1. International Accounting Standard 19 Employee Benefits Katelijne Simeons 4 November 2002

2. 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

3. 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

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

5. 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

6. 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

7. 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

8. 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

9. 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, …)

10. 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

11. 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

12. 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 -

13. 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

14. 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

15. 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.

16. 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

17. 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.

18. 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.

19. 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;

20. 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.

21. 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

22. 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.

23. 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

24. 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

25. 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

26. 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.

27. 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

28. 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

29. 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

30. 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

31. 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

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

33. 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 …

34. 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

35. 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

36. 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

37. 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

38. 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

39. 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

40. 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

41. 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

42. 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

43. 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

44. 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

45. 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

46. 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

47. 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

48. 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

49. 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

50. 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

51. 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

52. 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)

53. 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

54. 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

55. 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

56. 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

57. 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): EUR
Assumptions: discount rate: %
inflation: 2% p.a. salary increase (on top of inflation): 2% p.a. until age % p.a. until age 65 probability of being in the company at age 65: 75 %

58. 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 x (1,02)25 x (1,02)10 x (1,01)15 x 40 = ,21
Benefit for service up to calculation date = N1/N x total lump sum
= 15/40 x ,21 = ,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 ,83 = ,12

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

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

61. Post-employment Benefits: Defined Benefit Plan - Illustrative example
Expected DBO 31/12/2002 : = DBO 01/01/ current service cost + interest cost - benefits = , , , = ,90
Assuming salary increased in 2002 more than expected: Actual DBO 31/12/2002 =
Therefore: Loss on DBO is 1 912,10

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

63. Post-employment Benefits: Defined Benefit Plan - Illustrative example
Total Actuarial Loss/(Gain) as at 31/12/2002: = 1 912, ,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

64. 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/ /12/02
(21 405,12) (26 000,00)
15 000, ,00
(6 405,12) (9 600,00)
,23
________ _______
(6 405,12) (6 839,77)

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

66. 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
Amendments
Actuarial gain/(loss) (1 912,10)
Defined Benefit Obligation as at 31/12/2002 (26 000,00)

67. Post-employment Benefits: Defined Benefit Plan - Illustrative example
Reconciliation of plan assets (EUR) :
Fair value of plan assets as at 1/1/ ,00
Expected return on assets ,13
Employer contributions ,00
Employee contributions
Benefits paid
Assets gain/(loss) (848,13)
Fair value of plan assets as at 31/12/ ,00

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

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

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

71. 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.

72. 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.

73. 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

74. 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.

75. 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

76. 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