12 June 2009

Actuarial Valuation of Employee Benefits under IFRS

Arvind Gopalakrishnan, Head of South India Operations, Mercer Retirement Consulting Harshad Salaskar, Senior Consultant, Mercer Retirement Consulting +91 80 4185 7700 Arvind.Gopalakrishnan@mercer.com
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Agenda
IFRS Coverage IAS19 Employee Benefits Scope Disclosures Assumptions Actuarial Losses / (Gains) Likely changes in IAS19

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IFRS Coverage

IFRS
Prior to IFRS, International Accounting Standards were used Broadly, IFRSs refers to the entire body of IASB pronouncements,

including standards and interpretations approved by the IASB

IAS 19 prescribes the scope of Employee Benefits IAS 26 provides information on Accounting and Reporting by

Retirement Benefit Plans.

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IAS19 Employee Benefits Scope

IAS 19 Employee Benefits - Scope

The Standard prescribes the accounting and disclosure by employers for

employee benefits
This standard does not apply to benefits which needs to cover under the

IFRS2 share-based payment

This Standard does not deal with reporting by employee benefit plans

(covered under IAS 26) e.g. accounting and reporting by trust plans
The Standard identifies following categories of employee benefits to be

covered Short term employee benefits Post-employment benefits Other long term employee benefits Termination benefits
Will cover formal plans, state plans, constructive obligation (informal

practices)
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IAS 19 Short Term Benefits

Short-term employee benefits are employee benefits (other than

termination benefits) that are due to be settled within twelve months after the end of the period in which the employees render the service
Examples could be wages, salaries and social security contributions,

paid annual / sick leave, bonuses, non-monetary benefits (housing, cars)

No actuarial valuation is required and hence there would no possibility of

any actuarial loss or (gain)

Obligation is measured on undiscounted basis

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IAS 19 Post-employment benefits

Post-employment benefits (whether funded or not) include Retirement benefits such as pension benefit Post-employment life insurance, death benefit, medical benefit Post-employment benefits can be of two types Defined Benefit (DB) Defined Contribution (DC)

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Defined Benefit Plans

A retirement plan where employee benefits are sorted out based on a

formula, using factors such as salary history and duration of employment

A defined benefit scheme fixes the benefit in advance - usually as a

proportion of the members earnings when they exit

E.g. DB scheme might provide at retirement a pension of 1% of salary for

each year of service. If an employee retires after 30 years of service, employee would receive pension of 30% of salary before retirement
Actuarial valuation will be required for DB plans based on actuarial

assumptions

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Defined Contribution Plans

A retirement plan wherein a certain amount or percentage of money is

set aside each year by a company for the benefit of the employee. A defined contribution scheme has a set contribution for the employer and a set contribution for the employee As contribution rates are predetermined, employers know what they have committed to and employer is no longer obliged to add more to the fund E.g. In DC scheme, employer and employee each contributes 5% of eligible salary

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Combination of Defined Benefit and Defined Contribution Plans where employers obligation is not limited to contributions to the fund but has legal or constructive obligation such as Scheme having benefit formula that is not linked solely with accumulation (hybrid schemes) Scheme providing guarantee, either indirectly through a plan or directly, of a specified return on contributions For privately managed provident funds, the employer must provide for the fund return declared by the Government

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Other Long Term Benefits

Other long-term benefits are employee benefits (other than post-

employment benefits and termination benefits) that are not due to be settled within twelve months after the end of the period in which the employees render the related service
Examples could be long-service leave, jubilee or long service award,

profit sharing (payable twelve months or more after the end of the period)
The Standard requires a simpler method of accounting for other long-

term employee benefits than for post-employment benefits

Actuarial gains and losses are recognized immediately and no corridor

is to be applied
Past service cost are recognized immediately IAS19 does not require specific disclosures about other long-term

employee benefits
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Termination Benefits
Termination benefits are employee benefits payable as a result of Employers decision to terminate an employees employment Employees decision to accept voluntary redundancy in exchange for

those benefits
An entity is demonstrably committed to a termination when, and only

when, the entity has a detailed formal plan (with specified minimum contents) for the termination and is without realistic possibility of withdrawal.
Where termination benefits fall due more than 12 months after the

balance sheet date, they should be discounted. In the case of an offer made to encourage voluntary redundancy, the measurement of termination benefits should be based on the number of employees expected to accept the offer

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Disclosures

Disclosures Defined Contribution

Accounting and disclosure for defined contribution plans is straightforward No actuarial assumptions are required to measure the obligation or the

expense and there is no possibility of any actuarial gain or loss

The obligations are measured on an undiscounted basis, except where

they do not fall due wholly within twelve months after the end of the period in which the employees render the related service

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Disclosures Defined Benefit

Balance Sheet

DBO (Defined Benefit Obligation) Less: Fair value of plan assets Less: Unrecognized past service cost Less: Unrecognized actuarial losses / (gains) (in case of corridor approach)
Profit & Loss Statement

Current service cost + Past service cost + Interest cost Expected return on assets + Actuarial losses / (gains) + Effect of any curtailments or settlements

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Actuarial Assumptions

Actuarial Assumptions
Assumptions Unbiased and mutually compatible Based on market expectations over the projection period Employer to decide on the assumptions Demographic Mortality Employee turnover, disability and early retirement Claim rates under medical plans Financial Discount Rate Salary escalation rate Medical expenses Expected return on plan assets
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Effects of Changes in Actuarial Assumptions

Assumption Discount rate Salary Increase Rate Increase DBO would decrease and leads to actuarial gain Decrease DBO would increase and leads to actuarial loss

DBO would increase and leads to DBO would decrease and actuarial loss will lead to actuarial gain

Expected longterm rate of return

High expected return results in Low expected return results low pension cost in high pension cost

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Actuarial Assumptions Discount Rate

The rate used to discount post-employment benefit obligations shall be

determined by reference to market yields at the balance sheet date on high quality corporate bonds
In countries where there is no deep market in such bonds, the market

yields (at the balance sheet date) on government bonds shall be used
The currency and term of the corporate bonds or government bonds

shall be consistent with the currency and estimated term of the postemployment benefit obligations
However, AS15 (R) states that only Gilt Rate needs to be used without

margin for corporate bond spread

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Actuarial Losses & (Gains)

Actuarial Losses / (Gains)

Actuarial Losses / (Gains) arises due to Change in liability driven by change of assumptions Change in liability driven by variation in actual experience vis--vis

assumptions Change in fair value of assets driven by actual investment return different from the expected
IAS 19 provides the following options to recognize actuarial gains and

losses: Immediate recognition in P & L Immediately recognition in statement of recognised income and expense (SORIE) Corridor approach

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Recognition of Actuarial Losses / (Gains)

AS 15(R) requires immediate recognition of actuarial losses / (gains) in

Profit & Loss

This results in volatility in profits and losses of company especially in

case of significant change in gilt rate and change in fair value of unitlinked fund assets
IAS19 provides two more approaches to follow as compared to AS15 (R) Immediately recognition through SORIE enables to control volatility of

profits and losses

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Recognition of Actuarial Losses / (Gains)

Corridor approach can be used to delay recognition of losses / (gains) Corridor Approach amortizes over employees future service periods

any unrecognized gains or losses in excess of 10% of greater of projected benefit obligation or fair value of plan assets [Unrecognized L / (G) 10% * Max (DBO, Assets) ] / Average FS

Unrecognized net gain/loss

Net gain/loss subject to recognition

Corridor = 10% Max(PBO, Fund Assets)

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Recognition of Actuarial Losses / (Gains)

Corridor Approach requires to reconcile Unrecognized Losses / (Gains) Opening Unrecognized Losses / (Gains)

+ Actuarial loss / (gain) on DBO + Actuarial loss / (gain) on Assets Actuarial loss / (gain) recognized in the years P & L Closing Unrecognized Losses / (Gains) to be carried forward

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Likely Changes in IAS19

Likely Changes in IAS19

The International Accenting Standards Board is discussing changes to the

disclosures required and expect to come up with an exposure draft in the fourth quarter of 2009
The likely changes would be Entities should recognize all changes in the value of plan assets and

changes in the post-employment benefit obligation in the period in which they occur (immediate recognition) Replacement the term deep market with term active market and will define the term Requirement of disclosure of the effect of plan amendments with a narrative description of the amendments
The requirements under IAS19 will be more clearer after circulation of the

exposure draft

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Q&A

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