For any periodic valuation of the defined benefit plan such as End of Service Benefit, the actuarial gain or loss arises because of two reasons:
1.1 Due to change in the valuation assumption
For any actuarial valuation, the entity needs to make assumptions – 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 last valuation to the current valuation, then the change in liability due to a change in assumption(s) is quantified under Actuarial Gain or Loss due to change in the valuation assumption.
For example, for the last valuation the entity used the discount rate of 4.5% while for the current valuation the entity used the discount rate of 4%. Due to this change, there will be an increase in the liability and it is calculated by running the current valuation payroll assuming the discount rate of 4.5% keeping everything the same. The difference between the liability at 4% discount rate and 4.5% discount rate will be classified as Actuarial gain or loss due to the change in the financial assumption.
1.2 Due to the experience of the Scheme
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 2017), while the actual salary escalation awarded to the employees during FY 2018 is 5%. Then, while valuing the liability as at 31 December 2018, there would be an actuarial loss due to the experience of the Scheme being different from the assumption made, that being higher salary increases awarded – 5%, and benefits growing faster than assumed – 4%, leading to a larger liability than expected.
Where is the Actuarial Gain or Loss charged to?
Under IAS 19, the actuarial gain or loss is not charged to Profit & Loss Account but transferred to Other Comprehensive Income. This ensures that the impact of the change in the actuarial assumption or any volatility in the actual experience do not distort the profitability of the entity.
If you need to understand in more detail the actuarial gain or loss then contact us here at Lux. At Lux, our report contains the detailed explanation of the source of the actuarial gain or loss which help our clients and their auditor, any abrupt increase or decrease in the liability or defined benefit obligation.