INTERMEDiATE ACCOUNTiNG 2
CHAPTER 6: EMPLOYEE BENEFiTS (PART 2)
ACCOUNTING FOR DEFINED BENEFIT PLAN The asset ceiling is the present value of
The employer's obligation under a defined any economic benefits available in the form of
benefit plan is to provide the agreed benefits. refunds from the plan or reductions in future
Therefore, the employer bears the risk that the contributions to the plan.
promised benefits will cost more than expected if
actuarial or investment experience is worse than Step #3: Determine the defined benefits cost
expected. In such case, the related obligation
may need to be increased. Consequently, the CURRENT SERVICE COST
accounting for defined benefits plans is complex 1. Current service cost - is the increase in
because actuarial assumptions are necessary to the PV of DBO resulting from employee
measure the obligation on a discounted basis, service in the current period.
This results to actuarial gains or losses. Also, the An employee's retirement benefit
retirement benefit cost is not necessarily equal to increases as he/she renders service. For
contribution due for the period. example, an employee who has rendered
20 years of service would have higher
THE ACCOUNTING FOR DEFINED BENEFIT retirement benefits than an employee who
PLAN INVOLVES THE FOLLOWING STEPS has rendered only 10 years of service,
Step #1: Determine the deficit or surplus assuming they have similar position and
The deficit or surplus is the difference salary levels. Current service cost
between the following: represents the increase in the employee's
1. Present value of the defined benefit retirement benefit because of the services
obligation (PV of DBO) he/she has rendered during the current
2. Fair value of plan assets (FVPA), if any year.
PV of DBO represents the entity's PAST SERVICE COST
obligation for the accumulated retirement 2. Past service cost - is the change in the
benefits earned by employees to date. This is PV of DBO for employee service in prior
determined using an actuarial valuation periods resulting from a plan amendment
method called the projected unit credit or curtailment.
method. Past service cost (whether vested
FVPA represents the balance of any or unvested) is recognized immediately as
fund set aside for payment of the retirement expense (a) when the plan amendment or
benefits. curtailment occurs; or (b) when the entity
If FVPA is less than PV of DBO, the recognizes related restructuring costs or
difference is a deficit. termination benefits; whichever comes
If FVPA is greater than PV of DBO, the earlier. Unvested past service costs are
difference is a surplus. not deferred and amortized.
Step #2: Determine the Net defined benefit
liability/asset A plan amendment occurs when an
The net defined benefit liability or asset is entity:
the amount that presented in the statement of a) Introduces or withdraws a defined
financial position. benefit plan, or
b) Changes the benefits payable under
If there is a deficit, the deficit is a net an existing defined benefit plan
defined benefit liability. A curtailment occurs when an
If there is a surplus, the net defined entity significantly reduces the number of
benefit asset is the lower the: employees covered by a plan. A
a) surplus, and curtailment may arise from an isolated
b) asset ceiling 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 RETURN ON PLAN ASSETS
PV of DBO increases) or negative (when 2. Return on plan assets - represents the
PV of DBO decreases). investment income earned by the plan
assets during the year after deducting the
GAIN OR LOSS ON SETTLEMENT costs of managing the fund and taxes.
3. Gain or loss on settlement - arises when
the employer s obligation to provide REMEMBER THE FOLLOWING:
benefits is eliminated other than from ACCOUNTING FOR DEFINED BENEFIT PLAN
payment of benefits according to the terms 1. Determine the deficit or surplus: FVPA of
of the plan. DBO- deficit; FVPA> PV of DBO = Surplus
The gain or loss on a settlement is 2. Determine the Net defined benefit
the difference between: liability/asset: A deficit represents a net
a) The present value of the defined defined benefit liability. The lower between
benefit obligation being as determined a surplus and the 'asset ceiling' represents
on the date of settlement; and a net defined benefit asset.
b) The settlement price, including any 3. Determine the defined benefit cost
plan assets transferred and any Defined benefit cost Service cost + Net
payments made directly by the entity interest + Remeasurements
in connection with the settlement. The
gain or loss is recognized when the FAIR VALUE OF PLAN ASSETS T-ACCOUNT
settlement occurs. Fair value is the price that would be
received to sell an asset or paid to transfer a
NET INTEREST ON THE NET DEFINED liability in an orderly transaction between market
BENEFIT LIABILITY (ASSET) participants at the measurement date.
Net interest on the net defined benefit Plan assets comprise:
liability (asset) is the change in the net defined a) Assets held by a long-term employee
benefit liability (asset) during the period that benefit fund; and
arises from the passage of time. It comprises the b) Qualifying insurance policies.
three items listed in the formula above. The same
discount rate is used for the three items. This Assets held by a long-term employee
discount rate is based on high quality corporate benefit fund are assets held by an entity (a fund)
bonds or in the absence thereof, on government that is legally separate from the employer.
bonds, determined at the start of the annual A qualifying insurance policy is an
reporting period. insurance policy issued by an insurer that is not
related to the employer.
REMEASUREMENTS OF THE NET DEFINED Both the assets held by a long-term
BENEFIT LIABILITY (ASSET) employee benefit fund and the proceeds from a
qualifying insurance policy are intended solely for
ACTUARIAL GAINS AND LOSSES paying employee benefits, are not available to the
1. Actuarial gains and losses - are employer's creditors even in bankruptcy, and
changes in the PV of DBO resulting from cannot be returned to the employer except when
changes in actuarial assumptions. the amount returned represents surplus assets
Actuarial assumptions are that are not needed in settling employee benefit
estimates of variables used in determining obligations or a reimbursement to the employer
the ultimate cost of providing post- for employee benefits already paid.
employment benefits. These include Plan assets exclude unpaid contributions
demographic assumptions (e.g., employee due from the employer, as well as any non-
turnover rate, mortality or lifespan and transferable financial instruments issued by the
health condition) and financial employer and held by the fund. Plan assets are
assumptions (i.e., discount rate, future reduced by any liabilities of the fund that do not
salary levels, and future medical costs). relate employee benefits.
The discount rate used in
measuring defined benefit obligations and
costs is based on high quality corporate
bonds.
DETERMINING THE ULTIMATE COST OF A Any gain or loss on the changes in the carrying
DEFINED BENEFIT amount of the reimbursement asset is recognized
The ultimate cost of a defined benefit plan as an addition to (or deduction from) the defined
may be influenced by many variables, such as benefit cost.
final salaries, employee turnover and mortality,
employee contributions and medical cost trends. OVERFUNDING/UNDERFUNDING
The ultimate cost of the plan is uncertain and this The retirement plan is said to be
uncertainty is likely to persist over a long period of overfunded if there is net defined benefit asset
time. In order to measure the present value of the and underfunded if there is net defined benefit
post-employment benefit obligations and the liability. If the fair value of the plan assets is equal
related current service cost, it is necessary: to or greater than the present value of the defined
1. To apply an actuarial valuation method; benefit obligation, the retirement plan is said to be
2. To attribute benefit to periods of service; fully funded.
and
3. To make actuarial assumptions. OFFSETTING
An asset relating to one plan is offset
ACTUARIAL VALUATION METHOD - against a liability relating to another plan only
PROJECTED UNIT CREDIT METHOD when the entity has both:
The Projected unit Credit Method 1. A legally enforceable right to use a surplus
(sometimes known as the accrued benefit method in one plan to settle obligations under the
pro-rated on service or as the benefit/years of other plan; and
service method) sees each period of service as 2. An intention to either settle the obligations
giving rise to an additional unit of benefit on a net basis, or to realize the surplus in
entitlement and measures each unit separately to one plan and settle its obligation under the
build up the final obligation. other plan simultaneously.
Under the projected unit credit method,
retirement benefit obligations are measured OTHER LONG-TERM EMPLOYEE BENEFITS
based on future salary levels of employees Other long-term employee benefits are
(projected salaries). Assumptions are made to employee benefits (other than post-employment
estimate the salary level of employees on their benefits and termination benefits) that are due to
expected retirement date. be settled beyond 12 months after the end of the
period in which the employees have rendered the
ATTRIBUTING BENEFIT TO PERIODS OF related service. Examples:
SERVICE a) Long-term compensated absences,
Benefits are attributed to the periods of e.g., sabbatical leave
service using the plan formula. b) Jubilee or other long-service benefits
However, if benefits are materially higher c) Long-term disability benefits
for services rendered in later years than in earlier d) Profit-sharing, bonuses, and deferred
years, the benefits are attributed on a straight-line compensation payable beyond 12
basis from the date the employee's entitlement to months after the end of the period in
benefits starts to accrue until the date where which the benefits were earned
future services will no longer lead to material
amount of benefits. Other long-term employee benefits are
Benefits are attributed to the current accounted for similar to defined benefit plans
period in order to determine the current service except that all the components of the defined
cost, and current and prior periods in order to benefit cost are recognized in profit or loss,
determine the PV of DBO. including the remeasurements of the net defined
benefit liability/asset.
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.
TERMINATION BENEFITS
Termination benefits are those provided as
a result of either
1. The entity's decision to terminate the
employee before normal retirement
date; or
2. 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:
1. When the entity can no longer withdraw
the offer of those benefits; and
2. When the entity recognizes restructuring
costs that involve payment of termination
benefits.
MEASUREMENT
Termination benefits are accounted for
according to their nature. Termination benefits
that are:
1. Payable within 12 months are accounted
as short-term benefits.
2. Payable beyond 12 months are accounted
for as other long-term benefits.
3. Enhancement to post-employment
benefits are accounted for as post-
employment benefits.