Chapter 6 Employee Benefits (Part 2)

Accounting for defined benefit plan

The employer’s obligation under a defined benefit plan is to provide the agreed
benefits. Therefore, the employer bears the risk that the promised benefits will cost
more than expected if actuarial or investment experience is worse than expected. In
such case, the related obligation may need to be increased.
Consequently, the accounting for defined benefits plans is complex because
actuarial assumptions are necessary to measure the obligation on a discounted basis,
This results to actuarial gains or losses. Also, the retirement benefit cost is not
necessarily equal to contribution due for the period.
The accounting for defined benefit plan involves the following steps:  
Step #1: Determine the deficit or surplus
The deficit or surplus is the difference between the following:
a. Present value of the defined benefit obligation (PV of DBO)
b. Fair value of plan assets (FVPA), if any
 PV of DBO represents the entity's obligation for the accumulated retirement
benefits earned by employees to date. This is determined using an actuarial
valuation method called the projected unit credit method.
 FVPA represents the balance of any fund set aside for payment of the
retirement benefits.
-If FVPA is less than PV of DBO, the difference is a deficit.
-If FVPA is greater than PV of DBO, the difference is a surplus.
 Step #2: Determine the Net defined benefit liability/asset
The net defined benefit liability or asset is the amount that presented in the
statement of financial position.
-If there is a deficit, the deficit is a net defined benefit liability.
-If there is a surplus, the net defined benefit asset is the lower the:
a. surplus, and
b. asset ceiling
The asset ceiling is "the present value of any economic benefits available in the
form of refunds from the plan or reductions in future contributions to the plan." (PAS
19.8)
 
Step #3: Determine the Defined Benefit Cost
The defined benefit cost is determined using the formula below:
Service cost: (recognized in P/L)
(a) Current service cost xxx
(b) Past service cost xxx
(c) Any (gain) or loss on settlement xxx xxx
 
Net interest on the net defined benefit liability (asset): (recognized in P/L):
(a) Interest cost on the defined benefit obligation xxx
(b) Interest income on plan assets xxx
(c) Interest on the effect of the asset ceiling xxx xxx
 
Remeasurements of the net defined benefit liability (asset); (recognized in OCI)
(a) Actuarial (gains) and losses xxx
(b) Difference between interest income on plan assets and
return on plan assets xxx
(c) Difference between the interest on the effect of the asset
ceding and change in the effect of the asset ceiling xxx xxx
 
Total Defined Benefit Cost: xxx
Service cost:
Current service cost
a. Current service cost — is the increase in the PV of DBO resulting from employee
service in the current period. (PAS 198)
An employee's retirement benefit increases as he/she renders service. For
example, an employee who has rendered 20 years of service would have higher
retirement benefits than an employee who has rendered only 10 years of service,
assuming they have similar position and salary levels. Current service cost represents
the increase in the employee's retirement benefit because of the services he/she has
rendered during the current year. 
Past service cost
b. Past service cost — is the change in the PV of DBO for employee service in prior
periods resulting from a plan amendment or curtailment.
Past service cost (whether vested or unvested) is recognized immediately as
expense (a) when the plan amendment or curtailment occurs; or (b) when the entity
recognizes related restructuring costs or termination benefits; whichever comes earlier.
Unvested past service costs are not deferred and amortized.
 A plan amendment occurs when an entity:
a. Introduces or withdraws a defined benefit plan, or
b. Changes the benefits payable under an existing defined benefit plan
 A curtailment occurs when an entity significantly reduces the number of
employees covered by a plan. A curtailment may arise from an isolated event,
such as the closing of a plant, discontinuance of an operation or termination or
suspension of a plan.  
Past service cost can be positive (when PV of DBO increases) or negative (when
PV of DBO decreases).
 
Gain or loss on settlement
c. Gain or loss on settlement — arises when the employer' s obligation to provide
benefits is eliminated other than from payment of benefits according to the terms of
the plan.
The gain or loss on a settlement is the difference between:
a. the present value of the defined benefit obligation being as determined on the date of
settlement; and
b. the settlement price, including any plan assets transferred and any payments made
directly by the entity in connection with the settlement. The gain or loss is recognized
when the settlement occurs.  
Net interest on the net defined benefit liability (asset):
Net interest on the net defined benefit liability (asset) — is the change in the
net defined benefit liability (asset) during the period that arises from the passage of
time. It comprises the three items listed in the formula above.
  The same discount rate is used for the three items. This discount rate is based
on high quality corporate bonds or in the absence thereof, on government bonds,
determined at the start of the annual reporting period.
 
Remeasurements of the net defined benefit liability (asset):
Actuarial gains and losses
a. Actuarial gains and losses — are changes in the PV of DBO resulting from
changes in actuarial assumptions.  
Actuarial assumptions are estimates of variables used in determining the ultimate
cost of providing post-employment benefits. These include demographic assumptions
(e.g., employee turnover rate, mortality or lifespan and health condition) and financial
assumptions (i.e., discount rate, future salary levels, and future medical costs).
Demographic assumptions -Pertain to the employee.
Financial assumptions -Pertain to money matters, such as costs and market rates.
  The discount rate used in measuring defined benefit obligations and costs is
based on high quality corporate bonds.
PAS 19 encourages, but does not require, involving a qualified actuary in
measuring defined benefit obligations,
In practice, actuarial valuations are usually obtained every 3 years.
 
Return on plan assets
b. Return on plan assets — represents the investment income earned by the plan
assets during the year after deducting the costs of managing the fund and taxes.
 Remember the following: Accounting for defined benefit plan
1. Determine the deficit or surplus: FVPA of DBO- deficit; FVPA> PV of DBO =
Surplus
2. Determine the Net defined benefit liability/asset: A deficit represents a net
defined benefit liability. The lower between a surplus and the 'asset ceiling'
represents a net defined benefit asset.
3. Determine the defined benefit cost. Defined benefit cost Service cost + Net
interest + Remeasurements
Notes:
-The PV of DBO has a normal credit balance (obligations have normal credit balance).
Thus, the beginning balance is placed on the credit side. The ending balance is placed
on the opposite side to facilitate squeezing,
-Current service cost and interest cost are placed on the credit side because these
items increase the obligation.
-Benefits paid are placed on the debit side because this item decreases the obligation.
-The PV of DBO is also affected by adjustments resulting from plan amendment,
curtailment or settlement.
Fair value of plan assets T-account
 Fair value — is "the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the
measurement date." (PFRS 13. Appdx. A)
 Plan assets comprise:
a. Assets held by a long-term employee benefit fund; and
b. Qualifying insurance policies.
  Assets held by a long-term employee benefit fund are assets held by an
entity (a fund) that is legally separate from the employer.
  A qualifying insurance policy is an insurance policy issued by an insurer that is
not related to the employer.
Both the assets held by a long-term employee benefit fund and the proceeds
from a qualifying insurance policy are intended solely for paying employee benefits, are
not available to the employer's creditors even in bankruptcy, and cannot be returned to
the employer except when the amount returned represents surplus assets that are not
needed in settling employee benefit obligations or a reimbursement to the employer for
employee benefits already paid.
Plan assets exclude unpaid contributions due from the employer, as well as any
non-transferable financial instruments issued by the employer and held by the fund.
Plan assets are reduced by any liabilities of the fund that do not relate employee
benefits.
Notes:
-The FVPA has a normal debit balance (assets have normal debit balance). Thus, the
beginning balance is placed on the debit side; the ending balance on the opposite side
to facilitate squeezing.
-Return on plan assets and Contributions to the fund are placed on the debit side
because these items increase the plan assets.
-Benefits paid are placed on the credit side because this item decreases the plan
assets.
 
Determining the ultimate cost of a defined benefit
The ultimate cost of a defined benefit plan may be influenced by many variables,
such as final salaries, employee turnover and mortality, employee contributions and
medical cost trends. The ultimate cost of the plan is uncertain and this uncertainty is
likely to persist over a long period of time. In order to measure the present value of the
post-employment benefit obligations and the related current service cost, it is
necessary:
a. to apply an actuarial valuation method;
b. to attribute benefit to periods of service; and
c. to make actuarial assumptions.
Actuarial valuation method — Projected Unit Credit Method
The Projected unit Credit Method "(sometimes known as the accrued benefit method
pro-rated on service or as the benefit/years of service method) sees each period of
service as giving rise to an additional unit of benefit entitlement and measures each unit
separately to build up the final obligation." (PAS 19.67)  
Under the projected unit credit method, retirement benefit obligations are
measured based on future salary levels of employees (projected salaries). Assumptions
are made to estimate the salary level of employees on their expected retirement date.  
Attributing benefit to periods of service
Benefits are attributed to the periods of service using the plan formula.
However, if benefits are materially higher for services rendered in later years
than in earlier years, the benefits are attributed on a straight-line basis from the date the
employee's entitlement to benefits starts to accrue until the date where future services
will no longer lead to material amount of benefits.
  Benefits are attributed to the current period in order to determine the current
service cost, and current and prior periods in order to determine the PV of DBO.
  PAS 19 requires that interest income on plan assets shall be determined based
on the beginning balance of the FVPA, taking account of any changes in the plan assets
held during the period as a result of contributions and benefit payments.  
Reimbursements
When it is virtually certain that another party will reimburse some or all of the
expenditure required to settle a defined benefit obligation, an entity recognizes its right
to reimbursement as a separate asset, measured at fair value. That asset is treated in
the same way as plan assets. Any gain or loss on the changes in the carrying amount of
the reimbursement asset is recognized as an addition to (or deduction from) the defined
benefit cost.
Overfunding I Underfunding
The retirement plan is said to be overfunded if there is net defined benefit asset
and underfunded if there is net defined benefit liability. If the fair value of the plan assets
is equal to or greater than the present value of the defined benefit obligation, the
retirement plan is said to be fully funded.  
Offsetting
An asset relating to one plan is offset against a liability relating to another plan only
when the entity has both:
a. A legally enforceable right to use a surplus in one plan to settle obligations under
the other plan; and
b. An intention to either settle the obligations on a net basis, or to realize the surplus in
one plan and settle its obligation under the other plan simultaneously.
Other long-term employee benefits
Other long-term employee benefits are employee benefits (other than post-
employment benefits and termination benefits) that are due to be settled beyond 12
months after the end of the period in which the employees have rendered the related
service. Examples:
a. Long-term compensated absences, e.g., sabbatical leave
b. Jubilee or other long-service benefits
c. Long-term disability benefits
d. Profit-sharing, bonuses, and deferred compensation payable beyond 12 months after
the end of the period in which the benefits were earned
  Other long-term employee benefits are accounted for similar to defined benefit
plans except that all the components of the defined benefit cost are recognized in profit
or loss, including the remeasurements of the net defined benefit liability/asset.  
Termination benefits
Termination benefits are those provided as a result of either
a. the entity's decision to terminate the employee before normal retirement date; or
b. the employee's decision to accept the employees offer of benefits in exchange for
termination.
 Unlike the other types of employee benefits, the to pay termination benefits
arises from the employer's act of terminating an employee rather than from employee
service.
 
Accordingly, benefits resulting from termination at the employee's request without
the employer's offer are not termination benefits but rather post-employment benefits.  
Recognition
Termination benefits are recognized as a liability and expense at the earlier of the
following dates:
a. When the entity can no longer withdraw the offer of those benefits; and
b. When the entity recognizes restructuring costs under PAS 37 that involve payment of
termination benefits. (PAS 19.65)  
Measurement
Termination benefits are accounted for according to their nature.
Termination benefits that are:
a. payable within 12 months are accounted as short-term benefits.
b. payable beyond 12 months are accounted for as other long-term benefits.
c. enhancement to post-employment benefits are accounted for as post-employment
benefits.
 

Chapter 6: Summary
Accounting for defined benefit plan
I. Determine the deficit or surplus: (FVPA < PV of DBO (FVPA > PV of OBO = surplus
2. Determine the Net defined benefit liability/asset: (Deficit net defined benefit liability);
(Lower of surplus and 'asset ceiling' = net defined benefit asset)
3. Determine the benefit cost