pwc.com/ifrs Practical guide to IFRS IAS 19 amendment to significantly affect the reporting of employee benefits

At a glance  A curtailment will only occur when an entity significantly reduces the  The IASB has amended its standard number of employees. Curtailment on for employee benefits. gains and losses will be accounted for The biggest impact of the changes is as past-service cost. on defined benefit plans and other post-employment benefits; however,  A liability for a termination benefit termination benefits and other will be recognised at the earlier of employee benefits are also affected. when the entity can no longer withdraw the offer of the termination August 2011  Actuarial gains and losses, the effect of benefit and when the entity recognises the ceiling and the actual return any related restructuring costs. on plan (‘remeasurements’) are recognised in the  Enhanced disclosures are required in immediately, with a charge or credit to order to present the characteristics of other comprehensive income (OCI) in benefit plans and risks associated with the periods in which they occur. They them, and identify and explain the are not recycled. amounts recognised in the financial statements.  There will be less flexibility in presentation. Defined Background benefit cost will be split into two categories: (1) service cost, past- The amendment has been included in the service cost and settlement; and Memorandum of Understanding between (2) interest or income. the IASB and the FASB. Although there will still be significant differences,  Interest expense or income will now elimination of the options further aligns be net interest on the net defined IFRS and US GAAP. benefit liability (asset), calculated by applying the discount rate to the net PwC observation: Further changes to defined benefit liability (asset). This the accounting for employee benefits, replaces the interest cost on the including contribution-based promises, defined benefit obligation and the will be considered in the IASB's expected return on plan assets. consideration of the post-2011 agenda.

 Past-service cost will be recognised in Both the IASB and the FASB have profit or loss in the period of a plan indicated that further improvements and amendment. convergence are desirable in the future. Practical issues PwC observation: The corridor and spreading method and the immediate The amendment will change reporting for recognition of actuarial gains/losses in certain types of benefits and raise a profit or loss are no longer permitted. number of application issues, which are This will reduce diversity in presentation considered below. and will ensure that the balance sheet always reflects the extent to which a Net interest cost plan is funded. Amounts recognised in OCI are not recycled The amendment replaces the interest cost through profit or loss, but the standard on the defined benefit obligation, and the no longer requires these items to be expected return on plan assets with a net recognised immediately in retained interest cost based on the net defined earnings. This will allow benefit asset or liability and the discount remeasurements to be presented as a rate measured at the beginning of the separate category within . year. The net defined benefit asset or liability is adjusted for actual benefit Past-service cost payments and contributions during the year. There is no change in the discount The amendment changes the definition of rate; this continues to reflect the yield on past-service cost to clarify the distinction high-quality corporate bonds, or on between curtailments and past-service government debt when there is no deep costs; it also requires all past-service market in high-quality corporate bonds. costs to be recognised immediately in profit or loss, regardless of vesting PwC observation: This is the most requirements. A plan amendment that significant change in the measurement reduces the defined benefit obligation of employee benefit expense. It will will be a negative past-service cost, so increase the income statement charge there will be symmetry between the for many entities because the discount accounting for amendments that increase rate is typically lower than the or reduce the obligation for past service. expected-return-on-assets assumption A curtailment will be the effect of a currently used. However, this change is reduction in the number of employees neutral for total comprehensive income, participating in a plan. as the reduction in profit or loss is offset by an increase in OCI. PwC observation: IAS 19 currently requires unvested past-service costs to Remeasurements be recognised on a straight-line basis over the future service period until the The amendment introduces a new term: benefits become vested; vested past- ‘remeasurements’. This is made up of service costs are recognised actuarial gains and losses on the defined immediately. The changes require benefit obligation, the difference between management to recognise all past- actual investment returns and the return service costs in the period of a plan implied by the net interest cost and the amendment. Unvested past-service costs effect of the asset ceiling. Remeasure- can no longer be spread over a future- ments are recognised immediately in OCI service period. The amendment also and are not recycled. removes the requirement to determine whether a benefit reduction was a curtailment or a negative past-service cost. Changes to benefits that reduce the defined benefit obligation will also be past-service costs.

Practical guide to IFRS – IAS 19 (revised), ‘Employee benefits’ 2 Example PwC observation: The amended standard clarifies that the payment of An entity operates a pension plan that benefits provided in the terms of a plan provides a pension of 1% of final salary and included in the actuarial for each year of service, subject to a assumptions − for example, an option minimum of five years’ service. On at retirement for employees to take their 1 January 20X1, the entity improves the benefit in the form of a lump sum rather pension to 1.25% of final salary for each than a pension or routine pension year of service, including prior years. The payments − are not settlements. present value of the defined benefit obligation therefore increased by Risk and cost-sharing plans C500,000, as follows: The rising costs of post-employment C benefits − arising from improving Employees with more than 5 years’ of service at 1 January longevity, poor investment returns, legislative changes or increasing medical 20X1 400,000 costs − have led to changes in plan design Employees with less than 5 years’ of service at 1 January that do not always fit easily into the 20X1 (average of three years existing guidance. The amendment of service so two years until clarifies the accounting for features such vesting) 100,000 as employee contributions or benefits Increase in defined benefit that vary depending on the experience of obligation 500,000 the plan, contingent benefit increases relating to the investment performance of Existing IAS 19 the plan and limits on the employer's obligation to contribute to a plan. It A past service cost of C400,000 should requires the expected cost of benefits to be recognised immediately, as those reflect all these plan terms, which may benefits have already vested. The therefore require specific actuarial remaining C100,000 is recognised on a assumptions. For example, the cost of a straight-line basis over the two-year benefit linked to investment returns will period from 1 January 20X1. require an assumption about investment returns to be included in the expected increase in the pension. Amendment to IAS 19

A past service cost of C500,000 should PwC observation: Determining the be recognised and charged in the income substance of such arrangements, statement immediately. particularly constructive obligations beyond the contractual plan terms, will Settlement require judgement and significant disclosure. The substance of the benefit The amendment clarified the definition is also important to determine whether of a settlement but did not make changes in actual benefits are plan significant changes to the accounting for amendments or actuarial gains or gains and losses on settlement. losses, and whether they affect profit or Settlement gain or loss is defined as the loss or OCI. difference between (a) the present value on the settlement date of the defined Example benefit obligation being settled, and (b) the settlement price, including any plan Pension plan X has a long-established assets transferred and any payments practice of providing cost-of-living made directly by the entity. It is increases to in payment in line recognised in profit or loss when the with the movement in a consumer price settlement occurs. index (CPI). However, these are only awarded to the extent that the investment The settlement gain or loss will no longer returns earned on plan assets are above a include unrecognised actuarial gains or specific rate. There is no catch-up in losses, as these will be recognised future years for subsequent higher immediately in OCI. returns when an increase has been

Practical guide to IFRS – IAS 19 (revised), ‘Employee benefits’ 3 restricted due to the rate of return expected future contributions payable in earned. The assumption regarding future respect of past service. pension increases should reflect not only expectations for the future movement in Administration costs and other the CPI but also the expected returns on plan assets and the variability in those returns. The amendment requires costs associated with the management of plan assets to be Taxes deducted from the return on plan assets, which is unchanged from the existing Taxes payable by the plan are currently standard. Other expenses such as record- recognised in the return on plan assets. keeping costs or actuarial valuation fees The amended standard requires taxes should be recognised in profit or loss related to defined benefit plans to be when the services are received. This included either in the return on assets or changes the existing standard, where the calculation of the benefit obligation, there is a choice either to include depending on their nature. expenses in the calculation of the defined benefit obligation or in the actual and Taxes on the return on plan assets will be expected return on plan assets. part of the actual investment return and recognised in OCI. Social charges or The amendment gives a detailed other taxes levied on benefit payments or definition how the return on plan assets contributions to the plan should be is calculated: included in the measurement of the defined benefit obligation to the extent Interest that they relate to benefits in respect of + Dividends service before the balance sheet date. + Other income +/- Unrealised gains/losses PwC observation: Entities are only - Costs of managing investments affected if their current policy is different - Taxes payable on investment returns from the revised requirements. An = Total return on plan assets entity that has to change its policy for taxes will be required to recalculate the PwC observation: Entities are only defined benefit obligation, return on affected if their current policy is different plan assets and the pension costs from the new requirements. One because the amendment is applied example of this would be where costs retrospectively. other than investment management have been reflected in the expected Judgement is required to determine and actual return. When a policy has to whether taxes should be included in the be changed, it may be necessary to measurement of the defined benefit recalculate the defined benefit obligation or the return on plan assets. obligation, return on plan assets and The revised standard refers specifically the pension costs, as the amendment is to taxes payable by the plan, but we applied retrospectively. believe taxes relating to benefits and paid by the employer should be Termination benefits recognised in the same way The amendment makes changes to the Example definitions and accounting for termination benefits to bring IAS 19 In territory X, pension plans are subject broadly into line with the US GAAP to income tax on investment income treatment of one-time termination (interest, dividends and realised capital benefits. gains) and contribution income. The tax on investment income should be The changes clarify that any benefit that recognised in the actual return on assets. must be earned by working for a future The tax on contributions should be period is not a termination benefit. A recognised in the measurement of the termination benefit is given only in defined benefit obligation based on the exchange for the termination of employment. A benefit that is in any way

Practical guide to IFRS – IAS 19 (revised), ‘Employee benefits’ 4 dependent on providing services in the existing contracts and announces the future is not a termination benefit. following plan.

The amendment also clarifies the Each employee that renders service until identification of an obligating event the closure of the factory will receive, on when an employer offers voluntary the termination date, a payment of termination benefits. A liability is C30,000. Employees leaving before recognised when the entity can no longer closure of the factory will receive withdraw an offer. C10,000. There are 120 employees at the factory. Management expects 20 Termination benefits and past-service employees to leave before closure. The costs can be very similar and may often total expected cash outflows under the arise as part of a restructuring. The plan are C3,200,000 (20 × C10,000 + amendment clarifies that: 100 × C30,000). ● The gain or loss on a curtailment or plan amendment linked to a The entity accounts for benefits provided restructuring or termination benefit is in exchange for termination of recognised at the earlier of when the employment as termination benefits; it related restructuring costs or accounts for benefits provided in termination benefits are recognised exchange for services as short-term and when the curtailment or plan employee benefits. amendment occurs; and  Termination benefits  Termination benefits linked to a The benefit provided in exchange for restructuring are recognised at the termination of employment is earlier of when the related C10,000, which the entity would have restructuring costs are recognised and to pay for terminating the when the entity can no longer employment without any future withdraw an offer of the termination service. The entity recognises a benefit. liability of C1,200,000 (120 × C10,000) for the termination benefits PwC observation: The amendment at the earlier of when the plan of removes an element of choice regarding termination is communicated to the whether some benefits are treated as affected employees and when the termination or post-employment benefits. entity recognises the restructuring Management will have to assess whether costs associated with the closure of termination benefits meet the new the factory. definition or are earned by working for a  Benefits provided in exchange for future period, in which case they would service be classified as either a short-term, other The incremental benefits that long-term or post-employment benefit. employees will receive if they provide services for the 10-month period are This changes existing benefits and not given in exchange for services simply future terminations. Management provided over that period. They are should consider the timing of recognition accounted for as short-term employee for benefits that are termination benefits benefits, as the entity expects to settle and whether an offer can no longer be them within 12 months after the end withdrawn. Benefits that have been of the annual reporting period. In this previously classified as termination example, discounting is not required, benefits may be reclassified. This might so an expense of C200,000 result in later recognition of the related (C2,000,000 ÷ 10) is recognised in expense than the existing IAS 19. each month during the service period of 10 months, with a corresponding Example increase in the carrying amount of the liability. Under current IAS 19, it could be argued that the whole Management is committed to close a amount of C3,200,000 meets the factory in 10 months and, at that time, definition of a termination benefit and will terminate the employment of all of should be recognised when the closure the remaining employees at the factory. and terms are announced. Management needs the expertise of the employees at the factory to complete

Practical guide to IFRS – IAS 19 (revised), ‘Employee benefits’ 5 Other long-term employee benefit, as it does not expect to settle all benefits the benefit within 12 months of the period in which it has been earned. There is diversity in practice under the existing standard around whether the Entity B concludes that the vacation classification of the obligation as current represents a short-term benefit, or non-current under IAS 1 also drives as it expects to settle the benefit within 12 the classification of the benefit as short or months of the period during which it has long term. The diversity arises because been earned. both standards use the term ‘due to be settled’, which is not defined. PwC observation: Although the classification in Entity A and Entity B is The amendment clarifies the definitions different, this would only have a of short- and long-term benefits by noticeable impact if the effect of confirming that the distinction is based discounting in Entity A was material to on whether payment is expected to be the liability. As the benefit is expected within the next 12 months or not, rather to be settled within a little over 12 than when payment can be demanded. A months after the balance sheet date, if long-term benefit could be a current interest rates are low the impact may liability when the entity does not have the be small. unconditional right to defer settlement for more than 12 months. Interim reporting

PwC observation: Management The amendment does not make any should review the classification of short- consequential amendments to IAS 34, and long-term benefits, and reclassify ‘Interim financial reporting’, to simplify and remeasure obligations in the general requirements of IAS 19 in the accordance with the revised guidance. context of interim reporting. However, The accounting for short-term benefits the IASB notes in the Basis for remains unchanged and is generally Conclusions that an entity is not always simple, as no actuarial assumptions are required to remeasure a net defined required and any obligations are benefit liability (asset) for interim measured on an undiscounted basis. reporting purposes under IAS 19 and Long-term benefits are still accounted IAS 34. for in a similar way to defined benefit plans. PwC observation: The removal of the corridor and spreading approach may Example increase the complexity of interim reporting for some entities. Those using Employees accrue a 20-day vacation this approach typically only remeasure entitlement rateably over the year. the net defined benefit obligation Unused entitlement can be carried between year ends in the event of a forward indefinitely but is lost if not used plan amendment, curtailment or before the employee leaves the company. settlement. Entities choosing to Entitlement is utilised on a ‘first in first recognise actuarial gains and losses in out’ basis. OCI typically remeasure the defined benefit obligation and plan assets at Entity A has past experience that each interim date to establish a gain or indicates that employees often carry loss recognised in OCI. Service cost, forward their entitlement for a number of interest cost and expected return on years, building up balances greater than assets would not be recalculated unless 20 days. Entity B has past experience that there was a plan amendment, indicates that employees utilise their curtailment or settlement. The removal entitlement such that they do not build of the corridor and spreading options up balances in excess of 10 days and may make it necessary for an entity to typically use any carried forward value the obligation at each interim entitlement in the next year. balance sheet date. Back-end loading of benefit Entity A concludes that the vacation formula accrual represents an other long-term

Practical guide to IFRS – IAS 19 (revised), ‘Employee benefits’ 6 Under IAS 19, defined benefits should be There are many new disclosure attributed to periods of service following requirements, including: the plan’s benefit formula unless an  Risks specific to the entity arising employee’s service in later years will lead from defined benefit plans to a materially higher level of benefit A narrative description of the specific (and therefore current service cost) than or unusual risks arising from a in earlier years (back-end loading). defined benefit plan is required. Where this is the case, the benefits Judgement will be required to identify should be allocated to periods of service those risks that should be explained, on a straight-line-basis. which may be challenging if there are many defined benefit plans with The exposure draft stated that assumed different characteristics within a salary increases should be considered in group. determining whether or not there is back- end loading. The Board concluded that  Categories of plan assets based on this additional guidance should not be risks/nature included in the final standard. The amendment requires a breakdown of the plans assets into categories that distinguish the risk PwC observation: A conclusion that and liquidity characteristics and salary increases do not result in a plan whether or not they have a quoted benefit formula that is back-end loaded market price in an active market. leads to inconsistencies in the treatment of plans providing  Actuarial assumptions economically identical benefits, Entities are required to disclose the depending on how those benefits are significant actuarial assumptions, described in the plan documentation. together with a sensitivity analysis for Our view is that the current practice of reasonably possible variations in each including future salary increases in of the significant actuarial assumptions. determining whether a benefit formula Judgement is required to determine allocates a materially higher level of which the significant assumptions are. benefit to later years is appropriate.  Reconciliations A reconciliation between the opening Disclosure and closing balances for plan assets, the defined benefit obligation, the The amendment introduces additional balance sheet asset or liability and the disclosures. The Board focused the effect of the asset ceiling will be disclosure objectives on the matters most required. relevant to the users of the financial  Future cash flows statements. The amendment will require Entities will be required to disclose disclosure to: significant information, in addition to • explain the characteristics of and risks the sensitivity analyses mentioned associated with its defined benefit above, to help users understand the plans; potential impact on cash flows, including: • identify and explain the amounts in the entity’s financial statements − a narrative description of any arising from its defined benefit plans; asset-liability matching strategies; and − a description of the funding arrangements and funding policy; • explain how the defined benefit plans − the amount of the expected may affect the entity’s future cash contributions in the next year; and flows regarding timing, amount and − the weighted-average duration of uncertainty. the defined benefit obligation.  Extended disclosures for multi- employer plans The accounting for multi-employer plans has not changed. However,

Practical guide to IFRS – IAS 19 (revised), ‘Employee benefits’ 7 more information has to be disclosed accounting estimates and errors’, except for multi-employer plans. For for (a) changes to the carrying value of example: assets that include employee benefit costs − a description of the funding in the carrying amount and (b) arrangements; comparative information about the − the extent to which the entity sensitivity analysis of the defined benefit might be liable for other entities’ obligation. Early adoption is permitted. obligations; − qualitative information regarding PwC observation: The amendment any withdrawal liability unless it is has to be applied retrospectively, which probable that the entity will will require the disclosure of a third withdraw; balance sheet in accordance with IFRS − an indication of an entity's level of 1. There is an exception for assets that participation in a plan (for include employee costs so that assets example, proportion of total such as inventory and property, plant members); and and equipment that include employee − the expected contribution in the benefits in cost do not have to be following year. restated. This exception is not applicable for first-time adopters. The PwC observation: changes will also remove the employee The disclosure requirements under benefits exemption in IFRS 1. current IAS 19 are extensive and sometimes difficult to understand. The Next steps amendment moves away from a checklist of items to an objective of Management should determine the effect providing relevant information when of the revised standard and, in particular, plans are material to the entity. any changes in benefit classification or However, the new requirements are presentation. likely to require more extensive disclosures and more judgement to Management should consider the effect determine what disclosure is required. of the changes on any existing employee Management should also be aware that benefit arrangements and whether some of the new disclosures may additional processes are needed to require additional actuarial calculations and should consider whether the compile the information required to internal reporting has to be updated to comply with the new disclosure collect the new disclosures. requirements.

Transition Management should also consider the choices that still remain within IAS 19, The amendment is effective for annual including the possibility of early periods beginning on or after 1 January adoption, the possible effect of these 2013; full retrospective application is changes on key performance ratios and required in accordance with IAS 8 how to communicate these effects to ‘Accounting policies, changes in analysts and other users of the accounts.

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Practical guide to IFRS – IAS 19 (revised), ‘Employee benefits’ 8