Employee Benefits (PAS 19)

PAS 19 divides employee benefits into four kinds: short-term benefits, post-employment benefits, other long-term benefits, and termination benefits. Nearly all the difficulty, and nearly all the Board's attention, sits in one corner of the second: the defined benefit plan.

Core concept

Defined contribution against defined benefit

	Defined contribution	Defined benefit
Employer's obligation	To pay a fixed contribution into a fund	To provide the agreed benefit to the employee
Who bears the actuarial and investment risk	The employee	The employer
Expense recognised	The contribution payable for the period	A computed defined benefit cost
Actuarial assumptions	Not needed	Required

In a defined contribution plan the employer pays and walks away. Once the contribution is made, there is no further legal or constructive obligation. The expense is simply the contribution due for the period, and any unpaid amount is a liability while any prepayment is an asset.

Everything that is not a defined contribution plan is a defined benefit plan. If the employer guarantees a benefit formula, it bears the risk that the fund falls short, and the accounting becomes an exercise in measuring that shortfall.

The net defined benefit liability

Net defined benefit liability = present value of the defined benefit obligation - fair value of plan assets

If plan assets exceed the obligation, the result is a net defined benefit asset, but it is capped by the asset ceiling: the present value of any economic benefits available as refunds from the plan or reductions in future contributions.

The obligation is measured by the projected unit credit method, discounted at market yields on high quality corporate bonds at the end of the reporting period. Where no deep market for such bonds exists, market yields on government bonds are used. Plan assets are measured at fair value.

The three components of defined benefit cost

This split is the whole of PAS 19, and the Board tests it directly.

Component	What it contains	Goes to
Service cost	Current service cost, past service cost, and any gain or loss on settlement	Profit or loss
Net interest	Net defined benefit liability or asset at the start of the period, times the discount rate	Profit or loss
Remeasurements	Actuarial gains and losses on the obligation; the return on plan assets excluding amounts in net interest; changes in the effect of the asset ceiling excluding amounts in net interest	Other comprehensive income

Three consequences follow, and each is a favourite examination point.

• Past service cost is recognised immediately in profit or loss, at the earlier of the plan amendment or curtailment and the recognition of related restructuring costs. There is no spreading over any remaining vesting period.
• Net interest uses a single discount rate, the same one used to discount the obligation, applied to the net balance. There is no separate "expected return on plan assets" at a different rate. Any return above or below that discount rate is a remeasurement.
• Remeasurements are never reclassified to profit or loss. They sit permanently in other comprehensive income, though an entity may transfer them within equity.

Rolling forward the two balances

Every defined benefit problem is two roll-forwards, and the remeasurements are the plugs.

Defined benefit obligation

Beginning balance
plus interest on the obligation (discount rate x beginning balance)
plus current service cost
plus past service cost
less benefits paid
plus or less actuarial loss or gain (the plug to the actuary's ending balance)
Ending balance

Fair value of plan assets

Beginning balance
plus interest income on plan assets (discount rate x beginning balance)
plus contributions to the fund
less benefits paid
plus or less remeasurement gain or loss on plan assets (the plug to the actual ending fair value)
Ending balance

Benefits paid out of the fund reduce both balances by the same amount, so they never affect the net liability. Contributions reduce the net liability without touching profit or loss.

How this appears in the exam

• A full set of beginning balances, a discount rate, service cost, contributions, benefits paid, and actuarial ending balances. The item asks for the defined benefit cost in profit or loss, the remeasurement in other comprehensive income, or the ending net defined benefit liability.
• A plan amendment mid-year that increases the obligation. The past service cost is recognised immediately and in full, not amortised.
• A question that quotes an "expected rate of return on plan assets" different from the discount rate. Under the current PAS 19 that rate is a distractor: interest income on plan assets uses the discount rate.
• A request to distinguish which amounts are recycled to profit or loss. For remeasurements the answer is never.

Common traps

• Amortising past service cost. The superseded version of the standard permitted it. The current one requires immediate recognition.
• Using an expected return rate on plan assets. The discount rate applies to both the obligation and the plan assets, which is precisely why the net interest can be computed on the net balance in one step.
• Recycling remeasurements. They stay in other comprehensive income permanently.
• Treating benefits paid as an expense. They reduce the obligation and the plan assets equally and never touch the defined benefit cost.
• Forgetting the asset ceiling. A funded plan in surplus is not automatically an asset for the full surplus.

Worked examples

Example 1: the full defined benefit computation

Ilocos Manufacturing has a funded defined benefit plan. At 1 January:

• Present value of the defined benefit obligation: P4,000,000
• Fair value of plan assets: P3,500,000
• Discount rate: 10%

During the year: current service cost P500,000; contributions to the fund P600,000; benefits paid to retirees P300,000. At 31 December the actuary reports a defined benefit obligation of P4,700,000 and the fund's fair value is P4,000,000.

Step 1: net defined benefit liability at the start. P4,000,000 - P3,500,000 = P500,000

Step 2: amounts in profit or loss.

• Current service cost: P500,000
• Net interest: 10% x P500,000 = P50,000
• Defined benefit cost in profit or loss: P550,000

Step 3: roll forward the obligation to find the actuarial gain or loss.

Beginning obligation	4,000,000
Interest, 10% x 4,000,000	400,000
Current service cost	500,000
Benefits paid	(300,000)
Expected ending obligation	4,600,000
Actual ending obligation per actuary	4,700,000
Actuarial LOSS on the obligation	100,000

The obligation came in higher than expected, so the entity is worse off: a loss.

Step 4: roll forward the plan assets.

Beginning plan assets	3,500,000
Interest income, 10% x 3,500,000	350,000
Contributions	600,000
Benefits paid	(300,000)
Expected ending plan assets	4,150,000
Actual ending fair value	4,000,000
Remeasurement LOSS on plan assets	150,000

The fund earned less than the discount rate, so again a loss.

Step 5: remeasurements in other comprehensive income. P100,000 + P150,000 = P250,000 loss

Step 6: prove the ending net defined benefit liability.

Directly: P4,700,000 - P4,000,000 = P700,000

By roll-forward:

Beginning net liability	500,000
Defined benefit cost in profit or loss	550,000
Remeasurement loss in other comprehensive income	250,000
Contributions to the fund	(600,000)
Ending net liability	700,000

The two agree. Always close a defined benefit problem with this proof.

Example 2: past service cost

On 1 July, Ilocos Manufacturing amends the plan to improve benefits for past service, increasing the obligation by P360,000. Vesting of the improved benefits requires two further years of service.

The full P360,000 is recognised immediately in profit or loss as past service cost on 1 July, the date of the amendment. It is not spread over the two-year vesting period, and it is not prorated for the half year.

Note the knock-on effect: the interest computation for the year is unaffected, because net interest is based on the beginning balance. Where a plan amendment is significant, the standard requires the net interest for the remainder of the period to be based on the remeasured net liability, but the Board's problems ordinarily present the simple case.

Example 3: defined contribution

Pampanga Logistics contributes 8% of each employee's salary to a defined contribution plan. Total salaries for the year are P12,000,000, and the entity remitted P900,000 to the fund by year-end.

Expense = 8% x P12,000,000 = P960,000

Accrued liability = P960,000 - P900,000 = P60,000

There is no obligation beyond the contribution, no actuarial assumption, no plan asset to measure, and no remeasurement. Had the entity remitted P1,000,000, the P40,000 excess would be recognised as a prepaid asset, to the extent it leads to a refund or a reduction in future contributions.

Quick review

• Defined contribution: expense equals the contribution; the employee bears the risk. Defined benefit: the employer bears the actuarial and investment risk.
• Net defined benefit liability = present value of the obligation - fair value of plan assets, with a net asset capped by the asset ceiling.
• The obligation uses the projected unit credit method, discounted at yields on high quality corporate bonds, or government bonds where no deep market exists.
• Defined benefit cost splits three ways: service cost and net interest to profit or loss; remeasurements to other comprehensive income, never recycled.
• Past service cost is expensed immediately. There is no expected-return rate: interest income on plan assets uses the discount rate, and any excess or shortfall is a remeasurement.
• Benefits paid reduce the obligation and plan assets equally. Contributions reduce the net liability without touching profit or loss.
• Close every problem by proving the ending net liability two ways: directly, and by rolling the beginning balance through cost, remeasurements, and contributions.