The accounting standard IAS 19 Employee Benefits prescribes rules for recognition of various types of benefits that employers provide to employees.
Main objective of IAS 19 is accounting and disclosure for employee benefits. IAS 19 requires recognition of:
- a liability when an employee provides their service (work) in exchange for employee benefits (e.g. pension), paid in the future
- an expense when the entity consumes the economic benefit arising from service provided by an employee in exchange for benefits.
This is a demonstration of the matching principle – recognise an expense in the period when corresponding revenue is recognised.
Classification of benefits
Short-term benefits: Shorter than 12 months liabilities, for instance salary.
Termination benefits: Shorter than 12 months liabilities, for instance salary.
Post-employment: Other benefits than the two above.
Other long-term benefits: Other benefits, longer than 12 months, than the three above.
This one is the most interesting one in terms of IAS 19. Usually this is divided in:
- Defined contribution plans (DC)
- Defined benefit plans (DB)
In short, defined contribution means that the financial risk is with the employee. And defined benefit that the benefit itself is defined and therefore the insurer takes on the financial risk.
The accounting of DC plans is rather straightforward and not discussed further here.
Account for a defined benefit plan
- Estimate the ultimate cost of the benefit. This may include mortality and interest rate assumptions. It may depend on the end salary of the employee etc.
- Use the Projected Unit Credit (PUC) method to estimate how much the employees have earned for their work in the current and prior periods.
- Discount the benefit in order to determine the present value of the defined benefit obligation and the current service cost.
- Deduct the fair value of any assets related to this obligation from the present value calculated above.
- Determine amount in the profit or loss:
- Current service cost
- Any past service cost
- Any gain or loss on settlement
- Net interest
- Determine re-measurements in other comprehensive income:
- Actuarial gains and losses
- Return on plan assets, excluding amounts included in net interest
Under defined benefit (DB) plan, the employer has the obligation to pay benefits according to a plan, to the employee, and all investment and actuarial risk falls on the company.