Indian Accounting Standard Ind AS 19 prescribes the accounting practices to be followed for employee benefits reporting by companies and how the obligations should be accounted for.
TABLE OF CONTENTS
- Basic Accounting Principles under Ind AS 19
Basic Accounting Principles under Ind AS 19
Accounting under the Ind AS 19 standards includes both recognition as well as measurement. Further, the accounting standard prescribes what disclosures are to be made by the reporting entity.
Under Ind AS 19, an entity is required to
- Recognise a liability when an employee has rendered their service to the company, and
- Recognise an expense when the entity consumes the economic benefit arising from the service provided by the employee.
For example, when an employee works for a company, the company derives benefit from the effort put in by the employee. Thus, it can be said that the company consumes the services rendered by the employee, and in this case the company will recognise this as an expenditure. And consequently, a liability arises to the employee that is payable by the company which is equivalent to the benefits that are payable by the company.
The liability can be in the form of salaries which are payable every month, or sometimes the liabilities can be carried forward and be payable on retirement, or after completion of a few years. These depend on the nature of the contract between the employer and employee, and all such benefits that are agreed upon to be paid to the employee need to be accounted for. Under Ind AS 19, even constructive obligations need to be accounted for. For example, this may include a festival bonus (like Eid Bonus or Diwali Bonus) which may not be a legal or contractual requirement, but one which the employer voluntarily provides and is followed based on precedence (ie. The company may have paid the same in the previous year, and the employee would expect it).
Accounting for Short Term Employee Benefits
Short term employee benefits are settled within a period of 12 months from the end of the period in which the services were rendered by the employee. Examples include salaries, paid annual leave, rental accommodation, car benefit etc. They are accounted on a undiscounted basis because the settlement is expected to happen within the short term. Short Term Employee Benefits are recognised as
- A liability after deducting the amount paid within the year.
- As an asset, if the amount paid exceeds the undiscounted amount of the benefits payable.
- As an expense in the profit and loss
Example of accounting for Short Term Employee Benefits
Consider an employee with salary of 10,000 Rs per month and 1 month bonus payable every year. If at the end of the year, 2 months salary along with bonus are unpaid, then these are recognised as a liability. However if 2 months extra salary has been paid to the employee, then it is treated as an asset.
For Short term employee benefits, no specific disclosures are required under Ind AS 19.
Post-Employment Benefits: Defined Contribution Plans
Post-Employee benefit schemes where the obligation of an entity is to only contribute to a plan, and no further obligation arises on the entity is known as a Defined Contribution plans.
Defined Contribution Plans are recognised as
- A liability after deducting the amount paid within the year.
- As an asset, if excess amount has been contributed.
- As an expense in the profit and loss
If the contribution is due within 12 months, then no discounting factor is applied. When the contributions do not fall due within 12 months of the end of the reporting period, then it should be discounted using the discount rate.
Example of Defined Contribution Plan Accounting
Lets say a company contributes 10% of every employee’s salary to a employee benefits plan. In this case, the company takes up no further obligation. The Company should account this contribution, amounting to 10% of its salary to the profit and loss account as an expense.
Post-Employment Benefits: Defined Benefits Plan
While Ind AS 19 prescribes accounting for many types of employee benefits such as long term paid absences, long service benefits, profit sharing / bonus schemes and termination benefits, post-employment benefits of a Defined Benefit Plan are accounted with additional complexity under Ind AS 19. The complexity of accounting for post-employment benefits is high, since it requires the use of actuarial assumptions relating to the demographics of the company/industry and also financial assumptions related to the overall economy.
Accrual of Benefits
Post employment benefit schemes with a Defined Benefit Plan are usually structured in a way that the employees gain the benefit for each year of service they have rendered to the company. This benefit is accrued over time, and when the employee leaves the service, the entire benefit is payable to the employee. This is the accrual system of accounting for employee benefits. Under Ind AS 19, the Projected Unit Credit method of accounting is prescribed for calculation of employee benefits, taking into account the accruing nature of these benefits. The basic premise of the PUC method is that each year of service rendered by an employee will give rise to one unit of benefit entitlement to the employee.
PUC Method
Under the PUC method of accounting, a projected accrued benefit is calculated at the begging of the year, and again at the end of the year for all the employees under the plan. The employee’s benefit will depend on years of service and also considers the future salary increase and the plan’s benefit allocation formula. The Benefit attributable to an employee on a future separation date (date of retirement) is the benefit defined under the plan based on credited service as on the valuation date. The "projected accrued benefit" is based on the Scheme's accrual formula and upon service as of the beginning or end of the year, but using a member's final compensation, projected to the age at which the employee is assumed to leave active service. The Scheme Liability is the actuarial present value of the "projected accrued benefits" as of the beginning of the year for active members. An individual’s estimated benefit obligation is the present value of the attributed benefit for valuation purposes at the beginning of the year, and the service cost is the present value of the benefit attributed to the year of service in the plan year.
Important Aspects of Defined Benefit Plan Accounting
The present value of a defined benefit obligation is the present day value of post employment benefits based on the employee’s future salary, resulting from the employee's service in the current and past periods. The Plan Assets are measured at fair value as on the balance sheet date. The Net obligation is recognised in the profit and loss account as an expenditure, along with a corresponding liability.
Example: In a funded plan having net obligations as 10 crores, and plan assets as 8 crores. In this case, 2 crores is the expense that the company has to make towards the DBO, and this is treated as an expense in the company’s profit and a corresponding liability is accounted.
Current Service Cost is the cost incurred to the company due to the employee rendering service in the current year. If the employee renders no service, the current service cost is zero. For a Defined benefit obligation, current service cost can be defined as the increase in the present value of defined benefits obligation due to the employees service in the current year.
Interest Cost is the increase in defined benefits obligations that arise due to the passage of time. The present value of the DBO increases in a year, because the benefits are one time period closer to settlement. This is captured in interest cost.
Past Service Cost is the changes in present value of DBO due to plan amendments or curtailment. This may arise due to change in the nature of plan. For example, a company may amend the plan to increase the value of its defined benefit payable to its employees. This would result in recognition of the amounts that were not recognised earlier. In the alternative scenario for a plan curtailment, the company may curtail the bonus that is payable to employees who have completed 10 years of service from 6 month's salary to 3 month's salary. Thus, the employees will lose some benefits due to curtailment of the plan. These are captured in past service cost.
Plan Assets include the assets held by the Defined Benefit Plan in an employee benefits fund, or any insurance policy that is designed for employee benefit schemes.
Actuarial Gains/Losses are the changes in the DBO due to changes in actuarial assumptions. When accounting for defined benefit plans and post-employment benefits, certain assumptions have to be made on factors such as salary growth rate, attrition rate etc. Changes in these assumptions results in actuarial gain/loss. For example, salary growth rate of a company may fall from 10% to 3% due to economic slowdown. The gain or loss due to this change is known as actuarial gain/loss. These are treated as unrealised gains or losses, and is not debited to the profit and loss account but is captured in the Other Comprehensive Income (OCI).
Accounting for DBO
In the Profit and Loss account, the following components are recognised:
Under the head Service Cost: the current service cost, past service costs, settlements and curtailments (if any);
Under the head Net Interest Cost: Net Interest expense on DBO, Interest on Plan Assets, and interest on the effect of asset ceiling;
Additionally any administrative expenses and taxes.
See Figure1 for an example on recognising components due to DBO in the P&L Account.
Figure1: Summary of components recognised in the P&L Account
The Actuarial Gains and Losses are recognised as re-measurement effect in the OCI as shown in Figure2.
Figure2: Amounts recognised in the OCI.
In the Balance Sheet, the present value of the obligations less fair value of plan assets less unrecognised past service costs is captured as the amount recognised. An example of the balance sheet measurements is shown in Figure3.
Figure3: Amounts recognised in the balance sheet.
As per Ind AS 19, several disclosures for Post Employment Benefit Plans are required including a complete explanation of the characteristics of the plan, reconciliation of the opening and closing balance for present value of DBO and fair value of plan assets, amounts to be shown in the OCI, the net surplus or deficit to be shown in the balance sheet and also sensitivity analysis of the obligations to change in actuarial assumptions. For a full list of disclosures under Ind AS 19, please see our Handbook on Ind AS 19 Disclosures.
Accounting For Other Long Term Employee Benefits
Employee Benefits that are expected to be settled after 12 months from from the end of the period in which the services are rendered, but are not a post-employment benefits or termination/retrenchment benefit are called Other Long Term Employee Benefits . For example, the employee may be entitled to a loyalty bonus after working for 10 years. This is an Other Long Term Employee Benefit. Other examples include long service award or jubilee awards, long term compensated absences, and long term disability benefits.
Other Long Term Employee Benefits are accounted using the Projected Unit Credit Method in a similar method as that of Defined Benefit Plans, however the actuarial gains and losses arising out of Other Long Term Employee Benefit plans are not considered under the OCI but are considered in the profit and loss account. The components charged to the profit and loss account are service cost, net interest on the net defined benefit liability,
Accounting For Termination Benefits
Termination benefits arise when an employee is terminated by the employer or when an employee accepts the employer's offer of benefits in exchange of termination of employment. This is different to post-employment benefits. Classic example of termination benefits are retrenchment compensation where the employee has no option to accept the termination. Voluntary Retirement Scheme is also an example of termination benefits where the employees are due a compensation and in return accept early retirement.
Termination Benefits are to be recognised on the earlier date of when the company can no longer withdraw the offer of the termination benefits, or when the company recognises costs for restructuring which involves the payment of termination benefits. For instance, a company may face debt restructuring and accordingly, several employees would have to be laid off, and the termination benefits would be recognised.
Measurement of Termination Benefits
Termination Benefits are measured based on the criteria considering if they are an enhancement to post-employment benefits. If they are an enhancement to post-employment benefits (for instance payable after retirement), then they are accounted as per Defined Contribution Plan or Defined Benefit Plan, as the case maybe. If they are not an enhancement to post-employment benefits, based on whether the termination benefits are expected to be settled within 12months they are accounted as either Short Term Employee Benefits (for cases when the settlement is within 12 months) or Other Long Term Employee Benefits (for other cases).