1. Corporate Reporting

2. 2 Employment Benefits  Apply and discuss the accounting treatment of short term benefits.  Apply and discuss the accounting treatment of defined contribution and defined benefit plans.  Account for gains and losses on settlements and curtailments. Learning outcomes:

3. 3 Short term Employee Benefit Expense recognised as employee provide service AccumulatingNon-Accumulating Recognised as expense as employee provide service by reference to which the entitlement to such benefits accrues No expense or liability recognised until the time of the absence Wages, salaries Short-term compensated absences e.g.- annual leave, sick leave Profit-sharing and bonuses payable within 12 months Non-monetary benefits e.g.- medical care, housing Same as Wages, salaries Recognise an expense and a corresponding liability when:  entity has present / constructive obligation  reliable estimate can be made Short term Employee Benefit

4. 4 Post Employment Schemes Defined contribution: a fixed contribution is paid by the company on a monthly/annual basis eg $100 per month Yr 1 Yr 2 Yr 3 But, if fund does not have enough cash, company does not have to contribute more

5. 5 Post Employment Schemes Defined benefit: obligation of company to pay a defined benefit on retirement, so company contributes regularly and contributes shortfall if necessary. Eg pay an employee 80% of his final salary throughout retirement. Yr 1 Yr 2 Yr 3 payable at retirement

6. 6 Post Employment Schemes Multi employer scheme: assets pooled for separate entities and pooled assets used to meet obligations of all entities entity 1 entity 2 entity 3 Paid to different people from different entities

7. 7 Problems with Defined Benefit Schemes Difficult in reality! How do you know.  How long people will live?  How long they will work for you?  What the final salary will be?  How long they will need their pension?

8. 8 Actuarial Assumptions Demographic assumptions: deal with  mortality, both during and after employment  rates of employee turnover, disability and early retirement  the proportion of plan members with dependants who will be eligible for benefits  claim rates under medical plans Example Employees are eligible for additional pension after becoming 70 years. While determining the present value of the obligation the probability that not all employees will survive for 70 years needs to be considered. Mars will estimate that, for example, 80% of employees will reach 70 years. Need to factor in these points: an example of a demographic assumption

9. 9 Financial assumptions relate to:  the discount rate  future salary and benefit levels  in the case of medical benefits, future medical costs, including, where material, the cost of administering claims and benefit payments  the expected rate of return on plan assets Example (Refer Page 233) Saturn Ltd has a defined benefit plan for its employees. According to the plan, a lump sum of $2,500 is payable on retirement for each year of service. The benefit of $2,500 is attributable to each year of service. That means, for an employee completing 15 years in the entity, the benefit payable will be $37,500 ($2,500 x 15). Current service costs. An example of a financial assumption Actuarial Assumptions

10. 10 The projected unit credit method for determining the present value of the defined benefit obligation, current service cost & past service cost (if applicable) Example (Refer page 235) A lump sum benefit is payable on termination of service and equal to 1% of final salary for each year of service. The salary in year 1 is 15,000 and is assumed to increase at 9% (compound) each year. The discount rate used is 10% per annum. The following table shows how the obligation builds up for an employee who is expected to leave at the end of year 7, assuming that there are no changes in actuarial assumption. For simplicity, this example ignores the additional adjustment needed to reflect the probability that the employee may leave the entity at an earlier or later date. Required Determine the present value of the benefit obligation and show how this builds up over the years? Continued… Projected Unit Credit Method

11. 11 Step by step: Projected Unit Credit Method Step 1: Determine the salary at the time of retirement as follows:  Salary at the time of retirement = Salary of first year x (1 + rate of salary increase) (No. of years of service left – 1)  Final salary at year 7 (15,000 compounded at 9%) 15,000 x (1 + 0.09)6 = 25,157 Step 2: Determine the expected pension as follows:  1% of final salary attributed to each year (25,157 x 1%)252  Expected final benefit7 years x 1% x 25,157 = 1,761 Continued…

12. 12 Step by step: Projected Unit Credit Method Step 3: Calculate the present value of the current service cost for each year of service:  Current service cost = 252 (as calculated above)  Current service cost, being present value of 252 discounted at 10%: e.g.  Year 1252 x (1 + 0.1)-6 = 142  Year 2 252 x (1 + 0.1)-5 = 156  Year 3 252 x (1 + 0.1)-4 = 172  Year 4 252 x (1 + 0.1)-3 = 189  Year 5 252 x (1 + 0.1)-2 = 208  Year 6 252 x (1 + 0.1)-1 = 229  Year 7 = 252 Continued…

13. 13 Step by step: Projected Unit Credit Method Step 4: Determine the benefits attributed to current period and prior period as given Step 5: Determine the obligation for each period as given Interest & current service cost are expenses in SOCI Year 1234567 Benefit attributed to: Prior year02525047561,008 1,2601,512 Current year (1% of final salary) (see step 1 and 2)252 Current and prior years 2525047561,0081,2601,5121,764* Opening Obligation 1423125157551,0391,372 Interest at 10% (on opening obligation) 14315176104137 Current service cost (see STEP 3)142156172189208 229252 Closing obligation1423125157551,039 1,3721,761* Liability in SOFP

14. 14 Managing Retirement Benefits Financial Statements Fund for employees – (plan assets in SOFP)  Account for the liability each year  Make additional payments if needed  Show expenses in current service costs Contributions, Dividends interest Payments Netted off against liability in the SOFP Shown as a liability in the SOFP Liability to employees – (defined obligations in SOFP)

15. 15 Plan Assets Assets held by a long- term employee benefits fund are:  Held by a fund which is legally separate from reporting entity  Used solely to pay or fund employee benefits Plan assets excludes: Unpaid contributions due from the reporting entity to the fund Measurement: Measured at fair value and presented as net off of defined benefit obligation in SOFP Extract of SOFP$ Non-current liabilities Present value of defined benefit obligationxxx Less: Plan asset(xxx)

16. 16 Actual Return Actual Return: Fair value on date of SOFP LESS: FV of plan assets at beg of year LESS: Contributions received ADD: Benefits paid Actuarial gain / loss on assets = Actual Return - Expected Return Expected return is based on the opening market values Companies plan for assets to give an expected return. Usually the actual and expected returns are different: Plan asset Dr$$Cr Balance b/fxxxBenefits paidxxx Contribution receivedxxx Actual return (balancing fig)xxxBalance c/fxxx Recognised in SOCI Refer example (Pepco) on page 240

17. 17 Past Service Costs  What if your employer suddenly increases your benefits?  E.g. you are to be paid 5% of your final salary for each year you have worked, but the co now increases it to 7% of your final salary  Immediately the co will have to put in more money for all the years you have worked in past – past service cost! If benefits are not vested Past service costDr Defined benefit obligation Cr Being past service cost immediately recognised in SOCI & is included in closing obligation. If benefits are already vested Past service cost (on straight line basis)Dr Defined benefit obligationCr Being past service cost recognised on straight line over the average period until benefits become vested in SOCI & is included in closing obligation. Refer example on page 241

18. 18 In the SOFP … The following will be shown as a liability in SOFP: Present value of obligation X Less: Fair value of plan assets (X) Unrecognised actuarial (losses) / gains (X) / X Less: Unrecognised past service costs (X) Less: Unrecognised increase in the liability on initial adoption of the standard(X) Defined benefit obligation / (plan asset)(X) Is discussed later “Asset Ceiling” test: ceiling on the carrying value of an asset. Refer Example on Page 248 In case a negative amount i. e. an asset is derived in SOFP, the resulting asset shall be measured at the lower of following:  The amount as determined above OR  The total of any cumulative unrecognised net actuarial losses and past service cost; the PV of any economic benefits available in the form of refunds or reductions in future contributions Such restriction on the measurement of recognition of plan asset in SOFP is called “Asset Ceiling Test”

19. 19 Examples of actuarial gains and losses are:  differences between the actual return on plan assets and the expected return on plan assets  the effect of changes in the discount rate  the effects of changes in estimates of future employee turnover, early retirement or mortality or of increases in salaries, benefits or medical cost Actuarial gain or loss on DB obligations  Do actuaries always get the figure of defined benefit obligations right?  NO  Unexpected mortality rates  Higher/lower turnover of staff  Increases in salaries Actuarial gains or losses calculated: PV of obligation at beginning of period (actuary tells us)X Interest costs (to increase obligation)X Current and past service costs X Benefits paid (X) Actuarial gain/loss (balancing figure) (X)/X PV of obligation at end of period (actuary tells us) X Shown in the SOFP separately at unrecognised gain/loss

20. 20 Methods to recognise Actuarial Loss/Gains Higher of (A) & (B) is compared with net cumulative unrecognised gain/loss (A) 10% PV of defined benefit obligation before deducting plan asset (B) 10% FV of plan assets (C ) = “Corridor limit” = higher amongst (A) & (B) The excess of unrecognised actuarial gains & losses over (C) is spread over the working lives of the employees participating in the plan. If (C) > the unrecognised gains & losses, they are within the corridor limit 1.Corridor method: Refer Example on Page 246

21. 21 2.Systematic method resulting in faster recognition of actuarial gain/loss  Same method has to be applied to both the gains & losses.  It is applied consistently from period to period  Even if the actuarial gains and losses are within the specified limits this method may be applied Refer Example (Reva Ltd) on Page 247 Methods to recognise Actuarial Loss/Gains

22. 22 Current service cost X Interest costs X Expected return on plan assets (X) Recognised actuarial (gains)/losses (X) / X Recognised past service costs X Effect of curtailments or settlements X Reimbursements (X) Total amount of expense X In the SOCI (income statement) related expenses presented net of reimbursements : Reimbursements In case where part or all of the expenditure on settlement of defined benefit obligation is reimbursed by another party Such reimbursement of expenditure will be recognised at fair value in financial statements only if it is certain that the expenditure will be reimbursed. It may be treated in similar manner as that of a plan asset.

23. 23 Offset In SOFP the offsetting of an asset of one plan against the liability of another plan is permitted only if the entity :  has a legally enforceable right to do so  intends either to settle the obligations on a net basis, or to realise the surplus in one plan and settle its obligation under other plan simultaneously Accounting for Gains and losses on settlements and curtailments A curtailment occurs when an entity either: a) is demonstrably committed to make a material reduction in the number of employees covered by a plan or; b) 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. IAS 19 Para 112 Example (Refer Page 243) Share Ltd had a benefit plan for its employees. Under the pension plan, the pension paid was 2% of the retirement salary for each year of service. In 20X6, the entity decided that the future service by the current employees will not qualify for pension. This amounts to curtailment.

24. 24 A settlement occurs when an entity 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. Examples of such situations are:  sale of a subsidiary  transfer from defined benefit plan to defined contribution plan Example (Refer Page 244) Reva Ltd had a defined benefit plan for its employees. During 20X6, it decided to make a one time lump sum payment to its employees who were members of the plan in exchange for their rights to receive specified post-employment benefits. This is a situation of settlement of a plan. Here the benefit obligation is extinguished. Gain or loss on settlement or curtailment of defined benefit plan comprises Change in present value of the defined benefit obligation Change in the fair value of plan asset Related unrecognised actuarial gains or losses & past service cost For determining the effect curtailment & settlement the obligation and related plan asset should be remeasured Settlement and Curtailments

25. 25 If curtailment relates to only a part of the employees, the gain or loss includes, proportionate share of previously unrecognised past service cost & actuarial gains or loss. The proportionate share is determined on the basis of the present value of the obligations before and after the curtailment or settlement. Refer Example on Page 245 Settlement and Curtailments

26. 26  Apply and discuss the accounting treatment of short term benefits.  Apply and discuss the accounting treatment of defined contribution and defined benefit plans.  Account for gains and losses on settlements and curtailments. RECAP

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