t e c h ni c a l
This article outlines the principles ofaccounting for employee benefits, as definedby IAS 19,
. Unlike theUK standard, FRS 17, which sets out theaccounting treatment for retirement benefits– such as pensions and medical careduring retirement – IAS 19 deals with otheremployee benefits including:short-term employee benefits, such aswages and salariespost-employment benefits, such aspensionstermination benefits, such as severancepayother long-term employee benefits,including long service leave.
This article also deals with post-employmentbenefits and, in particular, defined contributionand defined benefit plans. An understandingof the definitions of certain terms is critical. Amajor problem for students is often confusionover what the various terms actually mean.The accounting entries are relatively simple butstudents find it difficult to relate to the natureof the transaction being carried out. First, it isimportant to understand the nature of the twotypes of pension scheme.
DEFINED CONTRIBUTION PLAN
In a defined contribution pension plan, acompany pays a fixed pension contributioninto a separate entity (fund) and has nolegal or constructive obligation to pay furthercontributions if the fund does not havesufficient assets to pay employee benefitsrelating to employee service in the current andprior periods. A company should recognisecontributions to a defined contribution planwhere an employee has rendered service inexchange for those contributions. All otherpost-employment benefit plans are classifiedas defined benefit plans.The accounting for a defined contributionscheme is fairly simple because the employer’s
IAS 19, employee beneﬁts
relevant to Professional Scheme Paper 3.6 (INT)and new ACCA Qualiﬁcation Paper P2 (INT)
obligation for each period is determined bythe amount that has to be contributed to thescheme for that period.
DEFINED BENEFIT PLAN
Under a defined benefit pension plan, thebenefits payable to the employee are not basedsolely on the amount of the contributions (asin the defined contribution scheme), but aredetermined by the terms of the defined benefitplan. This means that the risk remains withthe employer and the employer’s obligationis to provide the agreed amount of benefit tocurrent and former employees.In accounting for a defined benefit plan,a company should regularly determine thepresent value of any defined benefit obligationand the fair value of any plan assets. Thismakes sense as a company will need to knowits net liability for employee benefits.
It is important to understand certain key terms:
Current service cost
is the increase inthe present value of the defined benefitobligation which occurs as a result ofemployee service in the current period.In simple terms, this is the amount ofpension entitlement that employees haveearned in the accounting period. Therefore,it will increase the pension liability in thebalance sheet and be expensed in theincome statement.
Past service cost
is the increased presentvalue of a defined benefit obligationfor an employee’s service in previousperiods, which has arisen because of theintroduction of changes to the benefitspayable to employees. In other words, thisrepresents an increase or decrease in theemployer’s liability because of a changein the terms of the pension scheme. Thepension liability in the balance sheet willincrease or decrease, and the incomestatement will be affected accordingly.
is the increase in the periodin the present value of the defined benefitobligation which arises because thebenefits payable are one year closer to thesettlement of the scheme. It represents theunwinding of the discount on the plan’sliabilities. It is calculated by multiplyingthe discount rate at the beginning ofthe period by the present value of thedefined benefit obligation throughoutthe period. This, in theory, means thata form of averaging should take place tocalculate the ‘average’ present value ofthe obligation in the period. For exampurposes, the approach taken by theexample in IAS 19 will be adopted. Thatis, the interest cost will be calculated onthe basis of the opening obligation. Theinterest cost will increase the obligationand will be charged to the incomestatement.
Expected return on plan assets
is basedon the market’s expectations of the returnexpected from the pension scheme’sassets. It is calculated using the expectedlong-term rate of return on the planassets at the beginning of the period. Theamount so calculated will be added to thescheme’s assets and will be credited to theincome statement.
DEALING WITH DEFINED BENEFIT PLANSIN THE FINANCIAL STATEMENTS
The present value of a defined benefitobligation, and the fair value of the planassets are determined at the end of eachaccounting period. Additionally, the schemewill receive contributions that will increasethe plan assets, and will pay out pensionbenefits which will, in turn, reduce theobligation and the plan assets. Havingdefined key terms and events, it is nowpossible to show how these elements aredealt with in financial statements, as shownin
on page 61. Random amounts