ias 19 short presentation

7/29/2019 IAS 19 short presentation

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Emmanuel Eragne Lille University - M2 CCA US GAAP

Year 2010 - 2011

Employee Benefits

Post-employment benefits

Defined Benefit Plans

IAS 19


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Introduction

The International Accounting Standard 19 prescribes the accounting method and disclosure

by employers for employee benefits.

This standard is currently being revised by the IASB, which has issued an exposure draft inApril 2010. We will by default refer to the current version of the standard, and later we will

discuss the potential impact of the proposed amendments.

The current IAS 19 identifies four different types of employee benefits:

Short-term employee benefits are the wages, salaries and social securitycontributions, and all other forms of benefits (whether monetary or not) payable

within 12 months to current employees.

Post-employment benefits are essentially pensions, life insurance and healthcareplans.

Other long-term employee benefits refers to benefits that are payable 12 monthsor more after the end of the reporting period.

Termination benefits are benefits payable upon termination of the employmentcontract (regardless of whether it results from a decision of the employer or the

employee).

Also, post-employment benefit plans are divided into two types of plans: defined

contribution plans and defined benefit plans.

When the former applies, the employer pays a fixed amount of money to a third-party fund.

In return, this entity assumes full responsibility for providing retired employees with benefits.

The employer bears no obligation to pay the benefits if the fund happens to default.

Other plans are defined benefit plans. Here, the employer remains responsible for paying

employee benefits. The IAS 19 therefore requires that companies account for defined

benefit obligations as a liability, and provides the method for valuating it.

Under a defined benefit plan, the amount to which current and former employees are

entitled results from a formula (e.g. employees are entitled to 1% of their last annual salary

per year of service.)

The employer thus bears an actuarial risk, i.e. the risk that benefits will actually cost more

than what is currently expected, and the risk that investments aimed at financing theemployers obligation will yield less than anticipated.


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Tableofcontents

IAS19:EmployeeBenefits-Post-employmentbenefits-DefinedBenefitPlans 1

Introduction 2

ImplementationofIAS19Post-employmentbenefits-DefinedBenefitplans 4

Definedbenefitobligation 5

Planassets 7

Actuarialgainsandlosses 8

Pastservicecost 10

Disclosure 12

Conclusion:IAS19proposedamendments 15


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ImplementationofIAS19Post-employmentbenefits-Defined

Benefitplans

Because the employers liability will be settled in the future, several actuarial assumptions

need to be made in order to evaluate it.

1) The first step consists in estimating the defined benefit obligation, i.e. the amount to

which current and former employees are eligible to in return for their services in the past and

current reporting periods. The reporting entity then splits this amount into what is

attributable to past periods and to the current period, using the Projected Credit Unit

Method (PCUM).

Because the employers liability will be settled in the future, the gross obligation must be

discounted to reflect:

The time value of money The fact that all of the current employees will not necessarily be employed by the

entity by the time they reach the retirement age.Several actuarial assumptions need to be made in order to perform this calculation.

2) If the employer has committed money to funding the obligation, the fair value of

these investments (called plan assets) must be determined.

3) The third step consists in calculating actuarial gains and losses. Actuarial gains and

losses are linked to the assumptions made by the reporting entity, and arise in two cases:

Actual experience differs from assumptions. For example, as will be seen later, theemployer needs to estimate its turnover rate. If it turns out that this parameter had

been over/underestimated, actuarial losses or gains will ensue.

Revision of the assumptions (thanks to actual experience, the entity may decide tolower or raise its turnover rate estimate for the years ahead.)When actuarial gains and losses are determined, the entity may also have to calculate what

part of these gains/losses has to be recognized over the current period.

4) Finally, the company determines the result of amendments made to the plan, as well

as the impact from curtailments and settlements.

The Standard mentions that informal practices must also be taken into account, if the entity

has actually no choice but to comply with that informal practice.

The entity will report post-employment benefits as a liability in its statement of financial

position, for the amount defined as follows:

[EQ.1] Liability = + Present value of the defined benefit at the end of the

reporting period (i.e. the amount calculated in 1.)

+ Actuarial gains (minus actuarial loss) not yet recognized

- Any past service cost not yet recognized

- The fair value of plan assets (if any) held in order to cover thedefined benefit obligation

If the total is negative, an asset may be recognized under certain conditions, as will be seen

later.


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Definedbenefitobligation

The company shall use the PCUM to spread the total obligation over the time of service of

the related employees.

Example: a company has one employee on its payroll. His current salary is 20,000 and we

assume that it increases by 3% a year. He has been employed by the entity for 5 years and

is expected to retire in 10 years. According to the defined benefit plan, he is entitled to 1%

of his final annual salary per year of service.

The estimated benefit payable 10 years from now is:

!! = 20,0001.03!" 5 + 10 0.01 = 4,032Because at this point in time the employee has been rendering services for 5 years, the

gross obligation is scaled to reflect the part already earned:

!!! = 4,032 515= 1,344

The service cost is the additional benefit earned by the employee during the reporting

period. It is thus!,!"#

!"= 269 in our example.

Future value of benefits attributable to prior and current years:

Dec. 31 2010 2011 2012 2013 2014

Obligation by 2020 4,032 4,032 4,032 4,032 4,032

Benefit attributed to current and prior years 1,344 1,613 1,882 2,151 2,420

Benefit attributed to current year 269 269 269 269 269

Benefit attributed to prior years 1,075 1,344 1,613 1,882 2,151

The PCUM require that the company recognize the benefits over the period during which

they arise. This time frame may differ from the employment period. For instance, if in our

example the defined benefit is capped at 12% of the final salary:

!! = 20,0001.03!"120.01 = 3,225The 3,225 benefit will be attributed to the prior 5 years and next 7 years. The service cost

related to the 2018-2020 period will be zero.

The future value must then be discounted in order to reflect the time value of money and the

probability that current employees will actually be eligible to the benefits. It is recommended

that companies use the services of an actuary, because several assumptions need to be

made in order to perform the calculation:

Demographic assumptions:o Mortality, both during and after employment;o Rates of turnover, disability and early retirement;o The proportion of plan members with dependents who will be eligible for plan

benefits;o Claim rates if the plan covers healthcare costs.


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Financial assumptions:o Discount rate;o Future salary and benefit levels;o Future medical costs, if covered.

The assumptions must be unbiased (i.e. neither excessive or too conservative) and mutuallycompatible. Mutual compatibility means that assumptions must be consistent with one

another. For instance, a salary increase of .5% a year implies low inflation, so the discount

rate should also reflect an anticipation of low inflation.

Example: the 4,032 is a lump-sum payment on Dec. 31, 2020. The plan does not cover

healthcare costs, and we take the following values for our parameters:

Mortality rate 3% (flat)

Turnover, disability, early retirement 5.5%

Discount rate 7%

Annual salary increase 3% (see supra)

The actuarial value of the obligation at the end of the reporting period is thus:

1,344(1 .03)!"(1 .055)!"(1+ .07)!!" = 286The discounting factors are raised to the tenth power because the obligation is payable ten

years from now. All things staying equal, in 2011 the discounting factor will be

(1 .03)!(1 .055)!(1 + .07)!!. As the settlement date approaches, the impact ofdiscounting fades off, and the company recognizes an interest cost on its obligation.

Dec. 31 2010 2011 2012 2013 2014

Obligation by 2020 4032 4032 4032 4032 4032

Benefit attributed to current and prior years 1344 1613 1882 2151 2420

Benefit attributed to current year 269 269 269 269 269

Benefit attributed to prior years 1075 1344 1613 1882 2151

Discounting factor (Mortality + Turnover + Time

Value of Money) 21% 25% 29% 34% 40%

Present Value of Defined Benefit attributed to

prior and current year286 401 546 728 957

Present Value of Defined Benefit attributed to prior

year196 286 401 546 728

Interest on prior years Defined Benefit 33 48 67 91 122

Present Value of prior years Defined Benefit 229 334 468 637 850

Present value of service cost 57 67 78 91 106

Present Value of Defined Benefit attributed to

prior and current year286 401 546 728 957

The company shall use as its discounting rate the market yield on high quality corporate

bonds. These bonds should also be traded in the same currency as the defined benefit, and

have the same maturity date. When national financial markets do not provide reliable yield

curve for corporate bonds, government bonds (which are more liquid) can be used instead.

If there is no match in terms of maturity, the entity can extrapolate long-term rates from theknown short-term rates.


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According to the IAS 19 Estimates of future salary increases take account of inflation,

seniority, promotion and other relevant factors, such as supply and demand in the

employment market.

Planassets

The fair value of plan assets offsets the defined benefit obligation. Plan assets comprise

assets held by a long-term employee benefit fund, and insurance policies.

The assets must be held by a separate, bankruptcy-remote, entity and they must be

exclusively available for payment of the employee benefits.

In the same way, insurance policies are eligible only if proceeds can only be used for

payment of the benefits.

Fair valueis the amount for which an asset could be exchanged or a liability settled between

knowledgeable, willing parties in an arms length transaction. When no market price is

available, the fair value is estimated. The standard suggest using the discounted cash-flow

method, with a discount rate that reflects the risk of the assets and the maturity of the

obligation.

With regards to insurance policies that qualify as plan assets:

If the contract stipulates it matches euro for euro the obligation that has arisen fromone defined benefit plan, then the fair value is the present value of the obligation (it

would thus be 286 in our illustration)

If the right to reimbursement from the insurance company is a nominal amount, it isthe fair value.

Besides the fair value of plan assets, the entity deducts the expected return on assets from

the defined benefit obligation. The return on plan assets comprises interests, dividends, and

other revenues derived from plan assets, together with realized and unrealized gains and

losses on assets.

Administration costs related to the fund holding the assets that are not included in other

actuarial assumptions are deducted from expected return.

Example: every year, the employer invests in plan assets in order to partially fund its defined

benefit obligation. The expected rate of return on assets is 10% after tax. There is no

significant administration cost.

Dec. 31 2010 2011 2012 2013 2014

Present value of Defined Benefit (+) 286 401 546 728 957

Fair value of plan assets (-) 100 130 168 220 292

Expected return on plan assets, net of tax (-) 10 13 17 22 29

Additional contribution on Dec. 31 (-) 20 25 35 50 100

Net defined benefit obligation 156 233 326 436 536


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Actuarialgainsandlosses

Because actuarial assumptions are estimates, they will probably differ from observed

values. Actuarial gains and losses will arise as a result of:

Experience adjustments the difference between the anticipated and the actualvalue of parameters.

Change in actuarial assumptions thanks to additional information, the companymay decide to increase or lower the value of some parameters for future estimates.

All assumptions are concerned: salary increase rate, turnover, discounting rate, expected

return on plan assets, etc.

Example: in 2011 salaries went up by 6% and assets returned 70%. Actuarial assumptions

remain the same. The defined benefit payable on Dec. 31, 2020 is now:

21,2001.03! 6 + 9 0.01 = 4,149The part attributable to current and prior years (as at Dec. 31, 2011) is therefore:

4,149 615

(1 .03)!(1 .055)!(1 + .07)!! = 412There is a 11 actuarial loss, since the present value of the defined benefit obligation is

412, while the expectation on Jan. 1, 2011 was 401.

With regards to the return on assets, we observe an actuarial gain of 78 (actual: 130.7 =91 vs. expected 13), so the net effect is a gain of 67.

Table 4 - Revised plan on Dec. 31, 2011

Dec. 31 2011 2012 2013 2014 2015

Present value of Defined Benefit 412 561 749 984 1 276

Fair value of plan assets 246 306 387 525 727

Unrecognized actuarial gain of return of assets 0 ? ? ? ?

Net defined benefit obligation 166 255 363 459 549

Accounting for actuarial gains and losses

The IAS 19 allows for two accounting methods: the entity can recognize actuarial gains andlosses as profit or expense, or in other comprehensive income (OCI).

In the first case, actuarial gains and losses and be recognized:

o Immediately;o Or over the average remaining working time of the employees, using the

corridor method.

Example: according to [EQ.1], if actuarial gains and losses are recognized

immediately, the company will account for a defined benefit liability of 1661 in its

statement of financial position (assuming there is no unrecognized past service cost).

This method induces little overhead in the accounting process but brings volatility

1Table4,line7,col.2


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into the income statement, since actuarial gains and losses are by essence

unpredictable. The 2011 defined benefit expense would be 10 as detailed below:

Current service cost (67)

Interest on Obligation (48)

Actuarial loss (on current servicecost) (11)

Contribution paid into the plan 25

Expected return on plan assets 13

Actuarial gain (on return on assets) 78

Total (10)

This is consistent with a 166 liability, given that it was at 156 on Jan. 1st.

The corridor method consist in:

1. Determining the net cumulative actuarial gain/loss (i.e. the sum of all gainssince inception of the plan minus the sum of all losses)

2. Comparing the net cumulative actuarial gain/loss with the greater of: 10% of the present value of the defined benefit obligation on Dec. 31 10% of the fair value of plan assets on Dec. 31

3. If the net cumulative actuarial gain/loss is less than the 10%; then noactuarial gain or loss is recognized in the financial statements.

If not, the fraction above the 10% is recognized over the average remaining

working time frame of the employees.

Example: assuming this is the first year the company experience an actuarial gain or

loss, the net cumulative actuarial result is equal to the 2011 actuarial gain of 67.

The defined benefit obligation on Dec. 31 is 412 and the fair value of plan assets is 246.

The corridor is 41.20, so a 25.80 gain will be recognized over 10 years (25.80 = 67

41.20).

In this case, the entity accounts for a 230.42 liability:

Dec. 31 2011

Present value of Defined Benefit (+) 412

Fair value of plan assets (-) 246

Unrecognized actuarial gain (+) 41.20 + 25.80*9/10 = 64.42

Net defined benefit obligation 230.42

The year-over-over increase in liability of 74.42 (230.42 156 = 74.42) implies a

74.42 benefit expense. This result can also be obtained as shown below:

Current service cost (67)




Actuarial gain (25.80*1/10) 2.58Total (74.42)


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Every year, the net cumulative actuarial gain/loss is recalculated, as is the corridor. If the

present value as at Dec. 31, 2012 of the defined benefit obligation is 600 instead of 561 as

expected on Jan. 1st, 2012; then the net cumulative gain will be:

64.42 - (600 561) = 25.42. With a 60 corridor (600*10%) no actuarial gain or loss will be

recognized.

This method reduces income volatility, as gains and losses will likely offset each other in the

long term, and will thus stay within the limits of the corridor.

If the entity has opted for recognizing actuarial gains and losses in OCI, it must do so for

ALL actuarial gains and losses and across ALL defined benefit plans.

Actuarial and losses must be presented distinctively in the statement of comprehensive

income, and in the statement of retained earnings.

In any case, the entity shall not recycle them later through the income statement. The

standard states: They shall not be reclassified to profit or loss in a subsequent period.

Pastservicecost

The last item involved in the determination of the defined benefit obligation is the Past

Service Cost.

Past service cost can arise when the employer changes the terms of a defined benefit plan,

or when a plan is introduced. If, under the new plan, benefits are attributable to services

rendered by the employees in previous years, these benefits are considered past service

cost (even if they are not vested at that time). If the defined benefit obligation decreases as

a result of the new plan terms, the entity will account for negative past service cost.

Example: in 2011, our company changes the terms of the defined benefit plan. Employeeslisted on the payroll as of Jan. 1st, 2011 are entitled to 1,5% of final salary per year of

service instead of 1%.

The present value of the obligation as at Dec. 31, 2011 is now 618 instead of 412. The

total impact of the change is a 206 expense (206 = 618 412). The 2011 current service

cost becomes 100.50 (100.50 = 67*1.50), so the past service cost is 172.50 (172.50 = 206

[100.50 67]).

Recognition of past service cost

The standard states Such changes are in return for employee service over the period until

the benefits concerned are vested. Consequently, past service cost must be recognizedover that period.

In our example, since the employee becomes entitled to the benefit 10 years from Jan. 1st

2011, the company amortizes the 172.50 expense over 10 years, starting from 2011.

Now that all components of [EQ.1] have been defined, we can determine the actual liability

on Dec. 31, 2011:


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Dec. 31 2011


Fair value of plan assets (-) 246


Unrecognized past service cost (-) 172.50*9/10 = 155.25

Net defined benefit obligation 281.17

The implied expense of 125.17 (125.17 = 281.17 156) can also be determined as shown

below:

Current service cost (100.50)




Actuarial gain (25.80*1/10) 2.58Past service cost (172.50/10) (17.25)

Total (125.17)

Because of the complexity of managing the past service cost amortization schedule, it

should only be amended in the case of material subsequent changes. The IAS 19 cites

settlements and curtailments as events in which the amortization schedule can be modified

(settlements and curtailments occur when the employer extinguishes part or all of its

defined benefit obligation, by means of a cash settlement or changes in the terms of the

plan).

In some cases, the net defined benefit obligation can be negative. It can appear in thestatement of financial conditions as an asset, under certain circumstances.

Precisely, the asset recognized must be less or equal to:

The cumulative unrecognized actuarial loss and past service costAND

The present value of refunds or future reduction in contributions available from thefund that manages the plan assets (if the excess funding is not available to the

reporting entity, it cant be recognized as an asset)

Example: lets assume that the employer made a 1,025 contribution on Dec. 31, 2011

instead of 25.

Dec. 31 2011


Fair value of plan assets (-) 1,246


Unrecognized past service cost (-) 172.50*9/10 = 155.25

Net defined benefit obligation (718.83)

There is no unrecognized actuarial loss, so, assuming there is no restraining conditions with

regards to the availability of excess funding, the entity will account for a 718.83 asset.


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If actuarial gains and losses are in OCI they are considered as unrecognized.

Disclosure

The standard requires the employer to disclose information that enables users of financial

statements to evaluate the nature of its defined benefit plans and the financial effects of

changes in those plans during the period ( 120). In the next pages we will present the

main required disclosure and illustrate them with the 2009 Heineken NV consolidated

financial statements (Heineken NV is listed on the Amsterdam Stock Exchange and is thus

required to issue IAS/IFRS compliant financial statements).

The entity shall disclose [its] accounting policy for recognizing actuarial gains and losses

( 120 (a))

Inrespectofactuarialgainsandlossesthatarise,Heineken applies thecorridormethod incalculatingtheobligationinrespectofaplan.Totheextentthatanycumulativeunrecognizedactuarialgainorlossexceedstenper

centofthegreaterofthepresentvalueofthedefinedbenefitobligationandthefairvalueofplanassets,thatportion

is recognized in the income statement over the expected average remaining working lives of the employees

participatingintheplan.Otherwise,theactuarialgainorlossisnotrecognized.(HeinekenNV2009consolidated

financialstatements,note3-m-ii)

The entity shall disclose a reconciliation of opening and closing balances of the defined

benefit obligation showing separately, if applicable, the effects during the period attributable

to each of the following: (i) current service cost, (ii) interest cost, (iii) contributions by plan

participants, (iv) actuarial gains and losses, (v) foreign currency exchange rate changes on

plans measured in a currency different from the entitys presentation currency, (vi) benefitspaid, (vii) past service cost, (viii) business combinations, (ix) curtailments and (x)

settlements. ( 120 (c))

(HeinekenNV2009consolidatedfinancialstatements,note28)

The entity shall disclose an analysis of the defined benefit obligation into amounts arising

from plans that are wholly unfunded and amounts arising from plans that are wholly or partly

funded ( 120 (d))


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The entity shall disclose a reconciliation of the opening and closing balances of the fair

value of plan assets and of the opening and closing balances of any reimbursement right

recognized as an asset [] showing separately, if applicable, the effects during the period

attributable to each of the following: (i) expected return on plan assets, (ii) actuarial gainsand losses, (iii) foreign currency exchange rate changes on plans measured in a currency

different from the entitys presentation currency, (iv) contributions by the employer, (v)

contributions by plan participants, (vi) benefits paid, (vii) business combinations and (viii)

settlements ( 120 (e))


The entity shall disclose the total expense recognized in profit or loss for each of the

following, and the line item(s) in which they are included: (i) current service cost; (ii) interest

cost; (iii) expected return on plan assets; (iv) expected return on any reimbursement rightrecognized as an asset []; (v) actuarial gains and losses; (vi) past service cost; (vii) the

effect of any curtailment or settlement []( 120 (g))


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The entity shall disclose the principal actuarial assumptions used as at the end of the

reporting period []( 120 (n))



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Conclusion:IAS19proposedamendments

The IAS 19 is currently being revised. The IASB issued a discussion paper in 2008, followed

by the exposure draft in April 2010. The window period for sending comments ended in

September 2010.

The new approach offers less accounting options but makes recognition and measurement

simpler.

The entity would necessarily recognize actuarial gains and losses and past service cost in

OCI.

The year-over-year change in the defined benefit liability would be split into:

Service cost (still recognized as profit or expense) Finance cost (expense generated by the lesser impact of discounting from one year

to the next)

Remeasurement (actuarial gains/losses, past service costs, gains and losses arisingfrom settlements or curtailments of the defined benefit plan). The remeasurementcomponent should be recognized in OCI and then transferred immediately in

retained earnings. It should not be reclassified as profit or loss in subsequent

reporting periods.

The proposed new standard also requires additional disclosure about the characteristics of

the defined benefit plans, and about financial risk related to the plan assets.

This would bring back volatility into net income, but the entity would no longer need to keep

track of accumulated unrecognized actuarial gains/losses and past service cost.

As a result, it would make financial information more accessible to non-initiated users.


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Bibliography

International Accounting Standards Board, IAS 19 Employee Benefits (version with

amendments up to December 31, 2009).

Available for download at http://www.ifrs.org/IFRSs/IFRS.htm

International Accounting Standards Board, Exposure Draft ED/2010/3: Defined Benefit

Plans - Proposed Amendments to IAS 19, 2010

Heineken NV, Annual Report 2009

Available for download at http://www.annualreport.heineken.com/

ias 19 short presentation

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