International financial reporting standard
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IAS 19: Employee Benefits is an international financial reporting standard issued by the International Accounting Standards Board (IASB) that prescribes the accounting and disclosure for all types of employee benefits. [1] Under the standard, "employee benefits" encompass all forms of consideration given by an entity in exchange for service rendered by employees or for the termination of employment. [2] These benefits include short-term items such as wages and salaries, as well as post-employment benefits like pensions and life insurance. [3] The standard requires an entity to recognize a liability when an employee has provided service in exchange for benefits to be paid in the future. [4]
Post-employment benefit plans are classified as either defined contribution plans or defined benefit plans, depending on the economic substance of the plan. [5] In a defined benefit plan, the entity’s obligation is to provide the agreed benefits to current and former employees, and actuarial risk rests with the entity. [6] These plans often calculate pensions based on variables such as age, years of service, and compensation. [7] Many defined benefit plans are funded by the entity through contributions to a separate legal entity or fund. [8]
Accounting for defined benefit plans is complex because actuarial assumptions are required to measure the obligation and the expense. [9] The measurement process involves the following key requirements:
Remeasurements of the net defined benefit liability, including actuarial gains and losses, are recognized immediately in Other Comprehensive Income (OCI). [14] These remeasurements are not reclassified to profit or loss in subsequent periods. [15] Past service costs, which result from plan amendments or curtailments, must be recognized as an expense at the earlier of when the plan amendment occurs or when the entity recognizes related restructuring costs. [16] If a plan has a surplus, the recognized asset is limited to the lower of the surplus in the plan and the "asset ceiling." [17]
The following examples illustrate the journal entries for different categories of employee benefits as defined by IAS 19.
Short-term benefits are recognized as an expense when the service is rendered, with a corresponding liability for any unpaid amounts. [18]
Scenario: An entity's employees earn wages of $50,000 for December. As of December 31, $45,000 has been paid, and $5,000 remains outstanding.
| Event | Debit | Credit | Rationale |
|---|---|---|---|
| Recognition of wages | Wages and Salaries Expense (P&L) | Cash / Accrued Liabilities | Recognition of the cost in exchange for service rendered. [19] |
For defined benefit plans, the service cost (increase in the present value of the obligation) is recognized in profit or loss. [20]
Scenario: A company determines the current service cost for the year to be $10,000. During the same period, the company contributes $8,000 in cash to the pension fund assets.
| Event | Debit | Credit | Rationale |
|---|---|---|---|
| Current service cost | Pension Expense (P&L) | Net Defined Benefit Liability | Recognition of the cost of benefits earned by employees during the current period. [21] |
| Employer contribution | Net Defined Benefit Liability (or Plan Assets) | Cash | Reduction of the net liability through the funding of the plan. [22] |
Remeasurements, such as changes in actuarial assumptions, must be recognized immediately in Other Comprehensive Income (OCI). [23]
Scenario: At the end of the year, the discount rate decreases, causing the present value of the pension obligation to increase by $2,000 (an actuarial loss).
| Event | Debit | Credit | Rationale |
|---|---|---|---|
| Actuarial loss | Other Comprehensive Income (OCI) | Net Defined Benefit Liability | Immediate recognition of the loss outside of profit or loss. [24] |
Net interest is calculated by multiplying the net defined benefit liability (or asset) by the discount rate used to measure the obligation. [25]
| Event | Debit | Credit | Rationale |
|---|---|---|---|
| Net interest expense | Finance Cost (P&L) | Net Defined Benefit Liability | Reflecting the increase in the liability due to the passage of time. [26] |
IAS 19 requires an entity to disclose information that explains the characteristics of its defined benefit plans and the risks associated with them, identifies and explains the amounts in its financial statements arising from those plans, and describes how those plans may affect the amount, timing, and uncertainty of the entity’s future cash flows. [27]
| Paragraph | Category | Disclosure Requirement | Description / Examples |
|---|---|---|---|
| IAS 19.139 | Plan Characteristics | Nature of Benefits and Risks | A description of the types of benefits provided, the regulatory framework, and any specific risks to which the plan exposes the entity (e.g., asset-liability matching). |
| IAS 19.140 | Reconciliation of Balances | A reconciliation from the opening balance to the closing balance for the net defined benefit liability (asset), showing separate movements in plan assets and the present value of the obligation. | |
| IAS 19.141 | P&L and OCI Impact | Components of Defined Benefit Cost | Separate disclosure of service cost, net interest on the net defined benefit liability, and remeasurements recognized in Other Comprehensive Income (OCI). |
| IAS 19.142 | Plan Assets | Fair Value Breakdown | A breakdown of the fair value of plan assets into classes that distinguish the nature and risks of those assets (e.g., cash, equity instruments, debt instruments, real estate). |
| IAS 19.144 | Actuarial Assumptions | Significant Assumptions | Disclosure of the significant actuarial assumptions used to determine the present value of the defined benefit obligation (e.g., discount rate, salary increase rate, mortality rates). |
| IAS 19.145 | Sensitivity Analysis | A sensitivity analysis for each significant actuarial assumption showing how the defined benefit obligation would have been affected by changes in the relevant actuarial assumption that were reasonably possible. | |
| IAS 19.147 | Future Cash Flows | Funding and Maturity | Information about the funding strategy and the maturity profile of the defined benefit obligation (e.g., the weighted average duration of the obligation). |
| IAS 19.158 | Multi-employer Plans | Participation Details | For multi-employer defined benefit plans, a description of the funding arrangements and the extent to which the entity can be liable to the plan for other entities' obligations. |