Actuarial Gains and Losses are components of the employee benefit obligations that arise when the actual experience of the plan differs from what was anticipated using the actuarial assumptions. The actuarial loss is the excess of the plan’s unfunded actuarial accrued liability on the valuation date over the unfunded actuarial accrued liability that would have resulted had all of the actuarial assumptions been realised. If the actuarial loss is less than zero, it is called an actuarial gain. For example, an actuarial gain would occur if the plan assets earned 12% for the year while the assumed rate of return used in the valuation was 8%. Other causes of actuarial gains or losses would include changes in actuarial assumptions and / or demographic changes in the employee profile of the company.
TABLE OF CONTENTS
- Components of Actuarial Gains/Losses
- Treatment of Actuarial Gains/Losses in Ind AS 19
- Actuarial Gains/Losses Entries in OCI
- Understanding Changes in Actuarial Gains/Losses
Components of Actuarial Gains/Losses
The concept of actuarial gains and losses can arise in defined benefit obligation plans such as gratuity where in order to estimate the liabilities and obligations, certain assumptions such as salary growth rate, attrition rate (withdrawal rate) are decided upon, and based on these assumptions the obligations are estimated. Any changes in these assumptions and also the actuals of previous year compared with the assumptions used will result in either actuarial gain or loss.
Actuarial gains and losses are changes in the present value of the defined benefit obligation resulting from:
- Experience adjustments: the effects of differences between the previous actuarial assumptions and the actuals (for example - if a salary escalation rate of 12% was assumed, however as per actuals only 5% escalation in salary was observed). These are known as Actuarial Gain / Losses due to Experience.
- The effects of changes in actuarial assumptions.
Actuarial gains/losses due to changes in assumptions consists of the components
- Actuarial (Gain) / Losses due to Demographic Assumption changes in DBO
- Actuarial (Gain) / Losses due to Financial Assumption changes in DBO
Treatment of Actuarial Gains/Losses in Ind AS 19
The Ind AS 19 accounting standard prescribes a different system to account actuarial gain and loss entries when compared with the AS 15(R) standards. Whereas under AS 15(R), actuarial gains and losses are directly recognised in the statement of profit and loss, under Ind AS 19 the actuarial gains and losses are not recognised in the P&L statement but are instead recognised in a separate account known as Other Comprehensive Income (OCI). As per Ind AS 19 reporting standards, the actuarial gains and losses are reconciled in the OCI statement together with the return on plan assets and changes due to the asset ceiling.
The rationale behind this approach is that the actuarial gains and losses can fluctuate highly depending on the actuarial assumptions used in the valuation. If these components impact the P&L, they may cause big variations in the accounts of the company. Hence to mitigate these changes, in Ind AS 19 the actuarial gains and losses are accounted for in the OCI statement.
Actuarial Gains/Losses Entries in OCI
In Ind AS 19, the reporting company is required to recognise the re-measurements of the net defined benefit liability (asset) in other comprehensive income. This includes the individual actuarial gain/loss components and the total actuarial gain/loss that has to be included in the OCI. In Figure 1, the amounts in row (1), (2) and (3) indicate the Actuarial Gains / Losses due to demographic assumptions, financial assumptions and changes in experience respectively.
Figure 1: Actuarial Gain/Loss amounts recognised in OCI
The actuarial gains / losses are also reconciled with opening and closing balances of the net defined benefits liability and the reconciliation of plan assets.
Understanding Changes in Actuarial Gains/Losses
The amounts for gains and losses may vary due to the changes in assumptions. Some situations that may lead to actuarial gain or loss are:
1. If the actual attrition, retirement or mortality experience turns out to be higher or lower than expected based on the assumptions made at the start of the accounting period, it would lead to an Actuarial Gain or Loss on Plan Liabilities.
2. If the salary increases are higher or lower than expected based on the assumption made at the start of the accounting period, it would lead to an Actuarial Gain or Loss on Plan Liabilities.
3. If the actuarial assumptions of salary increase, attrition rate and discount rate change from one valuation year to another, it may lead to Actuarial Gain or Loss on Plan Liabilities. Also if there is a large growth in number of employees in the company due to new joiners, this may also lead to actuarial gain/loss on Plan Liabilities.
4. Return on plan assets greater /(lesser) than discount rate. For example, if the discount rate was 8% and the fund actually earned 7%, it would result in an actuarial loss on assets.