Updating your accounting for employee benefits
By Ysmael S. Acosta
First Published in Business World (7/1/2013)
In June 2011, the International Accounting Standards Board (IASB) issued amendments to IAS 19 Employee Benefits. These amendments were subsequently adopted by the Philippine Securities and Exchange Commission as amendments to PAS 19, Employee Benefits. Companies are required to apply the revised standard for annual periods beginning on or after January 1, 2013, with retrospective application.
The amendments to PAS 19 impact the recognition, presentation and disclosure requirements to ensure that the financial statements provide investors and other users with a clear picture of an entity’s commitments resulting from pension that is under a defined benefit plan. A defined benefit plan is a pension plan where the actuarial and investment risks are borne by the employer. For example, a company provides pension benefits to its employees based on the employee’s latest month’s salary for every year of service. In determining the amount of the liability, the company makes certain assumptions, which include mortality, employee turnover rates, future salary and discount rates. Since these assumptions change from time to time, there is a risk that the benefits will be greater than expected. This refers to the actuarial risk.
Some companies set aside money to pay for the pension of retiring employees. This is usually done through a fund, managed by a fund manager, in order to benefit from the return on investments. If the fund does not perform as expected and the amount set aside is not enough to pay the pensions, the company has the obligation to pay for the shortfall. This is an example of the investment risk.
The effects of changes in assumptions discussed above, and the effects of differences between the previous assumptions and the actual occurrences are referred to as actuarial gains and losses.
The following are the key changes introduced by the revised PAS 19:
• Recognition of pension cost – The option to defer the recognition of actuarial gains and losses resulting from defined benefit plans (previously referred to as the ‘corridor approach’) is eliminated. The ‘corridor approach’, which allowed much of the large and volatile changes in pension fund values to be deferred and not be recognized immediately, is eliminated. This now requires companies to immediately report on their statement of financial position any deficit or surplus in a plan.
• Presentation of pension cost – Alongside the requirement to report changes in the plan as they occur, the revised PAS 19 eliminates options for presenting gains and losses. It now requires companies to include re-measurements in other comprehensive income (OCI), an equity account. Amounts recognized in OCI are not reclassified to profit or loss in a subsequent period. However, the entity may transfer those amounts recognized in OCI within equity.
• Financial statements disclosures – The disclosure requirements are improved so as to better show the characteristics of defined benefit plans and the risks arising from those plans.
The disclosures under the old PAS 19 raised the following concerns: (a) the required information was not sufficient enough to allow users to understand the financial statement effects of pension liabilities and assets as a whole; and (b) the level of disclosures did not highlight the risks associated with the defined benefit plans.
The disclosures required by the revised PAS 19 address the said concerns. It now requires information such as: (a) the characteristics of a company’s defined benefit plans; (b) the amounts recognized in the financial statements; (c) the risks arising from defined benefit plans, including sensitivity analysis; and (d) the company’s participation in multi-employer plans, if applicable.
The following are examples of significant additional disclosures required by the revised standard:
a) Information about the characteristics of the entity’s defined benefit plans, including, the nature of the benefits provided by the plan and description of any other entity’s responsibilities for the governance of the plan (for example responsibilities of trustees or of board members of the plan);
b) Stating a principle for the disaggregation of plan assets rather than listing the categories required;
c) Disaggregation of the fair value of the plan assets into classes that distinguish the nature and risks of those assets, subdividing each class of plan assets into those that have a quoted market price in an active market and those that do not;
d) Information about asset-liability matching strategies, where an entity aims to match the amount and timing of cash inflow from retirement fund assets with those of cash outflow from the retirement obligation;
e) Sensitivity analysis showing how the effect of reasonably possible changes to significant actuarial assumptions (e.g., discount rates, rates of employee turnover and future salary increases) affect the defined benefit obligation;
f) Information about the funding and duration of the liability; and
g) Distinguishing between actuarial gains and losses arising from demographic (e.g., mortality and rates of employee turnover) and financial assumptions (e.g., future salary and discount rate).
Considering the retroactive application of the standard, there is a need to gather the required information soonest and, if necessary, review and implement new processes to be able to comply with the requirements.
In the discussion with actuaries, aside from highlighting the elimination of the corridor approach, it will be equally important to emphasize the need to disclose sensitivity analyses, which will require more than one simulation of various assumptions. Entities have to coordinate with their fund managers to obtain sufficient data regarding the required disclosures on the plan assets.
Depending on the impact of the resulting restatements of prior year’s financials vis-à-vis the current year, there may also be a need for the company to prepare the communication strategies for investors, creditors and other users of financial statements to explain the impact on the performance measures and the potential effect on their debt covenants.
Ysmael S. Acosta is a Senior Director of SGV & Co.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.