Finance & Accounting

Need for IAS 19 and its Accounting Principles for Employee Benefits

Employee benefit expenses and liabilities must be presented in your accounting records in a consistent and fair manner. Accounting, presentation, and disclosures for employee benefits are all governed by the rules of IAS 19. It aids in the recognition of liability when an employee provides service and an item of expenditure when the entity consumes the economic advantages of employee service. You’ll be able to match benefits and expenses in this way in the financial statements.

The objective of IAS 19

Employee benefits are any form of compensation provided by a company in exchange for the services provided by its employees.

The basic aim of this Standard is to specify the accounting and disclosure requirements for employee benefits. IAS 19 lays down the principle that the cost of giving employee benefits must be recorded in the period in which such benefit is earned by employees, instead of when it is paid or payable. It specifies how different types of employee benefits should be measured and also renders guidance in relation to post-employment benefits.

The Standard requires an organization to recognize a liability when an employee provides his/her service in exchange for some future employee benefits. When an entity consumes the economic advantage coming from service supplied by an employee in exchange for employee perks, the entity must also recognize an expense.

Applicability of IAS 19

Employee benefits of various forms are covered by IAS 19. These are some of them:

• Salary, earnings, and allowances, as well as compensated absences (paid vacation and sick leave), profit sharing, and bonuses, are all examples of short-term benefits.
• Pensions and lump sum pay-outs are examples of retirement benefits.
• Other long-term benefits include medical and life insurance after you leave your job.
• Benefits on termination

It should be noted that IAS 19 does not apply to employee benefits covered by IFRS 2 on Share-based Payment or to the reporting by employee benefit plans, which will be covered by IAS 26 on Accounting & Reporting by Retirement Benefit Plans.

Short-term benefits

These are benefits that will be paid out within a year of the end of the reporting period in which the employee provided services. The amount of the benefits expected to be paid for services done in a given accounting period is recorded in that period.

In other words, employee benefits (other than termination benefits) that are due entirely within twelve months of the conclusion of the period in which the employees deliver the associated service are referred to as short-term employee benefits.

When an employee performs service for an entity within an accounting period, the business must recognize the undiscounted amount of short-term employee benefits that are expected to be provided in exchange for that service.

After subtracting any amounts previously paid, the amount will be recorded as a liability (accrued expenditure). If the amount previously paid exceeds the undiscounted value of the benefits, the excess must be recorded as an asset (prepaid cost) to the extent that the prepayment would result in, for example, a decrease in future payments or a cash refund.

Furthermore, the amount shall be recorded as an expense unless another Accounting Standard mandates or authorizes the inclusion of benefits in the cost of an asset (for instance, IAS 2 on Inventories and IAS 16 on Property, Plant, & Equipment).

Post-employment benefits

Employee benefits (other than termination payments) that are payable to the employees after the conclusion of employment are referred to as post-employment benefits. Post-employment benefit schemes are formal or informal agreements in which a company offers one or more workers with post-employment benefits. Post-employment benefit schemes are categorized as either defined contribution plans or defined benefit plans based on the economic content of the plan as determined by its primary terms and conditions.

Defined contribution plans: post-employment

Defined contribution plans are those post-employment benefit schemes whereby an organization makes fixed contributions to a distinct corpus (or a fund) and is under neither legal nor constructive obligation to make additional contributions if somehow the fund does not have enough assets to meet all employee benefits in relation to the employee service in the present and prior periods.

The entity’s legal or constructive responsibility under a defined contribution plan is limited to the amount agreed to contribute to the fund. Thus, the volume of post-employment benefits received by an employee is decided by the amounts of contributions paid by an organization (and might be also by the employee) to a post-employment benefit plan/scheme or an insurance corporation, as well as the investment returns resulting from those contributions. As a result, the employee bears actuarial risk (where benefits would be less than expected) and investment risk (where the assets invested would be inadequate to fulfill projected benefits).

When an employee performs services for an organization during a period, the business must recognize the contribution payable to a defined contribution plan/scheme in return for that service. After subtracting any previously made contributions, the amount will be recorded as a liability (accrued expenditure). If the contribution previously paid outweighs the contribution due for service before the end of the reporting period, the excess must be recorded as an asset (prepaid cost) to the extent that the prepayment would result in, for example, a decrease in future payments or a cash return.

Further, the amount will be recognized as an expense unless another Accounting Standard mandates or authorizes the inclusion of such contribution in the cost of an asset (for instance, IAS 2 on Inventories and IAS 16 on Property, Plant, & Equipment).

Defined benefit plans: post-employment

Defined benefit plans/schemes, as opposed to defined contribution plans, are another category of post-employment benefit plans. The entity’s responsibility under defined benefit plans is to give the agreed-upon benefits to current and past workers. The entity bears the actuarial risk (that benefits will cost more than planned) and the investment risk. If actuarial or investment performance falls short of expectations, the entity’s liability may be raised.

Accounting for defined benefit plans by an entity entails the following steps:

• Applying actuarial techniques to generate a credible estimate of the amount of benefit gained by workers in exchange for their service in the current and past periods. This necessitates an entity determining how much benefit is attributable to the current and previous periods, as well as making estimates (or actuarial assumptions) regarding demographic variables (like the employee turnover and mortality) and financial variables (like the future salary and medical cost increases) that will influence the cost of the benefit.
• Using the Projected Unit Credit Technique to calculate the present value of the defined benefit obligation and current service cost, i.e., discounting the benefit.
• Calculating the fair market value of any plan assets
• Calculating the overall amounts of actuarial profits and losses, as well as the amount of those actuarial gains and losses to be recognized.
• Calculating the resultant previous service cost if a plan has been created or altered
• Evaluating the gain or loss as a result of a plan being restricted or settled

If a company has more than one defined benefit plan^[1], these processes must be followed individually for each material plan.

Other long-term employee benefits

Employee benefits (other than the post-employment and termination incentives), that do not become fully due within twelve months after the closure of the period in which the workers deliver the associated service, are referred to as other long-term employee benefits.

IAS 19 provides for an easy method of accounting in relation to other long-term employee benefits as compared to the one for post-employment benefits. Here, the actuarial gains and losses, as well as past service cost, is to be recognized on an immediate basis.

Termination benefits

Employee benefits payable as a consequence of either a corporation’s choice to terminate an employee’s employment before the usual retirement date or an employee’s choice to accept voluntary redundancy in return for such benefits are referred to as termination benefits.

When and only when an organization is unarguably committed to either terminating the employment of an employee or group of employees before the regular retirement date or providing termination benefits as a result of an offer made to promote voluntary redundancy, termination benefits are recognized as a liability and an expense.

Termination benefits must be discounted if they become payable more than 12 months after the end of the reporting period.

In the event of an offer made to promote voluntary redundancy, the calculation of termination incentives is based on the number of employees who are expected to accept the offer.

Conclusion

IAS 19 specifies the accounting rules for all the employee benefits, comprising short-term benefits (such as earnings, salaries, and periodic leave), post-employment benefits like any retirement benefits, other long-term benefits (for example, long service leave), and termination benefits.

Read our Article:A detailed guide on IAS 12 on Income Taxes