Employee Benefits Reference: IAS 19; IFRI 14 ontents: Page 1. Introduction 486 2. Short-term employee benefits 2.1 Overview of short-term benefits 2.2 Short-term compensated absences 2.2.1 Leave taken 2.2.2 Unused leave 2.2.2.1 Non-accumulating leave Example 1: short-term paid leave: non-accumulating: single employee Example 2: short-term paid leave: non-accumulating: group of employees 2.2.2.2 Accumulating leave Example 3: short-term paid leave: accumulating and vesting Example 4: short-term paid leave: accumulating and non-vesting Example 5: short-term paid leave: accumulating, vesting and nonvesting 2.3 Profit sharing and bonus plans Example 6: bonuses raising the bonus provision Example 7: bonuses paying the bonus Example 8: profit sharing 3. Post-employment benefits 3.1 Overview of post-employment benefits 3.2 Defined contribution plans Example 9: defined contribution plans 3.3 Defined benefits plans 3.3.1 Overview of a defined benefit plan 3.3.2 Measurement of a defined benefit plan 3.3.2.1 Deficit or surplus 3.3.2.2 Liability or asset 3.3.2.3 Measurement of the plan obligation 3.3.2.3.1 Present value and interest cost Example 10: DBP: effect of the unwinding of the discount 3.3.2.3.2 urrent service costs Example 11: DBP: current service costs 3.3.2.3.3 Past service costs Example 12: DBP: past service costs 3.3.2.3.4 Benefits paid Example 13: DBP: benefits paid 3.3.2.3.5 urtailments and settlements 487 487 489 489 489 489 489 490 490 491 491 493 494 495 496 496 497 497 497 498 499 499 499 499 500 500 501 501 502 502 503 504 506 506 507 484
ontents continued 3.3.2.4 Measurement of the plan assets Example 14: DBP: plan assets 3.3.2.5 Actuarial assumptions 3.3.2.6 hanges to actuarial assumptions Worked example: corridor versus no corridor Page 508 508 509 509 510 3.3.2.7 Recognising actuarial gains and losses: the amortised corridor approach et al (IAS 19.92, IAS 19.93 and IAS 19.95) Example 15: DBP: using the amortised corridor Example 16: DBP: to use the corridor or not 3.3.2.8 Asset balances: the asset ceiling: IAS 19.58 (b) Example 17: DBP: asset ceiling 3.3.2.9 Asset balances: the recoverability test: IAS 19.58A 3.3.2.10 Asset balances: link between recoverability test and ceiling Flowchart: inter-relationship of IAS 19.58A and IAS 19.58(b) Example 18: DBP: 58A and 58(b) Example 19: DBP: 58A and 58(b): loss and PV unchanged Example 20: DBP: 58A and 58(b): loss and PV decreased 512 513 517 520 520 521 522 523 524 524 526 4. Other long-term benefits 528 5. Termination benefits 529 6. Disclosure 6.1 Short-term employee benefits 6.2 Post-employment benefits 6.2.1 Defined contribution plans 6.2.2 Defined benefit plans Example 21: DBP: disclosure 6.3 Other long-term employee benefits 6.4 Termination benefits 530 530 530 530 530 530 532 533 7. Summary 534 485
1 Introduction Why do we work? Apart from philosophical reasons (that are unfortunately beyond the scope of this book), we generally work for rewards. In the mid 1890 s a Russian scientist, by the name of Ivan Pavlov, began investigating the gastric function of dogs. He very importantly noticed that dogs tend to salivate before food was delivered to their mouths. He called this a psychic secretion. He became so interested in this phenomena that his research, which began as a scientific study of the chemistry of their saliva, mutated into a psychological study and led to the establishment of what is commonly referred to as conditional reflexes or Pavlovian response. The answer to why do we work lies in this Pavlovian theory of conditional reflexes we work because we expect to receive a benefit a bit like the dog salivating in expectation of food. The term employee includes all categories: full-time, part-time, permanent, casual, temporary, management and even directors. The benefit we, as employees, expect to receive may be summarised into four categories: benefits in the short-term (benefits payable to us while employed and shortly after we provide the service, e.g. a salary); benefits in the long-term (benefits payable to us while employed but where the benefits may become payable long after we provide the service e.g. a long-service award); benefits post employment (i.e. after we have retired from employment e.g. a pension); and/ or termination benefits (those that would be receivable if our employment were to be terminated before normal retirement age (e.g. a retrenchment package). The definitions of these four categories of employee benefits are as follows: Short-term benefits Defined in IAS 19 as: Those that fall wholly within 12 months after the end of the period in which the employee renders the service Long-term benefits Defined in IAS 19 as: Those that do not fall wholly within 12 months after the end of the period in which the employee renders the service Post-employment benefits Defined in IAS 19 as: Those that are payable after the completion of employment Termination benefits Other than termination benefits Other than postemployment and termination benefits Other than termination benefits Defined in IAS 19 as: Those that are payable as a result of either the: a) entity s decision to terminate the employment before normal retirement date b) employee s decision to accept a voluntary redundancy package in exchange for those benefits include settlements made to employees, both past and present. They even include the situation where the employee s spouse, children or others are paid. The only criteria is that the payments were made in exchange for services provided by the employee. 486
apply to any type of settlement with the exception of share-based payments. These payments were previously included within this standard (IAS 19: Employee benefits) but are now covered by its very own standard, IFRS 2: Share based payments. therefore include settlements made by an entity in the form of: cash (e.g. cash salary); goods (e.g. free products); or services (e.g. free medical check-ups). Post-employment benefits could come in the form of defined contribution plans or defined benefit plans. Defined benefit plans are relatively complex to account for and require lots of disclosure. Although defined benefit plans are not as commonly encountered in practice as defined contribution plans, it is still important for you to understand how to account for them. IAS 19 requires a lot of disclosure for post-employment benefits where they are defined benefit plans whereas there is either little or no disclosure required for the other types of benefits. There are, however, other disclosure requirements that emanate from other standards such as: IAS 1 Presentation of Financial Statements: - requiring disclosure of the employee benefit expense IAS 24 Related Party Disclosures: - requiring disclosure of each type of benefit provided to key management personnel IAS 37 Provisions, ontingent Liabilities and ontingent Assets: - which may require that a contingent liability be disclosed. In addition to other standards requiring disclosure relating to the employee benefit/s, other disclosure may be required by the: ompanies Ordinance, 1984 : in respect of directors remuneration (see Part III of Schedule) ode of orporate Governance. 2 Short-term employee benefits (IAS 19.8 19.23) 2.1 Overview of short-term benefits Short-term employee benefits include benefits that are due within twelve months of the end of the period during which the employee provided the service. IAS 19.8 lists some of the items included under short-term employee benefits as follows: Wages, salaries and social security contributions; Short-term compensated absences (such as paid annual leave and paid sick leave) where the absences are expected to occur within twelve months after the end of the period in which the employees rendered the related employee service; Profit-sharing and bonuses payable within twelve months after the end of the period in which the employees rendered the related service; and Non-monetary benefits (such as medical care, housing, car and free or subsidised goods or services) for current employees. The accrual concept of accounting is applied when recognising a short-term employee benefit: an expense is recognised (debit) ; and a liability is recognised (credit) to the extent that any amount due has not been paid. This accrual approach is evident in the following journals shown overleaf: 487
Step 1: The employee benefit is raised as a liability when incurred: Debit redit Employee benefit expense Account payable (e.g. wages payable) (L) Recognising short-term employee benefits incurred (e.g. wages) Step 2: When the benefit is paid, the journal entry is: Account payable (e.g. wages payable) (L) Bank Payment of short-term employee benefit (e.g. wages/ company car etc) XXX XXX XXX XXX Step 3: If the expense has been underpaid, there will be a credit balance on the account payable. But if the expense has been overpaid, there will be a debit balance on the account payable. If an overpayment cannot be recovered from the employee (e.g. the employee is not obligated to return the cash or a future payment to the employee may not be reduced by the overpayment) then the overpayment is expensed: Employee benefit expense Account payable (e.g. wages payable) (L) Over-payment of short-term employee benefit (e.g. wages) expensed Debit XXX redit XXX It is also possible that another standard allows or requires that the employee cost be capitalised instead of expensed. This may happen if, for example, an employee is used on the construction of another asset such as inventory. In this case, the benefits payable to this employee (or group of employees) will be capitalised to inventory (IAS 2) instead of expensed (see Step 1 above). Inventory (or other asset) Account payable (e.g. wages payable) (L) apitalisation of short-term employee benefit (e.g. wages) Debit XXX redit XXX Measurement of the short-term employee benefit is relatively simple because: no actuarial assumptions are required to measure either the obligation or the cost; and no discounting is applied to short-term employee benefit obligations for the simple reason that the time between the receiving of the service and the payment of the benefit is short. As mentioned earlier, IAS 19 does not require any disclosure of a short-term benefit although other standards may require certain limited disclosure. In summary, although we may work in order to earn more than one type of benefit, most of us start working in order to earn basic short-term benefits. These can be summarised as follows: Short-term benefits Wages, salaries and social security contributions (e.g. medical aid) Short-term paid leave Profit sharing and/ or bonuses Use of non-monetary benefits (e.g. a company car) 488
Whereas we are all probably capable of processing the journals for wages (or salaries etcetera), the following other types of short-term benefits warrant a bit more attention: short-term compensated absences; profit sharing and bonuses. 2.2 Short-term compensated absences (IAS 19.11 19.16) Short-term compensated absences refer to paid leave. In other words, these absences are those when employers pay employees during periods during which no work is done. The leave offered to an employee may be taken or may remain unused at the end of the period. 2.2.1 Leave taken The cost of an employee s short-term absence is recognised as part of his salary expense. For example, if you were to take paid annual leave, your salary would be paid to you while you were on holiday: there would be no extra amount owing to you and therefore the leave that you have taken is simply absorbed into the usual salary expense journal (i.e. there is no extra journal entry). 2.2.2 Unused leave If there was any leave that was owed to an employee during the year that was not taken by the employee, a distinction will need to be made between whether the leave was: accumulating: where unused leave can be carried forward to another period; or non-accumulating: where unused leave cannot be carried forward (i.e. falls away if not used in the current period). 2.2.2.1 Non-accumulating leave Non-accumulating leave is recognised, as part of the salary expense, when the leave is taken (i.e. when the absence occurs). If an employee fails to take non-accumulating leave that was owed to him, any unused leave will be simply forfeited (since it is non-accumulating). Since the entity has no obligation to provide the unused leave in future years, (i.e. it is forfeited), no liability for unused leave is raised. Example 1: short-term paid leave: non-accumulating leave: single employee Mitch Limited has one employee. His name is Guy. Guy is owed 30 days leave per year. Guy is paid 90 000 per year. The year is 365 days and Guy is expected to work 5 days a week. Guy took 20 days leave in 20X1. Guy s leave is non-accumulating. Required: Show all related journal entries and calculate any leave pay provision as at the 20X1 yearend. Solution to example 1: short-term paid leave: non-accumulating leave: single employee omment: Of the 30 days leave that was offered to Guy, 20 days were used and 10 days remained unused. No provision is made for the 10 days that Guy did not take because the leave is nonaccumulating, which means that Mitch Limited is not obliged to give him this leave. The following journal would be processed as 12 individual journals over the year (90 000 / 12 = 7 500 per month): Debit redit Employee benefit expense Total salary processed over the year 90 000 Salaries payable 90 000 Salary owed to Guy for 20X1 (includes leave taken) 489
Example 2: short-term paid leave: non-accumulating: group of employees Lee Limited operates a five-day working week. At Lee Limited s financial year ended 31 December 20X4 (a year with 365 days): there were 50 similarly paid employees each earning an average salary of 50 000 and earning 20 days annual leave per year of service. The leave entitlement of 20 days has remained the same for years and will remain the same for years to come. Similarly, the salary of 50 000 has remained unchanged for years and no significant changes are expected in the next few years. The following are the actual average leave statistics to date: end of prior year 20X3: an average of 10 days was used, all earned in 20X3 end of current year 20X4: an average of 12 days was used, all earned in 20X4 The estimated future leave statistics for the year ended 31 December 20X5: an average of 14 days will be taken, all earned in 20X5 Ignore public holidays. Required: alculate the leave pay provision for Lee Limited s financial year ended 31 December 20X4 assuming that the annual leave does not accumulate (and therefore does not vest). Solution to example 2: short-term paid leave: non-accumulating: group of employees omment: this example is similar to example 1, with the difference being that the provision calculated in this example is for a group of employees whereas the provision in example 1 is calculated for an individual employee. No provision is made at 31 December 20X4 since the leave is non-accumulating. This therefore means that any leave that is not taken is simply forfeited by the employee at the end of the year. The employee therefore lost 10 days in 20X3 (20 10 days) and 8 days in 20X4 (20 12 days taken). Nonaccumulating leave is recognised as the leave is taken. The leave that was taken was simply recognised as part of the salary of 50 000 (which would have been debited to salaries and credited to bank over the year). The entity does not owe the employee any leave that the employee fails to take. If the company policy was to pay out any unused leave at the end of each year, an accrual would still have to be recognised. In this case, the unused 20X3 leave would have been paid to employees at the end of 20X3. Any unused leave at 31 December 20X4 would, however, be due to the employees on this date. Since the amount owed to the employee would be based on unused leave to 31 December 20X4, it would only be possible to make payment for unused leave in the next year. An accrual liability would therefore need to be raised at 31 December 20X4 for: 191.78 x (20 days 12 days taken) x 50 employees = 76 712 2.2.2.2 Accumulating leave Accumulating leave is recognised, as part of the salary expense, when the leave is taken (i.e. when the absence occurs). If an employee fails to take accumulating leave that was owed to him, any unused leave remains owing to him (since it is accumulating). Since the entity has an obligation to provide the unused leave in future years, a liability for unused leave must be raised. This liability is recognised when the employee has rendered the service that then entitles him to that leave. This type of leave may be either (IAS 19.13): vesting: unused leave can be taken in the future or can be exchanged for cash; or non-vesting: unused leave can be taken in the future but cannot be exchanged for cash. 490
Whether accumulating leave has to be taken in the future or can be converted into cash in the future, an obligation still exists at year end for any unused leave. This must be measured based on the average expected salary per day (on the basis that, even if the leave is not vesting, the entity will effectively be losing this value on the days that the employee stays away from work). Example 3: short-term paid leave: accumulating and vesting Mark Limited has one employee. His name is Jack. Jack is owed 30 days leave per year. Jack is paid 365 000 per year. The year is 365 days and Jack is expected to work 5 days a week. Jack took 20 days leave in 20X1. Jack s leave is accumulating. Jack may convert leave that he does not wish to take into cash. The financial year end is 31 December 20X1. Required: Show all related journal entries and calculate any leave pay provision at 31 December 20X1. Solution to example 3: short-term paid leave: accumulating and vesting omment: The provision is based on the effective daily cost of employing Jack multiplied by the total number of outstanding days (Jack will either take this leave or will be paid out for it). The cost per day is calculated as follows: Basic cost per day: 365 000 / 365 days = 1 000 Effective cost per day: 1 000 x 7/ 5 = 1 400 (since he not required to work every day but rather 5 days out of every 7 days, the effective cost per day is a little higher) Debit redit Employee benefit expense Total salary processed over the year 365 000 Salaries payable 365 000 Salary owed to Jack for 20X1 (includes leave taken) * Employee benefit expense (30 20 days) x 1 400 per day 14 000 Provision for leave pay 14 000 Leave still owing to Jack at 31 December 20X1 * this journal would actually be processed as 12 individual journals over the year (365 000 / 12 = 30 416) Example 4: short-term paid leave: accumulating and non-vesting William Limited has one employee. His name is Roger. Roger is paid 365 000 per year. Roger is owed 30 days leave per year. He took 20 days leave in 20X1. The year is 365 days and Roger is expected to work 5 days a week. His leave is accumulating and he may not convert leave that he does not wish to take into cash. Required: Show all related journal entries and calculate any leave pay provision to be raised at the year ended 31 December 20X1, assuming that: A. the leave is allowed to accumulate indefinitely B. the leave is allowed to accumulate for one year only, after which it will be forfeited: it is expected that Roger will take a further 3 days leave from his 20X1 leave entitlement in 20X2. 491
Solution to example 4A: short-term paid leave: accumulating indefinitely, non-vesting omment: Even though the 20X1 leave not taken by 31 December 20X1 cannot be converted into cash, a liability must be raised to reflect the cost that the company will incur due to the days of work that will be lost when Roger does take this leave in the future. Since the leave accumulates indefinitely, all outstanding days are provided for. The provision is based on the effective daily cost of employing Roger (365 000 / 365 x 7 / 5 days = 1 400 per day). Debit redit Employee benefit expense Total salary processed over the year 365 000 Salaries payable 365 000 Salary owed to Roger for 20X1 (includes leave taken)* Employee benefit expense (30-20 days) x 1 400 per day 14 000 Provision for leave pay 14 000 Leave still owing to Roger at 31 December 20X1 * this journal would actually be processed as 12 individual journals over the year (365 000 / 12 = 30 416) Solution to example 4B: short-term paid leave: accumulating for a period, non-vesting omment: Even though the 20X1 leave not taken by 31 December 20X1 cannot be converted into cash, a liability must be raised to reflect the cost that the company will incur due to the days of work that will be lost when Roger does take this leave in the future. Since the 20X1 leave not taken by 31 December 20X1 only accumulates for another year, we must base the liability on only the estimated number of days that Roger will actually take in 20X2 (3 days) any leave not taken will be forfeited (30 20 3 = 7 days will be forfeited) and will therefore not cost the company anything. The provision is based on the effective daily cost of employing Roger (365 000 / 365 x 7 / 5 days = 1 400 per day). Debit redit Employee benefit expense Total salary processed over the year 365 000 Salaries payable 365 000 Salary owed to Roger for 20X1 (includes leave taken) * Employee benefit expense 3 days x 1 400 per day 4 200 Provision for leave pay 4 200 Leave still owing to Roger at 31 December 20X1 * this journal would actually be processed as 12 individual journals over the year (365 000 / 12 = 30 416) In practice, there are many more employees than just one employee. It is normally impractical to estimate the leave pay provision (liability) for each employee and this is therefore estimated on an average basis. When calculating the leave pay provision on an average basis, we will need to: identify the number of employees within a certain salary/ leave bracket; calculate the average salary per employee within this salary bracket; calculate the average employee salary per day; and then estimate the average days leave that the entity owes each employee at year-end (either in days or in cash). The provision will therefore be: the estimated average days leave that the entity owes to each employee, multiplied by the average employee salary cost per day. 492
Example 5: short-term paid leave: accumulating, vesting and non-vesting Lee Limited operates a five-day working week. At Lee Limited s financial year ended 31 December 20X4 (a year with 365 days): there were 50 similarly paid employees each earning an average salary of 50 000 and earning 20 days annual leave per year of service. The leave entitlement of 20 days has remained the same for years and will remain the same for years to come. Similarly, the salary of 50 000 has remained unchanged for years and no significant changes are expected in the next few years. The following are the actual average leave statistics per employee: end of prior year 20X3: an average of 10 days of the 20X3 leave were unused end of current year 20X4: an average of 12 days was used, and on average this came from: - the 20X3 leave entitlement: 4 days - the 20X4 leave entitlement: 8 days. The estimated future leave statistics per employee for the year ended 31 December 20X5: an average of 14 days will be taken and on average this is expected to come from: - 20X3: 0 days - 20X4: 5 days - 20X5: 9 days Ignore public holidays. Required: alculate the leave pay provision for Lee Limited s financial year ended 31 December 20X4 if: A. annual leave is carried forward and available for use in the next financial year (i.e. accumulating) and is paid out in cash at the end of the next financial year if not used (i.e. vested: can be converted into cash). B. annual leave is carried forward to the next financial year (i.e. accumulates) but expires if not used by the end of the next financial year end (i.e. non-vesting: can t be converted into cash). Solution to example 5A and B: short-term paid leave omment: this example involves a calculation for a group of employees rather than for just one employee. The average rate per day is: 50 000 / 365 = 136.99 per actual day But, only 5 out of every 7 days are worked, therefore, the effective rate per day is actually higher: 136.99 x 7 / 5 days = 191.78 per working day Solution to example 5A: short-term paid leave accumulating and vesting 20X3 leave: No provision: unused leave will have been paid out in full by the end of 31 December 20X4 There were 10 days still due to the employee at end of 20X3: 4 of these days were taken in 20X4 and the remaining 6 days from 20X3 would have been paid out at the end of 20X4. No provision is therefore made in respect of 20X3 leave since there is no further obligation with regard to the 20X3 leave. 20X4 leave: Provision to be raised for 12 days leave 493
The entity is still obligated in terms of the unused 20X4 leave entitlement at 31 December 20X4 (12 days per employee: 20 days 8 days), since this leave may still be taken in the future. The provision is: Provision: 191.78 x (20 days 8 days taken) x 50 employees = 115 068 20X5 leave: No provision: the 20X5 services have not been provided and therefore there is no obligation Since the 20X5 leave has not yet been earned by the employees (because the services in 20X5 have not yet been provided by the employees), there is no past event that obligates the entity to provide any of the 20X5 leave). If there is no past event, there can be no obligation at 31 December 20X4. Total provision: 20X3 leave: 0 + 20X4 leave: 115 068 + 20X5 leave: 0 = 115 068 Solution to example 5B: short-term paid leave accumulated and non-vesting 20X3 leave: No provision: unused 20X3 leave will have been forfeited by 31 December 20X4 There were 10 days still due to the employee at end of 20X3: 4 of these days were taken in 20X4 and the remaining 6 days from 20X3 would have been forfeited at the end of 20X4. No provision is therefore made in respect of 20X3 leave since there is no further obligation with regard to the 20X3 leave. 20X4 leave: Provision to be raised for 5 days leave The employee is owed 20 days leave per year. Of the 20 days owed to the employee in 20X4, 8 days were taken as leave in 20X4 (P.S. another 4 days were also taken, but these came out of the 20X3 leave entitlement). This means that at 31 December 20X4, the entity owes the employee another 12 days. Since the employee has already rendered the service that entitles him to this leave, a past event has occurred and there is therefore an obligation at 31 December 20X4. A liability must therefore be recognised for at 31 December 20X4. The liability will, however, be measured based on the number of 20X4 days that the employee will probably take in 20X5: only 5 days not the full 12 days (we are therefore expecting that the employees will forfeit an average of 7 days of their 20X4 leave: 20 8 5 days = 7 days). ompare this to part A where the liability was based on the full 12 days since the terms of part A s leave entitlement was that the employee would be paid out for every day that he does not take. Although the entity will not be paying the employee out in cash, the cost to the entity is still 191.78 per day since the entity will effectively lose this value on the days that the employee stays at home. Provision: 191.78 x 5 days (20X4 unused leave expected to be used in 20X5) x 50 employees = 47 945 20X5 leave: No provision: the 20X5 services have not been provided and therefore there is no obligation The 20X5 leave entitlement of 20 days of which 9 days will probably be taken in 20X5 is ignored since the employee has not yet provided the 20X5 services that would entitle him to the 20X5 leave. Since there is no past event (services rendered) there can not be a present obligation. No liability is therefore recognised for any of the 20X5 leave entitlement. Total provision: 20X3 leave: 0 + 20X4 leave: 47 945 + 20X5 leave: 0 = 47 945 2.3 Profit sharing and bonus plans (IAS 19.17 19.22) Where employees are rewarded for services rendered with an offer of profit sharing or bonuses, these would also be considered to be employee benefits. If these are payable within 12 months of the year-end in which the employee provided the services, these would be considered to be short-term employee benefits (otherwise they would be other long-term employee benefits). 494
Recognition of these benefits should only occur when: there is a present obligation at year end (i.e. the settlement cannot realistically be avoided); resulting from a past event (the provision of the agreed upon services); and the obligation can be reliably estimated. The obligation can be either a legal obligation or constructive obligation. For instance: a legal obligation would arise if the employment contract detailed the profit-sharing or bonus arrangement, and if all conditions of service were met; a constructive obligation could arise if the entity created an obligation for itself through, for instance, a past practice of paying bonuses (or sharing in profits). Therefore, even though the employment contract may be silent on such profit-sharing or bonuses (in which case there would be no legal obligation), it is possible for the entity to create a constructive obligation through its past practices, policies, actions or public announcements etc. In accordance with IAS19.20, a reliable estimate can only be made if: the terms of the formal plan contains a formula for determining the amount of the benefit; the entity determines the amounts to be paid before the financial statements are authorised for issue; or past practice gives clear evidence of the amount of the entity s constructive obligation. A characteristic of profit sharing and bonuses are that they often accrue over a period of time, and may end up being only partially earned or even forfeited if an employee leaves before the payment date. This characteristic will impact on the measurement of the provision: the probability that the employee/s may leave before they become entitled to the benefit must be factored into the calculation. Example 6: bonuses raising the bonus provision During 20X2, Luke Limited created an obligation to pay a bonus of 120 000 to each employee for the year. There were 6 employees at 1 January 20X2, and 2 more employees were hired on 1 April 20X2 (resulting in 8 employees at 31 December 20X2). It was expected that 3 employees would resign during 20X3. Required: alculate the provision to be recognised in the financial statements of Luke Limited for the year ended 31 December 20X2 and show the journal entry if the terms of the agreement are such that: A. the bonus accrues to those employees still employed at year-end (31 December 20X2) B. the bonus accrues proportionately based on the number of months worked during 20X2;. the 20X2 bonus accrues to only those employees still employed at 31 December 20X3 (i.e. the end of the next year). Solution to example 6 A, B and : bonuses raising the provision Liability balance alculation at year-end: Part A: 120 000 x 8 employees 960 000 Part B: 120 000 x 6 employees x 12 / 12 + 120 000 x 2 employees x 9 / 900 000 12 Part : 120 000 x (8 3 employees) 600 000 31 December 20X2 Part A Dr/ (r) Part B Dr/ (r) Part Dr/ (r) Employee benefit expense 960 000 900 000 600 000 Provision for bonuses (960 000) (900 000) (600 000) Bonuses provided for 495
Example 7: bonuses paying the bonus Assume the same information as that in the previous example and that the 120 000 bonus accrued to those employees still employed on 31 December 20X3 (i.e. example 6). Assume that no employees resigned during 20X3 and that the bonus was paid on 31 December 20X3. Required: Show the journal entries to be processed by Luke Limited for the year ended 31 December 20X3. Solution to example 7: bonuses paying the bonus 31 December 20X3 Debit redit Employee benefit expense 8 x 120 000 600 000 360 000 Provision for bonuses 360 000 Increase in 20X2 bonus provision Provision for bonuses 8 x 120 000; OR 960 000 Bank 600 000 + 360 000 960 000 Payment of bonuses at 31 December 20X3 Example 8: profit sharing John Limited has 5 directors at 31 December 20X2 with whom it has employment contracts that provide for a 20% share of 10% of the profits that exceed a pre-determined target. The target is set at the end of each year for the next year s profit sharing calculation. At 31 December 20X1 it was decided that the target profit for 20X2 was 1 000 000. The actual profit achieved in 20X2 was 1 200 000. The targeted profit for 20X3, set on 31 December 20X2, is 1 400 000. Before the 20X2 financial statements were authorised for issue it looked probable that this profit target will also be achieved. Each of the directors still employed on 31 March of the year after the target is achieved is entitled to their 20% of the total 10% profit share. Required: Journalise any provision to be recognised in the financial statements of John Limited for the year ended 31 December 20X2 assuming: A. John Limited expects that no directors will resign before 31 March 20X3. B. John Limited expects that one director will resign before 31 March 20X3. Solution to example 8A: profit sharing 31 December 20X2 Debit redit Employee benefit expense 20% x 10% x (1 200 000 1 000 000) x 5 20 000 Provision for profit sharing (L) 20 000 Profit share provision: no directors are expected to resign before 31/3/20X3 Solution to example 8B: profit sharing 31 December 20X2 Debit redit Employee benefit expense 20% x 10% x (1 200 000 1 000 000) x 4 16 000 Provision for profit sharing (L) 16 000 Profit share provision: 1 director expected to resign before 31/3/20X3 Note: no provision is made for the expected profit share related to the 20X3 targeted profit (in either part A or part B) even though it seems probable that the target will be met, because the profit share depends on the actual and final achievement of the profit this has not yet happened and therefore there is no past event and therefore there is no present obligation at 31 December 20X2. 496
3 Post-employment benefits (IAS 19.24 19.125) 3.1 Overview of post-employment benefits If the employee remains employed by the entity until normal retirement age (i.e. does not terminate his employment before this date) he may be entitled to further benefits. Since these benefits would accrue while he was no longer employed, they would be referred to as postemployment benefits. It is important to note that it is the services that he provided whilst employed that entitle him to these benefits after employment. Therefore, there is a past event for which the entity has an obligation. As such, a journal entry to record the obligation and related cost must be recognised as the services are provided: Employee benefit expense Provision for post-employment benefits (L) Post-employment benefit provided for Debit XXX redit XXX As mentioned in the introduction, post-employment benefits are categorised into two basic types: defined contribution plans; and defined benefit plans. Defined contribution plans are easier to recognise, measure and require almost no disclosure whereas defined benefit plans are more complex to measure and require lots of disclosure. The post-employment plan may be a simple single employer plan or may be a: multi-employer plan: explained in IAS 19.29-32B; group administration plan: explained in IAS 19.33; common control shared-risk plan: explained in IAS 19.34-34B; state plan: explained in IAS 19.36-38; or an insured benefit plan: explained in IAS 19.39-42. The accounting and disclosure of such plans, although not complicated, are not covered further in this chapter. This chapter focuses on single-employer plans only. 3.2 Defined contribution plans (IAS 19.43 19.47) Defined contribution plans are post-employment benefit plans in which the entity and the employee agree to make contributions to a fund. On resignation or retirement, the contributions together with any gains (or less any losses) are paid to the employee. What is important here is that defined contribution plans limit the entity s obligation to the contributions that it agreed to make to the plan (or to the separate insurance company that runs the plan). The economic substance of a defined contribution plan is therefore that: the obligation is limited to the agreed upon contributions; and the risks (that the benefits will be less than expected) belong to the employee. The amount recognised as an expense in the statement of comprehensive income is the contribution payable by the employer to the defined contribution fund. Debit redit Employee benefit expense XXX ontributions payable (L) XXX Post-employment benefit: defined contributions provided for 497
The expense is recognised as and when the employee provides the services. The amount to be recognised is relatively easy to measure: no actuarial assumptions are needed; and it is normally undiscounted (but it will need to be discounted if the contributions become payable after 12 months from the end of the period in which the employee provides the service). Example 9: defined contribution plans Matthew Limited s annual salary expense for 20X4 is as follows: gross salary of 4 000 000: 30% is payable to the tax authorities, 7% is payable to a defined contribution plan (provident fund) and the balance is payable to the employees company contributions to the defined contribution plan: 10% of gross salaries Required: Show the relevant journals (on an annual basis despite normally being journalised on a monthly basis) and profit before tax note in the financial statements of Matthew Limited for the year ended 31 December 20X4. Solution to example 9: defined contribution plans Debit redit Employee benefit expense Given 4 000 000 urrent tax payable: employees tax 4 000 000 x 30% 1 200 000 (L) Defined contributions payable (L) 4 000 000 x 7% 280 000 Employees payable (L): net salary Balance (paid to the employee) 2 520 000 Gross salaries for the period (including tax and the employees contributions to the defined contribution plan) Employee benefit expense 4 000 000 x 10% 400 000 Defined contributions payable (L) 400 000 Matthew Limited s (employer) contribution to the defined contribution plan Matthew Limited Notes to the financial statements (extracts) For the year ended 31 December 20X4 20X4 20X3 3. Profit before tax Profit before tax is stated after taking into account the following disclosable expense/ (income) items: Employee benefit expenses 4 000 000 + 400 000 4 400 000 xxx Included in employee benefit expenses are the following: Defined contribution plan costs Employer contribution only 400 000 xxx Note: Both the employer and the employees contributed to the plan: the employees contributed 280 000 over the year whereas the employer contributed 400 000. However, it is only the employer s contribution that is separately disclosable as a defined contribution plan cost (although both the employees and the employer s contributions are included in the total employee benefit expense). The 280 000 contribution is a contribution cost incurred by the employees and not by Matthew Limited (the employees effectively paid the 280 000 out of their salary of 4 000 000). 498
3.3 Defined benefit plans (IAS 19.48-19.125) 3.3.1 Overview of a defined benefit plan (IAS 19.27) Where an entity guarantees (promises) that certain benefits will be payable to its employees after employment, the entity has opened itself up to both: an obligation that is potentially much bigger than simply the payment of future contributions to a post-employment plan (e.g. pension payments are often based on the employee s last salary which may be far greater than originally expected); and the risk that there will not be sufficient assets set aside to settle the obligation (i.e. to pay the benefit owing to the employee). Due to the risks involved in a defined benefit plan, there is also far more disclosure required than is required of a defined contribution plan. When accounting for a defined benefit plan we must recognise both: the plan obligation (i.e. the benefits that it owes to its employees); and the plan assets (i.e. those set aside in order to settle the obligation). The initial journal entries (to create the plan obligation and plan assets) are as follows: Employee benefit expense Defined benefit plan: obligation DBPO xxx EB expense xxx Defined benefit plan: asset Bank Bank yyy DBPA yyy As can be seen in these ledger accounts, any contributions made to a defined benefit plan will be recognised as a plan asset (i.e. an investment) instead of an expense (i.e. as in the case of a defined contribution plan). Whereas the measurement of the plan asset is simply its fair value (which is generally its market value and thus simple to determine), the measurement of the obligation is more complex. 3.3.2 Measurement of a defined benefit plan 3.3.2.1 Deficit or surplus Essentially we are dealing with two accounts (and a net employee benefit expense account): the plan obligation; and the plan assets. The two accounts are set-off against each other: if the obligation is greater than the asset, it is a deficit (we owe more than we own and are thus in trouble, having a net liability position); and if the assets are greater than the obligation, we have a surplus (we own more than we owe and are thus not in trouble, having a net asset position). The deficit or surplus is calculated as follows: Plan obligation Present value of future obligation XXX Less plan assets Fair value (XXX) Deficit/ (surplus) XXX 499
3.3.2.2 Liability or asset The liability or asset presented in the statement of financial position is not the same thing as a surplus or deficit. The surplus or deficit is simply part of the liability or asset calculation. The liability or asset (which is presented in the statement of financial position) is calculated as follows (IAS 19.54): Plan obligation Present value of future obligation XXX Less plan assets Fair value (XXX) Deficit/ (surplus) XXX Adjust for unrecognised items: Add unrecognised actuarial gains IAS 19.92 &.93 (corridor) XXX Less unrecognised actuarial losses IAS 19.92 &.93 (corridor) (XXX) Less unrecognised past service IAS 19.96 (XXX) costs Liability/ (asset) balance If it is an asset: consider IAS 19.58 (ceiling), as well as IAS 19.58A if there was also a surplus XXX If you look at this calculation (i.e. the calculation of the liability (or asset) balance), you will notice that IAS 19 makes the following distinctions: obligations: this is the present value of the plan obligation, deficits (or surpluses): this is the plan obligation less the plan asset, and liabilities (or assets): the deficit (or surplus) adjusted for certain unrecognised items. These unrecognised items can be categorised as: unrecognised actuarial gains or losses; and unrecognised past service costs. Some gains, losses and costs are not recognised immediately as income or expenses and are deferred in the statement of financial position until a later date. The recognition of these gains, losses and costs are explained later: unrecognised actuarial gains or losses: see 3.3.2.5 to 3.3.2.7; and unrecognised past service costs: see paragraph 3.3.2.3.3. The defined benefit plan can be either a net liability or a net asset. If it is an asset (i.e. if it has a debit balance), there is a certain ceiling (limit) that will need to be observed. The ceiling limit is set out in IAS 19.58(b). See 3.3.2.8 and 3.3.2.10. If a defined benefit plan asset has a surplus, a further adjustment may be necessary in terms of IAS 19.58A. See other measurement issues: asset limitations. See 3.3.2.9 and 3.3.2.10. 3.3.2.3 Measurement of the plan obligation The obligation is measured at its present value. The movement between the opening and closing balance on the obligation account can be summed up as follows: Plan obligation Paragraph Opening balance 3.3.2.3.1 PV of future obligation: actuarial assumptions at beginning of year XXX Interest costs 3.3.2.3.1 Opening balance (PV) x discount rate estimated at start of year XXX urrent service cost 3.3.2.3.2 Increase in obligation due to services provided in the current year XXX (PV) Past service cost 3.3.2.3.3 Increase in obligation due to services provided in prior years (PV) XXX Less benefits paid 3.3.2.3.4 Actual payments made (XXX) Less settlements 3.3.2.3.5 Actual payments made (XXX) urtailment (gain)/ 3.3.2.3.5 Present value using latest actuarial assumptions XXX loss Settlement (gain)/ loss 3.3.2.3.5 Present value using latest actuarial assumptions (XXX) Subtotal XXX Actuarial (gain)/ loss 3.3.2.5/6 Balancing figure (XXX) losing balance PV of future obligation: actuarial assumptions at end of year XXX 500
3.3.2.3.1 Present value and interest cost (IAS 19.63) A present value is a future amount that has been discounted to a present value using a discount rate that reflects the passage of time. As we get closer to the future date on which the future amount is expected to be paid, the present value will increase until it ultimately equals the future amount. The gradual increase of the present value (until it equals the future amount) is referred to as the unwinding of the discount. The following example explains the workings of a present value calculation and how one records the unwinding of the discount. Example 10: defined benefit plan: effect of the unwinding of the discount Assume that on 1 January 20X1 we owe an amount of 100 000, payable on 31 December 20X5. For simplicity, assume that: this future obligation arose due to services provided by the employee in the first few days of 20X1 and that services thereafter did not result in an increase in the obligation (i.e. the obligation remained static at 100 000); and the discount rate remained unchanged at 10% each year. Required: alculate the present value of the 100 000 and prepare the effective interest rate table. Show the journal entries posted in the ledger accounts. Solution to example 10: defined benefit plan: effect of the unwinding of the discount Step 1: PV factor at 10% after five years (5 years between 1 January 20X1 and 31 December 20X5): 1/(1.1) 5 = 1 / 1.1 /1.1 /1.1 /1.1 /1.1 OR = 1 / (1.1 x 1.1 x 1.1 x 1.1 x 1.1) = 0.620921323 100 000 x 0.620921323 = 62 092 Step 2: Effective interest rate table Year Opening balance Interest losing balance 5 years to payment date 62 092 6 209 68 301 4 years to payment date 68 301 6 830 75 131 3 years to payment date 75 131 7 513 82 644 2 years to payment date 82 644 8 264 90 908 1 year to payment date 90 908 9 092 100 000 37 908 The ledger accounts: Defined benefit plan: Obligation 20X1 Jnl 1 EB Exp: current cost 62 092 20X1 Jnl 2 EB Exp: interest 6 209 cost 20X1 losing balance 68 301 20X2 Jnl 3 EB Exp: interest 6 830 cost 20X2 losing balance 75 131 20X3 Jnl 4 EB Exp: interest 7 513 cost 20X3 losing balance 82 644 20X4 Jnl 5 EB Exp: interest 8 264 cost 20X4 losing balance 90 908 20X5 Jnl 7 Bank 100 000 20X5 Jnl 6 EB Exp: interest 9 092 cost 100 000 100 000 20X5 losing balance 0 501
Bank 20X5 Jnl 7 DBP: Obligation 100 000 Employee benefit expense: urrent cost 20X1 Jnl 1 DBP: Obligation 62 092 Employee benefit expense: Interest cost 20X1 Jnl 2 DBP: Obligation 6 209 20X2 Jnl 3 DBP: Obligation 6 830 20X3 Jnl 4 DBP: Obligation 7 513 20X4 Jnl 5 DBP: Obligation 8 264 20X5 Jnl 6 DBP: Obligation 9 092 3.3.2.3.2 urrent service costs (IAS 19.67) The defined benefit obligation increases over time: each day that the employee works increases this obligation. The current cost is measured at the present value of the obligation arising from services provided by the employee in the current year. Example 11: defined benefit plan: current service cost On 1 January 20X2, a plan obligation has a balance of 68 301 (the present value of an amount of 100 000, payable to an employee on 31 December 20X5). Further services provided in 20X2 increase the future obligation by 20 000 (PV of 15 026). For simplicity, assume that: these further services were provided at 31 December 20X2; the discount rate remained unchanged at 10% each year. Required: Show the journal entries posted in the ledger accounts in 20X1 and 20X2. Solution to example 11: defined benefit plan: current service cost Step 1: PV factor at 10% after three years (3 years between 31 Dec 20X2 and 31 Dec 20X5): This calculation was not required because the present value was given the calculation is given for interest sake only. 1/(1.1) 3 = 1 / 1.1 /1.1 /1.1 OR = 1 / (1.1 x 1.1 x 1.1) = 0.751314801 20 000 x 0.751314801= 15 026 (this amount was given) 502
Step 2: Effective interest rate table (revised for added current costs) Opening balance Interest A x 10% B urrent cost (provided end of year) losing balance (A + B + ) D Year A 20X1 62 092 6 209 68 301 20X2 68 301 6 830 15 026 90 157 20X3 90 157 9 016 99 173 20X4 99 173 9 917 109 090 20X5 109 090 10 910 120 000 42 882 The ledger accounts: Defined benefit plan: Obligation 20X1 Jnl 1 EB Exp: current cost 62 092 20X1 Jnl 2 EB Exp: interest cost 6 209 20X1 losing balance 68 301 20X2 Jnl 3 EB Exp: interest cost 6 830 20X2 Jnl 4 EB Exp: current cost 15 026 20X2 losing balance 90 157 Employee benefit expense: urrent cost 20X1 Jnl 1 DBP: Obligation 62 092 20X2 Jnl 4 DBP: Obligation 15 026 Employee benefit expense: Interest cost 20X1 Jnl 2 DBP: Obligation 6 209 20X2 Jnl 3 DBP: Obligation 6 830 3.3.2.3.3 Past service costs (IAS 19.96) The employer may introduce a new defined benefit plan after an employee has already provided a few years of service. Alternatively, if the defined benefit plan already exists, it may also be possible for an employer to adjust the terms of the plan such that there is either: an increase in the obligation (improved benefits for the employee) or a decrease in the obligation (reduced benefits for the employee). If these new benefits have already vested (i.e. the services required in order to qualify for the benefits have already been provided), they are recognised as an employee benefit expense immediately. If these new benefits have not yet vested, the benefit is recognised as an expense on the straight-line basis over the period until vesting is expected to occur. In other words, some of these benefits will remain unrecognised until they have vested. 503