Standard IAS 19 Employee Benefits prescribes rules for recognition and presentation of various types of benefits that employers provide to their employees.
Have you ever read about employee benefits that the best employer in the world—Google provides to its employees? Just to name a few of them (besides great salaries): Free haircuts, gourmet food, high-tech cleansing toilets, on-site medical care, travel insurance, fun stuff around the office, paid maternity leave…
Well, Google even introduced “death benefit”—so if a Google employee dies during his employment, his spouse continues to receive 50% of employee’s annual salary for the next decade.
But now, look at it as a CFO. No problem to account for the benefits such as salaries or free haircuts. But what about that death benefit? The issue here is that the benefit is not paid while the employee is in service… only after it. And Google really does not know when the employees die and thus the liability becomes payable.
So that’s where IAS 19 plays its crucial role. It tells us how to account for various kinds of employee benefits and how to present them in the financial statements.
Why IAS 19?
The main objective of IAS 19 is to prescribe the accounting and disclosure for employee benefits. IAS 19 requires and entity to recognize:
- a liability when an employee has provided service in exchange for employee benefits to be paid in the future; and
- an expense when the entity consumes the economic benefit arising from service provided by an employee in exchange for employee benefits.
That’s the clear demonstration of matching principle—to recognize an expense in the period when matching revenue is recognized.
So, Google should recognize the liability for its death benefit when the employee actually works (and not when he dies); and the expense when the results of employee’s work are consumed.
Classification of Employee Benefits
IAS 19 classifies employee benefits into 4 main categories:
- Short-term employee benefits= employee benefits (other than termination benefits) that are expected to be settled wholly before twelve months after the end of the annual reporting period in which the employees render the related service.
- Post-employment benefits= employee benefits (other than termination benefits and short-term employee benefits) that are payable after the completion of employment.
- Other long-term benefits= all employee benefits other than short-term employee benefits, post-employment benefits and termination benefits.
- Termination benefits= employee benefits provided in exchange for the termination of an employee’s employment as a result of either:
- (a) an entity’s decision to terminate an employee’s employment before the normal retirement date; or
- (b) an employee’s decision to accept an offer of benefits in exchange for the termination of employment.
Now, what do you think—in which category does the Google’s death benefit fall? Go on reading and you’ll see!
Short-term Employee Benefits
Short-term employee benefits include all the following items (if payable within 12 months after the end of the reporting period):
- wages, salaries and social security contributions;
- paid annual leave and paid sick leave;
- profit-sharing and bonuses; and
- non-monetary benefits (such as medical care, housing, cars and free or subsidized goods for current employees). Well, all Google’s expenses for free haircuts or gourmet food probably belong to this category.
How to account for short-term benefits
The entity shall recognize short-term employee benefits as an expense to profit or loss (unless another IFRS requires or permits the inclusion of the benefits in the cost of an asset).
The expense shall be recognized in the undiscounted amount of short-term employee benefits expected to be paid in exchange for employee’s service rendered during an accounting period.
The accounting entry is as follows:
Short-term paid absences: Expected cost of short-term paid absences shall be recognized when the employees render service that increases their entitlement to future paid absences (in the case of accumulating paid absences); or when the absences occur (in the case of non-accumulating paid absences).
Profit sharing and bonuses: An entity shall recognize the expected cost of profit-sharing and bonus payments when the entity has a present legal or constructive obligation to make such payments as a result of past events; and a reliable estimate of the obligation can be made. A present obligation exists when, and only when, the entity has no realistic alternative but to make the payments.
Post-employment benefits include items such as various pensions, retirement benefits, post-employment life insurance and post-employment medical care.
There are 2 basic types of post-employment benefits:
- Defined contribution plans
- Defined benefit plans
It is absolutely crucial to know the difference between the two and to classify your post-employment benefit correctly, as the accounting treatment is totally different for each of them.
Defined Contribution Plans
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.
How to account for defined contribution plans
The employer shall recognize contributions payable to a defined contribution plan as an expense to profit or loss (unless another IFRS requires or permits the inclusion of the benefits in the cost of an asset).
When the contributions are not expected to be settled wholly before twelve months after the end of the reporting period, they shall be discounted.
The accounting entry is as follows:
Defined Benefit Plans
Defined benefit plans are post-employment benefit plans other than defined contribution plans. Under defined benefit plan, the employer has the obligation to pay specified amount of benefits according to the plan to the employee and all investment and actuarial risk thus fall on the entity.
And here we come to an answer to the Google question: without having any further details on the benefit, I would classify Google’s death benefit as defined benefit plan in line with IAS 19, because:
- It is paid out after the completion of employment (after employee dies, remember?)
- Google’s obligation is not limited to the contributions to some fund; instead, Google’s obligation depends on the future salary levels and thus actuarial risk falls on Google.
Accounting for defined benefit plans is probably one of the most complex issues in IFRS because it involves incorporating actuarial assumptions into measurement of the obligation and the expenses. Therefore, actuarial gain and losses arise. Also, obligations are measured on a discounted basis, because they might be settled many years after the employees render the related services.
How to account for defined benefit plans
The employers shall perform the following steps in order to account for the defined benefit plan:
Step 1: Determine Deficit or Surplus
Deficit or surplus is a difference between the present value of defined benefit obligation and fair value of plan assets as at the end of the reporting period. In order to determine it, the entity must:
- Estimate the ultimate cost of a benefit.
The entity must use projected unit credit method to estimate how much the employees have earned for their work in the current and prior periods, to attribute the benefit to the periods of service and to incorporate estimates about demographic and financial variables (“actuarial assumptions”) into calculations.
- Discount the benefit in order to determine the present value of the defined benefit obligation and the current service cost.
- Deduct the fair value of any plan assets from the present value of the defined benefit obligation.
For simple illustration of projected unit credit method, please watch the following video:
Step 2: Determine amount in the statement of financial position
Although there is quite enough numbers involved in accounting for defined benefit plan, IAS 19 requires to present them as 1 single amount in the statement of financial position – the net defined benefit liability (asset), which is basically deficit or surplus calculated in the step 1, but adjusted for the effect of asset ceiling.
Asset ceiling is the present value of any economic benefits available in the form of refunds from the plan or reductions in the future contributions to the plan.
Step 3: Determine amount in the profit or loss
The entity shall present the following amounts to profit or loss:
- Current service cost = the increase in the present value of the defined benefit obligation resulting from employee service in the current period;
- Any past service cost = the change in the present value of the defined benefit obligation for employee service in prior periods, resulting from a plan amendment or a curtailment
- Any gain or loss on settlement
- Net interest on the net defined benefit liability (asset) = the change in the net defined benefit liability (asset) during the period due to passage of time (“unwinding the discount”)
Step 4: Determine remeasurements in other comprehensive income
The entity shall present the following remeasurements to other comprehensive income:
- Actuarial gains and losses = the changes in the present value of the defined benefit obligation resulting from experience adjustments or the effects of changes in actuarial assumptions
- Return on plan assets, excluding amounts included in net interest on the net defined benefit liability (asset)
- Any change in the effect of the asset ceiling.
Other long-term benefits
Other long-term benefits include the following items (if not expected to be settled within 12 months after the end of the period in which the employee renders the related service):
- long-term paid absences such as long-service or sabbatical leave;
- jubilee or other long-service benefits;
- long-term disability benefits;
- profit-sharing and bonuses; and
- deferred remuneration.
How to account for other long-term benefits
As other long-term benefits are not subject to so much uncertainty as defined benefit plans, the accounting treatment is a bit easier.
However, the entity should perform the same steps as I have described at defined benefit plans. The only difference is that all items such as service cost, net interest on the net defined benefit liability (asset) and remeasurements of the net defined benefit liability (asset) are presented in the profit or loss – so nothing goes to other comprehensive income.
Termination benefits represent quite a different cup of tea than the previous 3 categories. Why? Because they are not provided in exchange for the service of the employee; instead, they are provided in exchange for the termination of employment.
However, be careful here, because the termination benefit sometimes includes the benefit for BOTH the termination of employment AND the service of employee at the same time.
For example, a company closes one of its production plants and offers the bonus of 1 000 USD to all employees who will be laid off. But because this company needs qualified people to perform the closure, it offers the bonus of 3 000 USD to each employee who stays with the company until the closure is completed.
In this small example, the bonus of 1 000 USD paid to all fired employees represents termination benefit and additional 2 000 USD paid to all employees who stay until the closure is completed represents the benefit for the employee’s service, mostly classified as other long-term benefit in line with IAS 19.
How to account for termination benefits
The primary question here is WHEN to recognize the liability and expense for termination benefits. It is at the earlier of:
- when the company can no longer withdraw the offer of those benefits (either the termination plan exists or employee accepts the offer of benefits) and
- when the company recognizes cost for a restructuring (IAS 37) and involves the payment of termination benefits.
The next question is HOW to recognize termination benefits. This depends on the specific terms of the benefits:
- if the termination benefits are expected to be settled wholly before 12 months after the end of the reporting period, then we should apply the requirements for short-term employee benefits (so recognize it as an expense to profit or loss on undiscounted basis)
- if the termination benefits are not expected to be settled wholly before 12 months after the end of the reporting period, then we should apply the requirements for other long-term employee benefits (so recognize it as an expense to profit or loss on discounted basis)
Please watch the following video summarizing IAS 19:
- Top Excel Formulas for IFRS —learn several Excel formulas for dealing with your own benefits + download the Excel file!
- How to Extrapolate Along Yield Curve—this helps you to set your discount rate for discounting the benefits