International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

by International GAAP 2019 (pdf)

  of the annual reporting period after such an event. The amendments also clarify how the

  requirements for accounting for a plan amendment, curtailment or settlement affect the

  asset ceiling requirements. The amendments have an effective date of 1 January 2019 with

  early application permitted. See 10.2 and 10.3 below for further details.

  Employee benefits typically form a very significant part of any entity’s costs, and can

  take many and varied forms. Accordingly, IFRS devotes considerable attention to them

  in two separate standards. IFRS 2 – Share-based Payment –is discussed in Chapter 30.

  All other employee benefits are dealt with in IAS 19.

  Many issues raised in accounting for employee benefits can be straightforward, such as the

  allocation of wages paid to an accounting period, and are generally dealt with by IAS 19

  accordingly. In contrast, accounting for the costs of retirement benefits in the financial

  statements of employers presents one of the most difficult challenges in the whole field of

  financial reporting. The amounts involved are large, the timescale is long, the estimation

  process is complex and involves many areas of uncertainty which have to be made the

  subject of assumptions. Furthermore, the complexities for an International Standard are

  multiplied by the wide variety of arrangements found in different jurisdictions.

  2

  OBJECTIVE AND SCOPE OF IAS 19

  2.1 Objective

  IAS 19 sets out its objective as follows:

  ‘The objective of this Standard is to prescribe the accounting and disclosure for

  employee benefits. The Standard requires an entity to recognise:

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  (a) a liability when an employee has provided service in exchange for employee

  benefits to be paid in the future; and

  (b) an expense when the entity consumes the economic benefit arising from service

  provided by an employee in exchange for employee benefits.’ [IAS 19.1].

  This provides the first glimpse of the direction taken by the standard. Driven by the focus on

  assets and liabilities in the IASB’s Conceptual Framework (which is discussed in Chapter 2),

  it approaches the issues from the perspective of the statement of financial position.

  2.2 Scope

  Section 2.2.1 below deals with the general scope of the standard. The issue of employee

  benefits settled not by the employing entity but by a shareholder or other member of a

  group is discussed at 2.2.2 below.

  2.2.1

  General scope requirements of IAS 19

  As its name suggests, IAS 19 is not confined to pensions and other post-retirement

  benefits, but rather addresses all forms of consideration (apart from share-based

  payments which are dealt with by IFRS 2 and discussed in Chapter 30) given by an

  employer in exchange for service rendered by employees or for the termination of

  employment. [IAS 19.2, 8]. In particular, in addition to post-retirement benefits employee

  benefits include: [IAS 19.5]

  (a) short-term benefits, including wages and salaries, paid annual leave, bonuses,

  benefits in kind, etc. The accounting treatment of these is discussed at 12 below;

  (b) other long-term benefits, such as long-service leave, long-term disability benefits,

  long-term bonuses, etc. These are to be accounted for in a similar, but not identical,

  way to post-retirement benefits by using actuarial techniques and are discussed

  at 13 below; and

  (c) termination benefits. These are to be provided for and expensed when the

  employer becomes committed to the redundancy plan, on a similar basis to that

  required by IAS 37 – Provisions, Contingent Liabilities and Contingent Assets –

  for provisions generally, and are discussed at 14 below.

  The standard addresses only the accounting by employers, and excludes from its scope

  reporting by employee benefit plans themselves. These are dealt with in IAS 26 –

  Accounting and Reporting by Retirement Benefit Plans. [IAS 19.3]. The specialist nature

  of these requirements puts them beyond the scope of this book.

  The standard makes clear it applies widely and in particular to benefits:

  (a) provided to all employees (whether full-time, part-time, permanent, temporary or

  casual staff and specifically including directors and other management personnel);

  [IAS 19.7]

  (b) however settled, including payments in cash or goods or services, whether paid

  directly to employees, their spouses, children or other dependants or any other

  party (such as insurance companies); [IAS 19.6] and

  (c) however provided, including:

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  benefits

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  (i) under formal plans or other formal agreements between an entity and

  individual employees, groups of employees or their representatives;

  (ii) under legislative requirements, or through industry arrangements, whereby

  entities are required to contribute to national, state, industry or other multi-

  employer plans; or

  (iii) by those informal practices that give rise to a constructive obligation, that is where

  the entity has no realistic alternative but to pay employee benefits. An example of

  a constructive obligation is where a change in the entity’s informal practices would

  cause unacceptable damage to its relationship with employees. [IAS 19.4].

  The standard does not define the term ‘employee’. However, it is clear from the

  reference in (a) above to ‘full-time, part-time, permanent, casual or temporary’ staff and

  specifically including directors and other management personnel that the term is

  intended to apply widely. In particular, it is not necessary for there to be a contract of

  employment in order for an individual to be considered an employee for IAS 19

  purposes. In our view, the standard applies to anyone who is in substance an employee,

  and that will be a matter of judgement in light of all the facts and circumstances.

  2.2.2

  Employee benefits settled by a shareholder or another group entity

  In some circumstances, employee benefits may be settled by a party other than the

  entity to which services were rendered by employees. Examples would include a

  shareholder or another entity in a group of entities under common control.

  IAS 19 is silent on whether, and if so how, an entity receiving employee services in this

  way should account for them. IFRS 2, on the other hand, devotes quite some detail to

  this topic for employee services within its scope.

  An entity could make reference to the hierarchy in IAS 8 – Accounting Policies,

  Changes in Accounting Estimates and Errors (discussed in Chapter 3 at 4.3) when

  deciding on an accounting policy under IAS 19. Accordingly, these provisions of IFRS 2

  could be applied by analogy to transactions within the scope of IAS 19.

  The relevant requirements of IFRS 2 are discussed in Chapter 30 at 2.2.2.A and at 12.

  3

  PENSIONS AND OTHER POST-EMPLOYMENT BENEFITS –

  DEFINED CONTRIBUTION AND DEFINED BENEFIT PLANS

  3.1

  The distinction between defined contribution plans and defined

  benefit plans

  IAS 19 draws the important distinction between defined contribution plans and defined

  benefit plans. The determination is made based on the economic substance of the plan

  as
derived from its principal terms and conditions. [IAS 19.27]. The approach it takes is to

  define defined contribution plans, with the defined benefit plans being the default

  category. The relevant terms defined by the standard are as follows: [IAS 19.8]

  ‘Post-employment benefits are employee benefits (other than termination benefits and

  short-term employee benefits) that are payable after the completion of employment’.

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  ‘Post-employment benefit plans are formal or informal arrangements under which an

  entity provides post-employment benefits for one or more employees’.

  ‘Defined contribution plans are post-employment benefit plans under which an entity pays

  fixed contributions into a separate entity (a fund) and will have no legal or constructive

  obligation to pay further contributions if the fund does not hold sufficient assets to pay all

  employee benefits relating to employee service in the current and prior periods’.

  ‘Defined benefit plans are post-employment benefit plans other than defined

  contribution plans’.

  IAS 19 applies to all post-employment benefits (whether or not they involve the

  establishment of a separate entity to receive contributions and pay benefits) which

  include, for example, retirement benefits such as pensions; and post-employment life

  assurance or medical care. [IAS 19.26]. A less common benefit is the provision of services.

  Under defined benefit plans the employer’s obligation is not limited to the amount that

  it agrees to contribute to the fund. Rather, the employer is obliged (legally or

  constructively) to provide the agreed benefits to current and former employees.

  Examples of defined benefit schemes given by IAS 19 are: [IAS 19.29]

  (a) plans where the benefit formula is not linked solely to the amount of contributions

  and requires the entity to provide further contributions if assets are insufficient to

  meet the benefits in the plan formula;

  (b) guarantees, either directly or indirectly through a plan, of a specified return on

  contributions; and

  (c) those informal practices that give rise to a constructive obligation, such as a history

  of increasing benefits for former employees to keep pace with inflation even where

  there is no legal obligation to do so.

  The most significant difference between defined contribution and defined benefit plans

  is that, under defined benefit plans, some actuarial risk or investment risk (or both) falls,

  in substance, on the employer. This means that if actuarial or investment experience is

  worse than expected, the employer’s obligation may be increased. [IAS 19.30].

  Consequently, because the employer is in substance underwriting the actuarial and

  investment risks associated with the plan, the expense recognised for a defined benefit

  plan is not necessarily the amount of the contribution due for the period. [IAS 19.56].

  Conversely, under defined contribution plans the benefits received by the employee are

  determined by the amount of contributions paid (either by the employer, the employee

  or both) to the benefit plan or insurance company, together with investment returns, and

  hence actuarial and investment risk fall in substance on the employee. [IAS 19.28].

  3.2 Insured

  benefits

  One factor that can complicate making the distinction between defined benefit and

  defined contribution plans is the use of external insurers. IAS 19 recognises that some

  employers may fund their post-employment benefit plans by paying insurance

  premiums and observes that the benefits insured need not have a direct or automatic

  relationship with the entity’s obligation for employee benefits. However, it makes clear

  that post-employment benefit plans involving insurance contracts are subject to the

  same distinction between accounting and funding as other funded plans. [IAS 19.47].

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  benefits

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  Where insurance premiums are paid to fund post-employment benefits, the employer

  should treat the plan as a defined contribution plan unless it has (either directly or

  indirectly through the plan) a legal or constructive obligation to:

  (a) pay the employee benefits directly when they fall due; or

  (b) pay further amounts if the insurer does not pay all future employee benefits

  relating to employee service in the current and prior periods.

  If the employer has retained such a legal or constructive obligation it should treat

  the plan as a defined benefit plan. [IAS 19.46]. In setting out how to apply defined

  benefit accounting, however, the standard refers to slightly different criteria to

  determine whether a legal or constructive obligation is retained. Rather than

  referring to ‘either directly or indirectly through the plan’, paragraph 48 of IAS 19

  refers to ‘the entity (either directly, indirectly through the plan, through the

  mechanism for setting future premiums or through a related party relationship with

  the insurer) retains a legal or constructive obligation’ (emphasis added). [IAS 19.48]. In

  our view, this asymmetry is most likely a drafting error and the additional text

  applies in both instances.

  In cases where such obligations are retained by the employer, it recognises its rights

  under a ‘qualifying insurance policy’ as a plan asset and recognises other insurance

  policies as reimbursement rights. [IAS 19.48]. Plan assets are discussed at 6 below.

  By way of final clarification, the standard notes that where an insurance policy is in

  the name of a specified plan participant or a group of plan participants and the

  employer does not have any legal or constructive obligation to cover any loss on the

  policy, the employer has no obligation to pay benefits to the employees and the

  insurer has sole responsibility for paying the benefits. In that case, the payment of

  fixed premiums under such contracts is, in substance, the settlement of the employee

  benefit obligation, rather than an investment to meet the obligation. Consequently,

  the employer no longer has an asset or a liability. Accordingly, it should treat the

  payments as contributions to a defined contribution plan. [IAS 19.49]. The important

  point here is that employee entitlements will be of a defined benefit nature unless

  the employer has no obligation whatsoever to pay them should the insurance fail or

  otherwise be insufficient.

  The analysis of insured plans given in the standard, which is described above, along

  with the definition of defined benefit and defined contribution plans seems

  comprehensive at first glance. However, there will be circumstances where the

  distinction may not be so apparent and careful analysis may be required. For

  example, it is possible that an employer buys insurance on a regular basis (say

  annually), retaining no further obligation in respect of the benefits insured, but has

  an obligation (legal or constructive) to keep doing so in the future. In such a scenario,

  the employer may be exposed to future actuarial variances reflected in a variable cost

  of purchasing the required insurance in future years (for example, due to changing

  mortality estimates by the insurer).

  Another scenario would be where each year the employee earns an entitlement to a

  pension of (say) 2% of that year’s (i.e. current a
s opposed to final) salary and the employer

  purchases each year an annuity contract to commence on the date of retirement.

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  In our view, the standard is not entirely clear as to the nature of such an arrangement.

  On the one hand, it could be argued that it is a defined contribution plan because the

  definition of defined contribution plans is met when:

  • ‘fixed’ payments are paid to a separate fund; and

  • the employer is not obliged to pay further amounts if the fund has insufficient assets

  to pay the benefits relating to employee service in the current and prior periods.

  Further, as noted above the standard considers the payment of ‘fixed’ premiums to

  purchase insurance specific to an employee (or group thereof) with no retention of risk

  in respect of the insured benefits to be a defined contribution arrangement.

  On the other hand, it could be argued that this is a defined benefit plan on the grounds that:

  • the premiums of future years are not ‘fixed’ in any meaningful sense (certainly not in the

  same way as an intention simply to pay a one-off contribution of a given % of salary);

  • the standard acknowledges that one factor that can mean insured arrangements are

  defined benefit in nature is when the employer retains an obligation indirectly

  through the mechanism for setting future premiums; [IAS 19.48] and

  • the standard observes that under defined benefit plans ‘... 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 entity’s

  obligation may be increased’. [IAS 19.30].

  Much would seem to depend on just what ‘fixed’ means in such circumstances. Although

  not expressly addressed by the standard, in our view such arrangements will very likely

  be defined benefit in nature, albeit with regular (and perhaps only partial) settlement and,

  if so, should be accounted for as such. This is because the employer has retained actuarial

  risks by committing to pay whatever it takes in future years to secure the requisite

  insurance. Naturally, for any schemes that are determined to be defined benefit plans, the

  next step would be to see whether the frequent settlement renders the output of the two

  accounting models materially the same. That would depend, inter alia, on the attribution