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Classification of benefit plans
A defined contribution plan is a post-employment
benefit plan whereby an employer pays fixed contributions
into a separate entity (fund) and has no legal or
constructive obligation to pay further contributions
[IAS19R.7]. Payments or benefits provided to employees
may be a simple distribution of total fund assets,
or a third party, such as an insurance company,
may have assumed the obligation to provide an agreed
level of payments or benefits [IAS19R.25(a)]. Any
actuarial and investment risks of defined contribution
plans have been assumed either by the employee or
the third party [IAS19R.25(b)]. The employer is
not required to make up any shortfall in assets.
All plans that are not defined contribution plans
are defined benefit plans [IAS19R.7] .
Defined benefit therefore forms a 'residual' category.
If an employer cannot demonstrate that all actuarial
and investment risk has been shifted to another
party and its obligations limited to contributions
made during the period, a plan is defined benefit
[IAS19R.25]. Any benefit formula that is not solely
based on the amount of contributions, or that includes
a guarantee from the entity or a specified return,
means that elements of risk remain with the employer
and must be accounted for as a defined benefit plan
[IAS19R.26(a)(b)] . An employer may
create a defined benefit obligation where no legal
obligation exists if it has a practice of 'topping
up' a benefit fund such that assets are sufficient
to meet employee expectations of benefit [IAS19R.26(c)]
.
Many statutory obligations such as lump-sum end
of service arrangements fall into the category of
defined benefit plans [IAS19R.136]
.
An employer's obligation under a defined benefit
plan is to provide the agreed amount of benefits
to current and former employees [IAS19R.27(a)].
The benefits are typically based on such factors
as age, length of service and compensation. The
employer retains actuarial and investment risks
of the plan [IAS19R.27(b)]. Accounting for defined
benefit plans is substantially more complex than
for defined contribution plans.
Classification of multi-employer, group
administration and state plans
The common feature of multi-employer, group administration
and state plans (multi-employer plans) is that they
include more than one employer [IAS19R.7,33,36-37].
These plans can often involve pooling of plan assets
and, in some cases, of employer obligations. All
such plans should first be classified as defined
contribution or defined benefit in accordance with
the criteria described above [IAS19R.28-29,33,38]
.
An employer should account for its proportionate
share of the defined benefit obligation, plan assets
and costs of a multi-employer defined benefit plan
as for any other defined benefit plan [IAS19R.29(a),33,36,38].
However, there may be circumstances where the employer
has insufficient information and cannot follow defined
benefit accounting . The employer
would account for such a plan as a defined contribution
plan and make supplemental disclosures [IAS19R.30,32,38].
State-sponsored plans should be accounted for in
the same manner as multi-employer plans, and will
often present many of the same issues [IAS19R.36].
State-sponsored plans are established by legislation
and operated by national or local governments, or
another entity created by government [IAS19R.37].
Many state plans are funded on a pay-as-you-go basis,
with contributions set at a level that is expected
to be sufficient to fund the current period's benefit
distributions. The benefit formula for these plans
is often based on employee service, but the employer
has no legal or constructive obligation to pay those
benefits. The employer's only obligation is to pay
contributions as they fall due. The employer may
cease to employ individuals covered by the state
plan or may cease operations altogether. It will,
for most state plans, have no obligation to pay
the benefits its employees earned in previous years.
Thus, most state plans are defined contribution
plans [IAS19R.38].
Group administration plans are different from multi-employer
plans. Group administration plans are an aggregation
of single-employer plans, combined to allow participating
employers to pool assets for investment purposes
and reduce investment management and administration
costs. The claims of different employers are segregated
for the sole benefits of their employees. The information
to allow employers to properly account for group
administration plans is readily available, and thus
they pose no unique accounting problems. Group administration
plans do not expose the participating employers
to the actuarial risks associated with the current
and former employees of other employers [IAS19R.33]
.
Classification of insured plans
An employer may pay insurance premiums to fund a
post-employment benefit plan. These plans are generally
treated as defined contribution plans unless the
employer retains either a legal or constructive
obligation to pay benefits as they fall due, to
make supplemental payments if the insurer does not
have sufficient assets [IAS19R.39]. The employer
may retain the obligation directly through a guarantee
or commitment to the insurer or employees, or it
may retain the obligation indirectly through the
mechanism that sets contributions [IAS19R.41] .
Where the employer has retained the obligation,
it accounts for the plan as a defined benefit plan
with the qualifying insurance policies as plan assets
and other insurance policies as reimbursement rights
[IAS19R.42]. A qualifying insurance policy is one
issued by a non-related party insurer where the
proceeds can only be used to pay or fund employee
benefits and are bankruptcy remote from the employer's
creditors [IAS19R.7] .
Measurement of defined contribution expense and obligations
The accounting for a defined contribution plan
is straightforward because the employer's obligation
for each period is determined by the amounts to
be contributed for that period. Often, contributions
are based on a formula that uses employee compensation
in the period as its base. No actuarial assumptions
are required to measure the obligation or the expense,
and there are no actuarial gains or losses. Obligations
are usually short-term in nature, and thus discounting
is seldom required [IAS19R.43].
The employer should recognise the contribution
payable at the end of each period based on employee
services rendered during that period, reduced by
any payments made during the period. If the employer
has made payments in excess of those required, the
excess is a prepaid expense to the extent that the
excess will lead to a reduction in future contributions
or a cash refund [IAS19R.44(a)].
Measurement of defined benefit plan expense and obligations
An employer's obligation under a defined benefit
plan is to provide the agreed-on amount of benefits
to current and former employees [IAS19R.27(a)].
Benefits may be in the form of cash payments or
in kind, such as medical and dental benefits. The
benefits will typically be based on such factors
as age, length of service and compensation [IAS19R.63].
Measurement of pension and other long-term benefit
plans are essentially similar. The only exception
is that the 'corridor' for actuarial gains and losses
only applies to pension plans [IAS19R.92-95]. All
actuarial gains and losses of other long-term benefit
plans are reported immediately in net income [IAS19R.129(d)].
Defined benefit plans may be un-funded or wholly
or partially funded by the employer's contributions
to a separate entity or fund that is legally separate
from the reporting entity. The fund pays the benefits.
The payment of the funded benefits depends not only
on the fund's financial position and investment
performance, but also on the employer's ability
to make good any shortfall in the fund. Thus, the
employer effectively underwrites the fund's investment
and actuarial risk [IAS19R.49].
Accounting for defined benefit plans is complex
because actuarial assumptions are required to measure
the obligation and the expenses, with the possibility
that actual results differ from the assumed results.
These differences are actuarial gains and losses.
Obligations are measured on a discounted basis because
they will often be settled many years after the
employee renders the services [IAS19R.48]. Actuaries,
in conjunction with management, almost always perform
the calculations of the defined benefit obligation
and the current and prior service cost [IAS19R.57].
Accounting for defined benefit plans requires an
employer entity to undertake the following steps
separately for each material employee benefit plan:
| a) |
determine the present
value of the defined benefit obligation and
current service cost, using the projected unit
credit method [IAS19R.50(b)]; |
|
| b) |
make a reliable estimate of the amount
of benefits earned in return for services
rendered in current and prior periods, using
actuarial techniques [IAS19R.50(a)]; |
|
| c) |
measure the fair value of any
plan assets [IAS19R.50(c)]; |
|
| d) |
assess the total amount of
actuarial gains and losses and the amount of
those actuarial gains and losses that should
be recognised [IAS19R.50(d)]; |
|
| e) |
determine when a plan has been
enacted or changed, and the resulting past service
cost [IAS19R.50(e)]; and |
|
| f) |
compare the fair value of plan
assets and record the resulting asset or liability
[IAS19R.50(f)]. |
Measurement and recognition of expense -
defined benefit plans
The determination of the amount of expense (or income)
related for a specific period is driven by a number
of factors. The pension expense to be recognised
in a particular period is the net of the following
items [IAS19R.61]:
| a) |
current service
cost (the actuarial present value of benefits
attributed by the plan's benefit formula to
employee service during the current period)
[IAS19R.61(a),63-91]; |
|
| b) |
interest cost (computed by multiplying
the discount rate determined at the beginning
of the year by the average defined benefit
obligation during the year, taking into account
any significant changes in the obligation
caused by current service cost and benefit
payments) [IAS19R.61(b),82]; |
|
| c) |
expected return on plan assets
and on any reimbursement rights (computed by
multiplying the assumed long-term rate of return
by the average fair value of assets during the
year, taking into account changes caused by
contributions and benefit payments) [IAS19R.106]; |
|
| d) |
actuarial gains and losses
[IAS19R.61(e)] , to the extent
recognised ; |
|
| e) |
past service cost (amounts
arising from plan amendments that change benefits
for former employees and, to the extent recognised,
for current employees) [IAS19R.61(e),96] ; |
|
| f) |
the effect of any curtailments
or settlements [IAS19R.61(f),109-110] ; and |
|
| g) |
the amortisation of unrecognised
transition amount (if this option is selected). |
Measurement of the defined benefit obligation
Employers must use the Projected Unit Credit Method
to determine the present value of the defined benefit
obligation, the related current service cost and
any past service cost [IAS19R.50(b),64] . The Projected Unit Credit Method looks to
each period of service giving rise to an additional
unit of benefit entitlement, and measures each unit
separately to build up the final obligation [IAS19R.65]
. The entire post-employment benefit
obligation is discounted, even if part of the obligation
falls due within 12 months of the balance sheet
date [IAS19R.66].
Use of the Projected Unit Credit Method involves
a number of actuarial assumptions [IAS19R.68]. Actuarial
assumptions are an entity's best estimate of the
variables that determine the ultimate cost of providing
post-employment benefits [IAS19R.72-73]. These variables
include demographic assumptions such as mortality,
turnover and retirement age, and financial assumptions
such as discount rates, salary and benefit levels
[IAS19R.73]. Assumptions should be mutually compatible,
unbiased and neither imprudent nor excessively conservative
[IAS19R.74-75] . IFRS provide guidance
on the selection of certain key assumptions such
as the discount rate and the expected rate of return
on plan assets [IAS19R.78-91] . Management, with actuaries, will select
the assumptions to be used.
The obligation should include both legal obligations
under the formal terms of a plan and for any constructive
obligation that arises from the employer's usual
business practices that leave it no realistic alternative
to avoid the obligation [IAS19R.52]. A "constructive
obligation" arises from actions, such as an
established pattern of past practice, published
policies or a sufficiently specific current statement,
indicating that the entity will accept certain responsibilities
and, as a result, the entity has created a valid
expectation that it will discharge those responsibilities
[IAS19R.52] [IAS 37.10] .
IFRS do not require an annual actuarial valuation
of the defined benefit obligation. However, the
employer is required to determine the present value
of the defined benefit obligation and the fair value
of the plan assets with sufficient regularity that
the amounts recognised in the financial statements
do not differ materially from the amounts that would
be determined at the balance sheet date [IAS19R.56].
It is unlikely that a valuation older than 12 to
18 months would meet this criterion, even in a stable
economic environment. A volatile economic environment
will require more frequent valuations .
Measurement of plan assets
Plan assets are measured at fair value, being market
value where available or an estimated value where
it is not [IAS19R.102]. Fair value can be estimated
by discounting expected future cash flows using
a rate that reflects both the risk and expected
maturity of the assets, or their potential disposal
[IAS19R.102] .
Certain items are specifically excluded from plan
assets, as follows:
| a) |
unpaid contributions
due from the employer [IAS19R.103]; |
|
| b) |
non-transferable financial instruments
issued by the employer and held by the fund
[IAS19R.103] ; and |
|
| c) |
non-qualifying insurance policies
[IAS19R.104] . |
Initial measurement of the pension asset
or liability
An entity that was using IFRS at the date of adoption
of IAS 19 (r1997), computed a transitional adjustment
at the beginning of the year in which the entity
adopted the revised standard.
The transitional provisions do not apply when IFRS
are first applied in full as the primary accounting
basis [IFRS 1.9]. Any adjustment resulting from
the adoption of IAS 19R is treated as an adjustment
to the opening balance of retained earnings of the
earliest period presented in accordance with IFRS
[IFRS 1.11].
Recognition of the pension asset or liability
The amount recognised in the balance sheet may either
be an asset or liability, computed at the balance
sheet date as follows :
| a) |
the defined benefit
obligation (para 75.4.2) [IAS19R.54(a)]; |
|
| b) |
plus any actuarial gains/minus any actuarial
losses not yet recognised because of the treatment
of gains and losses falling outside the "corridor"
(para 75.5.1) [IAS19R.54(b)]; |
|
| c) |
minus any unrecognised past-service
cost from amendments increasing benefits for
active employees not yet vested (para 75.5.1),
and any unrecognised transition obligation (para
75.5.4) [IAS19R.54(c)]; and |
|
| d) |
minus the fair value of plan
assets (para 75.5.3) [IAS19R.54(d)] . |
A positive amount that results from the above calculation
is a liability and is recorded in full in the balance
sheet. A negative amount is an asset that is subject
to a limitation based on recoverability. The pension
asset is the lesser of the negative amount or the
net total of (a) any unrecognised actuarial losses
and past service cost, and (b) the present value
of any benefits available in the form of refunds
or reductions in future employer contributions to
the plan. Application of these limits should not
result in a gain being recognised solely as a result
of an actuarial loss or past service cost in the
current period or in a loss being recognised solely
as a result of an actuarial gain in the current
period [IAS19R.58A]. Any portion of the asset that
is not recognised in the balance sheet must be disclosed
[IAS19R.58-60].
Benefits available in the form of refunds or reductions
in future employer contributions can be difficult
to estimate. Governance of pension and benefit plans
is dependent on national law and can be significantly
regulated. Government regulation is unlikely to
allow direct and complete refunds to employers of
over-funded amounts, other than in exceptional circumstances.
Any refunds are likely to be less
than the over-funded amount and paid over a period
of time, based on continued over-funding. The amount
and timing of any refund available should be estimated
and then discounted, using the same rate as that
used to discount the benefit obligation.
Funded pension plans generally have trustees, often
drawn from management, unions, other employees and
independent individuals. The trustees will have
a fiduciary-type duty to the plan's beneficiaries,
and are unlikely to allow an entity's management
to unilaterally reduce contributions to a plan up
to the limit of the over-funded amount. Thus, any
reduction in contributions will be subject to negotiations
with employees and union representatives. A contribution
holiday granted to the employer will often need
to be accompanied by concessions to employees. These
concessions might include a contribution holiday
where the plan is an employee contributory plan
(with employees getting 'nominal' credit for contributions
absorbing the surplus) or an increase in benefits.
Concessions granted should be considered when assessing
the amount of the contribution holiday and factored
into the calculation of the defined benefit obligation
[IAS19R.58] .
Offsetting pension assets and liabilities
Multinational entities will often have a number
of employee benefit plans. Plan assets and plan
liabilities, arising from the different plans, are
usually presented separately in the balance sheet.
Offsetting of assets and liabilities is permitted
only when there is a legally enforceable right to
use a surplus in one plan to settle an obligation
in another plan. In addition, the employer must
intend to settle the obligations on a net basis
or to realise the surplus in one plan and settle
the obligation in another plan simultaneously [IAS19R.116-117].
These restrictive rules mean that offsetting is
unlikely to be possible in practice.
Pension assets and liabilities in business
combinations
The acquiring entity recognises assets and liabilities
arising from the acquiree's post-employment benefits
at the present value of the defined benefit obligation
less the fair value of any plan assets for business
combinations that are acquisitions. The present
value of the defined benefit obligation includes
all actuarial gains and losses that arose before
the acquisition; past-service costs that arose from
benefit changes or plan introductions before the
acquisition; and transition amounts that the acquiree
had not recognised before the acquisition. All items
related to an employee benefit plan are recognised
as part of the cost of acquisition [IAS19R.108]
.
Settlements, curtailments and terminations
A curtailment occurs when an entity either (a) is
demonstrably committed to making a material reduction
in the number of employees covered by a plan, or
(b) amends the terms of a defined benefit plan [IAS19R.111].
An amendment would be such that a material element
of future service by current employees will no longer
qualify for benefits or qualifies for reduced benefits
. Curtailments,
by definition, have a material impact on the entity's
financial statements [IAS19R.111]. Many curtailments
are linked to a restructuring or reorganisation
plan and should be recognised in the financial statements
at the same time as the restructuring (Disposal groups and discontinued operations – A plan for a discontinuing operation),
.
Any entity settles its obligations when management
enters into a transaction that eliminates all further
legal or constructive obligations for part or all
of the benefits provided under a defined benefit
plan [IAS19R.112] . Settlements
are usually lump-sum cash payments made to or on
behalf of plan participants in exchange for the
right to receive specified future post-employment
benefits [IAS19R.112]. Acquisition of rights under
an insurance policy is not a settlement if the entity
retains an obligation to pay further amounts if
the insurer fails to pay [IAS19R.113]. A settlement
should be recognised on the date when the entity
enters into a binding settlement agreement [IAS19R.112]
.
When a settlement or curtailment occurs, an entity
should re-measure the defined benefit obligation
(and plan assets) using current actuarial assumptions
(for example, a new discount rate based on market
interest rates) [IAS19R.110] . A settlement gain or loss is recognised
based on [IAS19R.109]:
| a) |
any resulting change
in the defined benefit obligation and fair value
of plan assets [IAS19R.109(a),(b)]; and |
|
| b) |
the related share of previously unrecognised
past-service costs, actuarial gains and losses,
and transition amounts [IAS19R.109(c)]. |
A settlement and curtailment occur together if
the plan is terminated such that the obligation
is settled and the plan no longer exists. Termination
of a plan is not a curtailment or settlement if
it is replaced by a new plan that offers benefits
that are in substance identical [IAS19R.114] .
Presentation and disclosure
Total plan assets and total plan liabilities arising
from separate plans are presented separately in
the financial statements, unless the exceptional
conditions for offset are met [IAS19R.116-117] . IFRS do not specify if assets or liabilities
resulting from employee benefit plans are separated
into current and non-current components. Most entities
will classify these as non-current if they prepare
a classified balance sheet, or relatively low in
the order of liquidity if a non-classified balance
sheet is presented [IAS19R.118] .
The components of pension expense can either be
segregated and presented as current service cost,
interest cost and return on plan assets, or presented
as a single amount, appropriately allocated in the
income statement [IAS19R.119] .
Sufficient disclosure is required to provide an
understanding of the significance of an entity's
employee benefit plans. Pension disclosures are
extensive and detailed. Specific disclosures include
[IAS19R.120]:
| a) |
accounting policy
for recognising actuarial gains and losses [IAS19R.120(a)]; |
|
| b) |
description of the plan [IAS19R.120(b),121]; |
|
| c) |
components of expense [IAS19R.120(f)]; |
|
| d) |
principal actuarial assumptions
used, including discount rate, expected return
on assets, salary increases, medical cost trend
rates, and any other significant assumptions
[IAS19R.120(h)]; |
|
| e) |
reconciliation of net balance
sheet liability/asset from one year to the next
[IAS19R.120(e)]; |
|
| f) |
funded status of the plan (defined
benefit obligation less market value of plan
assets) reconciled to amounts reported in the
balance sheet [IAS19R.120(c)]; |
|
| g) |
fair value of each category
of the reporting entity's own financial instruments
included in plan asset [IAS19R.120(d)]; and
|
|
| h) |
other disclosures about related-party
transactions and contingencies [IAS19R.124-125]. |
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