IAS 19 (2011) is the accounting standard for Employee Benefits, including benefits payable after the employee has left employment. This Standard requires extensive disclosures in respect of defined benefit plans, such as End of Service Gratuity schemes, including narrative descriptions of the regulatory framework, funding arrangements and potential risks.
The objective of the Standard is to prescribe the accounting entries and disclosures for Employee Benefits and reporting the financial impact and position of those Employee Benefits. This is generally easy for short-term employee benefits, such as salaries or sick pay. But longer-term employee benefits, which include employee benefit plans or benefits required by law, are more onerous to cost and report. A typical structure is to promise a set of post-employment benefits (lump sum, pension, leave accumulation) on retirement or earlier resignation or termination or death of an employee. This means that cost is accrued over many years, which typically requires the involvement of a qualified and experienced actuary to predict financial outcomes.
An IAS 19 Actuarial Valuation is required to cost these future and long-term employee benefit promises. An actuarial technique, the Projected Unit Credit method, together with a set of actuarial assumptions, are used to make a reliable estimate of the ultimate cost to an entity of a benefit that employees have earned during their service.
The IAS 19 disclosure requirements are extensive and complex, for both IAS 19 valuation and financial reporting purposes; typical disclosure elements include:
- Annual employee benefit plan cost – split into numerous components and booked in various ways. This includes past service cost or gain, current service cost, interest cost, benefits paid, actuarial gains or losses, exchange rate costs and more, booked to either P&L or OCI
- Liability split between current and non-current liabilities, discontinuance liability and projected liability to the end of the following financial year
- Methodology and assumptions bases – including long-term views on discount rates and salary escalation
- Various sensitivity and scenario tests – to illustrate possible or even likely divergence from the assumed basis and methodology.
IAS 19 includes valuation and treatment of such benefits as:
Short-term employee benefits
Benefits to be settled within 12 months, other than termination benefits. Examples include wages/salaries, profit-sharing and bonus sums and non-monetary benefits paid to current employees.
Benefits payable after the completion of employment. Examples include Gratuity, Pensions, Lump sum payments, Life Insurance and Medical Care etc.
Schemes providing post-employment benefits are classified as either defined contribution plans or defined benefit plans, depending on the economic substance of the plan as derived from its principal terms and conditions:
- A defined contribution (“DC”) plan is a post-employment benefit plan under which an entity pays fixed contributions into a separate vehicle and pays out benefits based on the accumulated funds. Given that the fund value is dependent on the contributions paid and the investment returns gained, the benefit is not a guaranteed amount.
- A defined benefit (“DB”) plan is a post-employment benefit plan under which a benefit is guaranteed and defined typically in terms of length of service and some form of final salary – such as the End of Service Gratuity prevalent in many parts of the world.
Under IAS 19, an entity uses an actuarial technique (the Projected Unit Credit or PUC method) to estimate the ultimate cost to the entity of the benefits that employees have earned in return for their service in the current and prior periods; discounts that benefit in order to determine the present value of the defined benefit obligation and the current service cost; deducts the fair value of any plan assets from the present value of the defined benefit obligation; determines the amount of the deficit or surplus; derives the amount to be recognized in profit and loss and other comprehensive income in the current period. These measurements are updated each period.