IAS 19 – Employee Benefits
IAS 19 Employee Benefits describes the accounting of employee benefits such as salaries, wages, paid and unpaid leaves, end of service benefits, pensions etc. paid to employees by their employers.
The standard requires to recognize a liability and an expense against a service received from an employee against benefits such as cash salary to be paid to him or her. The standard prescribes the accounting for both short term and long-term benefits.
This standard applies to all the benefits given to employees except for:
- Employee benefit plans under IAS 26 – Accounting and Reporting by Retirement Benefit Plans
- Employee benefits covered under IFRS 2 – Share based payments
The employee benefits that fall under the scope of the standard include:
- Those through formal arrangements between employers and employees and their representatives
- Those prescribed by laws and regulations (for example, certain laws dictate employers to pay end of service benefits to their employees)
- Those that arise through informal practices pursued by an entity.
Employee benefits include:
- Short term benefits that are expected to be settle within 12 months after the end of reporting period in which the employees provide the services that give rise to such benefits. Examples include salaries and wages, paid leaves and sick leaves, non-monetary benefits, bonuses, etc.
- Benefits after employment also known as post-employment benefits such as retirement benefits, pension and medical care and insurance.
- Other long term employment benefits such as sabbatical leave and disability benefits.
- Termination benefits.
Definitions (simplified and explained)
Employee benefits are all types of considerations paid by employers to their employees for the services rendered by the employees and benefits paid to terminate the employments such as golden handshake payments.
Short term employee benefits are benefits that are expected to be paid or settled within one year after the reporting period in which the employees provided the services against which such benefits are paid but these do not include termination benefits (which are defined below separately).
Post-employment benefits are benefits that are payable after the employment is complete and these do not include short term benefits and termination benefits.
Other long term employee benefits are all employee benefits other than short term, post – employment and termination benefits.
Termination benefits are provided as a result of termination of employment of an employee because of:
- The employer’s decision to terminate the employment before his or her normal retirement age
- The employee’s decision to accept a termination offer against benefits to be paid by the employer
Post-employment Benefit Plans are informal or formal arrangements under which employers provide after-employment benefits to employees.
Defined Contribution Plans are such plans as per which a fixed amount is paid to a separate plan or entity also known as fund on a recurring basis and its liability is restricted to such payments. In the future, if the fund does not have sufficient funds to pay to the employees, the employer has no legal or constructive liability to pay the difference.
Defined Benefit Plans are after-employment benefit plans other than the ones that are known as defined contribution plans.
Multi-employer plans are defined contribution plans (other than state plans) or defined benefit plans (other than state plans) that:
- Pool all those assets that have been contributed by different entities that are not under common control
- Use such assets to provide employees of different entities with benefits without regard to the identity of such entity.
The net defined benefit liability (asset) is the deficit or surplus, adjusted for any effects of limiting the defined benefit asset to the asset ceiling.
Deficit or Surplus is the difference between the present value of defined benefit liability less the fair value of plan asset if any.
Asset Ceiling represents the present value of amounts that can be refunded if such amounts exceed the benefits needed to pay the liabilities for the employee benefits under the plan.
A defined benefit obligation’s present value can be defined as all the future payments to be made to settle the liability of employees for their present or past services without deducting any plan assets.
Plan assets are:
(a) assets that have been held by an employee fund (long-term); and
(b) qualifying insurance policies.
Fair Value is the price that will be received on selling an asset or paid to extinguish a liability in a fair transaction between market participants.
Definitions Related to Defined Benefit Cost
Service Cost consist of:
- Current service cost which refers to the present value of the cost against the services provided by an employee in the current period
- Past Service cost refers to the present value of cost for services rendered by employees in prior periods resulting from a change in plan or employee number and
- Any gain or loss on settlement.
Net Interest on the Net Defined Benefit Liability is the interest component on liability during the period i.e. it arises from passage of time.
Remeasurements of the Net Defined Benefit Liability (asset) comprises:
- Actuarial losses or gains arising from estimation of these liabilities by the actuary
- The return on plan assets (excluding any amount included in interest on the defined benefit asset or liability); and
- Any kind of change in the impact of the asset ceiling (excluding any amount that has already been included in the interest amount on the defined benefit asset or liability).
Actuarial Gains and Losses are changes in the present value of the defined benefit obligation arising from
- Experience adjustments (the difference between actuarial assumptions in the prior period and their actualization in the current period)
- The effect of changes in actuarial assumptions.
The Return on Plan Assets is the return that such assets bring and could be interest, dividends etc. together with valuation gains on such assets either realized or not, LESS:
- Any management costs for such plan assets arrangements
- Any tax charge on the plan (other than tax included in actuarial assumptions)
A Settlement is a transaction that extinguishes all liabilities arising under a defined employee benefit plan (both actual and constructive obligations) other than normal payments that are in line with the normal conditions of the plan and actuarial assumptions.
Short Term Employee Benefits
These are such benefits which are expected to be settle within 12 months after the reporting period. For example, salaries, wages, annual leave benefits and annual air ticket benefits which have to be used within on year. This also include bonuses and non-monetary benefits such as various allowances as long as they are expected to be settled within one year after the reporting period.
There might be some temporary changes to the benefits that suggest that such benefits are not short term. However, if these conditions are only temporary, an entity need not reclassify its benefits to long term. But if these conditions are long term, then an entity needs to consider the classification of such benefits as long term.
Recognition and Measurement
All Short-Term Employee Benefits
When an employee provides services to an entity, the entity needs to recognize the amounts to be paid against such services as a liability or accrued expense net of any payments already made if any.
2nd impact of this transaction will be either an expense or it may be capitalized within fixed assets / intangible assets or investment property if it meets the conditions of capitalization criteria for those standards.
If an entity has paid more to an employee against his or her due amount for his or her services, the excess amount will be shown as an asset (prepayment) if such prepayment will provide benefit to the entity in future (for example in the next period, the entity will deduct such prepaid amount from the total salary to be paid to the employee in the next period).
Shazia is working for XYZ limited as full-time employee. Her salary for the month of January 2022 was AED 50,000 which was not received by her. On 1 February 2022, the employer paid her AED 75,000 (being 50,000 for the month of January 2022 and remaining 25000 in advance for the month of February 2022). Please provide the journal entries for the two months.
On 31 January 2022, the Company has not paid anything however the services provided by Shazia have been accrued, so an expense and accrual (payable) should be book as at 31 Jan 2022.
On 31 Jan 2022:
Salary expense Dr. 50,000
Salary Payable Cr. 50,000
On 1 Feb 2022, the salary has been paid and an advance of 25,000 which will be adjusted from the salary for the month of February 2022.
On 1 Feb 2022:
Salary payable Dr. 50,000
Bank / Cash Cr. 50,000
and for the advance, the entry will be:
Prepaid salary Dr. 25,000
Bank / Cash Cr. 25,000
Note: We have not considered the salary of one day (i.e., 1 Feb 2022) in this example.
Short Term Paid Absences
There are two types of short term paid leaves:
Accumulating leaves are those that can be carried forward to next period if not used in the current period (i.e. they can be used / availed in the next period).
Non-accumulating leaves are those which will be used only in the relevant period and if not utilized in the relevant period, they cannot be carried forward in the next period.
The related accounting treatment depends upon whether the leaves are accumulating or non-accumulating.
In case of accumulating leaves, expense is recorded as the employee provides service for which he is entitled to paid leaves in future.
an employee in company C provides services during the year ending 30 June 2021. For each completed year of service, he is entitled to paid leaves of 21 days which can be carried forward in next years and can be utilized at any time. The monthly salary of the employee is AED 50,000. Considering 30 days in each month, calculate the provision for leaves to be recorded in the books of Company C?
Since the leaves are accumulating and employee has not used any in the current period, the company needs to book an expense of 35,000 (50000/30*21) for leave benefits by the end of current reporting period. Then entry will be:
Employee leave benefit expense Dr. 35,000
Provision for leave benefits Cr. 35,000
Non – Accumulating leaves
Benefits expense against non-accumulating leaves is recorded when such leaves are taken.
Casey is working with X Co. She is entitled to 21 days leaves for the year ending 30 June 2021. By the year end of 30 June 2021, she has only taken 15 leaves. The remaining leaves cannot be carried forward nor any amount will be paid for these unutilized leaves. Suggest the journal entries if the salary of Casey is 25,000 per month. Consider 30 days in each month for simplicity.
Leave expense will be recorded for only those leaves which have been actually utilized. So, the expense for such leaves will be 12,500 (25000/30*15).
Entry for this arrangement will be:
Leave benefits expense Dr. 12,500
Bank/ Cash / Payable / Accrual Cr. 12,500
Vesting and Non-Vesting Accumulating Paid Leaves
Within Accumulating paid leaves, there are further two types, vesting and non-vesting.
Vesting leaves means if they are not utilized, they will be paid in cash at the time employee leaves or based on his request as per company’s policy. For such leaves, the provision is made for the full number of leaves as the service is rendered by the employees as they have to be paid in full or utilized in full.
Non-Vesting leaves means such accumulating leaves which if not utilized in the next periods and at the end if employee leaves, the Company will not pay for such outstanding balance of leaves which were not utilized.
Accounting for non-vesting leaves includes an estimation of how many leaves will not be utilized and will lapse at the end. Based on this estimate, provision for such leaves will be booked.
A Company, Zeta Limited provides 25 annual paid leaves to all its employees. These leaves are accumulating but non-vesting. As at the end of reporting year, the Company has accrued leaves that are not utilized are 50 leaves. It is expected that 70% of these leaves will be utilized, however, 30% will lapse i.e. employees are expected to leave with 30% leaves unpaid or unsettled which will not be paid by the Company. What will be the amount of provision to be booked if the average cost of one leave is AED 500.
The leave provision in the above scenario should be 17,500 (50*70%*500).
The entry will be:
Leave benefits expense Dr. 17,500
Provision for leave benefits Cr. 17,500
Profit Sharing and Bonus Plans
An expected amount for profit sharing or bonus will be recognized by an entity when it has created a present obligation by its past actions, or a constructive obligation and the amount of such bonus or profit sharing can be measured reliably.
A present obligation will occur when an entity has not realistic alternative but to settle such liability.
In some case, profit sharing is dependent upon some conditions that employee has to satisfy.
A Company Xeta Co. provides a profit-sharing arrangement, where the employees of the Company will get a cumulative amount of 2% of the profit for the years (year 1 and year 2) if they remain in service with Company for at least two years. Those employees who leave will not be paid any amount and the total amount i.e., 2% profit will be adjusted for the share of leavers and remaining amount will be paid to the continuing employees equally.
The Company has 50 employees at the start of year 1, the profit of the Company for the year amounted to AED 5million. By the end of year 1, 5 employees have left, and 45 employees are eligible for this profit-sharing scheme. It is further expected that another 10 employees will leave during the 2nd year. What will be the amount of bonus to be accrued at the of year 1?
Total Profit: 5,000,000
Profit share for all employees: 100,000 (5,000,000 * 2%)
Profit share per employee: 2,000 (100,000 / 50 employees)
Expected number of employees eligible for the scheme: 35 (50-5-10)
Provision for bonus: 70,000 (35 employees * 2,000 share per employee)
Entry for this transaction will be:
Bonus expense Dr. 70,000
Provision for bonus expense Cr. 70,000
In the 2nd year, if the expectation changes and actual number of leavers differ from expected, the estimate will be updated prospectively along with profit share for 2nd year.
A constructive obligation may arise from entity’s past history or practices that create a valid expectation in the employees that bonus or another amount will be paid. An entity can make a reliable estimate of its legal or constructive obligations when terms of the plan have been set out including a formula or calculation basis for such amount, and the amount will be paid before the authorization of financial statements or past practices give clear indications of the expected amount of such benefits to be paid.
Post-employment Benefit Plans
Such benefit include:
- Retirement benefits (e.g., pensions and lump sum payments on retirement)
- Other post-employment benefits such post-employment life insurance and medical benefits
Such benefit plans can be either defined contribution plans or defined benefit plans depending upon the terms of such plan.
Defined Contribution Plans
Under such plans, an entity is only required to pay a fixed or determinable contribution to a plan and its liability is limited only to such contribution. If in future, if the fund does not have sufficient funds and investment returns have been low, the Company has no obligation to make additional contributions. Thus, the risk of such funds lies with the employees.
Defined Benefit Plans
Under such plans, entity’s obligations extend beyond its contributions to provide agreed benefits to its employees and actuarial and investment risks will fall on the entity. For example, pension benefits, where it is agreed with employees to pay them a fixed amount of pension after their end of service with the Company. During the year under service, the Company makes contributions to such funds and if later it is found that such contributions are not sufficient, the Company will be required to make additional contributions.
Multi-employer plans, state plans and other such plans shall be classified as either defined contribution plan or benefit plans based on the terms and conditions of these plans (substance over form rule applies).
Accounting for Defined Contribution Plans
Accounting for defined contribution plans is simple as the entity’s liability is restricted to its contributions and no future estimates are needed. An expense is recorded for each reporting period against the contribution to be made by the company for an employee for its service.
Company X provides defined contribution plans to its employee whereby the Company is required to pay AED 500 for each employee’s one year of completed service to a separate fund. The company has 10 employees. What will be the accounting for this expense in year 1?
Employee benefit expense Dr. 5,000 (500*10)
Cash / Bank / Accrual Cr. 5,000
Such benefits if expected to be settled within 12 months, are not discounted. However, if they are expected to be settled after 12 months they will be shown at a discounted amount and then interest expense will be accrued in the coming years over such benefits.
Accounting for Defined Benefit Plans
Defined benefit plans are complex because estimation is needed for the amount of benefits that will be paid in future and takes into account certain factors such as employee’s expected age and inflation rates etc.
Following steps will be followed for accounting defined benefit plans.
- Determining the surplus or deficit involves using actuarial techniques whereby reliable estimate of benefits will be made which are expected to be paid in future
- Discounting of such benefit to show a present value at the current accounting period
- Subtracting the amount of fair value of any plan assets (such as investments) held for the purpose of meeting such benefits.
Adjustment will be made if the present value expected benefit liability or asset is different from currently recorded in the books.
Following amounts will be recognized in the P&L
- Current service cost
- Past service cost
- Net interest on the defined liability or asset
Following amounts will be recognized in other comprehensive income:
- Actuarial gains or losses
- Return on plan assets
- Any change in the effect of asset ceiling
An entity is required to make the estimation for actuarial valuations with sufficient regularity such that amounts represented in financial statement do not differ from the present value of such liabilities as per actuary calculations.
The standard does not require but encourages an entity to involve a qualified actuary for this process.
An entity shall reflect the net defined benefit liability or asset in its statement of financial position.
Actuarial Valuation Method
An entity shall use project credit unit (PCU method) to determine the present value of its defined benefit obligation. Such method considers each period of service as an additional unit of benefit obligation.
Assumptions should not be biased and shall be mutually compatible i.e., they reflect economic relationship between various factors such as inflation, salary growth etc.
- Demographic assumptions such as mortality, employee turnover rates etc.
- Financial assumptions such as discount rate, taxes, growth in salaries etc.
An entity shall offset a plan asset against a liability relating to same plan if it has a legally enforceable right to do so and it intends to settle these on a net basis.
This standard does not require the distinction of current and non-current liabilities (assets) relating to post employment plans.
An entity shall disclose:
- Characteristics and risks associated with its benefits plans
- Explanation of amounts arising from defined benefit plans in its financial statements
- Description of how its defined benefit plans affect the amount timing and uncertainty of its future cash flows.