Employee benefits comprise all forms of consideration given by a reporting entity for service rendered by employees or for the termination of employment. Employee benefits may be provided under agreements between an entity and an employee, under requirements of local law (e.g. state pension plans) or result from a constructive obligation. Employee benefits may be paid in cash or through other means (e.g. services) and provided to an employee or their relatives (IAS 19.4-7).
IAS 19 divides employee benefits into four categories (IAS 19.5):
- short-term employee benefits,
- post-employment benefits,
- other long-term employee benefits,
- termination benefits.
All employee benefits are in the scope of IAS 19 except for share-based payment.
Short-term employee benefits
Definition of short-term employee benefits
Short-term employee benefits are benefits expected to be settled wholly within 12 months after the end of the year when the service was rendered. They include (IAS 19.9):
- wages, salaries, bonuses (incl. profit sharing) and social security contributions,
- paid absences,
- free or subsidised non-monetary benefits (e.g. medical care, housing).
Note the phrase ‘wholly’ in the definition above, so for long-term arrangements, even if similar in nature to typical short-term benefits (e.g. bonuses), entities should follow the other long-term employee benefits accounting.
Recognition of short-term employee benefits
The employee benefit is recognised when an employee renders service (IAS 19.11). It is recognised as an expense unless it can be included in the cost of an asset (e.g. inventories, PP&E).
Short-term paid absences
The most common paid absences are holidays, sick leave and maternity leave. IAS 19 distinguishes between accumulating and non-accumulating paid absences. Accumulating paid absences are those that are carried forward and can be used in future periods if the current period’s entitlement is not used in full (IAS 19.15). This is usually the case with holidays, though it varies between countries. Non-accumulating paid absences do not carry forward, they lapse if the current period’s entitlement is not used in full and do not entitle employees to a cash payment for unused entitlement on leaving the entity. This is usually the case with sick leave or maternity leave (IAS 19.18).
For accumulating paid absences, employee benefit expense should be recognised when the employee renders service and earns their right to a paid absence (IAS 19.13(a)). If the paid absence is non-vesting, i.e. on leaving the company an employee does not receive any cash payment for unused absence – entities should still recognise employee benefit when this employee renders service, but taking into account the estimated unused absences (IAS 19.15).
For non-accumulating paid absences, entities should not recognise any expense until the absence occurs (IAS 19.13(a)).
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Example: Holiday pay accrual (accumulating paid absence)
Employees of Entity A are entitled to 20 days of paid leave each year. Unused holidays are carried forward indefinitely, but they are non-vesting, i.e. an employee does not receive cash equivalent for unused holidays. Entity A prepares its financial statements at 31 December.
Entity A has a piece of software that allows it to track unused holidays for each employee and therefore the holiday pay accrual is calculated for each employee. As at 31 December 20X1, John Smith has 15 unused holiday days. His annual remuneration amounts to $50,000 + $10,000 state-imposed taxes paid by the employer. This gives a total annual remuneration cost of $60,000. An average working year has 250 working days, calculated as all calendar days without weekends and bank holidays, but before allowing for employee holidays. Therefore, one working day of John Smith costs $240 ($60,000/250). Entity A must also adjust the accrual for the fact that the holidays are non-vesting. Entity A estimates, based on past experience, that an average employee leaves the company with 2 unused holiday days. Therefore, Entity A recognises (a liability and an expense) a holiday pay accrual amounting to $3,120 ($240 x (15 days – 2 days)). Such a calculation is prepared for each employee. If the holiday pay was vesting, the accrual would be recorded for 15 days (instead of 13 days).
Profit sharing and bonuses
Entities recognise expected costs of profit-sharing and bonus payments when there is a legal or constructive obligation and a reliable estimate of the amount (IAS 19.19). See more discussion contained in paragraphs IAS 19.20-24.
Under some local GAAP, payments from profit sharing plans are deducted directly from equity and are not expensed. This is not allowed under IAS 19, as employee profit sharing plans are not transactions with owners acting in their capacity as owners (IAS 19.23).
Definition of post-employment benefits
Post-employment benefits are employee benefits (other than termination benefits and short-term employee benefits) that are payable after the completion of employment. Examples of post-employment benefits are:
- one-off payments upon retirement,
- some severance payments (note the difference between post-employment benefits and termination benefits),
- post-employment medical care.
Defined contribution plans vs. defined benefit plans
Post-employment benefit plans can be either defined contribution plans or defined benefit plans. This distinction is crucial as the accounting treatment is completely different. Paragraphs IAS 19.26-49 set out the criteria to distinguish defined contribution plans from defined benefit plans.
In short, defined contribution plan is a plan when the entity pays a specified amount (the contribution) to a fund and has no legal or constructive obligation to make additional payment if the fund has not enough money to pay the benefits later, or for any other reason.
The most common example of a defined contribution plan is a retirement plan when the employer pays a contribution to an employee’s personal account. This money is then invested and after reaching a certain age (usually upon retirement or shorty before that), an employee receives payments from this account (or one lump-sum payment). The amount of payments that an employee receives upon retirement is determined by the contributions paid by employer and investment returns. If the investment returns are poor, or for any other reason, the employer does not have to make any further payments.
As for defined benefit plans, the entity (employer) does have a legal or constructive obligation to provide a certain level of benefit to an employee (as opposed to a certain level of contribution). A typical example of a post-employment defined benefit plan is a pension plan where a company pays a retiree a monthly pension in a predetermined amount and the entity bears the actuarial and/or investment risk. For example, a pension that equals 50% of the employee’s remuneration is a defined benefit plan.
IAS 19 stresses that an entity accounts not only for its legal obligation under the formal terms of a defined benefit plan, but also for any constructive obligation that arises from the entity’s informal practices. Constructive obligation is indirectly defined in paragraphs IAS 19.61-62. Note that benefits that are not legally binding can also fall into the scope of IAS 19. The standard notes that, in the absence of evidence to the contrary, accounting for post-employment benefits assumes that an entity that is currently promising such benefits will continue to do so over the remaining working lives of employees.
State run plans usually are funded on a pay-as-you-go basis where future benefits of an employee earned during the current period will be paid out of future contributions of other (younger) employees. Therefore, an entity has no legal or constructive obligation to pay those future benefits, which makes most state plans defined contribution plans (IAS 19.45).
Other long-term employee benefits
Other long-term employee benefits (see IAS 19.153-158) are defined by IAS 19 as employee benefits other than short-term employee benefits, post-employment benefits and termination benefits.
Such benefits can be straightforward and similar to short-term benefits with the exception that they are not expected to be settled within 12 months after the end of the year when the service was rendered (e.g. bonuses, profit sharing plans lasting for a few years). In this case, entities should look into accounting requirements relating to short-term benefits (and consider discounting them).
However, other long-term employee benefits can also take a form of defined benefit plans and their accounting will be as complex as for post-employment benefits. This will be the case for e.g. jubilee awards. In this case, entities should look into requirements relating to post-employment benefits, distinguish between defined benefit and defined contribution plans and apply IAS 19 requirements accordingly. It’s important to note that actuarial gains/losses (remeasurements) on long-term benefits are included in P/L (not in OCI as is the case with post-employment benefits) (IAS 19.156). Another major difference between other long-term benefits and post-employment benefits relates to disclosure – IAS 19 does not require any specific disclosures relating to other long-term benefits.
Defined contribution plans
Accounting for defined contribution plans is set out in IAS 19.50-54 and is simple in most cases – the employee benefit is recognised when an employee renders service (similarly to regular remuneration). There is no actuarial valuation or (usually) discounting involved.
Entities are required to disclose the amount recognised as an expense for defined contribution plans. This relates also to state-run plans when entities are required to make contributions on the top of an employee’s gross salary, but it’s true that most entities do not provide such a disclosure.
Defined benefit plans
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Introduction to defined benefit plans
Accounting for defined benefits plans is complex and usually requires a valuation prepared by an actuary using a projected unit credit method. This includes attributing benefit to periods of service and making actuarial assumptions. Defined benefit plans are governed by paragraphs IAS 19.55-152.
Below is an example of calculating an expense and obligation relating to a defined benefit plan for a single employee. More discussion follows.
John Smith joins the company on 31 December 20X0. All employees of this company are entitled to a one-off retirement payment that is 3-months’ worth of their monthly salary upon retirement. The table below presents a simple example of calculating an expense and obligation relating to a defined benefit plan for a single employee. You can download an excel file with all calculations.
Summary of facts and assumptions for this example is presented below:
- John Smith joins the company on 31 Dec 20X0
- John is 59 years old when he joins the company
- John will be eligible for retirement on 31 Dec 20X6
- John’s starting salary is $10,000
- estimated salary increase rate is 2% p.a.
- estimated salary at the retirement date is $11,262 ($10,000 x 1,02^6)
- estimated retirement payment amounts to $33,785 (3 x estimated salary at the retirement date)
- discount rate is 5%
Note: you can scroll the table horizontally if it doesn’t fit your screen
|Current service cost||4,412||4,632||4,864||5,107||5,363||5,631|
Current service cost shows the part of retirement payment that John Smith earned during a given year. This amount is discounted as the payment will take place in future. Let’s discuss year 20X3 from the above example in more detail.
It will be 6 years (20X1-20X6) before John Smith is eligible for retirement payment. Therefore, John Smith earns 1/6 of his retirement payment each year. Based on an expected salary increase rate, it is estimated that John Smith’s salary in 20X6 will be $11,262 ($10,000 x 1,02^6), therefore his estimated retirement payment will amount to $33,785 (3 x $11,262). In 20X3, as in every year, John Smith earned 1/6 of his retirement payment, i.e. $5,631 (1/6 of $33,785). However, this amount will be paid on 31 December 20X6, so it needs to be discounted to determine what the expense for 20X3 is. After discounting at 5%, the amount earned by John in 20X3 is $4,864. This is the current service cost – an employee benefit earned during the year.
In addition to the current service cost, there is a discounting expense. It works the same way as with discounting of other liabilities in general. Each year, entities unwind the discount for the liability recognised in previous periods. This expense is usually recognised under financing/interest expense (IAS 19 does not indicate financial statements’ lines in which these expenses should be presented). Check the excel file to see all calculations.
Current service cost and attributing benefit to periods of service
Current service cost is the increase in the present value of the defined benefit obligation resulting from employee service in the current period. It is recognised in P/L, unless it forms a part of a cost of another asset (IAS 19.120(a),121). Paragraphs IAS 19.70-74 set out the criteria for attributing benefit to periods of service. The general rule states that entities should attribute benefit to periods of service under the plan’s benefit formula, unless the benefit formula would result in a materially higher level of benefit allocated to future years. If this is the case, the entity should allocate the benefit on a straight-line basis from the date when service by the employee first leads to benefits under the plan (even if eventual payment is conditional on further service) until the date when further service by the employee will lead to no material amount of further benefits under the plan (other than resulting from further salary increases) (IAS 19.73-74). See also this agenda decision.
Example: Attributing benefit to periods of service
An entity pays a month’s worth of salary to every employee upon retirement provided that the employee worked at least 5 years for the entity. The benefit is attributed to first 5 years of employment, as further years do not increase the amount of the benefit, other than resulting from salary increases.
Impact of vesting conditions
Employee benefit obligation and expense is recognised even if it is subject to vesting conditions. The probability that some employee will not fulfil the vesting conditions is taken into account when measuring the benefit, e.g. by adjusting it for expected employee turnover rate (IAS 19.72).
Benefits that vest immediately
Lots of practical difficulties are posed by benefits that vest immediately, i.e. benefits to which employees are eligible from day 1 of their work and the value of benefits does not change with seniority (other than resulting from future salary increases). For example, let’s assume that each employee of a company, from day 1 of their employment, is entitled to a payment amounting to 3 months’ worth of their salary upon leaving the company, irrespective of reasons. It’s hard to ‘attribute benefit to periods of service under the plan’s benefit formula’, as the benefit vests immediately and therefore doesn’t dependent on the period of service. It’s also not the case that an employee’s service in later years will lead to a materially higher level of benefit than in earlier years.
Some analogy may be derived from paragraph IAS 19.157 relating to disability benefits. ‘If the level of benefit is the same for any disabled employee regardless of years of service, the expected cost of those benefits is recognised when an event occurs that causes a long-term disability.’ So the most practical way to approach this kind of benefits would be to recognise them in the most straightforward way possible: when the event that triggers payment of this benefit occurs.
Similar example was considered in the exposure draft of IAS 19 and related to death-in-service benefits when the IASB wanted to give the following guidance relating to the recognition of death-in-service benefits:
- in the case of benefits insured or re-insured with third parties, recognition in the period in respect of which the related insurance premiums are payable; and
- in the case of benefits not insured or re-insured with third parties, recognition to the extent that deaths have occurred before the end of the reporting period.
However, in the case of death-in-service benefits provided through a post-employment benefit plan, an enterprise should recognise the cost of those benefits by including their present value in the post-employment benefit obligation.
Where an entity provides death-in-service benefits directly, rather than through a post-employment benefit plan, the entity has a future commitment to provide death-in-service coverage in exchange for employee service in those same future periods (in the same way that the entity has a future commitment to pay salaries if the employee renders service in those periods). That future commitment is not a present obligation and does not justify recognition of a liability. Therefore, an obligation arises only to the extent that a death has already occurred by the end of the reporting period.
The death-in-service benefits were also on an agenda of IFRIC (IFRIC updates from November 2007 and January 2008). However, IFRIC decided not to take this issue on its agenda, but ‘was unable to agree on wording for its agenda decision’.
To sum it up: the solution is not obvious, I would recommend to recognise liability relating to such employee benefits when the event that triggers the payment occurs. However, if these benefits can be combined into wider perspective with other defined benefit plans, I suggest accounting for them in parallel. Sticking with the death-in-service example: if an entity has a pension scheme, estimated deaths during employment decrease the value of the defined benefit obligation relating to pensions. At the same time, I suggest including the death-in-service payments into the pension obligation and attributing the benefit to the periods until the anticipated date of death.
Definition of actuarial assumptions
Paragraphs IAS 19.75-98 cover actuarial assumptions which are estimates of the variables that will determine the ultimate cost of providing post-employment benefits. Actuarial assumptions are divided into two groups:
Demographic assumptions, e.g.:
- mortality (see IAS 19.81-82),
- rates of employee turnover, disability and early retirement,
- the proportion of plan members who will be eligible for benefits,
- claim rates.
Financial assumptions, e.g.:
- discount rate,
- benefit costs.
Actuarial assumptions should be unbiased (neither imprudent nor excessively conservative) and mutually compatible (IAS 19.77-78).
Discount rate should be determined by reference to market yields at the end of the reporting period on high quality corporate bonds. When there is no deep market in high quality corporate bonds for a given currency, yields on government bonds should be used. The currency and term of bonds should be consistent with the currency and estimated term of the post-employment benefit obligations. This can be achieved by applying a single weighted average discount rate that reflects the estimated timing and amount of benefit payments (IAS 19.83-86).
IAS 19 does not specify what is meant by high quality corporate bonds (‘HQCB’). Instead, paragraphs IAS 19.84-85 explain what the discount rate should represent. In practice, bonds issued by entities with the two highest investment ratings (AAA, AA) are considered to be HQCB.
July 2013 IFRIC Update confirmed that the discount rate should be a pre-tax discount rate.
Actuarial gains and losses
Actuarial gains or losses arise when the reality is different that the actuary had assumed (so-called experience adjustments) or when the actuarial assumptions change. See paragraph IAS 19.128 for more examples.
Actuarial gains and losses have the effect that the value of defined benefit obligation recognised in previous periods changes, i.e. the opening balance changes. The effect of actuarial gains and losses is included in other comprehensive income (OCI) for post-employment benefits (IAS 19.120(c)) or in P/L for other long-term benefits. Actuarial gains/losses on post-employment benefits are never recycled to P/L, even if the plan is amended or curtailed (IAS 19.122). See also paragraphs IAS 19.127-129.
Past service cost
Past service cost is the change in the present value of the defined benefit obligation resulting from a plan amendment or curtailment. A curtailment is a significant reduction in the number of employees covered by the plan. Plan amendment is a change in the value of benefits payable or introduction/withdrawal of a plan (IAS 19.102-105). Paragraph IAS 19.108 provides examples of circumstances that do not give rise to a past service cost.
Past service cost is always recognised in P/L. Note that it can be a credit to the P/L, e.g. when an entity decreases the value of benefits payable (IAS 19.106). The recognition of past service cost occurs at the earlier of the following dates (IAS 19.103):
- when the plan amendment or curtailment occurs; and
- when the entity recognises related restructuring costs under see IAS 37.
Gains and losses on settlement
A settlement occurs when an entity enters into a transaction that eliminates all further legal or constructive obligation for part or all of the benefits provided under a defined benefit plan (e.g. a lump sum cash payment to employees) (IAS 19.111).
A gain/loss on settlement is the difference between the present value of the defined benefit obligation being settled and the settlement price (IAS 19.109). Gain/loss on a settlement is recognised immediately in P/L.
An entity need not distinguish between past service cost resulting from a plan amendment, past service cost resulting from a curtailment and a gain or loss on settlement if these transactions occur together (IAS 19.100).
In some instances, an entity (a fund) that is legally separate from the reporting entity and exists solely to pay or fund employee benefits, holds plan assets which can be used only to pay or fund employee benefits. A qualifying insurance policy can also be a plan asset (see IAS 19.115). See relevant definitions in paragraph IAS 19.8.
If there are plan assets that meet the IAS 19 criteria, their fair value is deducted from the present value of the defined benefit obligation in the statement of financial position. See IAS 19.113-119 for more discussion. Changes in fair value of plan assets (including costs of managing the plan assets) are treated the same way as actuarial gains/losses, i.e. included in OCI for post-employment benefits and in P/L for other long-term benefits. If plan assets exist, entities usually present a line called ‘remeasurements of the net defined benefit liability (asset)’ that comprises actuarial gains/losses and changes in fair value of plan assets.
The discount expense on defined benefit obligation is decreased by an interest income on plan assets calculated using the same discount rate as for the obligation and applying it to the fair value of plan assets.
IAS 19 requires entities to disclose the characteristics and risks of defined benefit plans and give more details on amounts related to them. IAS 19 prescribes also specific requirements for disclosure of estimation uncertainty. See paragraphs IAS 19.135-152 for the list of disclosure requirements relating to defined benefit plans.
Definition of termination benefits
Termination benefits (IAS 19.159-171) are a separate category of employee benefits as the obligation arises on termination of employment rather than during an employee’s services. However, not all benefits paid upon termination of employment are termination benefits. See the definition below (IAS 9.8):
Termination benefits are employee benefits provided in exchange for the termination of an employee’s employment as a result of either:
- an entity’s decision to terminate an employee’s employment before the normal retirement date; or
- an employee’s decision to accept an offer of benefits in exchange for the termination of employment.
Therefore, if a benefit is owed to employee on termination of employment regardless of the reason or form of termination, it is a post-employment benefit, not a termination benefit. Similarly, termination benefits are not benefits resulting from termination of employment at the request of the employee without an entity’s offer.
The distinction between termination and post-employment benefits may sometimes be confusing, as benefits paid on termination of employment often have ‘termination’ in their legal description, but IAS 19 classification is based on different criteria, as discussed above.
Recognition and measurement
Entities should recognise termination benefits at the earlier of the following dates (IAS 19.165):
- when the entity can no longer withdraw the offer of those benefits (see paragraph IAS 19.166-167 for further details on application of this criterion); and
- when the entity recognises costs for a restructuring that is within the scope of IAS 37 and involves the payment of termination benefits.
Usually, the measurement of termination benefits is straightforward as they take a form of a lump-sum payment. Termination benefits are not provided for future service of an employee, therefore they should be recognised in P/L upfront, even if payments are spread over time. If they take a more complicated form, an actuarial valuation may be needed (e.g. when a termination benefit is similar to a pension plan).
Sometimes the termination benefit is a difference between a payment that an employee would receive if they left the company without an entity’s offer, and the higher payment that was made because the termination was an entity’s initiative (IAS 19.160). See the example in IAS 19 that follows paragraph IAS 19.170.
IAS 19 does not specify any disclosure requirements relating to termination benefits (IAS 19.171).