefits are earned over multiple reporting periods. Insights into IFRS notes also our view that, under the current standard, whether a benefit is due to be settled within 12 months depends upon when the employee could require settlement; the ED would change the focus to the employer s expectations for the timing of settlement.

11 New on the Horizon: Defined benefit plans 10 We expect that these proposals would result in entities spending more time determining how to classify, and therefore how to measure, certain benefit plans, e.g. vacation accruals, as such benefits might be long-term employee benefits in one reporting period but then be short-term employee benefits in the next reporting period depending on when management expects the employee to take their vacation benefits. Also, it is not clear whether the IASB is intending to require entities to split benefit plans between short-term and long-term classifications at the employee-by-employee level, as illustrated in the example above, or even for an individual employee. 3.4 Post-employment benefits vs other long-term benefits ED 4, 7, BC77 The IASB is proposing to amend the definition of post-employment benefits and other long-term employee benefits in order to remove any differences between the accounting for and disclosure of the two. In other words, the ED proposes one category of long-term employee benefits that would combine post-employment benefits and other long-term employee benefits. Observations Currently, other long-term employee benefits are accounted for in a manner similar to defined benefit post-employment benefits, except that all actuarial gains and losses and past service costs are recognised immediately in profit or loss; for actuarial gains and losses neither the corridor method nor immediate recognition in other comprehensive income may be applied. Under the proposal to have just a single category of long-term employee benefits, actuarial gains and losses on other long-term benefits would be recognised instead in other comprehensive income, which would be a significant change from current practice (see 3.5). Entities also would have to analyse the charge to profit or loss for such benefits into its service and interest components, which is not required currently under IAS 19 (see 3.7). This change will interact with the revised definitions of short- and long-term employee benefits. Extending the example given in 3.3 above, Employee D s vacation benefit would be a shortterm benefit, with all changes in value recognised in profit or loss. Employee C s vacation benefit would be a long-term benefit and related actuarial gains and losses therefore would be recognised in other comprehensive income under the proposed single category of longterm employee benefits, whereas actuarial gains and losses on other long-term benefits are recognised in profit or loss under the current version of IAS 19. The disclosure requirements outlined in the ED also would apply in full to benefits currently classified as other long-term benefits that continue to be classified as long-term under the ED and would be more extensive than the current disclosure requirements for such benefits. 3.5 Recognition, including elimination of the corridor method IAS Currently under IAS 19, the defined benefit liability is recognised in the statement of financial position as: (a) the present value of the defined benefit obligation; (b) less the fair value of any plan assets; (c) less (plus) unrecognised actuarial losses (gains); (d) less (plus) unrecognised past service cost (negative past service cost); and (e) taking into account any effect of the limit to the defined benefit asset, including any additional liability recognised for minimum funding requirements that relate to past service (together the effect of the asset ceiling).

12 11 New on the Horizon: Defined benefit plans The ED s proposed amendments with respect to the recognition of net defined benefit liabilities (assets) are focused on items (c) and (d) above, as those items permit deferred recognition of gains and losses. ED 61, 96A, BC9, BC12, BC13 The ED proposes to: l eliminate the corridor method, by requiring immediate recognition of actuarial gains and losses; and l require immediate recognition of all past service costs, including unvested amounts. As a result, all changes in the value of the defined benefit obligation, in the value of plan assets and in the effect of the asset ceiling would be recognised in the period in which they occur Actuarial gains and losses Current IAS 19 actuarial gains and losses IAS 19.7, There are two types of actuarial gains and losses, those that arise from differences between the 92-93A previous actuarial assumptions and what has actually occurred (experience adjustments) and those that result from changes in assumptions. Currently under IAS 19, an entity may choose an accounting policy of recognising actuarial gains and losses in profit or loss or alternatively immediately in other comprehensive income. If actuarial gains and losses are recognised in profit or loss, then an entity may choose to recognise such gains and losses using the corridor method which permits their recognition to be deferred. IAS 19.92, 93 IAS 19.BC38- BC41 Under the corridor method, actuarial gains and losses are recognised when the cumulative unrecognised amount thereof at the beginning of the period exceeds a corridor. The corridor is 10 percent of the greater of the present value of the defined benefit obligation and the fair value of the plan assets, measured at the beginning of the period. The net cumulative unrecognised actuarial gain or loss at the beginning of the period in excess of the corridor is amortised on a straight-line basis over the expected remaining working lives of the employees participating in the plan. This represents the minimum amount of cumulative actuarial gains and losses that should be recognised, but an entity may use a method that results in faster recognition. ED proposals actuarial gains and losses IAS 19 currently permits a deferred recognition approach for actuarial gains and losses, even though immediate recognition of actuarial gains and losses would be consistent with the Framework for the Preparation and Presentation of Financial Statements, as acknowledged in the Basis for Conclusions to the standard. Although the immediate recognition alternative was found attractive, it was believed not to be feasible to require that approach until substantial issues about performance reporting had been resolved. The deferral permitted by the corridor method has been subject to continuing criticism and the IASB now proposes its abolition. ED BC9-BC13 The IASB explains in the Basis of Conclusions to the ED that it believes that immediate recognition provides the most useful information to users of financial statements and improves comparability by eliminating the options currently allowed under IAS 19. With its proposal that actuarial gains and losses are recognised outside profit or loss, in other comprehensive income, the Board notes that the additional volatility that this would introduce for those entities currently using the corridor method could be isolated by being reported as a remeasurement (see 3.7) Past service cost ED BC13 The Board has also reassessed the accounting for past service cost. It believes that the attribution of unvested benefits to past service results in a liability, which therefore should be recognised in full. The ED therefore proposes ending the deferral of unvested past service cost.

13 New on the Horizon: Defined benefit plans Other implications IAS As a direct result of the IASB proposals to recognise actuarial gains and losses and past service cost immediately: The asset ceiling calculation would be simplified, relating only to the benefit available in the form of refunds from the plan or reductions in future contributions to the plan. l The guidance with respect to the recognition of post-employment benefit assets and liabilities upon a business combination would be deleted since it would be redundant. Currently under IAS 19, in a business combination the acquirer recognises the assets and liabilities arising from post-employment benefits at the present value of the obligation less the fair value of any plan assets even if the acquiree had deferred the recognition of amounts with respect to actuarial gains and losses and past service costs. The recognition of any net asset would be subject to the asset ceiling test Summary ED 54A In summary, under the ED, the net defined benefit liability would be recorded in the statement of financial position as: (a) the present value of the defined benefit obligation; (b) less the fair value of any plan assets; and (c) taking into account any effect of the limit to the defined benefit asset, including any additional liability recognised for minimum funding requirements that relate to past service (together, the effect of the asset ceiling). The table below summarises the potential effects of the ED s recognition proposals on the net defined benefit plan liability (asset) in the statement of financial position. Existing policy Proposed amendment long-term employee benefits Immediate recognition of actuarial gains and losses Immediate recognition of past service costs Actuarial gains and losses recognised in profit or loss on a deferred basis under the corridor method Post-employment benefits Expected change to the net defined benefit plan liability (asset). Actuarial gains and losses recognised immediately in profit or loss/other comprehensive income Other long-term employee benefits No effect on the net defined benefit plan liability (asset). Expected change to the net defined benefit plan liability (asset). No effect on the net defined benefit plan liability (asset). Observations For entities that currently apply the corridor method, this proposed change would generally have a significant effect. We expect that applying the immediate recognition approach would not introduce practical measurement difficulties, since the necessary information already is required to be prepared in order to calculate and disclose the effect of the corridor method. However, it might change substantially the net defined benefit liability (asset) in the statement of financial position and the amounts that are recognised in the statement of comprehensive income.

14 13 New on the Horizon: Defined benefit plans Furthermore, the proposals may cause a high level of volatility in reported net assets and performance, although we note that the proposal to report actuarial gains and losses in other comprehensive income would leave profit or loss unaffected by this volatility. This presentation may result in a greater prominence being given to the other section of the statement of comprehensive income. As a result, some entities may decide to change the financial ratios used to evaluate their position and/or performance. Entities also may need to consider the impact of the ED proposals on their financing arrangements, including their ability to meet covenants, and may wish to discuss the impact of the proposals with their lenders. In some jurisdictions the change may affect an entity s ability to pay dividends, if there are legal restrictions based on the amounts recognised in the financial statements that are affected by the ED proposals. 3.6 Measurement ED 64A, 71A, The ED proposes additional guidance in respect of the projected unit credit method and actuarial 73, 85 assumptions, including on the allocation of administrative costs and taxes payable by the plan to either the defined benefit obligation or the return on plan assets. Additionally, the ED proposes that contributions payable by the employees would be included in the determination of the employer s defined benefit obligation and would reduce the amount of service cost recognised as an expense by the employer The projected unit credit method ED 71A, The ED does not discuss changing the attribution method of benefits to periods of service based BC87-BC90 on the benefit formula and also retains the requirement to recognise the cost of employee benefits on a straight-line basis when the employee service in later years will lead to a materially higher level of benefit than in earlier years (i.e. a back-end loaded benefit formula). However, the Board has decided to propose in the ED that, in determining whether the benefit formula is back-end loaded, an entity would consider estimates of all factors that affect the level of benefits, including: expected future salary increases; and the best estimate of benefits that are contingent on performance hurdles. The ED proposes confirming, in particular, that expected future salary increases should be included in determining whether a benefit formula expressed in terms of current salary allocates a materially higher level of benefit to later years. The Board s basis for this proposal is that two economically similar plans, one expressed as being a current salary plan and the other as being a career average salary plan, should result in a similar benefit being attributed to periods of employee service hence, a straight-line attribution for both. Illustrative example benefit formula of a current salary benefit plan Company B operates a defined benefit plan that provides a one-time payment on retirement of 10 percent of current salary in each year of service. All the employees are expected to retire after 10 years of service and have worked for 5 years to date. The total annual salary of the employees for each of the last five years was 500,000. The entity expects the total annual salary for each of years 6 8 to be 600,000 and for each of years 9 10 to be 800,000. The total expected benefit payment at the end of year 10 is 590,000 (calculated as 10% x ((5 x 500,000) + (3 x 600,000) + (2 x 800,000)).

15 New on the Horizon: Defined benefit plans 14 Since salary in later periods is expected to be significantly higher than in earlier periods, service in later periods would lead to a materially higher level of benefit than service in earlier periods; the benefit formula is therefore back-end loaded and a straight-line attribution would be required. Attributing the benefit to periods of service on this basis would result in a gross defined benefit obligation (before discounting) of 295,000 (calculated as expected benefit payment of 590,000 / 10 years x 5 years of service provided). Observation The proposed amendment might increase the number of plans that entities would consider to be back-end loaded, although some already analyse plans in the way proposed by the ED. This issue is discussed in our publication Insights into IFRS ( ). In addition, it would increase the defined benefit obligation of entities that do not currently consider expected salary increases when identifying whether the benefit formula is back-end loaded Actuarial assumptions ED 73, 85C The ED provides additional examples of actuarial assumptions that should be reflected in the measurement of the defined benefit obligation, including those discussed below. ED BC78 ED 7 The proportion of plan members that will select each option available under the plan terms The Board proposes introducing text to state that, when the employees are able to choose the form of the benefit (e.g. lump sum payment versus annual pension), the employer would make an actuarial assumption about what proportion would make each choice. The Basis for Conclusions to the ED notes the consequence that settlement made under a settlement option envisaged by the terms of the plan, and about which an actuarial assumption would therefore have been made, would not be a non-routine settlement (see 3.7.4). Instead, the difference between the assumption made and the actual outcome would be an actuarial gain or loss. The ED proposes to define a non-routine settlement as a transaction that eliminates all further legal or constructive obligation for part or all of the benefits provided under a defined benefit plan. Observation As discussed in our publication Insights into IFRS ( ), in our experience an employer s expectation of an employee s choice to receive a lump sum payment at retirement instead of ongoing payments generally is covered by the actuarial assumptions underlying the measurement of the defined benefit obligation. However, there may be circumstances in which settlement accounting may be more appropriate under the current standard, e.g. in a situation in which a large number of individuals choose the lump sum payment option at the same time in response to the employer s action. Under the proposals of the ED it seems that even such cases would not be considered as settlements but that an actuarial gain or loss would result. The distinction will be less important under the proposals since both actuarial gains and losses and settlements would be classified as remeasurements. ED 73, BC84-BC86 The cost of administering claims and benefit payments relating to service before the reporting date The Board proposes to remove the current option in IAS 19 to include plan administration costs in either the return on plan assets or in the actuarial assumptions used to measure the defined benefit obligation. Instead a single treatment would be required depending on the nature of the costs:

16 15 New on the Horizon: Defined benefit plans When the benefit promise depends on the return on the plan assets less asset management costs, the asset management costs affect the amount of the obligation and therefore would be included in the measurement of the defined benefit obligation. When the benefit promise does not depend on the return on the plan assets (e.g. a salaryrelated promise), the asset management costs would be included in the return on plan assets. These are the only administration costs that would be included in the return on plan assets. All other administration costs, e.g. the cost of administering the payment of benefits earned by current or past service, would be included in the measurement of the defined benefit obligation. As a result, under the proposals, other than when the benefit promise depends on the return on plan assets, asset management costs would be recognised as part of the return on plan assets; all other administration costs would be included in the defined benefit obligation and, therefore, current service cost. ED 73, BC83 Taxes payable by the plan on contributions relating to service before the reporting date or on benefits resulting from that service The current definition of return on plan assets includes the deduction of any taxes payable by the plan itself. The Board proposes to require instead that the estimate of the defined benefit obligation would include the present value of taxes payable by the plan on contributions relating to service before the reporting date or on benefits resulting from that service; those taxes would not be deducted from the return on plan assets. This is because the Board sees such contribution and benefit taxes as part of the cost of providing the benefits. Observations The ED s proposals with respect to administration costs and taxes may require a change in practice for many entities. However, we note that classifying taxes payable by the plan according to their nature is consistent with the view that we take under the current standard: see our publication Insights into IFRS ( ). Administration costs that are currently included in the return on plan assets on an annual basis might need to be included in the measurement of the defined benefit obligation under the proposals, by estimating the future costs relating to benefits earned in respect of past service. This could cause a significant increase in the defined benefit obligation and current service cost. With regard to taxes payable by the plan, further clarification may be required about the treatment of taxes payable on contributions made when a plan is in surplus or that may relate in part to services not yet received. Clarification also may be required about taxes payable on the investment income of a plan, since these are not referred to specifically; however, the focus on the nature of the taxes suggests that they will be included in the return on plan assets. The concept of expected return on plan assets would no longer exist under the ED s proposals (see 3.7.2). Therefore, any administration costs and taxes that in future are treated as part of the return on plan assets would be recognised as remeasurements in other comprehensive income. This is because the return on plan assets recognised in profit or loss under the proposals would be calculated on a specified basis that would not reflect administration costs and taxes; remeasurements would include the return on plan assets, excluding amounts included in the net interest income or expense on the net defined benefit liability (asset) (see 3.7.3). We note that, under the proposals, the more taxes and administration costs that are treated as part of the return on plan assets, the lower the current service cost. And the more taxes and administration costs that are treated as part of the measurement of the obligation, the higher the current service cost and interest expense.

17 New on the Horizon: Defined benefit plans 16 The best estimate of the effect of risk-sharing and conditional indexation ED 64A, 85(c), The current standard does not state specifically how to deal with risk-sharing and conditional BC92-BC96 indexation features (e.g. reduced benefits when plan assets are insufficient). The Board proposes to clarify that they should be incorporated into the determination of the best estimate of the defined benefit obligation. In the Board s view, features in a plan that result in sharing the risks between the entity and the plan participants (e.g. sharing the benefit of a surplus or the costs of a deficit) do not change the fact that the plan is a defined benefit plan as the entity is exposed to some risks. However, the shared risks feature would be taken into consideration when determining the best estimate of the defined benefit obligation. Observations In November 2007 the IFRS Interpretations Committee (Interpretations Committee, previously referred to as the IFRIC) published in its IFRIC Update a decision not to take onto its agenda the issue of the treatment of employee contributions when the cost of providing the benefits is shared between the employer and the employees. The proposed changes would codify into the standard the comments made by the Interpretations Committee in that Update. We address the accounting treatment to be adopted when a surplus is shared under the terms of the plan in our publication Insights into IFRS ( ) and reach the same conclusion. It will be important to ensure that there is substance to the risk-sharing arrangement before the employer s defined benefit obligation is reduced to reflect this sharing of risk. 3.7 Presentation Current IAS 19 presentation IAS 19.61, Currently under IAS 19, service costs, interest expense on the defined benefit obligation and 92, 93 expected return on plan assets are presented in profit or loss by all entities, although the standard does not specify whether they should be presented in a single item of income or expense. The presentation of actuarial gains and losses depends on the accounting policy choice adopted by the entity. The choices currently available for recognition and presentation of actuarial gains and losses are: immediate recognition in other comprehensive income; deferred or loss under the corridor method; or a method that results in faster or loss, e.g. immediate or loss. The IASB staff published the following diagram summarising the current position:

18 17 New on the Horizon: Defined benefit plans Recognised in period In accordance with accounting policy Operating expense Service cost Finance costs Long-term employee benefit cost in period Interest cost Expected return on plan assets Other comprehensive income Not recognised in period Actuarial gains and losses from previous periods Actuarial gains and losses Not recognised within corridor Recognised in future periods ED proposals presentation ED 119A, 119B, The Board believes that disaggregated information about the components of defined benefit plan BC14-BC18 costs provides decision-useful information to users of financial statements. It believes that different components of defined benefit plan costs have different predictive values, as reflected in the Board s proposed presentation requirements. Further, it believes that both service cost and interest cost convey information about an entity s recurring costs (although non-recurring past service cost and curtailments would be included) and the Board therefore proposes to require these costs to be presented in profit or loss. In contrast, the Board believes that the information about remeasurements provides little direct information about estimated amounts and timing of future cash flows (although it provides information about the uncertainty of those cash flows), leading the Board to propose that such amounts would be recognised in other comprehensive income. The presentation approach proposed by the ED splits the changes in the net defined benefit liability (asset) into the following components, all recognised in the statement of comprehensive income and classified as noted below: service costs and gains and losses arising from curtailment recognised in profit or loss; net interest income or expense recognised in profit or loss as part of finance costs; and remeasurements of the defined benefit liability (asset) recognised in other comprehensive income. The IASB staff published the following diagram summarising the proposals in the ED: Recognised in period Service cost Required Employment expense (Profit or loss) Long-term employee benefit cost in period Net interest income (expense) Finance costs (Profit or loss) Remeasurement Other comprehensive income

19 New on the Horizon: Defined benefit plans 18 The ED proposes amendments in the presentation of costs related mainly to the expected return on plan assets and the actuarial gains and losses by redefining what these components should include and how these should be presented. The table below summarises the ED presentation proposals compared to the current requirements of IAS 19. Net defined benefit liability (asset) Service costs current service cost Service costs past service cost Interest costs on the obligation Expected return on plan assets Curtailment Settlement Effect of asset ceiling including minimum funding requirement liability for past service Post-employment benefits Immediate or loss. Recognition in profit or loss over vesting period. Immediate or loss (finance or operating). Immediate or loss (finance or operating). Immediate or loss. Immediate or loss. Immediate or loss or other comprehensive income, depending on policy choice for actuarial gains and losses. IAS 19 Other long-term employee benefits Immediate or loss. Immediate or loss. Immediate or loss (finance or operating). Immediate or loss (finance or operating). Immediate or loss. Immediate or loss. Immediate or loss. ED proposals Immediate or loss. Immediate or loss. Net interest income or expense on the net liability (asset); immediate or loss as finance costs, calculated on a different basis (see 3.7.2). } Immediate or loss. Immediate recognition in other comprehensive income as part of remeasurement (see 3.7.4). Immediate recognition, partly in net interest and the remainder in other comprehensive income as part of remeasurement (see 3.7.3).

20 19 New on the Horizon: Defined benefit plans Actuarial gains and losses/ remeasurements, including difference between actual return on plan assets and amount recognised in profit or loss Recognition in profit or loss under corridor method or faster or loss or immediate recognition in other comprehensive income, depending on policy choice. Immediate or loss. Immediate recognition in other comprehensive income (see 3.5 and 3.7.3). Observations For entities that currently apply the choice to recognise actuarial gains and losses immediately in profit or loss under current IAS 19, the ED proposal effectively transfers the volatility giving rise to the actuarial gains and losses from profit or loss to other comprehensive income. The Board had considered eliminating all references to curtailments from the revised standard but the ED proposes to retain the requirement that they be disclosed separately, although they would be accounted for and presented in the same way as past service costs under the proposals. Settlements would be recognised in other comprehensive income under the proposals, rather than in profit or loss as at present, since the Board views them as a sub-set of actuarial gains and losses; effectively, the obligation has been discharged at a cost different from that estimated under the plan s original actuarial assumptions. At present, entities providing other long-term benefits do not need to analyse the change during the year in the related net defined benefit liability (asset). Under the proposals, the change would have to be broken down into service cost, interest cost and remeasurements in order to present the various elements in the way set out in the table above. The volatility currently reported in profit or loss would, under the proposals, be reported instead in other comprehensive income Service costs The ED does not propose to change the presentation of service costs. ED 7, 61, 96A, However, the amount to be recognised in profit or loss for service costs often might be different 97A, 98A, from the amount determined under current IAS 19, due to other suggested amendments as follows: BC19 Service costs would include past service costs recognised in full immediately according to the ED s proposal, rather than only that part of the past service cost that has vested, as under current IAS 19 (see 3.5). Service costs for a period would include all expected costs of administering benefits earned in that period and, sometimes, asset management costs (see 3.6.2). Service costs for a period would include taxes payable by the plan in respect of contributions and benefits for service during the period (see 3.6.2). The amount of service costs according to the ED might differ from the amounts determined under current IAS 19, due to enhanced guidance on how to determine whether an entity has a back-end loaded defined benefit plan (see 3.6.2).