80828058 Chapter 16 Employee Benefits PDF

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Chapter 16Employee BenefitsReference: IAS 19; IFRIC 14Contents: Page1. Introduction4862. Short-term employee benefits2 of short-term benefits2-term compensated absences2.2 Leave taken2.2 Unused leave2.2.2 Non-accumulating leaveExample 1: short-term paid leave: non-accumulating: singleemployeeExample...

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Gripping IFRS

Employee benefits

Chapter 16 Employee Benefits Reference: IAS 19; IFRIC 14 Contents:

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1. Introduction 2. Short-term employee benefits

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2.1 Overview of short-term benefits

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2.2 Short-term compensated absences

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2.2.1 2.2.2

Leave taken Unused leave 2.2.2.1 Non-accumulating leave Example 1: short-term paid leave: non-accumulating: single employee Example 2: short-term paid leave: non-accumulating: group of employees 2.2.2.2 Accumulating leave Example 3: short-term paid leave: accumulating and vesting Example 4: short-term paid leave: accumulating and non-vesting Example 5: short-term paid leave: accumulating, vesting and nonvesting 2.3 Profit sharing and bonus plans Example 6: bonuses – raising the bonus provision Example 7: bonuses – paying the bonus Example 8: profit sharing

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3. Post-employment benefits

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3.1 Overview of post-employment benefits

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3.2 Defined contribution plans Example 9: defined contribution plans

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3.3 Defined benefits plans

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3.3.1

Overview of a defined benefit plan

3.3.2

Measurement of a defined benefit plan

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3.3.2.1 Deficit or surplus 3.3.2.2 Liability or asset 3.3.2.3 Measurement of the plan obligation 3.3.2.3.1 Present value and interest cost Example 10: DBP: effect of the unwinding of the discount 3.3.2.3.2 Current service costs Example 11: DBP: current service costs

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3.3.2.3.3 Past service costs Example 12: DBP: past service costs 3.3.2.3.4 Benefits paid Example 13: DBP: benefits paid 3.3.2.3.5 Curtailments and settlements

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3.3.2.4 Measurement of the plan assets Example 14: DBP: plan assets

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3.3.2.5 Actuarial assumptions

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3.3.2.6 Changes to actuarial assumptions Worked example: corridor versus no corridor

512 3.3.2.7 Recognising actuarial gains and losses: the amortised corridor approach et al (IAS 19.92, IAS 19.93 and IAS 19.95) 513 Example 15: DBP: using the amortised corridor 517 Example 16: DBP: to use the corridor or not 3.3.2.8 Asset balances: the asset ceiling: IAS 19.58 (b) Example 17: DBP: asset ceiling

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3.3.2.9 Asset balances: the recoverability test: IAS 19.58A

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3.3.2.10 Asset balances: link between recoverability test and ceiling Flowchart: inter-relationship of IAS 19.58A and IAS 19.58(b) Example 18: DBP: 58A and 58(b) Example 19: DBP: 58A and 58(b): loss and PV unchanged Example 20: DBP: 58A and 58(b): loss and PV decreased

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4. Other long-term benefits

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5. Termination benefits

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6. Disclosure 6.1 Short-term employee benefits 6.2 Post-employment benefits 6.2.1 Defined contribution plans 6.2.2 Defined benefit plans Example 21: DBP: disclosure 6.3 Other long-term employee benefits 6.4 Termination benefits

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7. Summary

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1

Employee benefits

Introduction

Why do we work? Apart from philosophical reasons (that are unfortunately beyond the scope of this book), we generally work for rewards. In the mid 1890’s a Russian scientist, by the name of Ivan Pavlov, began investigating the gastric function of dogs. He very importantly noticed that dogs tend to salivate before food was delivered to their mouths. He called this a ‘psychic secretion’. He became so interested in this phenomena that his research, which began as a scientific study of the chemistry of their saliva, mutated into a psychological study and led to the establishment of what is commonly referred to as ‘conditional reflexes’ or ‘Pavlovian response’. The answer to ‘why do we work’ lies in this Pavlovian theory of conditional reflexes – we work because we expect to receive a benefit – a bit like the dog salivating in expectation of food. The term ‘employee’ includes all categories: full-time, part-time, permanent, casual, temporary, management and even directors. The benefit we, as employees, expect to receive may be summarised into four categories: • benefits in the short-term (benefits payable to us while employed and shortly after we provide the service, e.g. a salary); • benefits in the long-term (benefits payable to us while employed but where the benefits may become payable long after we provide the service e.g. a long-service award); • benefits post employment (i.e. after we have retired from employment e.g. a pension); and/ or • termination benefits (those that would be receivable if our employment were to be terminated before normal retirement age (e.g. a retrenchment package). The definitions of these four categories of employee benefits are as follows: Employee benefits

Short-term benefits

Long-term benefits

Post-employment benefits

Termination benefits

Defined in IAS 19 as: Those that fall wholly within 12 months after the end of the period in which the employee renders the service

Defined in IAS 19 as: Those that do not fall wholly within 12 months after the end of the period in which the employee renders the service

Defined in IAS 19 as: Those that are payable after the completion of employment

Other than termination benefits

Other than postemployment and termination benefits

Defined in IAS 19 as: Those that are payable as a result of either the: a) entity’s decision to terminate the employment before normal retirement date b) employee’s decision to accept a voluntary redundancy package in exchange for those benefits

Other than termination benefits

Employee benefits include settlements made to employees, both past and present. They even include the situation where the employee’s spouse, children or others are paid. The only criteria is that the payments were made in exchange for services provided by the employee.

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Employee benefits apply to any type of settlement – with the exception of share-based payments. These payments were previously included within this standard (IAS 19: Employee benefits) but are now covered by its very own standard, IFRS 2: Share based payments. Employee benefits therefore include settlements made by an entity in the form of: • cash (e.g. cash salary); • goods (e.g. free products); or • services (e.g. free medical check-ups). Post-employment benefits could come in the form of defined contribution plans or defined benefit plans. Defined benefit plans are relatively complex to account for and require lots of disclosure. Although defined benefit plans are not as commonly encountered in practice as defined contribution plans, it is still important for you to understand how to account for them. IAS 19 requires a lot of disclosure for post-employment benefits where they are defined benefit plans whereas there is either little or no disclosure required for the other types of benefits. There are, however, other disclosure requirements that emanate from other standards such as: • IAS 1 Presentation of Financial Statements: - requiring disclosure of the employee benefit expense • IAS 24 Related Party Disclosures: - requiring disclosure of each type of benefit provided to key management personnel • IAS 37 Provisions, Contingent Liabilities and Contingent Assets: - which may require that a contingent liability be disclosed. In addition to other standards requiring disclosure relating to the employee benefit/s, other disclosure may be required by the: • Companies Ordinance, 1984 : in respect of directors’ remuneration (see Part III of Schedule) • Code of Corporate Governance. 2

Short-term employee benefits (IAS 19.8 – 19.23)

2.1 Overview of short-term benefits Short-term employee benefits include benefits that are due within twelve months of the end of the period during which the employee provided the service. IAS 19.8 lists some of the items included under short-term employee benefits as follows: • Wages, salaries and social security contributions; • Short-term compensated absences (such as paid annual leave and paid sick leave) where the absences are expected to occur within twelve months after the end of the period in which the employees rendered the related employee service; • Profit-sharing and bonuses payable within twelve months after the end of the period in which the employees rendered the related service; and • Non-monetary benefits (such as medical care, housing, car and free or subsidised goods or services) for current employees. The accrual concept of accounting is applied when recognising a short-term employee benefit: • an expense is recognised (debit) ; and • a liability is recognised (credit) to the extent that any amount due has not been paid. This accrual approach is evident in the following journals shown overleaf:

Step 1: The employee benefit is raised as a liability when incurred: Employee benefit expense 487

Debit

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Account payable (e.g. wages payable) (L) Recognising short-term employee benefits incurred (e.g. wages)

XXX

Step 2: When the benefit is paid, the journal entry is: Account payable (e.g. wages payable) (L) Bank Payment of short-term employee benefit (e.g. wages/ company car etc)

XXX XXX

Step 3: If the expense has been underpaid, there will be a credit balance on the account payable. But if the expense has been overpaid, there will be a debit balance on the account payable. If an overpayment cannot be recovered from the employee (e.g. the employee is not obligated to return the cash or a future payment to the employee may not be reduced by the overpayment) then the overpayment is expensed: Debit Credit Employee benefit expense XXX Account payable (e.g. wages payable) (L) Over-payment of short-term employee benefit (e.g. wages) expensed

XXX

It is also possible that another standard allows or requires that the employee cost be capitalised instead of expensed. This may happen if, for example, an employee is used on the construction of another asset such as inventory. In this case, the benefits payable to this employee (or group of employees) will be capitalised to inventory (IAS 2) instead of expensed (see Step 1 above). Debit Credit Inventory (or other asset) Account payable (e.g. wages payable) (L) Capitalisation of short-term employee benefit (e.g. wages)

XXX XXX

Measurement of the short-term employee benefit is relatively simple because: • no actuarial assumptions are required to measure either the obligation or the cost; and • no discounting is applied to short-term employee benefit obligations – for the simple reason that the time between the receiving of the service and the payment of the benefit is short. As mentioned earlier, IAS 19 does not require any disclosure of a short-term benefit although other standards may require certain limited disclosure. In summary, although we may work in order to earn more than one type of benefit, most of us start working in order to earn basic short-term benefits. These can be summarised as follows:

Wages, salaries and social security contributions (e.g. medical aid)

Short-term paid leave

Profit sharing and/ or bonuses

Use of non-monetary benefits (e.g. a company car)

Short-term benefits

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Whereas we are all probably capable of processing the journals for wages (or salaries etcetera), the following other types of short-term benefits warrant a bit more attention: • short-term compensated absences; • profit sharing and bonuses. 2.2 Short-term compensated absences (IAS 19.11 – 19.16) Short-term compensated absences refer to paid leave. In other words, these absences are those when employers pay employees during periods during which no work is done. The leave offered to an employee may be taken or may remain unused at the end of the period. 2.2.1

Leave taken

The cost of an employee’s short-term absence is recognised as part of his salary expense. For example, if you were to take paid annual leave, your salary would be paid to you while you were on holiday: there would be no extra amount owing to you and therefore the leave that you have taken is simply absorbed into the usual salary expense journal (i.e. there is no extra journal entry). 2.2.2

Unused leave

If there was any leave that was owed to an employee during the year that was not taken by the employee, a distinction will need to be made between whether the leave was: • accumulating: where unused leave can be carried forward to another period; or • non-accumulating: where unused leave cannot be carried forward (i.e. falls away if not used in the current period). 2.2.2.1 Non-accumulating leave Non-accumulating leave is recognised, as part of the salary expense, when the leave is taken (i.e. when the absence occurs). If an employee fails to take non-accumulating leave that was owed to him, any unused leave will be simply forfeited (since it is non-accumulating). Since the entity has no obligation to provide the unused leave in future years, (i.e. it is forfeited), no liability for unused leave is raised. Example 1: short-term paid leave: non-accumulating leave: single employee Mitch Limited has one employee. His name is Guy. Guy is owed 30 days leave per year. Guy is paid C90 000 per year. The year is 365 days and Guy is expected to work 5 days a week. Guy took 20 days leave in 20X1. Guy’s leave is non-accumulating. Required: Show all related journal entries and calculate any leave pay provision as at the 20X1 yearend.

Comment: Of the 30 days leave that was offered to Guy, 20 days were used and 10 days remained unused. No provision is made for the 10 days that Guy did not take because the leave is nonaccumulating, which means that Mitch Limited is not obliged to give him this leave. The following journal would be processed as 12 individual journals over the year (90 000 / 12 = 7 500 per month): Debit Credit Employee benefit expense Total salary processed over the year 90 000 Salaries payable 90 000 Salary owed to Guy for 20X1 (includes leave taken)

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Example 2: short-term paid leave: non-accumulating: group of employees Lee Limited operates a five-day working week. At Lee Limited’s financial year ended 31 December 20X4 (a year with 365 days): • there were 50 similarly paid employees • each earning an average salary of C50 000 • and earning 20 days annual leave per year of service. The leave entitlement of 20 days has remained the same for years and will remain the same for years to come. Similarly, the salary of C50 000 has remained unchanged for years and no significant changes are expected in the next few years. The following are the actual average leave statistics to date: • end of prior year 20X3: an average of 10 days was used, all earned in 20X3 • end of current year 20X4: an average of 12 days was used, all earned in 20X4 The estimated future leave statistics for the year ended 31 December 20X5: • an average of 14 days will be taken, all earned in 20X5 Ignore public holidays. Required: Calculate the leave pay provision for Lee Limited’s financial year ended 31 December 20X4 assuming that the annual leave does not accumulate (and therefore does not vest).

Comment: this example is similar to example 1, with the difference being that the provision calculated in this example is for a group of employees whereas the provision in example 1 is calculated for an individual employee. No provision is made at 31 December 20X4 since the leave is non-accumulating. This therefore means that any leave that is not taken is simply forfeited by the employee at the end of the year. The employee therefore lost 10 days in 20X3 (20 – 10 days) and 8 days in 20X4 (20 – 12 days taken). Nonaccumulating leave is recognised as the leave is taken. The leave that was taken was simply recognised as part of the salary of C50 000 (which would have been debited to salaries and credited to bank over the year). The entity does not owe the employee any leave that the employee fails to take. If the company policy was to pay out any unused leave at the end of each year, an accrual would still have to be recognised. In this case, the unused 20X3 leave would have been paid to employees at the end of 20X3. Any unused leave at 31 December 20X4 would, however, be due to the employees on this date. Since the amount owed to the employee would be based on unused leave to 31 December 20X4, it would only be possible to make payment for unused leave in the next year. An accrual liability would therefore need to be raised at 31 December 20X4 for: C191.78 x (20 days – 12 days taken) x 50 employees = C76 712

2.2.2.2 Accumulating leave Accumulating leave is recognised, as part of the salary expense, when the leave is taken (i.e. when the absence occurs). If an employee fails to take accumulating leave that was owed to him, any unused leave remains owing to him (since it is accumulating). Since the entity has an obligation to provide the unused leave in future years, a liability for unused leave must be

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raised. This liability is recognised when the employee has rendered the service that then entitles him to that leave. This type of leave may be either (IAS 19.13): vesting: unused leave can be taken in the future or can be exchanged for cash; or non-vesting: unused leave can be taken in the future but cannot be exchanged for cash. Whether accumulating leave has to be taken in the future or can be converted into cash in the future, an obligation still exists at year end for any unused leave. This must be measured based on the average expected salary per day (on the basis that, even if the leave is not vesting, the entity will effectively be losing this value on the days that the employee stays away from work). Example 3: short-term paid leave: accumulating and vesting Mark Limited has one employee. His name is Jack. Jack is owed 30 days leave per year. Jack is paid C365 000 per year. The year is 365 days and Jack is expected to work 5 days a week. Jack took 20 days leave in 20X1. Jack’s leave is accumulating. Jack may convert leave that he does not wish to take into cash. The financial year end is 31 December 20X1. Required: Show all related journal entries and calculate any leave pay provision at 31 December 20X1.

Comment: The provision is based on the effective daily cost of employing Jack multiplied by the total number of outstanding days (Jack will either take this leave or will be paid out for it). The cost per day is calculated as follows: Basic cost per day: C365 000 / 365 days = C1 000 Effective cost per day: C1 000 x 7/ 5 = C1 400 (since he not required to work every day but rather 5 days out of every 7 days, the effective cost per day is a little higher) Employee benefit expense Total salary processed over the year Salaries payable Salary owed to Jack for 20X1 (includes leave taken) * Employee benefit expense (30 – 20 days) x C1 400 per day Provision for leave pay Leave ...