International Accounting Standard 19 Employee Benefits Katelijne Simeons 4 November 2002

Agenda (1) Introduction: international financial reporting standards Objective and scope of IAS19 Short-term employee benefits Post-employment benefits Other long-term employee benefits Termination benefits Equity compensation benefits

Agenda (2) Post-employment benefits: Defined contribution plan Defined benefit plan Actuarial assumptions and actuarial methods Liabilities and plan assets Accounting Actuarial Gain/Loss Past Service Cost Implementation Illustrative example Curtailment and settlement Disclosures requirements

International financial reporting standards New standards will be known as IFRS Previous standards continue to be designated “ International Accounting Standards” (IAS)

International financial reporting standards Reminder: June 2000 communication from the Commission to the Council Proposal requiring all listed companies within the EU to prepare their consolidated financial statements under IAS (deadline: 2005) Option for member states to either encourage or require earlier adoption adoption by non listed companies adoption for the entity (i.e. non consolidated) financial statements Option for member states to authorize the use of other GAAP during all or part of transitory period - not thereafter

Objective of IAS19 Objective: prescribe the accounting and disclosure for employee benefits Requires the enterprise to recognise: A liability when an employee has provided service in exchange for employee benefits to be paid in the future An expense when the enterprise consumes the economic benefit arising from service provided by an employee in exchange for employee benefits

Scope of IAS19 Applies to all employee benefits, including: formal plans and other formal agreements between the enterprise and employees, groups or representatives legislative requirements or industry arrangements informal practice that give rise to a constructive obligation Constructive obligation: when the enterprise has no realistic alternative but to pay employee benefits

Scope of IAS19 Scope – all employee benefits Applicable since 1/1/1999 Short term employee benefits Post employment benefits Other long term employee benefits Termination benefits Equity compensation benefits Applicable since 1/1/1999

Short-term employee benefits Employee benefits (other than termination and equity compensation) within 12 months after the employee rendered the related service Salaries, social security contributions, short-term compensated absence (annual or sick leave), bonuses …and non-monetary benefits (medical care, car, …)

Short-term employee benefits Accounting is generally straightforward as: No actuarial assumptions No gain/loss No discounting Expense = undiscounted amount of benefits payable during the accounting period

Post-employment benefits Employee benefits (other than termination and equity compensation) payable after the completion of service Retirement benefits, such as pensions, and other post-employment benefits, such as life insurance and medical care, … Either Defined Benefit or Defined Contribution plan Specific guidance on classification of multi-employer plans, state plans and plans with insured benefits

Other long-term employee benefits Long-service leave, jubilee or other long-service benefits, long-term disability benefits, bonus if payable after 12 months, … Simplified method of accounting: Actuarial gain/loss are recognized immediately All past service cost is recognized immediately Liability recognised = Present value of the liabilities (based on Projected Unit Credit method) Minus fair value of plan assets – if any -

Termination benefits Employee benefits payable as a result of either: Enterprise’s decision to terminate an employment before the normal date Employee’s decision to accept voluntary redundancy in exchange of such benefits Event= termination rather than employee service

Termination benefits Recognition of a liability and a cost if the employer is demonstrably committed to: Terminate the employment of an employee or group of employees, or Provide termination benefits as a result of an offer made in order to encourage voluntary redundancy

Termination benefits Demonstrably committed when: the enterprise has a detailed formal plan including: location, function, and approximate number of employees concerned; termination benefits for each job classification or function; and time at which the plan will be implemented. without realistic possibility of withdrawal.

Termination benefits Typically lump-sum payments, but may also include: enhancement of retirement benefits salary until the end of a specified notice period Immediate recognition as an expense as do not provide an enterprise with future economic benefits Discounting if benefits payable within more than 12 months

Equity compensation benefits Equity compensation benefits include: shares, share options, and other equity instruments, issued to employees at less than the fair value at which those instruments would be issued to a third party; and cash payments, the amount of which will depend on the future market price of the reporting enterprise's shares.

Equity compensation benefits IAS19 does not specify recognition and measurement requirements for equity compensation benefits Requires detailed disclosures intended to give information on the enterprise’s financial position, performance and cash flows.

Equity compensation benefits Disclosures must include: the nature, terms and characteristics of equity compensation plans (including the accounting policy); the number and terms of the equity financial instruments which are held, issued and lapsed by equity compensation plans at the beginning and end of the period;

Equity compensation benefits Disclosures must also include: the fair value, at the beginning and end of the period, of the enterprise's own equity financial instruments (other than share options) held by equity compensation plans; and the fair value, at the date of issue, of the enterprise's own equity financial instruments (other than share options) issued by the enterprise to equity compensation plans or to employees, or by equity compensation plans to employees, during the period. If it is not practicable to determine the fair value, it should be disclosed. As no consensus exists on the determination of the fair value of share option, there is no requirement to disclose this value.

Post-employment benefits Retirement benefits, such as pensions, and Other post-employment benefits, such as life insurance and medical care, … Plan is classified as: Defined Benefit or Defined Contribution

Post-employment Benefits: Defined Contribution Plan Defined contribution plans are post-employment benefit plans under which an enterprise 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.

Post-employment Benefits: Defined Contribution Plan The contributions or premiums are defined in the rules of the plan Ex. Annual premium = 5% of salary The benefit is the result of the total contributions paid and the return on investments obtained

Post-employment Benefits: Defined Contribution Plan The enterprise's legal or constructive obligation is limited to the amount that it agrees to contribute to the fund Actuarial risk (that benefits will be less than expected) and investment risk (that assets invested will be insufficient to meet expected benefits) fall on the employee

Post-employment Benefits: Defined Contribution Plan Accounting is straightforward because: Obligation for each period is determined by the amounts to be contributed So, no actuarial assumptions No possibility for gain or loss Undiscounted basis, except if after 12 months Disclosure: amount recognized as expense

Post-employment Benefits: Defined Benefit Plan Post-employment benefits plans other than defined contribution plans The actuarial risk (benefits are more than expected) fall on the enterprise.

Post-employment Benefits: Defined Benefit Plan The benefit is defined in the rules of the plan The retirement benefit is determined by reference to a formula usually based on an employee’s remuneration (salary and other benefits), years of service, or other factors Ex. Pension = 70 % of final salary less State pension

Post-employment Benefits: Defined Benefit Plan Accounting involves following steps: determining estimate of the benefit relative to service rendered, based on actuarial assumptions about demographic and financial variables; discounting that benefit based on actuarial method, to determine the present value of the defined benefit obligation and the current service cost; determining the fair value of any plan assets; determining the total amount of actuarial gains and losses and the amount that should be recognised; if the plan has changed, determining the past service cost; in case of curtailment or settlement, determining the resulting gain or loss

Post-employment Benefits: Defined Benefit Plan Basic principles liability to be recognized in employer’s balance sheet cost to be accounted for through P&L Determination of the expense requires actuarial method actuarial assumptions

Post-employment Benefits: Defined Benefit Plan Actuarial Method required by IAS19 is the Projected Unit Credit method The Defined Benefit Obligation (DBO) = the present value of the benefit payable at due date (retirement) based upon projected salary based on past service

Post-employment Benefits: Defined Benefit Plan – actuarial assumptions present value of a benefit at retirement = probability x interest x benefit at of the event factor retirement - withdrawal - discount rate - inflation - mortality - future salary increase - disability - retirement age

Post-employment Benefits: Defined Benefit Plan - actuarial assumptions Demographic assumptions mortality in service and after retirement rates of withdrawal age at retirement disability …

Post-employment Benefits: Defined Benefit Plan - actuarial assumptions Financial assumptions discount rate expected long term return on plan assets salary increase salary scale social security increase inflation …

Post-employment Benefits: Defined Benefit Plan - actuarial assumptions employer is responsible unbiased and mutually compatible financial assumptions based on market expectations at the balance sheet date discount rate by reference to high quality corporate bonds government bonds where no deep market in corporate bonds

Post-employment Benefits: Defined Benefit Plan - actuarial method present value of a benefit at retirement = probability x interest x benefit at of the event factor retirement - withdrawal - discount rate - inflation - mortality - future salary increase - disability - retirement age

Post-employment Benefits: Defined Benefit Plan - actuarial method Some actuarial methods and typical financing for pension plans: Successive single premiums Level annual premiums Projected Unit Credit Method

Post-employment Benefits: Defined Benefit Plan - actuarial method Financing methods: Illustration: Constitution of a retirement lump sum of 100 over 4 periods of 10 years 100 25 25 25 25 Age IN =25 10 y 20 y 30 y 40 y Retirement age Basic Principle : “IN” = “OUT”:  4 x 25 = 100

Post-employment Benefits: Defined Benefit Plan - actuarial method 1st method: financing based on successive single premiums 100 25 25 25 25 interest interest interest premium premium premium premium X=25 10 y 20 y 30 y 40 y Retirement age

Post-employment Benefits: Defined Benefit Plan - actuarial method 2nd method: financing based on level annual premiums 100 Average = level annual => premium 25 25 25 25 interest interest premium premium premium premium X=25 10 y 20 y 30 y 40 y Retirement age

Post-employment Benefits: Defined Benefit Plan - actuarial method Overfunding at the beginning 100 25 interest interest interest premium premium premium premium X=25 10 y 20 y 30 y 40 y Retirement age

Post-employment Benefits: Defined Benefit Plan - actuarial method 208 Snow-ball effect!! 100 100 (x=25) 100 (x=35) 100 (x=45) 100 (x=55) 108 50 50 58 33 33 33 25 25 25 25 25 X=25 10 y 20 y 30 y 40 y Retirement age Early Leave : Underfunding

Post-employment Benefits: Defined Benefit Plan - actuarial method Conclusion for plan financed through level annual premium: beginning : overfunding (effect 1) later : underfunding (effect 2) & snowball effect - effect 2 + effect 1 Contrary to International Accounting Principles

Post-employment Benefits: Defined Benefit Plan - actuarial method 3rd method: financing based on Projected Unit Credit Method 400 10/40 x 400 = 20/40 x 400 - 100 = 100 30/40 x 400 - 200 = 100 40/40 x 400 - 300 = 100 100 (25y) 100 (35y) 100 (45y) 100 (55y) 100 X=25 10 y 20 y 30 y 40 y retirement age Proportional accrual of projected lump sum

Post-employment Benefits: Defined Benefit Plan - actuarial method Defined Benefit Obligation (DBO) is the present value of the employer’s liability at any point in time Based on the past service Based on the projected salaries Service Cost (SC) is the cost of the benefit for one year Under normal (Belgian) circumstances: Service cost = Accrued Liability / length of past service

Post-employment Benefits: Defined Benefit Plan – actuarial method DBO: Defined Benefit Obligation Last Year Now DBO Projected Salary Projection Service cost Current Salary Last year’s salary 25 Last Year Now Retirement age discounting

Post-employment Benefits: Defined Benefit Plan – actuarial method As compared to an insured plan Projected salary DBO Projection Unfunded DBO Current salary Assets (reserve) 25 Retirement age discounting

Post-employment Benefits: Defined Benefit Plan – Plan Assets Plan assets comprise: (1) assets held by a long-term employee benefit fund; and (2) qualifying insurance policies. (1) Assets held by a long-term employee benefit fund are assets that: are held by an entity (a fund) that is legally separate from the reporting enterprise and exists solely to pay or fund employee benefits; and are available to be used only to pay or fund employee benefits, are not available to the reporting enterprise's own creditors (even in bankruptcy), and cannot be returned to the reporting enterprise Plan assets measured at market value or at fair value

Post-employment Benefits: Defined Benefit Plan – Plan Assets (2) A qualifying insurance policy is an insurance policy issued by an insurer that is not a related party, if the proceeds of the policy: can be used only to pay or fund employee benefits under a defined benefit plan; are not available to the reporting enterprise's own creditors (even in bankruptcy) and cannot be paid to the reporting enterprise When it is certain that another party will reimburse some expenditure required, a reimbursement of rights may be recognised and treated as plan assets

Post-employment Benefits: Defined Benefit Plan - Accounting Basic principles Accrued Projected Past Service Liability (DBO) at any point in time to be reflected in employer’s balance sheet Overfunded DBO is recorded as a prepaid asset (attention to recoverability test) Unfunded DBO is recorded as a liability

Post-employment Benefits: Defined Benefit Plan - Accounting The liability in the balance sheet comprises: Defined Benefit Obligation (DBO) - fair value of assets unrecognised past service cost unrecognised actuarial losses (gains) unrecognised transitional liability (if any) In case of an asset (fair value of assets exceeding DBO), pay attention to recoverability test

Post-employment Benefits: Defined Benefit Plan - Accounting The amount to be recognized in an employer's financial statement as the Pension Expense comprises: Current service cost (net of employees contribution) + Interest cost - Expected return on plan assets + Amortization of past service cost Amortization of gains (losses) +/- Effect of curtailment or settlement

Post-employment Benefits: Defined Benefit Plan – Actuarial Gain/Loss Actuarial gains and losses originate from : experience adjustments effects of changes in assumptions Actuarial losses (gains) are equal to : (real DBO - expected DBO) + (expected assets - real assets)

Post-employment Benefits: Defined Benefit Plan – Actuarial Gain/Loss Expected DBO EoY = DBO BoY + current service cost + interest cost - benefits paid Expected assets EoY = assets BoY + expected return + premiums paid - benefits paid

Post-employment Benefits: Defined Benefit Plan – Actuarial Gain/Loss Actuarial gains and losses recognition if higher than 10% of the maximum of the DBO and the assets (“corridor”) amortization of this exceeding part over the average remaining career of the employees quicker amortization is allowed Amortization principle is in contradiction with 4th European Directive and is currently being examined by the Board

Post-employment Benefits: Defined Benefit Plan – Past service cost cost for past service due to a plan change amortized over the average period until the benefits become vested

Post-employment Benefits: Defined Benefit Plan – Implementation Transitional liability at implementation date: DBO less fair value of plan assets Compare with existing liability already recognised in the accounts under previous accounting policy If less: immediate recognition under IAS8 (pay attention to recoverability test) If more: immediate recognition through Equity, possible amortisation through P&L over maximum 5 years if previous accounting policy was IAS

Post-employment Benefits: Defined Benefit Plan - Illustrative example Pension plan formula: lump sum at retirement = 10% final salary per year of service Data: Retirement age: 65 Age as at 01/01/2002: 40 Past service as at 01/01/2002 (N1): 15 Salary on 01/01/2002 (S): 31 250 EUR Assumptions: discount rate: 5.5% inflation: 2% p.a. salary increase (on top of inflation): 2% p.a. until age 50 1% p.a. until age 65 probability of being in the company at age 65: 75 %

Post-employment Benefits: Defined Benefit Plan - Illustrative example DBO (Projected Unit Credit Method) Projected retirement lump sum (= payable at retirement) = 10% x FS x N = 10% x 31 250 x (1,02)25 x (1,02)10 x (1,01)15 x 40 = 290 226,21 Benefit for service up to calculation date = N1/N x total lump sum = 15/40 x 290 226,21 = 108 834,83 DBO as at 01/01/2002 (= present value of the liability) : = probability event x discounting factor x benefit = 75% x 1/(1,055)25 x 108 834,83 = 21 405,12

Post-employment Benefits: Defined Benefit Plan - Illustrative example DBO as at 01/01/2002 = 21 405,12 Current service cost = cost 1 year of service = DBO/ past service = 21 405,12 / 15 = 1 427,01 Interest cost = (DBO + SC) x discount rate = (21 405,12 + 1 427,01) x 0,055 = 1 255,77

Post-employment Benefits: Defined Benefit Plan - Illustrative example Plan assets: Fair value 01/01/02: 15 000 EUR Premiums paid in 2002: 1 500 EUR Expected return on plan assets: 4,75% Benefits: 0 Expected return on assets: = 4,75% x (15 000 + ½ x 1 500) = 748,13 Cost: = current service cost + interest cost – expected return on assets = 1 427,01+1 255,77 - 748,13 = 1 934,65

Post-employment Benefits: Defined Benefit Plan - Illustrative example Expected DBO 31/12/2002 : = DBO 01/01/2002 + current service cost + interest cost - benefits = 21 405,12 + 1 427,01 + 1 255,77 - 0 = 24 087,90 Assuming salary increased in 2002 more than expected: Actual DBO 31/12/2002 = 26 000 Therefore: Loss on DBO is 1 912,10

Post-employment Benefits: Defined Benefit Plan - Illustrative example Expected value of assets 31/12/2002 : = Assets 01/01/2002 + expected return + premiums paid - benefits = 15 000 + 4,75% x (15 000 + ½ x 1 500) + 1 500 - 0 = 17 248,13 Poor performance on assets: Actual assets 31/12/2002 = 16 400 Therefore: Loss on Assets is 848,13

Post-employment Benefits: Defined Benefit Plan - Illustrative example Total Actuarial Loss/(Gain) as at 31/12/2002: = 1 912,10 + 848,13 = 2 760,23 10% corridor = 10% of max (DBO;Assets) = 2 600 Amortisation of Loss in 2003 will be: = (2 760,23 – 2 600)/18 = 8,90

Post-employment Benefits: Defined Benefit Plan - Illustrative example Defined benefit obligation Plan assets at fair value Funded status Unrecognized net (gain) / loss Unrecognized past service cost (Accrued)/ prepaid pension cost 01/01/02 31/12/02 (21 405,12) (26 000,00) 15 000,00 16 400,00 (6 405,12) (9 600,00) 0 2 760,23 0 0 ________ _______ (6 405,12) (6 839,77)

Post-employment Benefits: Defined Benefit Plan - Illustrative example Total cost for the year 2002 current service cost (net of Ee contr) 1 427,01 interest cost 1 255,77 amortisation of past service cost 0 amortisation of gain/loss 0 return on assets (748,13) Total : 1 934,65 Employer contribution (1 500) Additional accrued pension cost 434,65

Post-employment Benefits: Defined Benefit Plan - Illustrative example Reconciliation of Defined Benefit Obligation (EUR) Defined Benefit obligation as at 1/1/2002 (21 405,12) Current Service Cost (1 427,01) Interest Cost (1 255,77) Benefits paid 0 Amendments 0 Actuarial gain/(loss) (1 912,10) Defined Benefit Obligation as at 31/12/2002 (26 000,00)

Post-employment Benefits: Defined Benefit Plan - Illustrative example Reconciliation of plan assets (EUR) : Fair value of plan assets as at 1/1/2002 15 000,00 Expected return on assets 748,13 Employer contributions 1 500,00 Employee contributions 0 Benefits paid 0 Assets gain/(loss) (848,13) Fair value of plan assets as at 31/12/2002 16 400,00

Post-employment Benefits: Defined Benefit Plan – Illustration Example: typical plan insured (one person only – from age 25-65)

Post-employment Benefits: Defined Benefit Plan – Illustration Example: typical plan insured (one person only – from age 25-65)

Post-employment Benefits: Defined Benefit Plan – Illustration Example: typical plan insured (one person only – from age 25-65)

Post-employment Benefits: Defined Benefit Plan – Curtailment/Settlement A curtailment occurs when an enterprise either: is demonstrably committed to make a material reduction in the number of employees covered by a plan; or amends the terms of a defined benefit plan such that a material element of future service by current employees will no longer qualify for benefits, or will qualify only for reduced benefits.

Post-employment Benefits: Defined Benefit Plan – Curtailment/Settlement A settlement occurs when an enterprise enters into a transaction that eliminates all further legal or constructive obligation for part or all of the benefits provided under a defined benefit plan, for example, when a lump-sum cash payment is made to, or on behalf of, plan participants in exchange for their rights to receive specified post-employment benefits.

Post-employment Benefits: Defined Benefit Plan – Curtailment/Settlement Settlement and Curtailment (Gain)/Loss= any resulting change in the present value of the defined benefit obligation (remeasure on current assumptions) any resulting change in the fair value of the plan assets any related actuarial gains and losses, past service cost and transition amounts that have not yet been recognised

Post-employment Benefits: Defined Benefit Plan – Curtailment/Settlement When curtailment relates to only some employees or only part of an obligation is settled: recognise proportionate share of unrecognised gain/loss, past service cost and transition amounts proportionate share based on DBO curtailed or settled unless another basis is more rational.

Post-employment Benefits: IAS19 - Disclosure Requirements Accounting policy for recognizing actuarial gains and losses A general description of the type of plan A reconciliation of the assets and liabilities in the balance sheet The amounts included in the fair value of assets of own financial instruments and property or other assets used by the employer

Post-employment Benefits: IAS19 - Disclosure Requirements Reconciliation of movements during the period of the liability in the balance sheet Details of total expense in the income statement Actual return on plan assets Principal actuarial assumptions used