ASSOCHAM IFRS Master Class

IFRS Compliance for Employee Benefits

Ben Facer, Regional Consulting Leader
14 July 2010
Agenda

Our discussion today will cover:

 The scope of retirement plan accounting

 AS-15 vs IAS19 – where are the
differences?
 IAS19 – Getting it right
 Potential changes to IAS19

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 The Scope of
Retirement Plan
Accounting

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Scope of AS-15 and IAS19

Long-term
disability
Retireme plans
nt
Benefits
Long-term
compensated
absences

Medical plans

Long term
service awards

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Scope: Defined benefit vs defined contribution

 IAS19 covers employee benefits in defined benefit form

Q:
What is “defined
Q: contribution”
What is “defined benefit”

A: A: A structure where:
Anything that is not
• Employer pays“defined contribution”
a fixed rate of contributions; and
• Following payment, employer has no further legal or
constructive obligation, even if plan goes into deficit

 Your DC fund might be included when:

– Guaranteed minimum interest rate Example:
Exempt
– Interest rate linked to a particular index
Provident
– Guaranteed minimum benefit Fund
– Interest rate smoothing, with a potential
call on the employer
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 AS-15 vs IAS19
What are the
Differences?

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AS-15 vs IAS19
Where are the differences?

 AS-15 (Revised 2005) was issued

as a stepping stone to full IFRS,
hence the standards are identical
in most respects.

 Three key differences:

– Discount rate
– Recognition of actuarial gains
and losses
– Balance Sheet (Statement of
Financial Position) Liability

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Discount Rate
What do the Standards say?

AS-15, Paragraph 78:

IAS19,
78. The rate used to discount post-employment benefit obligations
(both funded and unfunded) should be determined by reference to market
yields at the balance sheet date on government bondsbonds.endTheof currency
the reporting
and
term ofon
period thehigh
government
quality corporate
bonds should
bonds.beInconsistent
countries where
with thethere
currency
is notand
estimated
deep marketterm
in such
of thebonds,
post-employment
the market yields
benefit(at
obligations.
the end of the reporting
period) on government bonds shall be used. The currency and term of the
government bonds should be consistent with the currency and estimated
term of the post-employment benefit obligations.

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Recognising actuarial gains and losses

 Actuarial gains and losses arise from two broad sources:

– Changes in assumptions used from year to year
– The experience of the Plan, relative to the assumptions chosen
 Under AS-15, all actuarial gains and losses must be immediately
recognised in the Profit & Loss account
 IAS19 allows three methods of recognition:
– Deferred through the P&L – the ‘Corridor’
: approach
S S
– Immediately through the P&L PRE g !
O P g i n
STStatement
– Immediately through the ha n
of Comprehensive Income
bec
o u ld e!
c ac
S 19 s Sp
IA i
h Th
tc
Wa

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 IAS19 – Getting it right!

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Ensure that you include all plans within scope

1. Cap on Gratuity to increase from Rs350,000 to Rs1,000,000

Other
ExemptEmployee
Provident
Gratuity Benefits
CapFunds
2. Exempt Provident Funds
Impact:
Should
Leave
– Should Encashment
they
be be
• Increase
they valued?
valued?
to past service benefits
– How?• Provided
13% of companies
Increase byfuture
to all companies
surveyed
accrual ofsurveyed
do
benefits
• Even
82% have
for a accounting
“DC” Exempt provision,
PF, interest
36%rate
provide
guarantee
disclosures
must be
3. Other Treatment:
employee
valued benefits:
– Leave
Long ServicetoAwards
• encashment
Increase past service benefit disclosed as a “Past Service Cost”
How?
• Provided
– Jubilee by 12%recognition
• Immediate of companies surveyed
for vested employees
/ Long Service Awards
• 75%
IAS19have
Paraaccounting
83: Make provision,
assumptions 25% provideterm
regarding disclosures
state
• Straight
– Post Retirement line
Medical amortisation over average tobenefits
vesting, for
impacting plan benefits
non-vested employees if “past history, or other reliable
evidence,
Post Retirement indicates
Medical that those state benefits will change in
• some predictable
Provided by 35% ofmanner,
companies for surveyed
example, in line with future
• changes
92% haveinaccounting
general price levels
provision or disclosures
and general salary levels”

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Ensure that you set assumptions correctly

IAS19:
72. Actuarial assumptions shall be unbiased and mutually compatible.
73. Actuarial assumptions are an entity’s best estimates of the
variables that will determine the ultimate cost of providing post
employment benefits

Assumptions include:

Demographic Assumptions Financial Assumptions

• Mortality • Discount rate

• Disability • Return on assets
• Resignation • Salary Inflation
• Retirement • Future benefit levels
• Medical claim rates • Future medical costs
• Employees with dependents

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Effects of Changes in Actuarial Assumptions

Assumption Increase Decrease

Liab would decrease and leads to Liab would increase and leads
Discount rate
actuarial gain to actuarial loss

Liab would increase and leads to Liab would decrease and will
Salary Increase Rate
actuarial loss lead to actuarial gain

Expected long-term High expected return results in low Low expected return results in
rate of return pension cost high pension cost

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Assumptions: Setting the discount rate
Which bonds to reference?

 Corporate vs Government Bonds

– IAS19 requires reference to “high quality” corporate bonds, unless no
deep market
• “High quality” typically considered AA rating
• Spread between AA Corporate and Central Govt 10 year bonds was
130 bps at 31 March 2010

 State Government vs Central Government Bonds?

– Central Govt Bonds hold a sovereign guarantee
• Sovereign Rating (S&P) BBB-
– State Govt Bonds are offering higher yields – by around 100 bps
• At lower security

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Assumptions: Setting the Discount Rate
The Yield Curve in India - Duration

Central Government Bond Yields: India

9

8.5

7.5
YTM (% p.a.)

6.5

5.5

4.5

4
0 5 10 15 20 25 30

Term to Maturity
Mar-10 Mar-09 Log. (Mar-10) Log. (Mar-09)

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Ensure that your disclosures are compliant

IAS19:
120. An entity shall disclose information that enables users of financial
statements to evaluate the nature of its defined benefit plans and the
financial effects of changes in those plans during the period.

 Para 120A sets out in detail specific disclosure items that are required.
 Let’s look at some simplified examples:
– Balance Sheet
– Profit & Loss
– Treatment of Gains and Losses

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Disclosures: Balance Sheet

31 December 2010 31 December 2009

Benefit Obligation 12,000,000 11,200,000

Fair value of plan assets 3,000,000 5,000,000

Funded status (9,000,000) (6,200,000)

Unrecognised net actuarial 0 0

gain/(loss)

Unrecognised past service 0 0

(cost)/benefit

Net amount recognised (9,000,000) (6,200,000)

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Assets

 Must be valued at fair value

– Exchanged by willing parties in an arm’s length transaction
 May comprise:
– Assets in an employee benefits fund
– An insurance policy
 To qualify, assets in an employee benefits fund must generally:
– Be held in an entity which is legally separate from the company
– Are available only to pay or fund employee benefits
 Reconciled from year to year with:
– Contributions
– Benefit payments
– Expected return on assets
– Actuarial gains / losses

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Actuarial gain/loss: Assets

Contributions
and Expected
Asset Gain
Benefit Investment Return
Market value Payments
of assets (leavers)

Year Year Year End Year End

Start End Expected Actual

Asset gain/(loss)
Actual - Expected market value of assets

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Disclosures: Balance Sheet

31 December 2010 31 December 2009

Benefit Obligation 12,000,000 11,200,000

Fair value of plan assets 3,000,000 5,000,000

Funded status (9,000,000) (6,200,000)

Unrecognised net actuarial 0 0

gain/(loss)

Unrecognised past service 0 0

(cost)/benefit

Net amount recognised (9,000,000) (6,200,000)

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Disclosures: Benefit Obligation

 Named the “Defined Benefit Obligation”, or “DBO”

 The actuarial present value of all benefits attributed to employee service
rendered to date
– Gradual accrual of benefits promised, not benefits vested
– Projected Unit Credit method – includes expected future salary increases
– Present value is calculated using discount rate assumption (bond yield)
 Reconciled from year to year with:
– Service cost
– Interest cost
– Benefit payments
– Actuarial gains / losses

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Actuarial gain/loss: Liability

Extra year’s
interest and Liability Loss
Benefit benefit accrual
Payments
Liability (leavers)

Year Year Year End Year End

Start End Expected Actual

Actuarial Loss/(gain) =
Actual liability - Expected liability
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Disclosures: Profit & Loss

31 December 2010 31 December 2009

Current service cost 780,000 585,000

Interest cost 20,000 15,000

Expected return on assets (10,000) (15,000)

Amortisation of net gain/(loss) 0 0

Curtailment (gain)/loss 0 0
recognised

Settlement (gain)/loss 0 0
recognised

Total pension expense 790,000 585,000

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Key components of pension cost

 Service cost
– The increase in DBO resulting from one extra year of employee service
 Interest cost
– The increase in DBO resulting from the passage of time
 Expected return on assets
– The amount of the DBO increase that is expected to be funded from
investment returns
– Credit for the expected risk premium

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Disclosures: Reporting gains and losses

 IAS19 allows three methods to report the unrecognized net actuarial gain and loss.
– “10% corridor”
• allows for some annual variability in experience
• corridor = 10% of max (assets, liabilities)
• Excess unrecognized gain/(loss) excess is spread over expected average
remaining working lifetime and included in pension expense
– Immediate Recognition
Example
• Balance sheet = Funded Status
• Assets = 1,000
No amortization of gain/loss – immediately recognized on the Balance
Sheet Deficit = 500
Liabilities = 1,500
• Gains/losses may pass though either:
– Profit & Loss, via pension expense
10% x Max (Assets, Liabilities) = 150
– Statement of Comprehensive Income
Deficit outside “corridor” = 500 – 150 = 350
Expected Remaining Working Lifetime = 15 years

Amortisation = 350 / 15 = 23 per year

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Hot Off The Press! Potential Changes to IAS19

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 IASB Exposure Draft
Current Requirements in IAS19

Source: IASB

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 IASB Exposure Draft
Proposed Requirements in IAS19

Source: IASB

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Summary

 IAS19 is not a material change from AS-15

– Key change is the allowable methods of gain/loss recognition

 Consider carefully your assumption setting process

– Are assumptions your realistic best estimate
– Avoid unnecessary volatility resulting from poorly chosen assumptions

 Consider ALL of your employee benefits, and ensure you are appropriately
accounting for your expense and liability

 And finally – some of this may change anyway!

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