General Discussion
Absent specific information to the contrary, it is assumed that a company will continue to provide retirement benefits well into the future. The accounting for the plan's costs should be reflected in the financial statements and these amounts should not be discretionary. All pension costs—
with the exception noted below—should be charged against income. No amounts should be charged directly to retained earnings. The principal focus of IAS 19 is on the allocation of cost to the periods being benefited, which are the periods in which the covered employees provide service to the reporting entity.
Periodic Measurement of Cost for Defined Contribution Plans
Under the terms of a defined contribution plan, the employer will be obligated for fixed or determinable contributions in each period, often computed as a percentage of the wage and salary base paid to the covered employees during the period. For one example, contributions might be set at 4% of each employee's wages and salaries, up to €50,000 wages per annum. Generally, the contributions must actually be made by a specific date, such as 90 days after the end of the reporting entity's fiscal year, consistent with local law. The expense must be accrued for accounting purposes in the year the cost is incurred, whether the contribution is made currently or not.
IAS 19 requires that contributions payable to a defined contribution plan be accrued currently, even if not paid by year‐end. If the amount is due over a period extending more than one year from the end of the reporting period, the long‐term portion should be discounted at the rate applicable to high quality long‐term corporate bonds. For currencies, where a deep market for high‐quality corporate bonds is not available, the market yields applicable to government bonds of the appropriate term consistent with the estimated term of the obligation denominated in the respective currencies are used as the alternative discount rate.
Past service costs arise when a plan is amended retroactively, so that additional attribution for benefits is given to services rendered in past years. The expense related to past service cost is recognised in income when the related plan amendment, curtailment or settlement occurs.
Periodic Measurement of Cost for Defined Benefit Plans
Defined benefit plans present a far greater challenge to accountants than do defined contribution plans, since the amount of expense to be recognised currently will need to be determined on an actuarial basis. Under current IFRS, only the accrued benefit valuation method may be used to measure defined benefit plan pension cost. Furthermore, only a single variant of the accrued benefit method—the “projected unit credit”
method—is permitted.
Net periodic pension cost will consist of the sum of the following components:
1. Service costs:
1. Current service costs.
2. Past service costs.
3. Gain or loss on settlement.
2. Net interest cost for the current period on the net defined benefit liability (asset).
3. Remeasurement of the net defined benefit liability (asset):
1. Actuarial gains and losses. Return on plan assets, excluding amounts included in net interest on;
2. The net defined benefit liability (asset); and
3. Any change in the effect of the asset ceiling, excluding amounts included in net interest on the net defined benefit liability (asset).
Disclosures required by IAS 19 effectively require that these cost components be displayed in the notes to the financial statements.
Current Service Cost
Current service cost must be determined by an actuarial valuation and will be affected by assumptions such as expected turnover of staff, average retirement age, the plan's vesting schedule and life expectancy after retirement. The probable progression of wages over the employees'
remaining working lives will also have to be taken into consideration if retirement benefits will be affected by levels of compensation in later years, as will be true in the case of career‐average and final‐pay plans, among others.
It is worth stressing this last point: when pension arrangements call for benefits to be based on the employees' ultimate salary levels, experience will show that those benefits will increase, and any computation based on current salary levels will surely understate the actual economic commitment to the future retirees. Accordingly, IFRS requires that, for such plans, future salary progression must be considered in determining current period pension costs. While future salary progression (where appropriate to the plan's benefit formula) must be incorporated (via
estimated wage increase rates), current pension cost is a function of the services provided by the employee in the reporting period, emphatically not including services to be provided in later periods.
Under IAS 19, service cost is based on the present value of the defined benefit obligation and is attributed to periods of service without regard to conditional requirements under the plan calling for further service. Thus, vesting is not taken into account in the sense that there is no justification for non‐accrual prior to vesting. However, in the actuarial determination of pension cost, the statistical probability of employees leaving
employment prior to vesting must be taken into account.
In December 2020, IFRIC Committee has taken a decision about the periods of service to which an entity attributes benefit for a particular defined benefit plan.
Paragraph 70 of IAS 19 specifies the principle for attributing benefit to periods of service and paragraphs 71–74 of IAS 19 include requirements that specify how an entity applies that principle. Paragraph 71 requires an entity to attribute benefit to periods in which the obligation to provide post‐employment benefits arises. That paragraph also specifies that the obligation arises as employees render services in return for post‐ employment benefits an entity expects to pay in future reporting periods. Paragraph 72 specifies that employee service before any vesting date gives rise to a constructive obligation because, at the end of each successive reporting period, the amount of future service an employee will have to render before becoming entitled to the benefit is reduced.
The Committee concluded that the principles and requirements in IFRS Standards provide an adequate basis for an entity to determine the periods to which retirement benefit is attributed.
An example to help understand the above is presented:
Under the terms of the plan:
1. Employees are entitled to a retirement benefit only when they reach the retirement age of 62 provided they are employed by the entity when they reach that retirement age;
2. The amount of the retirement benefit is calculated as one month of final salary for each year of service before the retirement age;
3. The retirement benefit is capped at 16 years of service (ie the maximum retirement benefit an employee is entitled to is 16 months of final salary); and
4. The retirement benefit is calculated using only the number of consecutive years of employee service immediately before the retirement age.
For the defined benefit plan illustrated:
1. If an employee joins the entity before the age of 46 (ie there are more than 16 years before the employee's retirement age), any service the employee renders before the age of 46 does not reduce the amount of future service the employee will have to render in each successive reporting period before becoming entitled to the retirement benefit. Employee service before the age of 46 affects neither the timing nor the amount of the retirement benefit. Accordingly, the entity's obligation to provide retirement benefits arises only from the age of 46.
2. If an employee joins the entity on or after the age of 46, the amount of future service the employee will have to render before becoming entitled to the retirement benefit is reduced at the end of each successive reporting period. Accordingly, the entity's obligation to provide retirement benefits arises from the date the employee first renders service.
Paragraph 73 of IAS 19 specifies that an entity's obligation increases until the date when further service by the employee will lead to no material amount of further benefits under the plan. Thus in substance:
1. Each year of service between the age of 46 and the age of 62 leads to further benefits because service rendered in each of those years reduces the amount of future service an employee will have to render before becoming entitled to the retirement benefit; and
2. An employee will receive no material amount of further benefits from the age of 62, regardless of the age at which the employee joins the entity. The entity therefore attributes retirement benefit only until the age of 62.
3. The entity attributes retirement benefit to each year in which the employee renders service from the age of 46 to the age of 62 (or, if employment commences on or after the age of 46, from the date the employee first renders service to the age of 62).
Interest on the Accrued Benefit Obligation
As noted, since the actuarial determination of current period cost is the present value of the future pension benefits to be paid to retirees by virtue of their service in the current period, the longer the time until the expected retirement date, the lower will be the service cost recognised. However, over time this accrued cost must be further increased, until at the employees' respective retirement dates the full amounts of the promised payments have been accreted. In this regard, the accrued pension liability is much like a sinking fund that grows from contributions plus the earnings thereon.
While service cost and interest are often the major components of expense recognised in connection with defined benefit plans, there are other important elements of benefit cost to be accounted for. IAS 19 identifies the expected return on plan assets, actuarial gains and losses, past service costs and the effects of any curtailments or settlements as categories to be explicitly addressed in the disclosure of the details of annual pension cost for defined benefit plans. These will be discussed in the following sections in turn.
The Expected Return on Plan Assets
IAS 19 has adopted the approach that since pension plan assets are intended as long‐term investments, the random and perhaps sizeable fluctuations from period to period should not be allowed to excessively distort the operating results reported by the sponsoring entity. This standard identifies the expected return rather than the actual return on plan assets as the salient component of pension cost, with the difference between actual and expected return being an actuarial gain or loss to be dealt with as described below. Expected return for a given period is determined at the same rate that the discount rate applied to determine the defined benefit pension obligation.
The IAS 19 amendment adopted in 2000 also added certain new requirements which relate to recognition and measurement of the right of reimbursement of all or part of the expenditure to settle a defined benefit obligation. It established that only when it is virtually certain that another party will reimburse some or all of the expenditure required to settle a defined benefit obligation, the sponsoring entity would recognise its right to reimbursement as a separate asset, which would be measured at fair value. In all other respects, however, the asset (amount due from the pension plan) is to be treated in the same way as plan assets. In the statement of profit or loss and other comprehensive income or separate income statement presented, defined benefit plan expense may be presented net of the reimbursement receivable recognised.
After the amendment in 2000, qualifying insurance policies are to be included in plan assets, arguably because those plans have similar economic effects to funds whose assets qualify as plan assets under the revised definition.
Actuarial Gains and Losses
Changes in the amount of the actuarially determined defined benefit pension obligation, and differences in the actual versus the expected return on plan assets, as well as demographic changes (e.g., composition of the workforce, changes in life expectancy, etc.) contribute to actuarial (or
“experience”) gains and losses and are immediately recognised in other comprehensive income, without deferral or any off‐balance‐sheet treatment previously permitted under the “corridor approach.”
Past Service Costs
Past service costs refer to increases in the amount of a defined benefit liability that results from the initial adoption of a plan, or from a change or amendment to an existing plan which increases the benefits promised to the participants with respect to previous service rendered. Less commonly, a plan amendment could reduce the benefits for past services, if local laws permit this. Employers will amend plans for a variety of reasons, including competitive factors in the employment marketplace, but often it is done with the hope and expectation that it will engender goodwill among the workers and thus increase future productivity. For this reason, it is sometimes the case that these added benefits will not vest immediately, but rather must be earned over some defined time period.
IAS 19 requires immediate recognition of past service costs when they occur as a result of a plan amendment, curtailment or settlement as the case may be.
Settlements occur when the entity enters into a transaction which effectively transfers the obligation to another entity, such as an insurance company, so that the sponsor has no legal or constructive obligation to fund any benefit shortfall. Merely acquiring insurance which is intended to cover the benefit payments does not constitute a settlement, since a funding mechanism does not relieve the underlying obligation.
With the issuance of an amendment to IAS 19 in February 2018, which is required to be applied to all amendments, curtailments or settlements to a plan occurring on or after the beginning of the first annual reporting period that begins on or after January 1, 2019, there is a change in the basis of application to determine past service cost and computation of current service cost and net interest for the period after such amendment, curtailment or settlement. The amendments require an entity to use updated assumptions to determine current service cost and net interest for the period after a plan amendment, curtailment or settlement. Earlier application is permitted but in case of such early application is to be disclosed.
Transition Adjustment
Where an entity has to change its accounting policy to bring these accounting requirements into effect it shall do so on a fully retroactive basis.
However, an entity need not adjust the carrying amount of assets outside the scope of IAS 19 for changes in employee benefit costs that were included in the carrying amount before the date of initial application. The date of initial application is the beginning of the earliest prior period presented in the first financial statements in which the entity adopts this standard.