not just to unfunded obligations of employers but also to funded plans. The details of
pension scheme arrangements vary widely from jurisdiction to jurisdiction and, indeed,
within them. Frequently though, they involve some entity or fund, separate from the
employer, to which contributions are made by the employer (and sometimes
employees) and from which benefits are paid. Typically, the employer (through either
legal or constructive obligations) essentially underwrites the fund in the event that the
assets in the fund are insufficient to pay the required benefits. This is the key feature
which means such an arrangement is a defined benefit plan (see 3 above). [IAS 19.56].
In addition to specifying accounting and disclosure requirements, IAS 19 summarises the
steps necessary to apply its rules, to be applied separately to each separate plan, as follows:
(a) determining the deficit or surplus by:
(i) using an actuarial technique, the projected unit credit method, to make a
reliable estimate of the ultimate cost to the entity of the 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 (actuarial assumptions)
about demographic variables (such as employee turnover and mortality) and
financial variables (such as future increases in salaries and medical costs) that
will affect the cost of the benefit;
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(ii) discounting that benefit in order to determine the present value of the defined
benefit obligation and the current service cost; and
(iii) deducting the fair value of any plan assets from the present value of the
defined benefit obligation.
(b) determining the amount of the net defined benefit liability (asset) as the amount of
the deficit or surplus determined in (a), adjusted for any effect of limiting a net
defined benefit asset to the asset ceiling;
(c) determining amounts to be recognised in profit or loss:
(i) current service cost;
(ii) any past service cost and gain or loss on settlement;
(iii) net interest on the net defined benefit liability (asset); and
(d) determining the remeasurements of the net defined benefit liability (asset), to be
recognised in other comprehensive income, comprising:
(i) actuarial gains and losses;
(ii) return on plan assets, excluding amounts included in net interest on the net
defined benefit liability (asset); and
(iii) any change in the effect of the asset ceiling, excluding amounts included in
net interest on the net defined benefit liability (asset). [IAS 19.57].
Retirement benefits will often be very significant in the context of an employer’s
financial statements. Therefore, the standard encourages, but does not require
involvement of a qualified actuary in the measurement of all material post-employment
benefit obligations. [IAS 19.59]. However, the standard acknowledges that in some
circumstances estimates, averages and computational shortcuts may provide a reliable
approximation. [IAS 19.60]. These steps are discussed in further detail in the sections 7.5
and 7.6 below.
6
DEFINED BENEFIT PLANS – PLAN ASSETS
6.1
Definition of plan assets
IAS 19 provides the following definitions relating to plan assets:
‘Plan assets comprise:
(a) assets held by a long-term employee benefit fund; and
(b) qualifying
insurance
policies.’
[IAS 19.8].
‘Plan assets exclude unpaid contributions due from the reporting entity to the fund, as
well as any non-transferable financial instruments issued by the entity and held by the
fund. Plan assets are reduced by any liabilities of the fund that do not relate to employee
benefits for example, trade and other payables and liabilities resulting from derivative
financial instruments.’ [IAS 19.114].
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‘Assets held by a long-term employee benefit fund are assets (other than non-
transferable financial instruments issued by the reporting entity) that:
(a) are held by an entity (a fund) that is legally separate from the reporting entity and
exists solely to pay or fund employee benefits; and
(b) are available to be used only to pay or fund employee benefits, are not available to
the reporting entity’s own creditors (even in bankruptcy), and cannot be returned
to the reporting entity, unless either:
(i)
the remaining assets of the fund are sufficient to meet all the related employee
benefit obligations of the plan or the reporting entity; or
(ii) the assets are returned to the reporting entity to reimburse it for employee
benefits already paid.’
Whilst non-transferable financial instruments issued by the employer are excluded from
the definition of plan assets, plans can, and do, own transferrable instruments issued by
the employer (such as listed shares and bonds) and these would qualify as plan assets.
‘A qualifying insurance policy is an insurance policy issued by an insurer that is not a
related party (as defined in IAS 24 – Related Party Disclosures) of the reporting entity,
if the proceeds of the policy:
(a) can be used only to pay or fund employee benefits under a defined benefit plan; and
(b) are not available to the reporting entity’s own creditors (even in bankruptcy) and
cannot be paid to the reporting entity, unless either:
(i) the proceeds represent surplus assets that are not needed for the policy to
meet all the related employee benefit obligations; or
(ii) the proceeds are returned to the reporting entity to reimburse it for employee
benefits already paid.’ [IAS 19.8].
A footnote to this definition clarifies that a qualifying insurance policy is not necessarily
an insurance contract as defined in IFRS 4/IFRS 17 – Insurance Contracts.
IFRS 4 further mentions insurance contracts in the context of pensions. It discusses
insurance policies issued by an insurer to a pension plan covering employees of the
insurer or another entity consolidated in the same financial statements as the insurer. In
such circumstances, IFRS 4 provides that the contract will generally be eliminated from
the financial statements. The financial statements will:
• include the full amount of the pension obligation under IAS 19, with no deduction
for the plan’s rights under the contract;
• not include a liability to policyholders under the contract; and
• include the assets backing the contract. [IFRS 4.IG2. E1.21].
The above has not been carried over into IFRS 17.
6.2
Measurement of plan assets
IAS 19 requires plan assets to be measured at their fair value, [IAS 19.113], which is defined
as the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. [IAS 19.8]. This
is the same definition as is used in IFRS 13 – Fair Value Measurement (see Chapter 14).
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The fair
value of any plan assets is deducted from the present value of the defined
benefit obligation in determining the deficit or surplus – see 8 below. [IAS 19.113].
6.3 Qualifying
insurance
policies
Where plan assets include qualifying insurance policies that exactly match the amount
and timing of some or all of the benefits payable under the plan, the fair value of those
insurance policies is deemed to be the present value of the related obligations, subject
to any reductions required if the amounts receivable under the insurance policies are
not recoverable in full. [IAS 19.115].
6.4 Reimbursement
rights
Some employers may have in place arrangements to fund defined benefit obligations
which do not meet the definition of qualifying insurance policies above but which do
provide for another party to reimburse some or all of the expenditure required to settle
a defined benefit obligation. In such a case, the expected receipts under the
arrangement are not classified as plan assets under IAS 19 (and hence they are not
presented as part of a net pension asset/liability – see 8 below). Instead, the employer
should recognise its right to reimbursement as a separate asset, but only when it is
virtually certain that another party will reimburse some or all of the expenditure
required to settle a defined benefit obligation. The asset should be measured at fair value
and, in all other respects, it should be treated in the same way as a plan asset. In
particular, changes in fair value are disaggregated and accounted for in the same way as
plan assets – see 10.3 below. In profit or loss, the expense relating to a defined benefit
plan may be presented net of the amount recognised for a reimbursement. [IAS 19.116-118].
As is the case for qualifying insurance policies, for reimbursement rights that exactly
match the amount and timing of some or all of the benefits payable fair value is
determined as the present value of the related obligation, subject to any reduction
required if the reimbursement is not recoverable in full. [IAS 19.119].
6.5
Contributions to defined benefit funds
Contributions to defined benefit plans under IAS 19 are a movement between line items
in the statement of financial position – the reduction in cash for the employer being
reflected by an increase in the plan assets. Perhaps because of this straightforward
accounting, the standard provides no guidance on contributions, which it implicitly
deals with as always being in the form of cash.
Although contributions are very commonly in cash, there is no reason why an employer
could not contribute any other assets to a defined benefit plan and that raises the question
of how to account for the disposal – particularly so, since from the point of transfer the
assets will be measured at fair value under IAS 19. In our view, such a transfer of a non-
cash asset should be treated as a disposal, with proceeds equal to the fair value of the
asset. That would give rise to gains and losses in profit or loss (unless the asset in question
was already carried at fair value) and, for certain assets (such as debt instruments held at
fair value through other comprehensive income), the reclassification into profit or loss of
amounts previously recognised in other comprehensive income.
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6.6 Longevity
swaps
A longevity swap transfers, from a pension scheme to an external party, the risk of
members living longer (or shorter) than expected.
The Interpretations Committee was asked in August 2014 to clarify the measurement of
longevity swaps held by an entity’s defined benefit plan, and in particular discussed
whether an entity should:
(a) account for a longevity swap as a single instrument and measure its fair value as
part of plan assets (discussed at 6.2 above) with changes in fair value being
recorded in other comprehensive income; or
(b) split longevity swaps into two components.
The two components in (b) would be a ‘fixed leg’ and a ‘variable leg’. As the variable leg
exactly matches some or all of the defined benefit obligation it would represent a
qualifying insurance policy and be measured at the present value of the related
obligation (discussed at 6.3 above).The fixed leg comprises a series of fixed payments to
be made in return for the receipt of the variable leg receipts. In other words, a longevity
swap could be considered to be economically equivalent to the purchase of qualifying
insurance (commonly called a ‘buy-in’) but with the premium paid over a period of time
rather than at inception.
The likely effect of disaggregating a longevity swap in this way would be to recognise a
loss at inception very similar to that for a buy-in. Conversely, considering the swap as a
single instrument measured at fair value would likely have no initial effect as typically
its fair value would be zero (that is, a premium neither received nor paid).
If the two legs were to be considered separately, an appropriate accounting policy
would need to be applied to the fixed leg. Two possibilities were discussed by the
Interpretations Committee as follows. The fixed leg would initially be measured at fair
value with subsequent accounting either:
• if treated as part of plan assets, at fair value with interest reported in profit or loss
and other changes being included in other comprehensive income (discussed at 6.2
above); or
• if a financial liability at amortised cost using the effective interest rate with interest
recognised in profit and loss and no other remeasurements.
The Interpretations Committee noted that when such transactions take place, the
predominant practice is to account for a longevity swap as a single instrument and
measure it at fair value as part of plan assets.
The Interpretations Committee decided not to add this issue to its agenda as it did not
expect diversity to develop in the application of IAS 19.8 Given that the Interpretations
Committee decided not to add this to its agenda we believe that either of the subsequent
accounting options detailed above would be acceptable.
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7
DEFINED BENEFIT PLANS – PLAN LIABILITIES
7.1
Legal and constructive obligations
IAS 19 refers to the liabilities of defined benefit plans as the present value of defined
benefit obligations, which it defines as ‘... the present value, without deducting any plan
assets, of expected future payments required to settle the obligation resulting from
employee service in the current and prior periods’. [IAS 19.8].
The obligations should include not only the benefits set out in the plan, but also any
constructive obligations that arise from the employer’s informal practices which go
beyond the formal plan terms, and should where relevant include an estimate of expected
future salary increases (taking into account inflation, seniority, promotion and other
relevant factors, such as supply and demand in the employment market). [IAS 19.61, 87-90].
A constructive obligation exists where a change in the employer’s informal practices
would cause unaccept
able damage to its relationship with employees and which
therefore leaves the employer with no realistic alternative but to pay those employee
benefits. [IAS 19.61]. The term constructive obligation is not defined by IAS 19; however,
as can be seen from the above it is very similar to the meaning of the term as used in
IAS 37 where it is defined as follows:
‘A constructive obligation is an obligation that derives from an entity’s actions where:
(a) by an established pattern of past practice, published policies or a sufficiently
specific current statement, the entity has indicated to other parties that it will
accept certain responsibilities; and
(b) as a result, the entity has created a valid expectation on the part of those other
parties that it will discharge those responsibilities.’ [IAS 37.10].
However, IAS 19 goes on to add a further nuance. The standard observes that it is usually
difficult to cancel a retirement benefit plan (without payment) whilst still retaining staff,
and in light of this it requires that reporting entities assume (in the absence of evidence to
the contrary) any currently promised benefits will continue for the remaining working lives
of employees. [IAS 19.62]. In our view, this is a somewhat lower hurdle, and could bring into
the scope of defined benefit accounting promises which are (strictly) legally unenforceable
and which would not necessarily be considered constructive obligations under IAS 37.
An employer’s obligations (legal or constructive) may also extend to making changes to
benefits in the future. The standard requires all such effects to be built into the computation
of the obligation and gives the following examples of what they might comprise:
(a) a past history of increasing benefits, for example, to mitigate the effects of inflation,
and no indication that this practice will change in the future;
(b) the entity is obliged, either by the formal terms of the plan (or a further constructive
obligation) or by legislation to use any surplus in the plan for the benefit of plan
participants; or
(c) benefits vary in response to a performance target or other criteria. For example, the
terms of the plan may state that it will pay reduced benefits or require additional
contributions from employees if the plan assets are insufficient. The measurement of
the obligation reflects the best estimate of the effect of target or other criteria. [IAS 19.88].
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 555
