For any periodic valuation of a defined benefit plan, such as an End of Service Benefit Scheme, the actuarial gain or loss arises because of two reasons:
1. Due to Change in the Valuation Assumption(s)
For any actuarial valuation, certain assumptions need to be made; Financial assumptions (discount rate and salary escalation rate) and Demographic assumptions (mortality rate and withdrawal rate). If there is a change in the assumptions from the last valuation to the current valuation, then the change in liability (DBO) due to a change in assumption(s) is recognized as an Actuarial Gain or Loss.
As an example, for the prior valuation the actuary used a discount rate of 4.5%, whilst for the current valuation the actuary adjusted the discount rate down to 4% (due to a change in the economic conditions in the intervening period). As a result of this 0.5% change, there will be an increase in the liability. The actuarial loss in this case is calculated by comparing the current valuation DBO at 4.5% discount to DBO at 4% discount, with all other parameters kept the same.
2. Due to Scheme Experience
This is due to the actual experience of the Scheme, from the last valuation to the current valuation, differing from the assumption(s) made at the last valuation.
For example, the salary escalation rate was assumed to be 4% for the last valuation (say 31 December 2018), whilst the actual salary escalation awarded to the employees during FY 2019 is 5%. Valuing the liability as at 31 December 2019 would show an actuarial loss due to the experience of the Scheme being different from the assumption made, i.e. a higher than expected salary increase awarded (5%) resulting in benefits growing faster than assumed (4%). This, in turn, leads to a larger liability than expected. The difference gives rise to an Actuarial Loss.
Where is the Actuarial Gain or Loss charged to?
Under IAS 19, the Actuarial Gain or Loss is not charged to the P&L but transferred to Other Comprehensive Income. This ensures that the impact of the change in the actuarial assumption(s), or any volatility in the actual experience of the Scheme, does not distort the profitability of the entity/Scheme sponsor.
If you need to understand the Actuarial Gain or Loss in more detail, then please contact us. Our IAS 19 valuation report contains a detailed explanation of the source(s) of Actuarial Gain or Loss, which helps our clients and their auditors understand the reason(s) for any increase or decrease in the liability/DBO.