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Post-Employment Benefits (Financial Accounting)
The firm needs it. The employees as well needs it. Overall, both are benefiting on it, with an organization paying for services render by an employee.
This page will talk about retirement benefits and how does it measure.
PREFACE
This is in accordance with the written standards of International Financial Reporting Standards, International Accounting Standards and other legitimate standards as is relevant to this topic. The topic and all of the samples given are indeed right and just.
OVERVIEW
This is in accordance with the written standards of International Financial Reporting Standards, International Accounting Standards and other legitimate standards as is relevant to this topic. The topic and all of the samples given are indeed right and just.
OVERVIEW
Post-Employment Benefits are employee benefits, aside from termination benefits, which are payable after the completion of employment. It includes: Retirements such as pensions; and other post-employment benefits pertaining to insurances such as life insurances and medical care.
Post-employee benefit plans are either formal or informal arrangements under which an entity provides post-employment benefits for one or more employees of an organization.
Formal plans are documented and approved by the entity's board of directors and are normally included in the employee's manual.
Informal plans are not documented. However, employees are still entitled to the benefits based on minimum requirements of law.
Post employment benefits are classified as either:
- Defined contribution plans;or
- Defined benefit plans.
Under defined contribution plans, there are many things that needs to consider. Namingly:
a. The entity's legal or constructive obligation is limited to the amount that it agrees to contribute to the fund. Thus, the amount of the post-employment benefits received by the employee is determined by the amount of contributions paid to the plan, together with the investment returns arising from the contributions,and
b. Actuarial risk (that benefits will cost more than expected) and investment risk (that assets invested will be insufficient to meet the expected benefits) fall, in substance, on the employee.
Meanwhile, under defined benefit plans, consider:
a. The entity's obligation is to provide the agreed benefits to current and former employees; and
b. Actuarial risk and investment risk fall,in substance, on the employer. If actual or investment experience are worse than expected,the employer's obligation may be increased.
ACCOUNTING FOR DEFINED CONTRIBUTION PLAN
It is straight forward because obligation each period is determined by the amounts to be contributed for the period. In this case, no actuarial assumptions are required to measure the obligation or the expense and there is no possibility of actuarial gains or loss. The obligations are measured on an undiscounted basis except where they do not fall due wholly within 12 months after the end of the period.
Recognition and Measurement
When an employee has rendered service to an entity during a period, the entity shall recognize the contribution payable to a defined contribution plan in exchange for that service, either:
a. As a liability (accrued expense) - recognition after deducting any contribution already paid. If the contribution paid exceeds the contribution due, that excess is recognized as an asset.
b. As an expense - recognized directly as expense.
If: The contributions to the defined contribution plan do not fall due wholly within 12 months after the end of the period in which the employees render the related service,they shall be discounted using a discount rate based on high quality corporate bonds (or in this case, government bonds if the aforementioned bond is not given).
ACCOUNTING FOR DEFINED BENEFIT PLAN
It is complex by nature because actuarial assumptions are required to measure the obligation and the expense and there is possibility of actuarial gains or losses. The obligation is measured on a discounted basis because they may be settled for may years after the employees render the services related to their specifications.
Accounting for constructive obligation
The entity shall also account for any constructive obligation that arises from the entity's informal practices where the entity has no realistic alternative but to pay employee benefits.
Accounting procedures for defined benefit plans
Step 1: Determine the PV of defined benefit obligation (DBO)
Step 2: Determine the FV of plan assets (PA)
Step 3: Determine the net defined benefit liability (asset) to be presented in the Financal Statements.
Step 4: Determine the components of defined benefit cost to be recognized in:
a. Profit or loss
b. Other comprehensive income
The first step: Determine the Present Value of the Deferred Benefit Obligation
The Present Value of the Deferred Benefit Obligation is indeed the present value without deducting any plan assets, of expected future payments required to settle the obligation resulting from employee service in the current and prior periods.
Components:
a. Current service cost - increase in PV-DBO due to services rendered in the current period.
b. Interest cost - incease in PV-DBO because the benefits are one period closer to settlement. This is simply the application of the time value of money concept.
c. Benefits paid - decrease in PV-DBO due to benefits payments made to the employees.
d. Actuarial gain from decrease (or loss from increase) in present value of DBO due to changes in actuarial assumptions.
Projected Unit Credit Method
It is the actuarial valuation method required to be used by PAS 19. It sees each period of service as giving rise to an additional unit of benefit entitlement and measures each unit separately to build up the final obligation. The retirement benefit obligation are recognized on the basis of the future salary levels of the employees (projected salaries)
Actuarial Assumptions
Actuarial assumptions are an entity's best estimates of the variables that will determine the ultimate cost of providing post-employment benefits. Actuarial assumptions comprises of the following.
a. Demographic assumptions such as:
- Mortality, both during and after employment
- Employee turnover rate, disability and early retirement
- Claim rates under medical plans
b. Financial assumptions such as:
- The discount rate
- Future salary and benefit levels
- Future medical costs
- The expected rate of return on plan assets
Actuarial Assumptions - Discount Rate
The discount rate shall be determined by reference to market yields on high quality corporate bonds (use government bonds if corporate bonds are not stated). The discount rate reflects the time value of money but not the actuarial or investment risk.
The second step: Determine the Future Value of Plan Assets
In this step, we will determine the future value of plan assets. It is comprise of the following:
1. Assets held by a long-term employee benefit fund; and
2. Quality insurance policies.
Assets hold by a long term employee benefits bond are assets that:
a. Are held by a fund that is legally from the reporting entity and exists solely to pay or fund employee benefits; and
b. Are available to be used only to pay or fund employee benefits and are not available to the reporting entity's creditors even in bankruptcy, and cannot be returned to the reporting entity unless:
i. The remaining assets of the fund are sufficient to meet all the related employee benefit obligations; or
ii. The assets are returned to reimburse it for employee benefits that are already paid.
Qualifying Insurance Policy
Qualifying Insurance Policy is an insurance policy wherein the proceeds:
a. Can be used only to pay or fund employee benefits under a defined benefit plan; and
b. Are not available to the reporting entity's own creditors (even in bankruptcy) and cannot be paid to the reporting entity, unless it is either:
i. The proceeds represent surplus asssets that are not needed for the policy to meet all the related employee benefit obligations; or
ii. The proceeds are returned to the reporting entity to reimburse it for employee benefits already paid.
The following are the components of Fair Value of Plan Assets:
a. Return on plan assets - represents the actual income ( return on investment) derived from the retirement fund during the period, net of direct costs incurred in generating the income. This will increase the value of plan assets.
b. Contributions made to the retirement fund - increases plan assets
c. Benefits paid - decreases plan assets
The third step: Determine the net defined benefit liability (or asset)
The defined benefit liability or asset is the deficit or surplus, adjusted for any effect of limiting a net defined benefit asset to the asset ceiling. This is presented in the balance sheet.
In this case, the deficit or surplus will be calculated by solving the Present Value of the deferred benefit obligation (which is step 1) less the face value of plan assets, if there is any.
Asset Ceiling
It is where there is a surplus that the entity shall measure the net defined benefit asset at the lower of:
- The surplus in the defined benefit plan; and
- The asset ceiling
The asset ceiling is the PV of the economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan determined using a discount rate based on high quality corporate bonds. (in other words, the FV of the Plan Assets using PV of the discounted cash flows)
The fourth step: Determine the components of defined benefit cost
The following are the components of defined benefit cost:
a. Service cost in profit or loss;
b. Net interest on the defined benefit liability (asset) in profit or loss; and
c. Re-measurements of the net defined benefit liability (asset) in other comprehensive income.
In this case, the service cost can be consisted by the following:
a. Current service cost
b. Past service cost – the change in the PV of DBO for employee service in prior periods, resulting from either:
– Plan amendment or
– Curtailment
c. Any gain or loss on settlement
Past service cost are recognized as expense immediately, with the possible occurrence with the following results based on given circumstances.
– A plan amendment occurs when an entity introduces, or withdraws a defined benefit plan or changes the benefits payable under an existing plan.
– A curtailment occurs when an entity significantly reduces the number of employees covered by a plan.
The gains and losses on settlement is the difference between The PV of the DBO being settled as determined on the date of settlement and the settlement price, including any plan assets transferred and any payments made directly by the entity in connection with the settlement.
Net interest consist of the following:
a. Interest income on plan assets (FV of plan assets, beg. adjusted to changes during the year x discount rate)
b. Interest cost on the defined benefit obligation (PV of DBO, beg. adjusted to changes during the year x discount rate)
c. Interest on the effect of asset ceiling (Beginning balance of the effect of asset ceiling x discount rate)
Actuarial assumptions are an entity's best estimates of the variables that will determine the ultimate cost of providing post-employment benefits. Actuarial assumptions comprises of the following.
a. Demographic assumptions such as:
- Mortality, both during and after employment
- Employee turnover rate, disability and early retirement
- Claim rates under medical plans
b. Financial assumptions such as:
- The discount rate
- Future salary and benefit levels
- Future medical costs
- The expected rate of return on plan assets
Actuarial Assumptions - Discount Rate
The discount rate shall be determined by reference to market yields on high quality corporate bonds (use government bonds if corporate bonds are not stated). The discount rate reflects the time value of money but not the actuarial or investment risk.
The second step: Determine the Future Value of Plan Assets
In this step, we will determine the future value of plan assets. It is comprise of the following:
1. Assets held by a long-term employee benefit fund; and
2. Quality insurance policies.
Assets hold by a long term employee benefits bond are assets that:
a. Are held by a fund that is legally from the reporting entity and exists solely to pay or fund employee benefits; and
b. Are available to be used only to pay or fund employee benefits and are not available to the reporting entity's creditors even in bankruptcy, and cannot be returned to the reporting entity unless:
i. The remaining assets of the fund are sufficient to meet all the related employee benefit obligations; or
ii. The assets are returned to reimburse it for employee benefits that are already paid.
Qualifying Insurance Policy
Qualifying Insurance Policy is an insurance policy wherein the proceeds:
a. Can be used only to pay or fund employee benefits under a defined benefit plan; and
b. Are not available to the reporting entity's own creditors (even in bankruptcy) and cannot be paid to the reporting entity, unless it is either:
i. The proceeds represent surplus asssets that are not needed for the policy to meet all the related employee benefit obligations; or
ii. The proceeds are returned to the reporting entity to reimburse it for employee benefits already paid.
The following are the components of Fair Value of Plan Assets:
a. Return on plan assets - represents the actual income ( return on investment) derived from the retirement fund during the period, net of direct costs incurred in generating the income. This will increase the value of plan assets.
b. Contributions made to the retirement fund - increases plan assets
c. Benefits paid - decreases plan assets
The third step: Determine the net defined benefit liability (or asset)
The defined benefit liability or asset is the deficit or surplus, adjusted for any effect of limiting a net defined benefit asset to the asset ceiling. This is presented in the balance sheet.
In this case, the deficit or surplus will be calculated by solving the Present Value of the deferred benefit obligation (which is step 1) less the face value of plan assets, if there is any.
Asset Ceiling
It is where there is a surplus that the entity shall measure the net defined benefit asset at the lower of:
- The surplus in the defined benefit plan; and
- The asset ceiling
The asset ceiling is the PV of the economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan determined using a discount rate based on high quality corporate bonds. (in other words, the FV of the Plan Assets using PV of the discounted cash flows)
The fourth step: Determine the components of defined benefit cost
The following are the components of defined benefit cost:
a. Service cost in profit or loss;
b. Net interest on the defined benefit liability (asset) in profit or loss; and
c. Re-measurements of the net defined benefit liability (asset) in other comprehensive income.
In this case, the service cost can be consisted by the following:
a. Current service cost
b. Past service cost – the change in the PV of DBO for employee service in prior periods, resulting from either:
– Plan amendment or
– Curtailment
c. Any gain or loss on settlement
Past service cost are recognized as expense immediately, with the possible occurrence with the following results based on given circumstances.
– A plan amendment occurs when an entity introduces, or withdraws a defined benefit plan or changes the benefits payable under an existing plan.
– A curtailment occurs when an entity significantly reduces the number of employees covered by a plan.
Net interest consist of the following:
a. Interest income on plan assets (FV of plan assets, beg. adjusted to changes during the year x discount rate)
b. Interest cost on the defined benefit obligation (PV of DBO, beg. adjusted to changes during the year x discount rate)
c. Interest on the effect of asset ceiling (Beginning balance of the effect of asset ceiling x discount rate)
Re-measurements of the net defined benefit liability consist of:
a. Actuarial gains or losses
b. Difference between return on plan assets and interest income on plan assets
c. Difference between the change in the effect of asset ceiling and interest on the effect of asset ceiling.
Re-measurements are recognized in Other Comprehensive Income (OCI). They shall NOT
be reclassified to profit or loss in a subsequent period. However, they may be transferred within equity.
Actuarial Gains or Losses are changes in the Present Value of the defined benefit obligation resulting from experience adjustments (the effects of the differences between the previous actuarial assumptions and what has actually occurred); and The effects of changes in actuarial assumptions.
Causes of actuarial gains or losses:
• Unexpected high or low rates of employee turnover, early retirement or mortality or of
increases in salaries, benefits or medical costs;
• The effect of changes to assumptions concerning benefit payment options;
• The effect of changes in estimates of future employee turnover, early retirement or mortality or of increases in salaries, benefits or medical costs; and
• The effect of changes in the discount rate.
increases in salaries, benefits or medical costs;
• The effect of changes to assumptions concerning benefit payment options;
• The effect of changes in estimates of future employee turnover, early retirement or mortality or of increases in salaries, benefits or medical costs; and
• The effect of changes in the discount rate.
THE SUMMARY OF DISCUSSION
• Post-Employment Benefits are employee benefits, aside from termination benefits, which are payable after the completion of employment.
• There were four steps in accounting defined benefit plans, which is, determining present value of deferred benefit obligation, future value of plan assets, net defined benefit asset or liability, and the components of the deferred benefit cost.
• Actuarial assumptions - are an entity's best estimates of the variables that will determine the ultimate cost of providing post-employment benefits.
• Post-employee benefit plans are either formal or informal arrangements under which an entity provides post-employment benefits for one or more employees of an organization.
• Post employment benefits are classified as defined contribution plans or
defined benefit plans.
It is in fact technically easy but hard to try. Have time to sink it in and try to solve case problems related to this topic. Have time, and good day! - Author
It is in fact technically easy but hard to try. Have time to sink it in and try to solve case problems related to this topic. Have time, and good day! - Author
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