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Chapter 13

Accounting for employee benefits


13.1

According to AASB 119 Employee Benefits, employee benefits means all forms of
consideration given by an entity in exchange for services rendered by employees. Employee
benefits would include, but would not be limited to, wages and salaries (including fringe
benefits and non-monetary benefits), annual leave, sick leave, long service leave,
superannuation and other post-employment benefits.

13.2

AASB 119 requires that short-term employee benefit obligations be measured on an


undiscounted basis. Short-term employee benefits could include wages, salaries, social
security contributions, short-term compensated absences, profits sharing and bonuses payable
within 12 months.
Obligations for employee benefits, inclusive of salary and wages, that are payable beyond 12
months after balance sheet date are to be recorded at their present value. For the purpose of
determining present values, the discount rate is to be based on market yields at the reporting
date of high quality corporate bonds. The currency and terms of the bonds are to be
consistent with the current and estimated term of the obligations.
While paragraph 78 of AASB 119 states that reference should be made to high quality
corporate bonds, it also states that where there is no deep market in such bonds, the market
yields on government bonds shall be used. Within Australia, it is the view of the standardsetters that we do not have a sufficiently active and liquid market for high quality corporate
bonds. With this in mind, paragraph Aus78.1 states:
In applying the requirement of paragraph 78, Australia does not have a sufficiently
active and liquid market for high quality corporate bonds. Accordingly, market yields
on government bonds shall be used to discount post-employment benefit obligations
denominated in Australian currency.

13.3

The rates on high quality corporate bonds shall be used to discount employee benefit
obligations payable beyond 12 months after balance sheet date when there is active and liquid
market in high quality corporate bonds.

13.4

Government bond rates shall be used to discount employee benefit obligations payable
beyond 12 months after balance sheet date when there is no deep (active and liquid) market
in high quality corporate bonds. Australia is deemed not to have a deep market hence we
are required to use government bond rates when calculating present values.

13.5

At issue here is whether we can really argue that they are present values if the discounting is
done by applying a rate that relates to the bonds of other corporations, rather than the
market-determined risk-adjusted rate for the specific entity. Conceptually, applying high
quality corporate bond rates (or applying government bonds rates where no deep market
exists within a country for corporate bonds) does not provide present values. However,
determining organisation-specific rates is a difficult task which involves a great deal of
professional judgement. With this in mind, AASB 119 requires that present values be
determined by applying high quality corporate bond rates (or government bond rates). This
would be an easier (and less costly) approach to determining the value of the future cash
flows and it would eliminate the need for a great deal of professional judgement (although, of

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course, there is still much judgement necessary to calculate the undiscounted value of the
future cash flows pertaining to the employee benefits). The regulators must believe that the
costs associated with determining organisational-specific rates are greater than the associated
benefits.
13.6

The following employee benefits are to be disclosed at their nominal amounts: employee
benefits in the form of wages and salaries, annual leave, sick leave and other employee
benefits which are expected to be settled within twelve months of the reporting date. All
employee benefits to be settled beyond 12 months after balance sheet date are to be measured
at the present value of the estimated cash outflows to be made by the employer in respect of
employee services rendered up to the reporting date.

13.7

The general principle would be that where the payments are expected to generate future
benefits which can be reliably measured then the payments made to employees can be
considered to constitute an asset. For example, consider amounts due to employees working
on the production of particular items of inventory that will subsequently be sold, thereby
providing future economic benefits for the employer. The salaries and wages in such cases
would initially be recorded as part of work in progress. They would then be transferred to
finished goods and ultimately would become an expense in the form of cost of goods sold. As
AASB 102 Inventory states:
The costs of conversion of inventories include costs directly related to the units of
production, such as direct labour. They also include a systematic allocation of fixed
and variable production overheads that are incurred in converting materials into
finished goods. Fixed production overheads are those indirect costs of production
that remain relatively constant regardless of the volume of production, such as
depreciation and maintenance of factory buildings and equipment, and the cost of
factory management and administration. Variable production overheads are those
indirect costs of production that vary directly, or nearly directly, with the volume of
production, such as indirect materials and indirect labour.
The cost of employee benefits can also be included in the cost of property, plant and
equipment to the extent that employees are involved in establishing an item of property, plant
and equipment for use. As paragraph 17 of AASB 116 Property, Plant and Equipment
stipulates, costs of employee benefits directly attributable to the construction or acquisition of
an item of property, plant and equipment shall be included within the cost of the asset. Other
than through possible impairment losses, such costs would typically be recognised through
periodic depreciation.
Assets can also arise as a result of prepayments of employee benefits. Consistent with the
above requirements, and the recognition of assets relating to prepayments, paragraph 10 of
AASB 119 states:
When an employee has rendered service to an entity during a reporting period, the
entity shall recognise the undiscounted amount of short-term employee benefits
expected to be paid in exchange for that service:
(a) as a liability (accrued expense), after deducting any amount already paid. If the
amount already paid exceeds the undiscounted amount of the benefits, an entity
shall recognise that excess as an asset (prepaid expense) to the extent that the
prepayment will lead to, for example, a reduction in future payments or a cash
refund; and
(b) as an expense, unless another Australian Accounting Standard requires or permits

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the inclusion of the benefits in the cost of an asset (see, for example, AASB 102
Inventories, and AASB 116 Property, Plant and Equipment).
13.8

If a liability decreases and it is not as a result of a reduction in another asset (for example in
cash as a result of the payment of the liability) or as a result of a contribution by an owner,
then this can lead to the recognition of income. For example, due to staff departures and/or
revisions in expected inflation rates, the provision for long-service leave may be reduced from
the end of one period to the next. This reduction in the liability will be treated as income (just
as the increase in the liability was treated as an expense).

13.9

A defined benefit plan or fund is one in which the amount of benefits to be paid to members,
i.e., employees, is determined by a formula, such as a multiple of the employees average
salary; whereas in a defined contribution plan or fund, the amount of benefits paid to the
member comprises the contributions paid by and/or for that member and the net return
achieved by the fund. The accounting treatment for a defined contribution plan is relatively
simply relative to defined benefit plans. With a defined contribution plan, the investment risk
falls with the employee and the commitment of the employer is restricted to the amount of the
agreed contributions. As paragraph 43 of AASB 119 states:
Accounting for defined contribution plans is straightforward because the entitys
obligation for each period is determined by the amounts to be contributed for that
period. Consequently, no actuarial assumptions are required to measure the
obligation or the expense and there is no possibility of any actuarial gain or loss.
Moreover, the obligations are measured on an undiscounted basis, except where they
do not fall due wholly within twelve months after the end of the period in which the
employees render the related service.
For a defined benefit plan, the employee has to determine the amount to contribute to ensure
that sufficient benefits are available to pay employees the agreed amount upon retirement.
Many actuarial assumptions are necessary. The risks tend to fall on the employer. As
paragraph 27 of AASB 119 states:
Under defined benefit plans:
(a) the entitys obligation is to provide the agreed benefits to current and former
employees; and
(b) actuarial risk (that benefits will cost more than expected) and investment risk, fall, in
substance, on the entity. If actuarial or investment experience are worse than
expected, the entitys obligation may be increased.
There are a number of steps involved in accounting for a defined benefit plan. These steps
include:
(a) estimate the amount of benefit that employees have earned in return for their service
in the current and prior periods. This requires an entity to determine how much
benefit is attributable to the current and prior periods and to make estimates about
demographic variables (such as employee turnover and mortality) and financial
variables (such as future increases in salaries and medical costs) that will influence
the cost of the benefit;
(b) discounting that benefit in order to determine the present value of the defined benefit
obligation and the current service cost;
(c) determining the fair value of any plan;

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(d) determining the total amount of actuarial gains and losses.


13.10 If unused entitlements to sick leave are to be paid out when the employee leaves the
organisation then these sick leave entitlements are generally referred to as vesting sick leave
entitlements. If the entitlements continue to accrue as the employee continues to work for the
employer, then the accounting treatment is the same as that used to account for annual leave.
A liability will be recognised which will not be dependent upon assigning probabilities to the
likelihood that the employee will actually take the leave.
If sick leave is considered to be non-vesting, entitlements will only be paid when the
employee is sick, and they will not be paid out when the employee ceases employment. For
non-vesting sick leave, accounting entries must be made which recognise the employees
entitlements to sick leave based on past service, and the probability that the sick leave will
actually be taken. For example, if an individual employee on a salary of $100 000 has an
entitlement to two weeks sick leave and it is expected that the employee has a 50 per cent
probability of taking one week leave, and a 50 per cent probability of taking no leave, then
the accounts would need to recognise a liability of $100 000 x 1/52 x 0.50 = $962 in relation
to the employee.
13.11 As the illustrations in chapter 13 indicate, a number of factors need to be considered in
determining the total expenses to be recognised in relation to a defined benefit plan. These
include:
current service costs;
interest costs;
expected return on assets; and
net actuarial gain or loss.
13.12 A common reason that is stated is that providing employees with shares, or options to shares,
will help to engender a greater commitment to the organisation as the employees also become
owners. Sharing in the gains that will result if the entitys shares increase in value should
motivate employees to undertake activities which increase the value of the organisation. What
must be remembered, however, is that holding shares in the entity might only be motivational
if the employees feel as though they are in a position to actually influence share prices. This is
a reason that is often provided to justify why lower-level employees should not be provided
with shares in the entity. Individually, the lower-level employees are unlikely to be able to
influence share prices, regardless of how hard they work.
13.13 Long-service leave is an entitlement to additional leave that employees accrue as they work
for an employer. Although the entitlement typically accrues from the first day of employment,
access to the entitlement is dependent upon the employee remaining with the employer for a
stated period of time. Paragraph G4 of the former version of AASB 119 identifies three
common long-service leave entitlement categories, these being (AASB 119 was re-released in
2006 and the Australian Guidance paragraphs G1 to G 20 - were removed. This was part of
a process in which the AASB removed Australian Guidance from the accounting standards.
Nevertheless, the guidance is still relevant, and hence it is provided below):
(a)

Pre-conditional period
In the early years of employment no legal entitlement to any cash payment or leave
will exist until such time as the individual has been employed for the minimum period

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of service necessary to qualify for the entitlement. If the employee leaves in this early
period, no long-service leave entitlement is required to be paid by the employer.
(b)

Conditional period
In certain circumstances a legal entitlement to pro-rata payment in lieu of long-service
leave arises after a conditional period of service has been completed. For example, the
employment agreement may provide that employees are entitled to take 13 weeks
leave after 15 years of service. The agreement may further provide that once a
conditional period of employment has been served, for example, 10 years, then the
employee is entitled to a pro-rata cash payment in relation to long-service leave. In
such an arrangement, an employee who has served nine years before resignation
would not be entitled to any cash payment. An employee who serves 11 years may not
be entitled to take leave, but would be entitled to 9.53 weeks salary on resignation
(which equals 11/15 multiplied by 13 weeks).

(c)

Unconditional period
An unconditional legal entitlement to payment arises after a qualifying period of
service (usually 10 or 15 years). After this qualifying period, the long-service leave
can be taken. Accumulation of long-service leave entitlement continues after this
point, until the leave is taken.

An employer should not defer recognition of long-service leave entitlements until a preconditional period has been served. Rather, using various actuarial assumptions (such as
probabilities that the employee will stay until at least the conditional period, projected
promotions, wages rates, and so on), a liability should be recognised throughout the term of
employment, starting from the first year of service.
13.14 (a)

The accounting entry at balance date to recognise eight days salary and wages
expense would be (this assumes a ten day working week, of which 8 days remain
unpaid at balance date):

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30 June
Dr
Cr
Cr

Wages and salaries expense


PAYG tax payable
Wages and salaries payable

24 000
8 000
16 000

($24 000 = $30 000 x 8/10)


(b)

When the amount is ultimately paid to employees on 2 July, the entry would be:
2 July
Dr
Dr
Cr
Cr

Wages and salaries expense


Wages and salaries payable
PAYG tax payable
Cash at bank

6 000
16 000
2 000
20 000

($6000 represents two days salary, which would be included as an expense of the new
financial period. The employees would receive the net amount after deduction of the
PAYE tax, that is, $30 000 less $10 000. This entry assumes that no reversing entries
were made on 1 July.)
(c)

When the amounts are paid to the Taxation Office on Monday, the entry would be:
5 July
Dr
Cr

13.15 (a)

PAYG tax payable


Cash

10 000
10 000

Jerry Lopezs annual leave will cost his employer $100 000 x 4/52 x 1.175. This
equals $9038 or $174 per week. Therefore, the total amount paid to Lopez each year
would be:
For 48 weeks at normal pay-rate: $100 000 x 48/52 =
For 4 weeks inclusive of loading: $100 000 x 4/52 x 1.175
Total salary and annual leave

$92 308
$9 038
$101 346

If Lightning Bolt Ltd recognises the annual leave obligation throughout the year there
would be the following entry each week:
Dr
Cr
(b)

Annual leave expense


Provision for annual leave

174
174

If Lopez was to take two weeks annual leave, and assuming the related tax is $1200,
the entry would be:
Dr
Cr
Cr

Provision for annual leave


PAYG tax payable
Cash at bank

4519
1200
3319

($4519 = $9038/2)

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Lightning Bolt Ltd would also need to provide the usual weekly annual leave journal
entry, even when Lopez is on holidays. That is:
Dr
Cr

Annual leave expense


Provision for annual leave

174
174

13.16
Years of
service

6 yrs
7 yrs
8 yrs

Current
salary

50 000
65 000
70 000

No.

Salary x
number of
employees

2
2
2

Inflation

100 000
130 000
140 000

N to
maturity

1.025
1.025
1.025

4
3
2

Proj. sal.

110 381.3
139 995.8
147 087.5

Entitlement

16 557.19
24 499.26
29 417.5

PV

Prob.

11 729.53
19 998.7
26 181.47

LSL provn

0.45
0.7
1

5 278
13 999
26 181
$45 459

Dr LSL Expense $12 959


Cr LSL Provision $12 959
13.17 (a)

The expected annual sick leave expense for Bear Island Ltd (on the basis of average
salaries) would be:
$300 000 x 2 x 0.6 =
$300 000 x 1 x 0.2 =
$300 000 x 1/5 x 0.1 =

(b)

$360 000
$60 000
$6 000
$426 000

This would equate to $8192 per week. On this basis, Bear Island Ltd could post the
following journal entry each week:
Dr
Cr

Sick leave expense


Sick leave payable

8192
8192

($8192 = $426 000/52)


13.18 (a)

Calculations (see notes below for explanation of calculations under each column):

Employee
name

Black
White
Brown
Green
Purple

Projected
salary

Accumulated
LSL benefit

Present
value of
LSL
obligation

48 760
46 866
56 308
64 946
72 828

1 563
3 004
5 414
8 326
11 671

724
17 481
3 710
6 595
10 426

Probability
that LSL
will be paid

15%
20%
50%
70%
90%

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LSL
liability

109
350
1 855
4 617
9 383
16 314

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Notes
1.

The projected salary is determined by the following calculation:


Current salary x (1 + inflation rate) n, where n = number of years until the long service
leave entitlement vests. In this question it is assumed that the inflation rate will
continue to be 2%. For the first listed employee, the calculation would be $40 000 x
(1.02)10 = $48 760.

2.

Accumulated LSL benefit is determined by the following calculation:


Accumulated LSL entitlement = (Years of employment)/(number of periods until
entitlement can be taken in leave) x weeks of LSL entitlement/52 x projected salary.
For the first listed employee, the calculation would be 2/12 x 10/52 x $48 760 =
$1563.

3.

The present value of the long-service leave calculation is determined by the following
calculation:
Accumulated long service leave benefit
(1 + appropriate government bond rate) n
where n is the number of years until long service leave entitlements can be taken. For
the first listed employee the calculation would be $1563/(1.08)10 = $724.

4.

Probability that long-service leave will be taken:


The probability that long service leave will be taken would be determined by
reference to prior experience within the organisation and industry. For example, it has
been assessed that an employee with 2 years service has a probability of 15% of
staying in the firm until long-service leave must be taken. Once an employee reaches
the pre-conditional period (in this question, 12 years) the probability is 100% that a
payment will be made. For the first listed employee, the calculation would be $724 x
0.15 = $109.
Following on from the above calculations, after considering all five employees, the
long service leave provision at the end of the period should total $16 314.

(b)

If the balance in the provision account at the beginning of the year had been $12 500,
then the expense for the year would be $3814. This would represent the increase in
the obligation that has occurred throughout the year. The accounting entry to
recognise the long-service leave expense would be:
Dr
Cr

Long-service leave expense


Provision for long-service leave

3814
3814

13.19
(a) 2007 recruits $600 000 x (1 + 0.01)7 x 3/10 x 13/52 = $48 246
2009 recruits $400 000 x (1 + 0.01)9 x 1/10 x 13/52 = $10 937
$59 183
Note that the above amount reflects the total amount of LSL accumulated for each employee and
does not take account of the probability that the employees will stay until the conditional period
is over.

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(b) $48 246/(1+0.06)7 x 40% = $32 086 x 40% = $12 403


$10 937/(1+0.08)9 x 30% = $5471 x 20% = $1094 = $13 497
(c)
Dr
Cr

Long-service leave expense


Provision for long-service leave

$7497
$7497

(d) $6 000 x 5% = $300


13.20
a)
Dr Employee benefits cost superannuation
Cr Employee benefits payable
b)

$200 000 x (1 + .05)3 x 3.2 = $740 880

c)

$740 880/(1 + .07)3 = $604 779

d)

Interest cost $529 887 x 7% = $37 092;

$20 000
$20 000

current service cost = $37 800 (which equals the current aggregated salaries ($200 000)
multiplied by the expected growth in salaries over 3 years at 5% ($200 000 x (1.05) 3 =
$231 525) calculated at present value ($231 525/(1.07) 3 = $188 995) and then multiplied
by the increase in times salary to be earned as a result of one years service ($188 995 x
(3.2 3.0) = $37 800).
e)
Obligation
Undiscounted benefit attributable to prior years
Current year
Current and prior years
Present values
Prior years
Interest cost
Present value of the undiscounted current year
increase in benefits (the current service cost)
Actuarial gain or loss
Closing present value of obligation
Plan assets
Opening fair value of plan assets
Expected return on plan assets 8%
Contributions
Actuarial gain/loss on plan assets
Closing fair value of plan assets

$694 574
46 306
$740 880
$529 887
37 092
37 800
nil
$604 779
$529 887
42 391
20 000
(7 278)
$585 000

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