Accounting for Employee

Benefits
Created @April 17, 2021 1:27 PM

Class ACYFAR4

Type Class Lecture

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Accounting for Employee Benefits

Employee Benefits

All forms of consideration given by an entity in exchange for service rendered by

employees or for the termination of employment

Categories of Employee Benefits

Short-term Employee Benefits

As an employee renders services to a company, the company recognizes an

Expense and a Liability for services that have not yet been paid

In some cases, the employees render services to generate an Asset and

employee benefits can be included in the Cost of an Asset in accordance
with the Accounting Standards such as

IAS16 PPE

Accounting for Employee Benefits 1

 IAS2 Inventory

Because the Liability is settled within 12 months from the end of the
reporting period, there is no need to discount future cash payments

Using the Undiscounted Cash Flows as a basis for measuring Liability is

a fundamental difference between Accounting for Short-term Benefits
and Accounting for Long-term Employee Benefits

Examples:

Wages, Salaries, and Social Security Contributions

SSS, PhilHealth, PAG-IBIG

Paid Annual Leave and Paid Sick Leave

Profit-sharing and Bonuses

Non-monetary Benefits

Medical Care, Housing, Cars, and free subsidised goods or services for
current employees (Rice Subsidy)

Short-term Paid Absences could be:

Accumulating Paid Absences: Unused leave carried forward to future

period

An employer recognizes an Expense during the period when employees

are entitled to accumulating leave

Can be:

Vesting: Unused leave at the end of the future period is paid off on
resignation

Company has an obligation to pay the employee the peso

amount of the unpaid leave on resignation, whether the leave is
taken or not

Liability is recorded at the end of the current reporting period

Non-Vesting: Unused leave expires at the end of the future period

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 We have to measure the expected cost to the company arising
from the unused leave at the end of the reporting period

The expected cost requires an estimate of the amount of

leave days that will be used by the employees in the future
period

Liability is recorded at the end of the current reporting period

Non-Accumulating Paid Absences: Unused leave expires at the end of

the current reporting period

An employer recognizes an Expense during the period when Non-

Accumulating Leave is taken

Forfeited at the end of the current accounting period if the employee

did not take the leave

No Liability at the end of the current reporting period

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 Computation:
Salary per Day (Annual Salary/365 Days) xxx
Multiplied by: Unused Leave (Given) xxx

Liability for Unused Leave xxx

Journal Entry Computation 1:
Liability for Unused Leave xxx
Multiplied by: Expected Utilization Rate xx%

Journal Entry Computation 2:

Total Liability of the Previous Year xxx
Less: Liability for Unused Leave (Current) xxx

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 Annual Salary: 300,000 + 250,000 + 110,000 (Semi-annual salary since stated in the
problem joined during the half of the year) = 660,000
Accumulating Vested Paid Leave (Calculated a while ago): Sum of all Liability for
Unused Leave

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 Computation:
Salary per Day (Annual Salary/365 Days) xxx
Multiplied by: Unused Leave (Given) xxx
Multiplied by: Rate of Utilization xx%

Liability for Unused Leave xxx

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 Annual Salary: 300,000 + 250,000 + 110,000 (Semi-annual salary since stated in the
problem joined during the half of the year) = 660,000
Accumulating Vested Paid Leave (Calculated a while ago): Sum of Liability for
Unused Leave x Expected Utilization Rate

Post-employment Benefits

Retirement Benefits

Examples: Pensions and Lump-sum Payments on Retirement

Pension Plans: Provide Income to individuals during their retirement

years

Accomplished by setting aside funds during an employee's working

years so that at retirement, the accumulated funds plus earnings
from investing those funds are available to replace wages

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 Basic Nature: Company and/or the employees make contributions
to a fund manager

Fund Manager invests the fund and makes payment to retired

employees

Amount contributed to the Fund Manager is often determined

by an actuary

Reasons why companies establish Pension Plans:

Sponsorship of Pension Plans provide employees with a degree

of Retirement Security

Fulfills a moral obligation by many employers

Can induce a degree of Job Satisfaction and Loyalty that may

enhance productivity and reduce turnover

Motivation to sponsor a plan sometimes comes from Union

Demands

If a company has Employee Unions and often to be

competitive in the labor market

2 Types of Pension Plans:

Defined Contribution Plan: Promise fixed annual contribution

to a pension fund

Employees choose where funds are invested

Usually in Stock or Fixed Income Securities (Bonds)

Retirement Pay depends on the size of the fund at

retirement

Characteristics:

Contributions are defined by agreement

Agreement between the employee and the

employer

Employer deposits an agreed-upon amount into an

employee-directed investment fund

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 Employee bears all risk of pension fund performance

No further commitment is made by the employer

regarding the benefit amounts at retirement

Defined Benefit Plan: Promise fixed Retirement Benefits

defined by a designated formula

Typically, the Pension Formula bases retirement pay on the

employee's years of service, annual compensation, the
compensation can be based on the final pay of the
employee, or could be average for the last few years

Sometime the formula also considers the age of the

employee

Employers are responsible for ensuring that sufficient funds

are available to provide the promised benefits

Characteristics:

Employer is committed to specified retirement benefits

Retirement Benefits are based on a formula that

considers years of service, compensation level, and
age

Employer bears all risk of pension fund performance

Unlike the Defined Contribution Plan wherein the

employee bears all the risk of pension fund
performance

An Actuary assesses the various uncertainties (employee

turnover, salary levels, mortality, etc.) and estimates the
company's obligation with its pension plan

Key Elements:

Employer's obligation to pay retirement benefits in the

future

Plan Assets set aside by the employer from which to

pay the retirement benefits in the future

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 Periodic Expense of having a pension plan

NOTE: Neither the Defined Benefit Obligation nor the Plan

Assets are reported individually in the Statement of Financial
Position

Even though they are not reported separately, it is

critical that you understand the compensation of both
the Defined Benefit Obligation and the Plan Assets
because they are reported as a Net Amount in the
Statement of Financial Position and their balances are
reported in the disclosure notes

Defined Benefit Cost reported in the Statement of

Comprehensive Income is a direct composite of periodic
changes that occur in both the Defined Benefit
Obligation and Plan Assets

Defined Benefit Cost: Reflect changes in both the Defined

Benefit Obligation and the Plan Assets

Ways to Measure the Defined Benefit Obligation:

Accumulated Benefit Obligation

Vested Benefit Obligation

Projected Benefit Obligation: The Actuary's estimate

of the total retirement benefit (at their discounted
Present Value) earned so far by employees, applying

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 the pension formula using estimated future
compensation levels

NOTE: Should be at discounted amount (Present

Value)

Under the Projected Credit Unit Approach: Units

of Benefits increase with each year of service

Only this Approach is permitted by IAS19

Service Cost: The primary component of annual

Defined Benefit Expense
Remeasurement Gain or Loss
NOTE: Estimates are necessary to derive the Defined
Benefit Obligation

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 When one ore more of these estimates require
revision the estimate of Defined Benefit
Obligation also will require revisions

The resulting increase or decrease in

Defined Benefit Obligation: Referred to as
Actuarial Gain or Loss respectively

Example: An increase in the final salary

estimate increase the Defined Benefit Obligation
and represent a Loss on the Defined Benefit
Obligation because the obligation turned out to
be higher than previously expected

But, however, an increase in the assumed

discount rate used in the Present Value
calculation for the Defined Benefit Obligation
would result in a decrease of the estimate of the
Defined Benefit Obligation

Would result in a Gain on the Defined

Benefit Obligation because the obligation
turned out to be less than the previously
expected

Not reported as Expense in the Income

Statement but reported as OCI in the
Statement of Financial Position
(Shareholders' Equity account)

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 Report Gain or Losses in an accumulative
basis as a Net Loss Accumulated OCI or as
a Net Gain Accumulated OCI depending on
whether we have greater losses or gains
over time

Plan Assets: Not reported separately in the Statement of

Financial Position but are netted together with the Defined
Benefit Obligation to report either a Net Defined Benefit
Asset (debit balance) or a Net Defined Benefit Liability
(credit balance)

Its separate balance must be reported as a disclosure

note in the Notes to the Financial Statements

Return on Plan Assets is included in the calculation of

the Periodic Expense

Plan Assets of a Defined Benefit Plan must be held by

a Trustee to manage the fund

Trustee accepts employer contributtion

Invests the contribution

Stocks

Bonds

Other Income Producing Assets

Accumulates the earnings on the investments

Accumulated Balance of the annual employee

contributions plus the Return on Investment
(Dividends, Interest, or Market Price
Appreciation) must be sufficient to pay benefits
as they come due

NOTE: When an employer estimates how much

must be set aside every year to accumulate
sufficient funds to pay retirement benefits as they

Accounting for Employee Benefits 13

 come due, it is necessary to estimate the Return
those investment will produce

The higher the expected return on Plan Assets,

the lesser the employer must actually
contribute

A relatively low expected return means the

difference must be made up by higher
contribution

Pays benefit from the Plan Asset to retired

employees or their beneficiaries

Funded Status of a Pension Plan:

Overfunded: Fair Value of Plan Assets exceeds the

Actuarial Present Value of all Benefits earned by
participants

Underfunded: Fair Value of Plan Assets is below the

Actuarial Present Value of all Benefits earned by
participants

Reporting the Funded Status of Defined Benefit Plan

A company's Defined Benefit Obligation is not reported

separately from the company's Liabilities

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 A company's Plan Assets set aside to pay those Benefits
are not reported separately from the company's Assets

BUT, firms do report the Net Difference between these 2

amounts and referred to as the Funded Status or Statues of the
Plan

The amount of Overfunding or Underfunding is reported in

the current period of the Statement of Financial Position as
either a Defined Benefit Liability (Underfunding) or Defined
Benefit Asset (Overfunding)

Relationship between Defined Benefit Cost and Changes in

the Defined Benefit Obligation and Plan Assets

Accounting Objective: Achieve a matching of the Cost of

providing these forms of compensation with the Benefits of
the services performed

Other Post-employment Benefits

Examples: Post-employment Life Insurance and Post-

employment Medical Care

Accounting for Employee Benefits 15

 Post-employment Benefit Obligation:

Expected Post-employment Benefit Obligation (EPBO):

The Actuary's estimate of the total Post-employment
Benefits (at their discounted Present Value) expected to be
received by Plan Participants

Defined Benefit Obligation (DBO): The portion of the

EPBO attributed to employee service to date

Most Common so far is Health Care Benefits

Illustrative Problems (Retirement Benefits)

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 330,000 x 3% = 9,900

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 Service Cost increases Defined Benefit Expense

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 Interest Cost increase Defined Benefit Cost

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 Return on Plan Assets decreases the Defined Benefit Cost

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 Past Service Cost is the Present Value of the retroactive Benefit from Modification of the Plan
Formula or Amendment to the Plan and increases the Defined Benefit Obligation and is included in
the Net Income as part of Expense

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 Service Cost and Interest Cost: Add to Defined Benefit Obligation
Return on Plan Assets: Adds to the Plan Assets

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 Illustrative Problems (Other Post-employment Benefits)

Accounting for Employee Benefits 27

 Other Long-term Employee Benefits

Long-term paid absences

Examples: Long-service Leave or Sabbatical Leave, Jubilee or Other Long-

service Benefits (Longevity Pay), and Long-term Disability Benefits

Termination Benefits

Benefit given to a terminated employee

Could be:

Prior to retirement of employee

Retirement Package given by the company

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