1. Employee Benefits: Pensions

Question 1

What accounting standard governs employee benefits?

Answer 1

IAS 19 - Employee Benefits

Question 2

Which type of employee is not subject to IAS 19

Answer 2

Those which are equity-based and to which IFRS 2 applies

Question 3

Explain the difference between accumulating and non-accumulating absences and give an example of each. Which is more likely to be the subject of a calculation and what will this look like?

Answer 3

Accumulating absences accrue over the employees period of service and can be carried forward. Examples include holidays.

Non-accumulating absences are entitlements and are not capable of being carried forward. Examples include maternity leave or sick leave.

Accumulating absences are more likely to involve a calculation because there will be a year end accrual for unused, carried forward elements.

This calculation is relatively simple: just multiply the affected number of employees by their unused holiday and then multiply the result by the monetary value given in the question for each day of holiday

Question 4

When should an expense and corresponding liability be recognised in relation to profit-sharing and bonus payment schemes? (2)

Answer 4

If:

1. The entity has a legal or constructive obligation, and,
2. A reliable estimate of the obligation can be made

Question 5

IAS 19 provides 3 scenarios under which a reliable estimate can be made. State them

Answer 5

(1) Formal terms setting out the determination of the amount
(2) Amount payable is determined before financial statements authorised for issue
(3) Past practice provides evidence of amount

Question 6

What is the normal adjustment required when finding the bonus/profit amount which has accrued?

Answer 6

Always adjust downwards based on the best estimate of the number of employees who will leave

Question 7

Briefly define a defined contribution pension scheme and a defined benefit scheme. Which has the more difficult accounting?

Answer 7

Defined contribution (money purchase) - employees pay a fixed amount in and this is invested. The final salary is not known and depends on the performance of the investment. More formally, the employee is said to bear the ‘actuarial risk’

Defined benefit (final salary) - employees pay a varying amount in. The company guarantees a particular level of salary. Therefore the company bears the ‘actuarial risk’.

The defined benefit plan has the more complicated accounting.

Question 8

Explain the accounting for a defined contribution pension plan.

Answer 8

Relatively simple - this is just a normal expense, with a possible year end liability if not paid in cash (or, less likely, a year end asset if there has been an overpayment). There is no complicated pro-forma.

Example:

An employer pays 5% of employee remuneration into a defined contribution benefit plan. Employee remuneration in the year was $1m and $20,000 had been physically paid in at the year end.

Dr Staff Costs (5% x $1m) 50,000
Cr Cash (actually paid) 20,000
Cr Accruals 30,000

Question 9

What 2 items of information must be disclosed in relation to a defined contribution plan?

Answer 9

(1) Amount recognised as an expense in relation to the plan in the period
(2) Description of the plan

Question 10

Assume you have set up a pension pro-forma in which the PV of the defined benefit obligation is presented as a positive figure (this is easier to work with).

State whether the following lines increase or reduce that figure.

(1) Retirement benefits paid out
(2) Contributions paid into the plan
(3) Interest cost on obligation
(4) Current service cost

Answer 10

(1) Reduce figure - when the benefits have been paid out, there is no longer a liability for them so if we are presenting the PV of defined benefit obligation as a positive figure then we need to reduce it
(2) Trick question - this affects the asset side
(3) Adds to figure - unwinding the interest updates and increases the liability to its current value
(4) Adds to figure - this is the additional liability incurred during the year

Question 11

In the pension pro-forma, what is unusual / specific regarding the “Retirement benefits paid out” line?

Answer 11

This is the only entry which should hit both columns i.e. both the PV of defined benefit obligation and the FV of plan assets. (Of course, there will be opening and closing figures in both columns and a gain / loss for both - what we mean here is that the “retirement benefits paid out” line is the only row before the carried forward amounts which hits both columns).

If you are using the easier presentation of the PV of defined benefit as a positive figure, then the Retirement benefits paid out line will be a negative entry in both columns

Question 12

In a standard, uncomplicated pension pro-forma, which line entries should be taken into the income statement?

Answer 12

(1) Net interest on the net defined benefit liability / asset
(2) Current service cost

Do not include contributions paid into the plan in the income statement - this is a cash issue only. Note that this is the typical error made by a company accountant in the exam question and which you are expected to correct and explain.

The net interest line is the net of the interest return on plan assets and the interest cost on the obligation

Question 13

What are past service costs? How are they recognised?

Answer 13

Past service costs mean changes to the pension plan to increase the benefits payable. They increase (credit) the PV of the defined benefit obligation.

Under the revised IAS 19, past service costs are recognised in the period of plan amendment (rather than being split into vested and unvested elements as under the old rules)

Question 14

A company reduces the value of some benefits but increases others at the same time. Explain the treatment

Answer 14

Treat this on a net basis

Question 15

IAS 19 requires a qualified actuary to measure the defined benefit obligation. True or False?

Answer 15

False - this is encouraged but it is not required

Question 16

Summarise the basic requirements of IFRS 13 regarding the correct methodology to determine fair value (6)

Answer 16

(1) Use market-based measurement and not entity-specific measurement
(2) Apply exit / selling prices
(3) Take into account market conditions at the measurement date
(4) Use methods which are appropriate and sufficient to the data available
(5) Maximise use of observable inputs
(6) Minimise use of unobservable inputs

Question 17

A company operates a pension plan with the following qualification criteria:

• Pension benefit for employees who leave before 5 years of service = nil
• Pension benefit for employees who leave after completing 5 years of service but before completing 20 years of service = 10%
• Pension benefit for employees who leave after completing 20 years of service = 40%

it is estimated that 30% of staff leave before completing 5 years of service and a further 50% before completing 20 years of service.

Explain how the benefit should be calculated in the yearly calculation of profits

Answer 17

Find a weighted average. If 30% leave before completing 5 years and another 50% before completing 20 years, this leaves a balance of 20% who will gain the maximum entitlement

Weighted average is (30% serving less than 5 years x 0% benefit awarded) + (50% x 10%) + (20% x 40%) = 13%

Question 18

State the 3 entries we might see in the IS in relation to a defined benefit pension plan

Answer 18

(1) Current service cost = expense
(2) Net interest = expense or income
(3) Past service costs = expense

Again, note that the contributions into the scheme do NOT go into the IS - this is a common error that you are expected to note and correct in the exam

Question 19

State the one entry we expect to see in OCI regarding a pension scheme

Answer 19

Re-measurement of the net defined benefit liability or asset

Question 20

State some disclosures required under IAS 19 as revised

Answer 20

Main disclosures:

(1) Description of the plan
(2) Accounting policy applied to actuarial gains and losses
(3) Reconciliation of the PV of the defined benefit obligation and FV of plan assets from opening to closing amounts, including analysis of each element within this
(4) Actual return on plan assets
(5) Analysis of total expenses recognised in profit or loss
(6) Principal actuarial assumptions made

Question 21

State 2 examples of long-term employee benefits other than pensions and explain the accounting in each case

Answer 21

(1) Long-term disability benefits
(2) Paid sabbatical leave

In each case, the accounting is a simplified version of teh defined benefit plan

Question 22

State the accounting considerations in relation to the following termination benefits:

(1) Firm commitment via a detailed formal plan and cannot realistically withdraw
(2) Voluntary redundancy with uncertainty as to the number of employees who will accept
(3) Termination benefits falling due more than 12 months after the reporting date

Answer 22

(1) Recognise a provision and related expense
(2) Contingent liability rather than the provision because cannot be measured reliably. This is disclosed rather than recognised under IAS 37
(3) Discount to present value

Question 23

What is the interest rate used to discount the defined benefit obligation? Why is this rate used?

Answer 23

The rate on high quality cor, porate bonds

This will give the lowest possible interest rate and therefore the discounting will be by the smallest possible amount i.e. discounting at 5% gives a higher liability than discounting at 20%.

This leaves the PV of the defined benefit obligation at its highest possible amount, reflecting prudence

Question 24

What 3 types of risk should the discount rate chosen NOT reflect?

Answer 24

(1) Investment risk
(2) Actuarial risk
(3) Specific risk relating to the entity’s business

Considering the final risk above, do not confuse pension discounting with the appropriate discounting approach to a project in a business analysis (SBM) question where it is of course appropriate to look at the specifics of the scenario

Question 25

State the 3 benefits of moving to a defined contribution scheme

Answer 25

(1) Easier to administer and manage
(2) Risk is borne by the employee, not the company
(3) Accounting is easier

Question 26

An entity has 2 employees. Both are entitled to the same holiday pay, which accrues at a rate of $150 per day. Both employees are entitled to 30 days of paid holiday per year.

State the journals in relation to employee expenses if employee A uses all of his holiday during the year and employee B has 6 unused days at the year end.

Answer 26

Employee A:

Simply expense 30 days at $150 per day to a total of $4,500

Dr Employee expenses
Cr Cash (assuming all wags paid) or Current Liability (if some not paid)

Employee B:

The 6 days are still an expense during the year but we need a liability for the 6 x $150 = $900 owed to the employee in the holiday pay.

Dr Employee expenses
Cr Current liability

Question 27

An entity operates a bonus scheme. To be eligible, employees must be in employment on the final day of the accounting period.

The scheme pays a bonus of 5% of net profit to each qualifying individual.

At the start of the year, there are 6 individuals at the entity. By the year end, there are 4 qualifying individuals. The average number of individuals employed during the year is therefore 5. Net profit of $1m is made during the period.

State the bonus liability at the year end (assume that the bonus is not paid in cash by the year end)

Answer 27

Ignore the information on employees at the start of the year and average employees - this simply does not matter

Therefore there are 4 individuals who each qualify for a payment of $50,000, so a total liability of $200,000

Question 28

A company has a policy of paying 10% of total staff remuneration into a defined contribution plan.

During the year the company paid $1m into the plan. During that period, total salaries were $25m and bonuses paid were $5m.

Show the year end journals in relation to the pension plan.

Answer 28

The total expense should be 10% of ($25m plus $5m) or an expense of $3m in total. However, only $1m has been paid in: therefore there is a $2m accrual.

Dr Staff costs expense 3m
Cr Cash 1m
Cr Accruals 2m

Question 29

State whether the following entries should be recorded on the PV of defined benefit obligation or FV of plan assets columns and whether they should be positive or negative amounts. (Assume that both PV and FV are stated as positive figures brought forward)

(1) Retirement benefits paid out
(2) Contributions paid into plan
(3) Interest on plan assets
(4) Interest cost on obligation
(5) Current service cost

Answer 29

PV of defined benefit obligation:

All the expenses need to be put on the PV side, as well as the retirement benefits paid out row which remember is the only entry to go on both sides (as a negative entry as there is no longer an obligation in relation to these).

So for PV column:

B/f x
Retirement benefits paid out (x)
Interest cost on obligation x
Current service cost x

FV of plan assets:

All income needs to be put on the FV side, as well as retirement benefits paid out, which are a negative entry because these assets have now been lost from the scheme

B/f x
Retirement benefits paid out (x)
Contributions paid into plan x
Interest on plan assets x

Exam tip - you will see different presentations in the Study Manual and past papers but if you present both PV and FV as positive figures then you do not have to worry about the signs - just remember that Retirement benefits paid out are (uniquely) a negative entry to both sides