What is a defined benefit plan
IAS 19: Employee Benefits
IAS 19 regulates all forms of consideration by a company in exchange for services rendered by employees as well as the accounting and disclosure requirements for such services. The principle underlying all the requirements of this standard is to record the cost of providing employee benefits in the period in which they are earned by the employee and not when they are paid or due.
Scope [edit | Edit source]
IAS 19 (along with other types of employee benefits) applies to the following issues:
- Wages and salaries
- Paid absence (paid vacation or sick pay)
- Profit Sharing Plans
- Health and life insurance during the employment relationship
- Housing benefit
- Free or discounted goods or services given to employees
- Pension benefits
- Post-employment health and life insurance
- Special leave after long service and other benefits for long service
- Anniversary bonuses
- Compensation components due later, such as deferred salaries
- Termination benefits
Short-term employee benefits Edit source]
For short-term employee benefits (due within 12 months of the provision of the service, e.g. wages, paid vacation and sick pay, bonuses and monetary benefits such as medical care and accommodation), the undiscounted amount must be recorded in the period in which the service is provided by the employee , which is expected to be paid in exchange for the work performed [IAS 19.10]. The expected cost of short-term employee benefits in the form of compensated absences should be recognized if the work is performed by employees who increase their entitlements or, in the case of non-accumulating entitlements, at the time the absence occurs [IAS 19.11 ].
Profit-sharing plans and bonus payments [edit | Edit source]
The company only has to record the expected costs of a profit or profit-sharing plan if the company currently has a legal or constructive obligation due to a past event and the expected costs can be reliably estimated [IAS 19.17].
Types of post-employment benefits Edit source]
The accounting method for post-employment benefits is determined according to whether it is a defined contribution or a defined benefit plan:
- In the case of defined contribution plans, a company pays fixed amounts to a fund, but has no legal or factual obligation to make further payments if the fund does not have sufficient assets to meet employee claims for post-employment benefits.
- A defined benefit plan is a post-employment benefit plan that is not a defined contribution plan. This includes both formal plans and informal procedures that establish a de facto obligation on the part of the company to the employees.
Defined contribution plans Edit source]
For defined contribution plans (including multi-employer plans, state plans and insured plans where the employer's obligation is similar to that of a defined contribution plan), the contribution to be paid in exchange for the employee's benefits during the period is an expense for the period to be recorded [IAS 19.44].
If contributions to a defined contribution plan are not due in full within twelve months after the end of the period in which the employees performed their work, they must be discounted to their present value [IAS 19.45].
Defined benefit plans Edit source]
For defined benefit plans, the amount recorded on the balance sheet should correspond to the present value of the defined benefit obligation. This is the present value of the required, expected future payments to settle the obligation arising from employee performance in the current and previous period, corrected for unrecognized actuarial gains and losses and unrecognized past service costs, less the plan assets measured at fair value on the balance sheet date [IAS 19.54].
The present value must be determined using the projected unit credit method [IAS 19.64]. The valuation must be carried out with sufficient regularity so that the amounts recorded in the financial statements do not differ significantly from the amounts that would result on the balance sheet date [IAS 19.56]. The assumptions that are made for the purpose of such evaluations must be chosen impartially and coordinated with one another [IAS 19.72]. The interest rate used to discount estimated cash flows is to be determined on the basis of the yields that are achieved on the balance sheet date for high-quality corporate bonds [IAS 19.78].
Over time, actuarial gains and losses will occur again and again, which on the one hand represent adjustments based on empirical values (differences between previous actuarial assumptions and the actual circumstances) and on the other hand are the effects of changes in actuarial assumptions. Actuarial gains and losses can offset each other in the long run. Because of this, companies are not required to record all of these gains and losses immediately. The standard specifies that if the cumulative unrecognized actuarial gains and losses exceed 10% of the higher of the defined benefit obligation and the fair value of the plan assets, then part of the net gains or losses must be recognized immediately as income or expense. The recorded part is the surplus, distributed over the expected average remaining working life of the employees covered by the plan. Actuarial gains and losses that do not reach the 10% limit described above (the "corridor") do not have to be recorded, but can optionally [IAS 9.92-93].
In December 2004, the IASB issued an amendment to IAS 19 in which it grants companies the option to record actuarial gains and losses in full in the reporting period in which they arise, outside of the results for the period in a statement of comprehensive income . This option is similar to the provisions in the UK standard FRS 17 Retirement Benefits. The Board concluded that the FRS 17 approach should be available as an option, subject to the preparation of IFRS financial statements [IAS 19.93A].
Over the term of the plan, changes in benefits under the plan will lead to increases or decreases in the company's obligation.
The term Past service cost describes the changes in the obligations for employee benefits from previous periods resulting from changes in the plan agreements in the current period. Past service cost can either be positive (if benefits are included or improved) or negative (if existing benefits are reduced). Past service cost must be recognized immediately to the extent that it is attributable to former employees or to vested claims of active employees. Otherwise, it is to be recorded on a straight-line basis over the average periods remaining until vested [IAS 19.96].
With the term Curtailments or Accomplishments describes the IASB valuation results from reductions or the fulfillment of a plan, which are to be recorded at the time of occurrence. Reductions are reductions in the scope of the employees or benefits covered by the plan.
If the calculation of the amounts on the balance sheet as described above results in a negative asset, the amount is limited to the lesser of that
- the value of this calculation and
- the total netted unrecognized actuarial losses plus past service costs plus the present value of reimbursements and reductions in future contribution payments
to be valued [IAS 19.58].
The IASB issued the final amendment to IAS 19 relating to the 'asset ceiling' in May 2002. The change prevents the recognition of valuation gains from the accrual of actuarial losses or past service cost, and prohibits the recognition of valuation losses that only occurred due to the accrual of actuarial gains [IAS 19.58A].
The amount to be recognized as an expense for the period in connection with defined benefit plans is calculated as the balance of the following components [IAS 19.61]:
- current service cost (the actuarial estimate of the benefit entitlements earned from employee benefits in the period);
- Interest expense (the increase in the present value of the obligation as an event approaching the date of performance by one period);
- expected return on plan assets;
- actuarial gains and losses to the extent that they are recognized;
- Past service cost to the extent that it is recognized;
- the effects of curtailments and compensations
The expected return on plan assets consists of interest, dividends and other income on plan assets and includes realized and unrealized gains and losses on plan assets, less any costs of managing the plan (other than costs that have already been incorporated into the actuarial assumptions used to measure the defined benefit obligation) and less the taxes to be paid by the plan itself [IAS 19.7].
IAS 19 contains detailed disclosure requirements for defined benefit plans [IAS 19.120-125].
IAS 19 also provides guidance on how to allocate costs in
- a multi-employer plan on individual companies [IAS 19.29-33]
- a group-wide performance-oriented plan for the individual group companies [IAS 19.34-34B]
- a government plan on the companies participating in this [IAS 19.36-38].
Other long-term benefits Edit source]
IAS 19 requires a simplified application of the method described above for other long-term employee benefits. This method differs from the accounting requirements for post-employment benefits in that [IAS 19.128-129]
- actuarial gains and losses are recognized immediately and the "corridor" (as outlined above for post-employment benefits) is not applied; and
- all past service costs are recognized immediately.
Employment termination benefits [edit | Edit source]
For such services, liabilities are only to be recognized if the company is demonstrably obliged to either [IAS 19.133]
- to terminate the employment relationship of an employee or a group of employees before the date of regular retirement or
- To provide benefits upon termination of the employment relationship on the basis of an offer to promote voluntary early departure.
A company is only demonstrably obliged to terminate an employment relationship if it has a detailed formal plan for the termination of the employment relationship and has no realistic possibility of evading it [IAS 19.134]. If termination benefits are due more than twelve months after the balance sheet date, they must be discounted [IAS 19.139].
Recent developments Edit source]
August 2009: IASB publishes draft to determine the discount rate [edit | Edit source]
On August 20, 2009, the IASB issued proposals for changes to the determination of the discount rate in the valuation of employee benefits for the purpose of public comment. The suggestions are a response to requests from users to address a problem that has become particularly acute as a result of the financial market crisis.
IAS 19 stipulates that the discount rate that an entity uses to measure employee benefits must be based on the rate of return for high-quality corporate bonds. However, when there is no liquid market for high quality corporate fixed income, a company has to use market yields on government bonds. However, the global financial market crisis has widened the spread between corporate bond yields and government bond yields. Therefore, companies with similar performance obligations to employees report these sometimes at very different amounts.
In order to address this issue quickly, the IASB proposes to remove the rule on the use of yields from government bonds. Instead, companies would value the returns on high quality corporate fixed income bonds. If these changes were adopted, it would be ensured that the comparability of financial statements between individual legal circles would be guaranteed regardless of whether there was a liquid market for high-quality, fixed-income corporate bonds.
In view of the urgency of the matter and the limited scope of the proposed changes, the IASB has agreed a shortened comment period for the draft. The IASB intended to allow entities to adopt the changes in this draft in their December 2009 financial statements.
October 2009: IASB decides not to finalize draft discount rate determination [edit | Edit source]
An analysis of the responses to its proposed amendments to IAS 19 Discount Rate for Employee Benefits (ED / 2009/01) was presented to the Board at its October 2009 meeting. The conclusions in the draft were also discussed again.
Da staff noted that 100 comments had been received; in addition, there had been written exchanges with users since the staff papers were made available for this meeting.
The staff noted that the positions were very polarized: those who supported the changes were emphatically doing so; those who oppose it are no less violent in their rejection. In addition, it had become clear that the process of publication for comment had highlighted a number of areas where the proposals would create problems of which the staff were not previously aware. The Board's proposals could lead to more deviations in practice than less. Therefore, the staff presented three options:
- Government bond market returns should be used when it is difficult to estimate high-quality corporate bond returns, not when there is no liquid high-quality corporate bond market. The staff would further elaborate what is meant by "difficult" if the Board chooses this option.
- Proposals in the draft to remove the requirement to use a market return on government bonds will continue.
- The existing requirement to refer to a market return on government bonds when there is no liquid market for high-quality corporate bonds will be maintained. That would then correspond to the setting of the project.
Some Board members found the staff's analysis overly simplistic and underhanded. Others pointed out that the proposed change shows the danger of a company using a valuation input that is not consistent with either the currency or the duration of its defined benefit obligation.
Board members were not satisfied with the three options. In the end, however, there was not enough support among them for the amendments to be adopted. Therefore, the requirement in IAS 19.78 remains in effect that in the absence of high-quality corporate bond yields, market yields on government bonds should be used.
April 2010: IASB proposes to amend IAS 19 with regard to defined benefit plans Edit source]
On April 29, 2010, the IASB issued a draft of proposed amendments to IAS 19 for public comment.The proposals would change the accounting for defined benefit plans that some employers use to provide long-term employee benefits such as pensions and post-employment health care. With defined benefit plans, employers bear the risk of cost increases and potentially poor investment returns. The draft suggests improvements in approach, presentation, and disclosure of defined benefit plans. The evaluation of defined benefit plans and accounting for defined contribution plans are not addressed in the draft.
Among the changes proposed to IAS 19 are the following:
- Immediate recognition of any estimated changes in the cost of providing the promised benefits and any changes in the value of plan assets. This would eliminate the various methods currently included in IAS 19, including the so-called "corridor", which allows some of these gains and losses to be deferred.
- A new approach to presentation that clearly differentiates between the different types of gains and losses that arise from defined benefit plans. In particular, it is proposed in the draft that the following changes in the service costs should be presented separately:
- Service cost - in profit or loss for the period
- Financing costs (i.e. net interest on the net defined benefit debt) - as part of the financing costs in profit or loss for the period
- Revaluations - in other comprehensive income
Presenting these items separately means removing from IAS 19 the possibility for companies to record all changes in the defined benefit obligations and in the fair value of the plan assets in the result for the period. There are now improved information on such topics as:
- Characteristics of a company's defined benefit plans
- Amounts that are recognized in the financial statements
- Risks arising from defined benefit plans
- Participation in multi-employer plans.
June 2011: Amendments to IAS 19 published [edit | Edit source]
On June 16, 2011, the IASB issued the final version of the amendments to IAS 19. The changes introduce new rules for accounting for employee benefits. The amendments to IAS 19 are somewhat broader, but can also be seen as a pragmatic minimum of what the IASB hoped to achieve when the comprehensive project was launched in the early stages of convergence. Accounting for pensions and other post-employment benefits has long been a complex and difficult area, and the original plans for a complete overhaul of pension accounting had to be postponed in light of other priorities, leaving the IASB ultimately solely concerned with improving certain aspects of the existing regulations continued in IAS 19.
The draft proposed removing the "corridor" approach and instead requiring that all effects of a revaluation be recognized in other comprehensive income (and the remainder in the statement of comprehensive income). It was also proposed to extend these rules to all long-term employee benefits (such as earned sabbatical years). With the final changes, only changes are made to the presentation of the other comprehensive income in relation to pensions (and similar matters), but all other long-term benefits are accounted for identically, although the changes in the amount recognized are fully reflected in the income statement.
In addition, the treatment of severance payments was changed in IAS 19. This is especially true with regard to the point in time at which a company recognizes a liability for severance payments. With the final changes, the corresponding regulations according to US-GAAP will be adopted - even if not verbatim (according to which individual employees must be notified), especially the time frame for the approach may be longer in some cases.
Finally, various other changes to IAS 19 may have an impact in certain areas. For example, employee benefits that are not fully met twelve months after the end of the reporting period should be recognized as "other long-term benefits" rather than "short-term benefits" and although they are recognized as a current item on the balance sheet, they will valued differently according to the amended version of IAS 19. The most important contents in brief:
- The recognition of changes in the net debt (net assets) from defined benefit plans including the immediate recognition of defined benefit costs, the breakdown of defined benefit costs according to components, the recognition of revaluations in other comprehensive income as well as plan changes, plan curtailments and fulfillments is prescribed.
- Better information on defined benefit plans is required.
- The accounting for severance payments, including the distinction between benefits in exchange for service time and benefits in return for termination of the employment relationship, will be changed, which will have an impact on the recognition and measurement of severance benefits.
- Various other issues are clarified. This includes the classification of employee benefits, current estimates of death rates, tax and administrative expenses, and risk-sharing and other contingent indexing characteristics.
- Other issues submitted to the IFRS Interpretations Committee were also considered.
- The changes are to be applied for reporting periods beginning on or after January 1, 2013. Early application is permitted.
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