2.1 Objective

IAS 19 sets out its objective as follows:

‘The objective of this Standard is to prescribe the accounting and disclosure for employee benefits. The Standard requires an entity to recognise:

1. a liability when an employee has provided service in exchange for employee benefits to be paid in the future; and
2. an expense when the entity consumes the economic benefit arising from service provided by an employee in exchange for employee benefits.’ [IAS 19.1].

This provides the first glimpse of the direction taken by the standard. Driven by the focus on assets and liabilities in the IASB's Conceptual Framework (which is discussed in Chapter 2), it approaches the issues from the perspective of the statement of financial position.

2.2 Scope

The general scope of the standard is dealt with at 2.2.1 below. The issue of employee benefits settled not by the employing entity but by a shareholder or other member of a group is discussed at 2.2.2 below.

3.1 The distinction between defined contribution plans and defined benefit plans

IAS 19 draws the important distinction between defined contribution plans and defined benefit plans. The determination is made based on the economic substance of the plan as derived from its principal terms and conditions. [IAS 19.27]. The approach it takes is to define defined contribution plans, with the defined benefit plans being the default category. The relevant terms defined by the standard are as follows: [IAS 19.8]

‘Post-employment benefits are employee benefits (other than termination benefits and short-term employee benefits) that are payable after the completion of employment’.

‘Post-employment benefit plans are formal or informal arrangements under which an entity provides post-employment benefits for one or more employees’.

‘Defined contribution plans are post-employment benefit plans under which an entity pays fixed contributions into a separate entity (a fund) and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods’.

‘Defined benefit plans are post-employment benefit plans other than defined contribution plans’.

IAS 19 applies to all post-employment benefits (whether or not they involve the establishment of a separate entity to receive contributions and pay benefits) which include, for example, retirement benefits such as pensions; and post-employment life assurance or medical care. [IAS 19.26]. A less common benefit is the provision of services.

Under defined benefit plans the employer's obligation is not limited to the amount that it agrees to contribute to the fund. Rather, the employer is obliged (legally or constructively) to provide the agreed benefits to current and former employees. Examples of defined benefit schemes given by IAS 19 are: [IAS 19.29]

1. plans where the benefit formula is not linked solely to the amount of contributions and requires the entity to provide further contributions if assets are insufficient to meet the benefits in the plan formula;
2. guarantees, either directly or indirectly through a plan, of a specified return on contributions; and
3. those informal practices that give rise to a constructive obligation, such as a history of increasing benefits for former employees to keep pace with inflation even where there is no legal obligation to do so.

The most significant difference between defined contribution and defined benefit plans is that, under defined benefit plans, some actuarial risk or investment risk (or both) falls, in substance, on the employer. This means that if actuarial or investment experience is worse than expected, the employer's obligation may be increased. [IAS 19.30]. Consequently, because the employer is in substance underwriting the actuarial and investment risks associated with the plan, the expense recognised for a defined benefit plan is not necessarily the amount of the contribution due for the period. [IAS 19.56]. Conversely, under defined contribution plans the benefits received by the employee are determined by the amount of contributions paid (either by the employer, the employee or both) to the benefit plan or insurance company, together with investment returns, and hence actuarial and investment risk fall in substance on the employee. [IAS 19.28].

In 2019 the Interpretations Committee received a request concerning the classification of a post-employment benefit plan that is administered by a third party. The only relevant terms and conditions in the request were that:

• the entity has an obligation to pay fixed annual contributions into the plan. The entity has determined that it will have no legal or constructive obligation to pay further contributions into the plan if it does not hold sufficient assets to pay all employee benefits relating to employee service in current and prior periods; and
• the entity is entitled to a potential discount on its annual contributions if the ratio of plan assets to plan liabilities exceeds a set level.

The Interpretations Committee was asked to consider whether the existence of a right to a potential discount would result in classification as a defined benefit plan under IAS 19. The Committee concluded that based on the fact pattern provided in the request the existence of a right to a potential discount would not in itself result in the classification as a defined benefit plan. However, they re-iterated the importance of assessing all the relevant terms and conditions of a plan, as well as any informal practices that might give rise to a constructive obligation, in the classification of a plan. The Committee also concluded that the requirements of IAS 19 provide an adequate basis for an entity to determine the classification of a post-employment benefit plan as a defined contribution plan or a defined benefit plan and decided not to add this matter to its standard-setting agenda.¹

The committee reached this conclusion through consideration of the definition of a defined contribution plan, which requires:

• contributions to be fixed with no further legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits; [IAS 19.8]
• that this does not exclude the upside potential where the cost to the entity may be less than expected; [IAS 19.BC29] and
• the fact that in a defined contribution scheme the actuarial risk falls in substance on the employee. [IAS 19.28, 30].

The classification of plans such as those described in the fact pattern submitted will require careful consideration of all the facts and circumstances to determine whether actuarial risk has remained with the employee and a defined contribution classification is appropriate. An entity should also consider whether any significant judgements made in this determination should be disclosed in accordance with IAS 1– Presentation of Financial Statements. [IAS 1.122].

3.2 Insured benefits

One factor that can complicate making the distinction between defined benefit and defined contribution plans is the use of external insurers. IAS 19 recognises that some employers may fund their post-employment benefit plans by paying insurance premiums and observes that the benefits insured need not have a direct or automatic relationship with the entity's obligation for employee benefits. However, it makes clear that post-employment benefit plans involving insurance contracts are subject to the same distinction between accounting and funding as other funded plans. [IAS 19.47].

Where insurance premiums are paid to fund post-employment benefits, the employer should treat the plan as a defined contribution plan unless it has (either directly or indirectly through the plan) a legal or constructive obligation to:

1. pay the employee benefits directly when they fall due; or
2. pay further amounts if the insurer does not pay all future employee benefits relating to employee service in the current and prior periods.

If the employer has retained such a legal or constructive obligation it should treat the plan as a defined benefit plan. [IAS 19.46]. In setting out how to apply defined benefit accounting, however, the standard refers to slightly different criteria to determine whether a legal or constructive obligation is retained. Rather than referring to ‘either directly or indirectly through the plan’, paragraph 48 of IAS 19 refers to ‘the entity (either directly, indirectly through the plan, through the mechanism for setting future premiums or through a related party relationship with the insurer) retains a legal or constructive obligation’ (emphasis added). [IAS 19.48]. In our view the additional text included with paragraph 48 should also be applied in paragraph 46.

In cases where such obligations are retained by the employer, it recognises its rights under a ‘qualifying insurance policy’ as a plan asset and recognises other insurance policies as reimbursement rights. [IAS 19.48]. Plan assets are discussed at 6 below.

By way of final clarification, the standard notes that where an insurance policy is in the name of a specified plan participant or a group of plan participants and the employer does not have any legal or constructive obligation to cover any loss on the policy, the employer has no obligation to pay benefits to the employees and the insurer has sole responsibility for paying the benefits. In that case, the payment of fixed premiums under such contracts is, in substance, the settlement of the employee benefit obligation, rather than an investment to meet the obligation. Consequently, the employer no longer has an asset or a liability. Accordingly, it should treat the payments as contributions to a defined contribution plan. [IAS 19.49]. The important point here is that employee entitlements will be of a defined benefit nature unless the employer has no obligation whatsoever to pay them should the insurance fail or otherwise be insufficient.

The analysis of insured plans given in the standard, which is described above, along with the definition of defined benefit and defined contribution plans seems comprehensive at first glance. However, there will be circumstances where the distinction may not be so apparent and careful analysis may be required. For example, it is possible that an employer buys insurance on a regular basis (say annually), retaining no further obligation in respect of the benefits insured, but has an obligation (legal or constructive) to keep doing so in the future. In such a scenario, the employer may be exposed to future actuarial variances reflected in a variable cost of purchasing the required insurance in future years (for example, due to changing mortality estimates by the insurer).

Another scenario would be where each year the employee earns an entitlement to a pension of (say) 2% of that year's (i.e. current as opposed to final) salary and the employer purchases each year an annuity contract to commence on the date of retirement.

In our view, the standard is not entirely clear as to the nature of such an arrangement. On the one hand, it could be argued that it is a defined contribution plan because the definition of defined contribution plans is met when:

• ‘fixed’ payments are paid to a separate fund; and
• the employer is not obliged to pay further amounts if the fund has insufficient assets to pay the benefits relating to employee service in the current and prior periods.

Further, as noted above the standard considers the payment of ‘fixed’ premiums to purchase insurance specific to an employee (or group thereof) with no retention of risk in respect of the insured benefits to be a defined contribution arrangement.

On the other hand, it could be argued that this is a defined benefit plan on the grounds that:

• the premiums of future years are not ‘fixed’ in any meaningful sense (certainly not in the same way as an intention simply to pay a one-off contribution of a given % of salary);
• the standard acknowledges that one factor that can mean insured arrangements are defined benefit in nature is when the employer retains an obligation indirectly through the mechanism for setting future premiums; [IAS 19.48] and
• the standard observes that under defined benefit plans ‘… actuarial risk (that benefits will cost more than expected) and investment risk fall, in substance, on the entity. If actuarial or investment experience are worse than expected, the entity's obligation may be increased'. [IAS 19.30].

Much would seem to depend on just what ‘fixed’ means in such circumstances. Although not expressly addressed by the standard, in our view such arrangements will very likely be defined benefit in nature, albeit with regular (and perhaps only partial) settlement and, if so, should be accounted for as such. This is because the employer has retained actuarial risks by committing to pay whatever it takes in future years to secure the requisite insurance. See 3.1 above for further discussion on ‘fixed’ contributions. Naturally, for any schemes that are determined to be defined benefit plans, the next step would be to see whether the frequent settlement renders the output of the two accounting models materially the same. That would depend, inter alia, on the attribution of the benefit to years of service and the impact of an unwinding discount.

The wide variety of possible arrangements in practice mean that careful consideration of individual circumstances will be required to determine the true substance of such arrangements.

3.3 Multi-employer plans

3.4 State plans

IAS 19 observes that state plans are established by legislation to cover all entities (or all entities in a particular category, for example a specific industry) and are operated by national or local government or by another body (for example an autonomous agency created specifically for this purpose) which is not subject to control or influence by the reporting entity. [IAS 19.44]. The standard requires that state plans be accounted for in the same way as for a multi-employer plan (see 3.3.1 above). [IAS 19.43]. It goes on to note that it is characteristic of many state plans that:

• they are funded on a pay-as-you-go basis with contributions set at a level that is expected to be sufficient to pay the required benefits falling due in the same period; and
• future benefits earned during the current period will be paid out of future contributions.

Nevertheless, in most state plans, the entity has no legal or constructive obligation to pay those future benefits: its only obligation is to pay the contributions as they fall due and if the entity ceases to employ members of the state plan, it will have no obligation to pay the benefits earned by its own employees in previous years. For this reason, the standard considers that state plans are normally defined contribution plans. However, in cases when a state plan is a defined benefit plan, IAS 19 requires it to be treated as such as a multi-employer plan. [IAS 19.45].

Some plans established by an entity provide both compulsory benefits which substitute for benefits that would otherwise be covered under a state plan and additional voluntary benefits. IAS 19 clarifies that such plans are not state plans. [IAS 19.44].

3.5 Plans that would be defined contribution plans but for the existence of a minimum return guarantee

It is common in some jurisdictions for the employer to make contributions to a defined contribution post-employment benefit plan and to guarantee a minimum level of return on the assets in which the contributions are invested. In other words, the employee enjoys upside risk on the investments but has some level of protection from downside risk.

The existence of such a guarantee means the arrangement fails to meet the definition of a defined contribution plan (see 3.1 above) and accordingly is a defined benefit plan. Indeed, the standard is explicit, as it uses plans which guarantee a specified return on contributions as an example of a defined benefit arrangement. [IAS 19.29(b)]. The somewhat more difficult issue is how exactly to apply defined benefit accounting to such an arrangement, as this would require projecting forward future salary increases and investment returns, and discounting these amounts at corporate bond rates. Although this approach is required by the standard, some consider it to be inappropriate in such circumstances. This issue was debated by the Interpretations Committee, which published a draft interpretation on 8 July 2004 entitled D9 – Employee Benefit Plans with a Promised Return on Contributions or Notional Contributions. The approach taken in D9 was to distinguish two different types of benefits:

1. a benefit of contributions or notional contributions plus a guarantee of a fixed return (in other words, benefits which can be estimated without having to make an estimate of future asset returns); and
2. a benefit that depends on future asset returns.

For benefits under (a) above, it was proposed that the defined benefit methodology in IAS 19 be applied as normal. In summary, that meant:

• calculating the benefit to be paid in the future by projecting forward the contributions or notional contributions at the guaranteed fixed rate of return;
• allocating the benefit to periods of service;
• discounting the benefits allocated to the current and prior periods at the rate specified in IAS 19 to arrive at the plan liability, current service cost and net interest; and
• recognising any remeasurements in accordance with the entity's accounting policy (note that there is no longer an accounting policy choice under IAS 19 and remeasurements must be recorded in other comprehensive income).

For benefits covered by (b) above, it was proposed that the plan liability should be measured at the fair value, at the end of the reporting period, of the assets upon which the benefit is specified (whether plan assets or notional assets). No projection forward of the benefits would be made, and discounting of the benefit would not therefore be required.

D9 suggested that plans with a combination of a guaranteed fixed return and a benefit that depends on future asset returns should be accounted for by analysing the benefits into a fixed component and a variable component. The defined benefit asset or liability that would arise from the fixed component alone would be measured and recognised as described above. The defined benefit asset (or liability) that would arise from the variable component alone would then be calculated as described above and compared to the fixed component. An additional plan liability would be recognised to the extent that the asset (or liability) calculated for the variable component is smaller (or greater) than the asset (or liability) recognised in respect of the fixed component.

In August 2005, the Interpretations Committee however announced the withdrawal of D9, observing the following: ‘The staff found the fixed/variable and modified fixed/variable approaches inadequate to give a faithful representation of the entity's obligation for more complex benefit structures. They believed that some aspects of the fixed/variable approach in D9 were not fully consistent with IAS 19. … The staff … recommended that the correct treatment for D9 plans should be determined as part of an IASB project.'

The Interpretations Committee was asked in 2012 whether the revisions to IAS 19 in 2011 affect the accounting for these types of employee benefits and concluded they do not.²

The Interpretations Committee re-opened its examination of the subject and spent some time considering the issue. In May 2014, it decided not to proceed with the issue, stating the following: ‘In the Interpretations Committee's view, developing accounting requirements for these plans would be better addressed by a broader consideration of accounting for employee benefits, potentially through the research agenda of the IASB. The Interpretations Committee acknowledged that reducing diversity in practice in the short term would be beneficial. However, because of the difficulties encountered in progressing the issues, the Interpretations Committee decided to remove the project from its agenda. The Interpretations Committee notes the importance of this issue because of the increasing use of these plans. Consequently, the Interpretations Committee would welcome progress on the IASB's research project on post-employment benefits'.³

In February 2018 the Board announced a research project on pension benefits that depend on asset returns, see 16.1 below for further details.

3.6 Death-in-service benefits

The provision of death-in-service benefits is a common part of employment packages (either as part of a defined benefit plan or on a standalone basis). We think it is regrettable that IAS 19 provides no guidance on how to account for such benefits, particularly as E54 (the exposure draft preceding an earlier version of IAS 19) devoted considerable attention to the issue.⁴ IAS 19 explains the removal of the guidance as follows: ‘E54 proposed guidance on cases where death-in-service benefits are not insured externally and are not provided through a post-employment benefit plan. IASC concluded that such cases will be rare. Accordingly, IASC deleted the guidance on death-in-service benefits.’ [IAS 19.BC253].

In our view, this misses the point – E54 also gave guidance on cases where the benefits are externally insured and where they are provided through a post-employment benefit plan. In our view, the proposals in E54 had merit, and it is worth reproducing them here.

‘An enterprise should recognise the cost of death-in-service benefits … as follows:

1. in the case of benefits insured or re-insured with third parties, in the period in respect of which the related insurance premiums are payable; and
2. in the case of benefits not insured or re-insured with third parties, to the extent that deaths have occurred before the end of the reporting period.

‘However, in the case of death-in-service benefits provided through a post-employment benefit plan, an enterprise should recognise the cost of those benefits by including their present value in the post-employment benefit obligation.

‘If an enterprise re-insures a commitment to provide death-in-service benefits, it acquires a right (to receive payments if an employee dies in service) in exchange for an obligation to pay the premiums.

‘Where an enterprise provides death-in-service benefits directly, rather than through a post-employment benefit plan, the enterprise has a future commitment to provide death-in-service coverage in exchange for employee service in those same future periods (in the same way that the enterprise has a future commitment to pay salaries if the employee renders service in those periods). That future commitment is not a present obligation and does not justify recognition of a liability. Therefore, an obligation arises only to the extent that a death has already occurred by the end of the reporting period.

‘If death-in-service benefits are provided through a pension plan (or other post-employment plan) which also provides post-employment benefits to the same employee(s), the measurement of the obligation reflects both the probability of a reduction in future pension payments through death in service and the present value of the death-in-service benefits (see [E-54's discussion of mutual compatibility of actuarial assumptions]).

‘Death-in-service benefits differ from post-employment life insurance because post-employment life insurance creates an obligation as the employee renders services in exchange for that benefit; an enterprise accounts for that obligation in accordance with [the requirements for defined benefit plans]. Life insurance benefits that are payable regardless of whether the employee remains in service comprise two components: a death-in-service benefit and a post-employment benefit. An enterprise accounts for the two components separately.’

We suggest that the above may continue to represent valid guidance to the extent it does not conflict with extant IFRS. In particular, an appropriate approach could be that:

• death-in-service benefits provided as part of a defined benefit post-employment plan are factored into the actuarial valuation. In this case any insurance cover should be accounted for in accordance with the normal rules of IAS 19 (see 6 below). An important point here is that insurance policies for death-in-service benefits typically cover only one year, and hence will have a low or negligible fair value. As a result, it will not be the case that the insurance asset is equal and opposite to the defined benefit obligation;
• other death-in-service benefits which are externally insured are accounted for by expensing the premiums as they become payable; and
• other death-in-service benefits which are not externally insured are provided for as deaths in service occur.

The first bullet is particularly important. The measure of the post-employment benefit (like a pension) will be reduced to take account of expected deaths in service. Accordingly, it would be inappropriate to ignore the death in service payments that would be made. The question that arises is how exactly to include those expected payments. This raises the same issue as disability benefits (discussed at 13.2.2 below), i.e. what to do with the debit entry. However, IAS 19 has no explicit special treatment for death-in-service benefits comparable to that for disability benefits. Given the absence of specific guidance, the requirement is to apply the projected unit credit method to death in service benefits. As the benefit is fully vested, an argument could be made that the expected benefit should be accrued fully (on a discounted basis). Another approach would be to build up the credit entry in the statement of financial position over the period to the expected date of death.

An alternative approach could be to view death-in-service benefits as being similar to disability benefits. Proponents of this view would argue that the recognition requirements for disability benefits (discussed at 13.2.2 below) could also be applied to death-in-service.

In January 2008, the Interpretations Committee published its agenda decision explaining why it decided not to put death-in-service benefits onto its agenda.⁵ In the view of the Interpretations Committee, ‘divergence in this area was unlikely to be significant. In addition, any further guidance that it could issue would be application guidance on the use of the Projected Unit Credit Method’. In our view, the second reason seems more credible than the first.

As part of its analysis, the ‘rejection notice’ sets out some of the Interpretations Committee's views on the subject. It observes the following:

1. in some situations, IAS 19 requires these benefits to be attributed to periods of service using the Projected Unit Credit Method;
2. IAS 19 requires attribution of the cost of the benefits until the date when further service by the employee will lead to no material amount of further benefits under the plan, other than from further salary increases;
3. the anticipated date of death would be the date at which no material amount of further benefit would arise from the plan; and
4. using different mortality assumptions for a defined benefit pension plan and an associated death-in-service benefit would not comply with the requirement of IAS 19 to use actuarial assumptions that are mutually compatible.

Points (a) to (c) above support the analysis that a provision should be built up gradually from the commencement of employment to the expected date of death. They also suggest that making an analogy to the specific rules in the standard on disability may not be appropriate. In addition, point (c) is simply re-iterating a clear requirement of the standard. The above agenda decision of the Interpretations Committee is not as helpful as we would have liked. The use of the phrase ‘in some situations’ in point (a) above leaves uncertain just what those circumstances may be. In September 2007, the Interpretations Committee published a tentative agenda decision which said ‘[i]f these benefits are provided as part of a defined benefit plan, IAS 19 requires them to be attributed to periods of service using the Projected Unit Credit Method’.⁶ At the following meeting the Interpretations Committee discussed the comment letters received which noted that it could be argued that such attribution would be required only if the benefits were dependent on the period of service. No decision was reached on the final wording of the rejection notice because ‘IFRIC … was unable to agree on wording for its agenda decision’.⁷

Given the lack of explicit guidance on death-in-service benefits in IAS 19 itself, and given the Interpretations Committee's decision not to address the matter, it seems likely that practice will be mixed.

4.1 Accounting requirements

6.1 Definition of plan assets

IAS 19 provides the following definitions relating to plan assets:

‘Plan assets comprise:

1. assets held by a long-term employee benefit fund; and
2. qualifying insurance policies.’ [IAS 19.8].

‘Plan assets exclude unpaid contributions due from the reporting entity to the fund, as well as any non-transferable financial instruments issued by the entity and held by the fund. Plan assets are reduced by any liabilities of the fund that do not relate to employee benefits for example, trade and other payables and liabilities resulting from derivative financial instruments.’ [IAS 19.114].

‘Assets held by a long-term employee benefit fund are assets (other than non-transferable financial instruments issued by the reporting entity) that:

1. are held by an entity (a fund) that is legally separate from the reporting entity and exists solely to pay or fund employee benefits; and
2. are available to be used only to pay or fund employee benefits, are not available to the reporting entity's own creditors (even in bankruptcy), and cannot be returned to the reporting entity, unless either:
   1. the remaining assets of the fund are sufficient to meet all the related employee benefit obligations of the plan or the reporting entity; or
   2. the assets are returned to the reporting entity to reimburse it for employee benefits already paid.'

Whilst non-transferable financial instruments issued by the employer are excluded from the definition of plan assets, plans can, and do, own transferrable instruments issued by the employer (such as listed shares and bonds) and these would qualify as plan assets.

‘A qualifying insurance policy is an insurance policy issued by an insurer that is not a related party (as defined in IAS 24 – Related Party Disclosures – see Chapter 39) of the reporting entity, if the proceeds of the policy:

1. can be used only to pay or fund employee benefits under a defined benefit plan; and
2. are not available to the reporting entity's own creditors (even in bankruptcy) and cannot be paid to the reporting entity, unless either:
   1. the proceeds represent surplus assets that are not needed for the policy to meet all the related employee benefit obligations; or
   2. the proceeds are returned to the reporting entity to reimburse it for employee benefits already paid.' [IAS 19.8].

A footnote to this definition clarifies that a qualifying insurance policy is not necessarily an insurance contract as defined in IFRS 4/IFRS 17 – Insurance Contracts – see Chapters 55 and 56.

IFRS 4 further mentions insurance contracts in the context of pensions. It discusses insurance policies issued by an insurer to a pension plan covering employees of the insurer or another entity consolidated in the same financial statements as the insurer. In such circumstances, IFRS 4 provides that the contract will generally be eliminated from the financial statements. The financial statements will:

• include the full amount of the pension obligation under IAS 19, with no deduction for the plan's rights under the contract;
• not include a liability to policyholders under the contract; and
• include the assets backing the contract. [IFRS 4.IG2. E1.21].

The above has not been carried over into IFRS 17, although we would expect the same practice to continue under this standard.

6.2 Measurement of plan assets

IAS 19 requires plan assets to be measured at their fair value, [IAS 19.113], which is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. [IAS 19.8]. This is the same definition as is used in IFRS 13 – Fair Value Measurement (see Chapter 14).

The fair value of any plan assets is deducted from the present value of the defined benefit obligation in determining the deficit or surplus – see 8 below. [IAS 19.113].

6.3 Qualifying insurance policies

Where plan assets include qualifying insurance policies that exactly match the amount and timing of some or all of the benefits payable under the plan, the fair value of those insurance policies is deemed to be the present value of the related obligations, subject to any reductions required if the amounts receivable under the insurance policies are not recoverable in full. [IAS 19.115].

6.4 Reimbursement rights

Some employers may have in place arrangements to fund defined benefit obligations which do not meet the definition of qualifying insurance policies above but which do provide for another party to reimburse some or all of the expenditure required to settle a defined benefit obligation. In such a case, the expected receipts under the arrangement are not classified as plan assets under IAS 19 (and hence they are not presented as part of a net pension asset/liability – see 8 below). Instead, the employer should recognise its right to reimbursement as a separate asset, but only when it is virtually certain that another party will reimburse some or all of the expenditure required to settle a defined benefit obligation. The asset should be measured at fair value and, in all other respects, it should be treated in the same way as a plan asset. In particular, changes in fair value are disaggregated and accounted for in the same way as plan assets – see 10.3 below. In profit or loss, the expense relating to a defined benefit plan may be presented net of the amount recognised for a reimbursement. [IAS 19.116‑118].

As is the case for qualifying insurance policies, for reimbursement rights that exactly match the amount and timing of some or all of the benefits payable fair value is determined as the present value of the related obligation, subject to any reduction required if the reimbursement is not recoverable in full. [IAS 19.119].

6.5 Contributions to defined benefit funds

Contributions to defined benefit plans under IAS 19 are a movement between line items in the statement of financial position – the reduction in cash for the employer being reflected by an increase in the plan assets. Perhaps because of this straightforward accounting, the standard provides no guidance on contributions, which it implicitly deals with as always being in the form of cash.

Although contributions are very commonly in cash, there is no reason why an employer could not contribute any other assets to a defined benefit plan and that raises the question of how to account for the disposal – particularly so, since from the point of transfer the assets will be measured at fair value under IAS 19. In our view, such a transfer of a non-cash asset should be treated as a disposal, with proceeds equal to the fair value of the asset. That would give rise to gains and losses in profit or loss (unless the asset in question was already carried at fair value) and, for certain assets (such as debt instruments held at fair value through other comprehensive income), the reclassification into profit or loss of amounts previously recognised in other comprehensive income.

6.6 Longevity swaps

A longevity swap transfers, from a pension scheme to an external party, the risk of members living longer (or shorter) than expected.

The Interpretations Committee was asked in August 2014 to clarify the measurement of longevity swaps held by an entity's defined benefit plan, and in particular discussed whether an entity should:

1. account for a longevity swap as a single instrument and measure its fair value as part of plan assets (discussed at 6.2 above) with changes in fair value being recorded in other comprehensive income; or
2. split longevity swaps into two components.

The two components in (b) would be a ‘fixed leg’ and a ‘variable leg’. As the variable leg exactly matches some or all of the defined benefit obligation it would represent a qualifying insurance policy and be measured at the present value of the related obligation (discussed at 6.3 above). The fixed leg comprises a series of fixed payments to be made in return for the receipt of the variable leg receipts. In other words, a longevity swap could be considered to be economically equivalent to the purchase of qualifying insurance (commonly called a ‘buy-in’) but with the premium paid over a period of time rather than at inception.

The likely effect of disaggregating a longevity swap in this way would be to recognise a loss at inception very similar to that for a buy-in. Conversely, considering the swap as a single instrument measured at fair value would likely have no initial effect as typically its fair value would be zero (that is, a premium neither received nor paid).

If the two legs were to be considered separately, an appropriate accounting policy would need to be applied to the fixed leg. Two possibilities were discussed by the Interpretations Committee as follows. The fixed leg would initially be measured at fair value with subsequent accounting either:

• if treated as part of plan assets, at fair value with interest reported in profit or loss and other changes being included in other comprehensive income (discussed at 6.2 above); or
• if treated as a financial liability at amortised cost using the effective interest rate method with interest recognised in profit and loss and no other remeasurements.

The Interpretations Committee noted that when such transactions take place, the predominant practice is to account for a longevity swap as a single instrument and measure it at fair value as part of plan assets.

The Interpretations Committee decided not to add this issue to its agenda as it did not expect diversity to develop in the application of IAS 19.⁹ Given that the Interpretations Committee decided not to add this to its agenda we believe that either of the subsequent accounting options detailed above would be acceptable.

7.1 Legal and constructive obligations

IAS 19 refers to the liabilities of defined benefit plans as the present value of defined benefit obligations, which it defines as ‘… the present value, without deducting any plan assets, of expected future payments required to settle the obligation resulting from employee service in the current and prior periods’. [IAS 19.8].

The obligations should include not only the benefits set out in the plan, but also any constructive obligations that arise from the employer's informal practices which go beyond the formal plan terms, and should where relevant include an estimate of expected future salary increases (taking into account inflation, seniority, promotion and other relevant factors, such as supply and demand in the employment market). [IAS 19.61, 87‑90].

A constructive obligation exists where a change in the employer's informal practices would cause unacceptable damage to its relationship with employees and which therefore leaves the employer with no realistic alternative but to pay those employee benefits. [IAS 19.61]. The term constructive obligation is not defined by IAS 19; however, as can be seen from the above it is very similar to the meaning of the term as used in IAS 37 where it is defined as follows:

‘A constructive obligation is an obligation that derives from an entity's actions where:

1. by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and
2. as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.' [IAS 37.10].

However, IAS 19 goes on to add a further nuance. The standard observes that it is usually difficult to cancel a retirement benefit plan (without payment) whilst still retaining staff, and in light of this it requires that reporting entities assume (in the absence of evidence to the contrary) any currently promised benefits will continue for the remaining working lives of employees. [IAS 19.62]. In our view, this is a somewhat lower hurdle, and could bring into the scope of defined benefit accounting promises which are (strictly) legally unenforceable and which would not necessarily be considered constructive obligations under IAS 37.

An employer's obligations (legal or constructive) may also extend to making changes to benefits in the future. The standard requires all such effects to be built into the computation of the obligation and gives the following examples of what they might comprise:

1. the entity has a history of increasing benefits, for example, to mitigate the effects of inflation, and no indication that this practice will change in the future;
2. the entity is obliged, either by the formal terms of the plan (or a further constructive obligation) or by legislation to use any surplus in the plan for the benefit of plan participants; or
3. benefits vary in response to a performance target or other criteria. For example, the terms of the plan may state that it will pay reduced benefits or require additional contributions from employees if the plan assets are insufficient. The measurement of the obligation reflects the best estimate of the effect of target or other criteria. [IAS 19.88].

By contrast, any other future changes in the obligation (i.e. where no legal or constructive obligation previously existed) will be reflected in future current service costs, future past service costs or both (discussed at 10.1 below). [IAS 19.89].

IAS 19 also deals with the situation where the level of defined benefits payable by a scheme varies with the level of state benefits. When this is the case a best estimate of any changes in state benefit should be factored into the actuarial computations only if they are enacted by the end of the reporting period or are predictable based on past history or other evidence. [IAS 19.87, 95].

Some defined benefit plans limit the contributions that an entity is required to pay. The ultimate cost of the benefits takes account of the effect of a limit on contributions. The effect of a limit on contributions is determined over the shorter of the estimated life of the entity and the estimated life of the plan. [IAS 19.91].

7.2 Contributions by employees and third parties

The standard notes that some defined benefit plans require employees or third parties to contribute to the cost of the plan. Contributions by employees reduce the cost of the benefits to the entity. The standard requires an entity to ‘consider’ whether third-party contributions reduce the cost of the benefits to the entity, or are a reimbursement right (discussed at 6.4 above). Contributions by employees or third parties are either set out in the formal terms of the plan (or arise from a constructive obligation that goes beyond those terms), or are discretionary. IAS 19 requires discretionary contributions by employees or third parties to be accounted for as a reduction in service cost when they are paid to the plan. [IAS 19.92].

The standard draws a distinction between non-discretionary contributions from employees or third parties set out in the formal terms of the plan which are ‘linked to service’ and those which are not. Such contributions not dependent upon years of service reduce remeasurements of the net defined benefit liability (asset). An example given by the standard is if the contributions are required to reduce a deficit arising from losses on plan assets or actuarial losses. [IAS 19.93].

For contributions which are linked to service, the standard states that they reduce the service cost as follows:

• if the amount of the contributions is dependent on the number of years of service (e.g. contributions that increase with years of service), they should be attributed to periods of service using the same attribution method required for the gross benefit (i.e. either using the plan's contribution formula or on a straight-line basis – see 7.3 below); or
• if the amount of the contributions is independent of the number of years of service (e.g. contributions that are a fixed percentage of salary), they are permitted to be recognised as a reduction of the service cost in the period in which the related service is rendered. Examples of contributions that are independent of the number of years of service include those that are a fixed percentage of the employee's salary, a fixed amount throughout the service period or dependent on the employee's age. [IAS 19.93].

Application guidance is given in Appendix A to the standard in the form of the following flow chart.

(1) This dotted arrow means that an entity is permitted to choose either accounting

Regrettably, the standard does not explain the ‘mechanics’ of an attribution which is required where contributions are linked to service.

In particular, it is unclear how to treat employee contributions made over the service period. As shown in Example 35.2 at 7.3 below, the projected unit credit method requires the net benefit to be expressed as a single net sum as at the date of retirement. Example 35.2 illustrates post-employment benefit payments being discounted to their present value as at the retirement date using the IAS 19 discount rate (discussed at 7.6 below). On the same principle, therefore, employee contributions made over the period of employment would logically need to be inflated to be expressed in the ‘time value’ as at retirement. However, IAS 19 does not indicate what rate should be used for this purpose.

We note, in this regard, that when the Interpretations Committee discussed the matter in November 2012, it considered a Staff Paper which touched on the matter. The numerical examples appended to the paper expressed the ‘future value’ of in-service employee contributions as at the date of retirement using the IAS 19 discount rate.¹⁰ The content of the third example in this Staff Paper is reflected in the example set out below. This example pre-dates the amendments to IAS 19 in respect of employee contributions and therefore, we assume, that under the current standard that the entity has made an accounting policy choice to attribute contributions to periods of service, even though contributions are independent of the number of years of service.

The standard notes that changes in employee or third-party contributions dependent on number of years of service result in:

• 1. current and past service cost if the changes are not set out in the formal terms of the plan and do not arise from a constructive obligation; or
  2. actuarial gains and losses if the changes in contributions are set out in the formal terms of the plan or arise from a constructive obligation. [IAS 19.94].

7.3 Actuarial methodology

IAS 19 notes that the ultimate cost of a defined benefit plan may be influenced by many variables, such as final salaries, employee turnover and mortality, employee contributions and medical cost trends. The ultimate cost of the plan is uncertain and this uncertainty is likely to persist over a long period of time. In order to measure the present value of the post-employment benefit obligations and the related current service cost, it is necessary:

• to apply an actuarial valuation method;
• to attribute benefit to periods of service; and
• to make actuarial assumptions. [IAS 19.66].

These steps are discussed in the following sections.

Plan obligations are to be measured using the projected unit credit method, [IAS 19.67], (sometimes known as the accrued benefit method pro-rated on service or as the benefit/years of service method). This method sees each period of service as giving rise to an additional unit of benefit entitlement and measures each unit separately to build up the final obligation. [IAS 19.68]. This actuarial method also determines the current service cost and any past service cost. [IAS 19.67]. IAS 19 provides a simple example of what this entails as follows: [IAS 19.68]

As can be seen in this simple example, the projected unit credit method produces a figure for current service cost and interest cost (and, although not illustrated here, would where appropriate produce a figure for past service cost). These cost components are discussed at 10 below.

This example from the standard contains no underlying workings or proofs. The most useful would be as follows:

7.4 Attributing benefit to years of service

The projected unit credit method requires benefits to be attributed to the current period (in order to determine current service cost) and the current and prior periods (in order to determine the present value of defined benefit obligations). IAS 19 requires benefits to be attributed to the periods in which the obligation to provide post-employment benefits arises. That is taken to be when employees render services in return for post-employment benefits which an entity expects to pay in future reporting periods. The standard takes the view that actuarial techniques allow an entity to measure that obligation with sufficient reliability to justify recognition of a liability. [IAS 19.71].

In applying the projected unit credit method, IAS 19 normally requires benefits to be attributed to periods of service under the plan's benefit formula (as is the case in Example 35.2 above). If, however, an employee's service in later years will lead to a materially higher level of benefit, the benefit should be attributed on a straight-line basis from:

1. the date when service by the employee first leads to benefits under the plan; until
2. the date when further service by the employee will lead to no material amount of further benefits under the plan, other than from further salary increases. [IAS 19.70].

The standard considers that this requirement is necessary because the employee's service throughout the entire period will ultimately lead to benefit at that higher level. [IAS 19.73].

The standard explains that employee service gives rise to an obligation under a defined benefit plan even if the benefits are conditional on future employment (in other words they are not vested). [IAS 19.70]. Employee service before the vesting date is considered to give rise to a constructive obligation because, at each successive period end, the amount of future service that an employee will have to render before becoming entitled to the benefit is reduced. In measuring its defined benefit obligation, an entity should consider the probability that some employees may not satisfy any vesting requirements. Similarly, although certain post-employment benefits, such as post-employment medical benefits, become payable only if a specified event occurs when an employee is no longer employed, an obligation is considered to be created when the employee renders service that will provide entitlement to the benefit if the specified event occurs. The probability that the specified event will occur affects the measurement of the obligation, but does not determine whether for accounting purposes the obligation exists. [IAS 19.72].

The obligation is considered to increase until the date when further service by the employee will lead to no material amount of further benefits, and accordingly all benefit should be attributed to periods ending on or before that date. [IAS 19.73].

IAS 19 illustrates the attribution of benefits to service periods with a number of worked examples as follows: [IAS 19.71‑74]

The following points of note are brought out in the above:

• the scenarios in 3 and 5 are economically identical, and are attributed to years of service accordingly. In each case benefits only vest after ten years, however an obligation is to be built up over that period rather than at the end; and
• example 8 illustrates that accruing a 10% benefit over a period of 20 years of service which jumps to 50% once 20 years have been completed is an example of service in later years leading to a materially higher level of benefit. Accordingly, the obligation is to be built-up on a straight-line basis over 20 years.

As regards example 9, the standard explains that where the amount of a benefit is a constant proportion of final salary for each year of service, future salary increases will affect the amount required to settle the obligation that exists for service before the end of the reporting period, but do not create an additional obligation. Therefore:

1. for the purpose of allocating benefits to years of service, salary increases are not considered to lead to further benefits, even though the amount of the benefits is dependent on final salary; and
2. the amount of benefit attributed to each period should be a constant proportion of the salary to which the benefit is linked. [IAS 19.74].

7.5 Actuarial assumptions

The long timescales and numerous uncertainties involved in estimating obligations for post-employment benefits require many assumptions to be made when applying the projected unit credit method. These are termed actuarial assumptions and comprise:

1. demographic assumptions about the future characteristics of current and former employees (and their dependants) who are eligible for benefits and deal with matters such as:
   1. mortality, both during and after employment;
   2. rates of employee turnover, disability and early retirement;
   3. the proportion of plan members with dependants who will be eligible for benefits;
   4. the proportion of plan members who will select each form of payment option under the plan terms, (for example, a plan may offer participants a choice between a lump-sum cash payment, annuities and instalments over a defined period and these alternatives may have a significantly different impact on the measurement of the defined benefit obligation; and
   5. claim rates under medical plans; and
2. financial assumptions, dealing with items such as:
   1. the discount rate;
   2. future salary and benefit levels, excluding the cost of benefits that will be met by the employees;
   3. in the case of medical benefits, future medical costs, including claim handling costs, which the standard describes as costs that will be incurred in processing and resolving claims, including legal and adjuster's fees; and
   4. taxes payable by the plan on contributions relating to service before the reporting date or on benefits resulting from that service. [IAS 19.76].

The requirements of IAS 19 in this regard are set out below, with the exception of the discount rate which is discussed at 7.6 below.

The standard requires that actuarial assumptions be unbiased (that is, neither imprudent nor excessively conservative), mutually compatible and represent the employer's best estimates of the variables that will determine the ultimate cost of providing post-employment benefits. [IAS 19.75‑77]. Actuarial assumptions are mutually compatible if they reflect the economic relationships between factors such as inflation, rates of salary increase and discount rates. For example, all assumptions which depend on a particular inflation level (such as assumptions about interest rates and salary and benefit increases) in any given future period should assume the same inflation level in that period. [IAS 19.78].

The financial assumptions must be based on market expectations at the end of the reporting period, for the period over which the obligations are to be settled. [IAS 19.80].

The standard requires that a defined benefit obligation be measured on a basis that reflects:

1. the benefits set out in the terms of the plan (or resulting from any constructive obligation that goes beyond those terms) at the end of the reporting period;
2. any estimated future salary increases that affect the benefits payable;
3. the effect of any limit on the employer's share of the cost of the future benefits; and
4. contributions from employees or third parties that reduce the ultimate cost to the entity of those benefits. [IAS 19.87].

Regarding mortality, the standard requires assumptions to be a best estimate of the mortality of plan members both during and after employment. [IAS 19.81]. In particular, expected changes in mortality should be considered, for example by modifying standard mortality tables with estimates of mortality improvements. [IAS 19.82].

Assumptions about medical costs should take account of inflation as well as specific changes in medical costs (including technological advances, changes in health care utilisation or delivery patterns, and changes in the health status of plan participants). [IAS 19.96‑97]. The standard provides a quite detailed discussion of the factors that should be taken into account in making actuarial assumptions about medical costs, in particular:

1. measuring post-employment medical benefits requires assumptions about the level and frequency of future claims, and the cost of meeting them. An employer should make such estimates based on its own experience, supplemented where necessary by historical data from other sources (such as other entities, insurance companies and medical providers); [IAS 19.97]
2. the level and frequency of claims is particularly sensitive to the age, health status and sex of the claimants, and may also be sensitive to their geographical location. This means that any historical data used for estimating future claims need to be adjusted to the extent that the demographic mix of the plan participants differs from that of the population used as the basis for the historical data. Historical data should also be adjusted if there is reliable evidence that historical trends will not continue; [IAS 19.98] and
3. estimates of future medical costs should take account of any contributions that claimants are required to make based on the terms (whether formal or constructive) of the plan at the end of the reporting period. The treatment of contributions by employees and third parties is discussed at 7.2 above.

Clearly, the application of actuarial techniques to compute plan obligations is a complex task, and it seems likely that few entities would seek to prepare valuations without the advice of qualified actuaries. However, IAS 19 only encourages, but does not require that an entity take actuarial advice. [IAS 19.59].

However sophisticated actuarial projections may be, reality will (apart from the most simple scenarios) always diverge from assumptions. This means that when a surplus or deficit is estimated, it will almost certainly be different from the predicted value based on the last valuation. These differences are termed actuarial gains and losses. The standard observes that actuarial gains and losses result from increases or decreases in the present value of a defined benefit obligation because of changes in actuarial assumptions and experience adjustments (see 10.4.1 below). Causes of actuarial gains and losses could include, for example:

1. unexpectedly high or low rates of employee turnover, early retirement or mortality or of increases in salaries, benefits (if the formal or constructive terms of a plan provide for inflationary benefit increases) or medical costs;
2. differences between the actual return on plan assets and amounts included as part of net interest in profit or loss;
3. the effect of changes to assumptions concerning benefit payment options;
4. the effect of changes in estimates of future employee turnover, early retirement or mortality or of increases in salaries, benefits (if the formal or constructive terms of a plan provide for inflationary benefit increases) or medical costs; and
5. the effect of changes in the discount rate. [IAS 19.128].

Actuarial gains and losses are discussed further at 10.4.1 below.

7.6 Discount rate

Due to the long timescales involved, post-employment benefit obligations are discounted. The whole obligation should be discounted, even if part of it is expected to be settled within twelve months of the end of the reporting period. [IAS 19.69]. The standard requires that the discount rate reflect the time value of money but not the actuarial or investment risk. Furthermore, the discount rate should not reflect the entity-specific credit risk borne by the entity's creditors, nor should it reflect the risk that future experience may differ from actuarial assumptions. [IAS 19.84]. The discount rate should reflect the estimated timing of benefit payments. For example, an appropriate rate may be quite different for a payment due in, say, ten years as opposed to one due in twenty. The standard observes that in practice, an acceptable answer can be obtained by applying a single weighted average discount rate that reflects the estimated timing and amount of benefit payments and the currency in which the benefits are to be paid. [IAS 19.85]. The standard does not preclude the use of a more granular approach in discounting cash flows at different periods along the yield curve. Nor does it preclude the use of different discount rates for different classes of participant in the interest of achieving a more precise measure of the defined benefit obligation than the computational shortcut which is allowed by the standard. An example of where discount rates may vary by class or participant is where there are both active and pensioner members, discount rates will vary by each of these classes purely as a result of their ages and the resultant timing of outflows associated to these classes. Whether it is acceptable to use the weighted average discount rate or a more granular approach is an entity's judgement which should be applied consistently. However, we would not expect an entity that elects to use the granular approach premised on it being a more precise measure to move back to the weighted average approach in subsequent periods.

The standard requires that actuarial assumptions, including discount rates be unbiased. [IAS 19.83]. A subpopulation of high quality corporate bonds (see 7.6.1 below) used to derive a discount rate would only result in an unbiased assumption if the selection from the population of bonds was not skewed. For example, the exclusion of bonds from a population outside two standard deviations of the mean (both at the higher end and the lower end) would not result in an unbiased selection of the discount rate. However, if the entity were to exclude say bonds the lowest 40% and the highest 10% yields, or bonds with a yield below the median, these methods would produce biased results.

IAS 19 also stipulates that the discount rate (and other financial assumptions) should be determined in nominal (stated) terms, unless estimates in real (inflation-adjusted) terms are more reliable, for example, in a hyper-inflationary economy (see Chapter 16 for a discussion of IAS 29 – Financial Reporting in Hyperinflationary Economies), or where the benefit is index-linked and there is a deep market in index-linked bonds of the same currency and term. [IAS 19.79].

The basic part of this requirement – that a nominal rate be used – is consistent with the definition of the present value of a defined benefit obligation in that it should be ‘ … the present value … of expected future payments required to settle the obligation …’ (see 7.1 above). In other words, as the future cash flows are stated at the actual amounts expected to be paid, the rate used to discount them should reflect that and not be adjusted to remove the effects of expected inflation. In contrast, the reference to the use of index-linked bonds seems to allow taking account of inflation through the discount rate (which would require expressing cash flows in current prices). This approach seems to be in conflict with the definition of the obligation. However, in practice few index-linked corporate bonds exist (so it may be quite rare to have a deep market in them) and a more reliable approach may often be to take account of inflation via the projected cash flows.

The Interpretations Committee in July 2013 discussed whether the rate should be pre- or post-tax. It observed that the discount rate used to calculate a defined benefit obligation should be a pre-tax discount rate and decided not to add this issue to its agenda.¹¹

7.7 Frequency of valuations

When it addresses the frequency of valuations, IAS 19 does not give particularly prescriptive guidance. Rather, its starting point is simply to require that the present value of defined benefit obligations, and the fair value of plan assets, should be determined frequently enough to ensure that the amounts recognised in the financial statements do not differ materially from the amounts that would be determined at the end of the reporting period. [IAS 19.58]. An argument could be launched that, without a full valuation as at the end of the reporting period to compare with, it cannot be possible to know whether any less precise approach is materially different. However, it is reasonably clear that the intention of the standard is not necessarily to require full actuarial updates as at the reporting date. This is because the standard goes on to observe that for practical reasons a detailed valuation may be carried out before the end of the reporting period and that if such amounts determined before the end of the reporting period are used, they should be updated to take account of any material transactions or changes in circumstances up to the end of the reporting period. [IAS 19.59]. Much may depend on what is considered to be a ‘material change’, however it is expressly to include changes in market prices (hence requiring asset values to be those at the end of the reporting period) and interest rates, as well as financial actuarial assumptions. [IAS 19.59, 80].

In this regard, it is also worth noting the observation in the standard that ‘[i]n some cases, estimates, averages and computational shortcuts may provide a reliable approximation of the detailed computations illustrated in this Standard’. [IAS 19.60]. It should be remembered, though, that it is the amounts in the financial statements which must not differ materially from what they would be based on a valuation at the end of the reporting period. For funded schemes, the net surplus or deficit is usually the difference between two very large figures – plan assets and plan liabilities. Such a net item is inevitably highly sensitive, in percentage terms, to a given percentage change in the gross amounts.

In summary, a detailed valuation will be required on an annual basis, but not necessarily as at the end of the reporting period. A valuation undertaken other than as at the end of the reporting period will need to be updated as at the end of the reporting period to reflect at least changes in observable market data, such as asset values and discount rates. The need for updates in respect of other elements of the valuation will depend on individual circumstances.

8.1 Net defined benefit liability (asset)

IAS 19 defines the net defined benefit liability or asset as the deficit or surplus in the plan adjusted for any effect of the asset ceiling (see 8.2 below).

The deficit or surplus is the present value of the defined benefit obligation (see 7 above) less the fair value of the plan assets (if any) (see 6 above).

The standard requires that the net defined benefit liability (asset) be recognised in the statement of financial position at each reporting period. [IAS 19.63].

8.2 Restriction of assets to their recoverable amounts

The net defined benefit balance determined under IAS 19 may be an asset. The standard asserts that an asset may arise (that is, an asset measured on the basis of IAS 19) where a defined benefit plan has been ‘over-funded’ or when actuarial gains have arisen. The standard justifies the recognition of an asset in such cases because:

1. the entity controls a resource, which is the ability to use the surplus to generate future benefits;
2. that control is a result of past events (contributions paid by the entity and service rendered by the employee); and
3. future economic benefits are available to the entity in the form of a reduction in future contributions or a cash refund, either directly to the entity or indirectly to another plan in deficit; the present value of those benefits is described as the asset ceiling. [IAS 19.8, 65].

In practice, pension plans tend to be funded on a significantly more prudent basis than would be the case if a surplus or deficit was measured in accordance with IAS 19. In particular, the discount rate used for funding purposes is typically lower than the rate required by the standard. For this reason, an IAS 19 valuation may produce a surplus, when for funding purposes there is a deficit.

When there is a surplus in a defined benefit plan, the standard requires the net asset recognised to be restricted to the lower of the surplus in the plan and the asset ceiling discounted using the same discount rate used for determining the defined benefit obligation (see 7.6 above). [IAS 19.8, 64, IFRIC 14.1].

Any adjustment required by the ceiling test is accounted for in other comprehensive income (see 10.4 below).

This limitation has proved quite problematic in practice and as a result was considered by the Interpretations Committee, initially in the context of statutory minimum funding requirements (‘MFR’). This resulted in the publication, in July 2007, of IFRIC 14 – IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction. Whilst dealing with the interaction of the asset ceiling with MFR, IFRIC 14 also deals more generally with the restriction of an asset on recoverability grounds. [IFRIC 14.1‑3, 6]. Subsequently, IFRIC 14 was amended to deal with pre-paid MFR – see 8.2.3 below. It should also be noted that the IASB has published an exposure draft of proposed amendments to IAS 19 and IFRIC 14 which addresses whether other parties' (for example pension trustees) power to enhance benefits for plan members or wind up a plan affects the availability of a refund (see 16.2.1 below). There is no current date for the finalisation of amendments to the interpretation and, at the date of writing, the current status of the project is described as follows: ‘The Board is performing further work to assess whether it can establish a more principles-based approach in IFRIC 14 for an entity to assess the availability of a refund of a surplus. The Board will further consider the amendments at a future meeting.’

The Interpretations Committee notes that MFR exist in many countries and normally stipulate a minimum amount or level of contribution that must be made to a plan over a given period. Therefore, a minimum funding requirement may limit an entity's ability to reduce future contributions. [IFRIC 14.2].

In addition, the limit on the measurement of a defined benefit asset may cause a minimum funding requirement to be onerous. Normally, a requirement to make contributions to a plan would not affect the measurement of the defined benefit asset or liability. This is because the contributions, once paid, will become plan assets and so the additional net liability is nil. However, a minimum funding requirement may give rise to a liability if the required contributions will not be available to the entity once they have been paid. [IFRIC 14.3].

The issues addressed by IFRIC 14 are: [IFRIC 14.6]

• when refunds or reductions in future contributions should be regarded as available in accordance with the definition of the asset ceiling (discussed at 8.2.1 and 8.2.2 below);
• how a minimum funding requirement might affect the availability of reductions in future contributions (discussed at 8.2.3 below); and
• when a minimum funding requirement might give rise to a liability (discussed at 8.2.4 below).

10.1 Service cost

Service cost comprises:

1. current service cost – the increase in the present value of the defined benefit obligation resulting from employee service in the current period;
2. past service cost –the change in the present value of the defined benefit obligation for employee service in prior periods, resulting from a plan amendment (the introduction or withdrawal of, or changes to, a defined benefit plan) or a curtailment (a significant reduction by the entity in the number of employees covered by a plan); and
3. any gain or loss on settlement –the difference, at the date of settlement, between the present value of the defined benefit obligation being settled and the settlement price, including any plan assets transferred and any payments made directly by the entity in connection with the settlement. [IAS 19.8, 109].

The current service cost should be determined using the projected unit credit method. [IAS 19.67]. The basic computation is illustrated in Example 35.2 at 7.3 above.

There is no need to distinguish between past service cost resulting from a plan amendment, past service cost resulting from a curtailment and a gain or loss on settlement if these transactions occur together. In some cases, a plan amendment occurs before a settlement, such as when an entity changes the benefits under the plan and settles the amended benefits later. In those cases an entity recognises past service cost before any gain or loss on settlement. [IAS 19.8, 100].

A settlement occurs together with a plan amendment and curtailment if a plan is terminated with the result that the obligation is settled and the plan ceases to exist. However, the termination of a plan is not a settlement if the plan is replaced by a new plan that offers benefits that are, in substance, the same. [IAS 19.101].

10.2 Changes in a defined benefit plan

Accounting for past service costs (plan amendments or curtailments) and settlements are discussed in sections 10.2.1 and 10.2.3 below, respectively. The acquisition of a qualifying insurance policy not directly connected with a settlement is discussed at 10.2.2 below. Each of these sections detail where any gain or loss arising is recorded which will either be in the profit and loss account or other comprehensive income.

In summary, when determining the effect of such a transaction, the net defined benefit liability (asset) should be remeasured using up to date values for plan assets and actuarial assumptions before and after the event to determine the effect of it. [IAS 19.99].

Any past service cost, or gain or loss on settlement should be recognised and measured without considering the effect of the asset ceiling (see 8.2 above). The effect of the asset ceiling should then be determined after the plan amendment, curtailment or settlement with any change in that effect, excluding amounts included in net interest, recognised in other comprehensive income. [IAS 19.101A].

Current service cost should ordinarily be determined using actuarial assumptions as at the start of the reporting period. However, as discussed at 10.2.1 below, a plan amendment, curtailment or settlement during a reporting period will require remeasurement of the net defined benefit liability (asset). In such cases the current service cost for the remainder of the period, that is, after the plan amendment, curtailment or settlement, should be calculated using the actuarial assumptions used to for the remeasurement. [IAS 19.122A].

The point in time at which a plan amendment occurs will often be a matter of fact based on the legal entitlements of plan members. Judgement may be required, based on individual facts and circumstances, if the benefits concerned constitute constructive, as opposed to legal, obligations (see 7.1 above).

Sometimes benefit plans are amended in such a way as to allow members a choice, for a limited period, between two or more benefit arrangements. In such cases a plan amendment occurs (and a positive or negative past service cost will be recognised) on the date at which the new arrangement comes into existence (legally or constructively) and not at the later date by which members are required to make their choice. This may mean that the initial accounting for the plan amendment will require estimates to be made of the choices which members will make. However, if it is known, at the time the relevant financial statements are prepared, what choices members have made (for example, because the ‘window’ for making selections closes before the financial statements are authorised for issue) this definitive data would remove the need for estimation. Any subsequent changes in estimates in the following years resulting from the confirmation process would be a change in estimate and recognised as a remeasurement gain or loss.

10.3 Net interest on the net defined benefit liability (asset)

Net interest on the net defined benefit liability (asset) is the change during the period in the net defined benefit liability (asset) that arises from the passage of time. [IAS 19.8]. It is determined by multiplying the net defined benefit liability (asset) by the discount rate (see 7.6 above which also discusses the use of a more granular approach to determining the discount rate) taking into account any changes in the net defined benefit liability (asset) during the period resulting from contributions or benefit payments. [IAS 19.123, 123A].

Unless there are certain plan changes in the period, the discount rate used for the whole period is that determined at the start of the reporting period. However, if the net defined benefit liability (asset) is remeasured to determine a past service cost, or a gain or loss on settlement the net interest for the remainder of the reporting period is determined using: [IAS 19.123A]

1. the net defined benefit liability (asset) reflecting the benefits offered after the plan amendment, curtailment or settlement; and
2. the discount rate used to remeasure the net defined benefit liability (asset).

Accounting for defined benefit schemes in interim financial statements is discussed in Chapter 41 at 9.3.3.

As the net item in the statement of financial position is comprised of up to three separate components (the defined benefit obligation, plan assets and the asset ceiling), the net interest is made up of interest unwinding on each of these components in the manner described above. [IAS 19.124]. Although, computationally, the net interest is so composed, for the purposes of presentation in profit or loss it is a single net amount.

Interest on plan assets calculated as described above will not, other than by coincidence, be the same as the actual return on plan assets. The difference is a remeasurement recognised in other comprehensive income (see 10.4.2 below). If the net plan liability (asset) is remeasured as a result of a plan amendment, curtailment or settlement the entity shall determine interest income for the remainder of the annual reporting period after the plan amendment, curtailment or settlement using the plan assets used to remeasure the net defined benefit liability (asset). In performing this calculation the entity shall also take into account any changes in the plan assets held during the period resulting from contributions or benefit payments. [IAS 19.125].

Similarly, the difference in the asset ceiling between the start and end of the period is unlikely to equal the interest on this component described above. An entity shall determine the effect of the asset ceiling at the start of the annual reporting period. However, if an entity remeasures the net defined benefit liability (asset) as a result of a plan amendment, curtailment or settlement, the entity shall determine interest on the effect of the asset ceiling for the remainder of the annual reporting period after the plan amendment, curtailment or settlement taking into account any change in the effect of the asset ceiling as discussed in 10.2 above. The difference between the total change in the effect of the asset ceiling and the interest effect is accounted for as a remeasurement in other comprehensive income. [IAS 19.126].

10.4 Remeasurements

Remeasurements of the net defined benefit liability (asset) comprise:

1. actuarial gains and losses;
2. the return on plan assets, excluding amounts included in net interest on the net defined benefit liability (asset); and
3. any change in the effect of the asset ceiling (see 8.2 above), excluding amounts included in net interest on the net defined benefit liability (asset). [IAS 19.8, 127].

12.1 General recognition criteria for short-term employee benefits

An entity should recognise the undiscounted amount of short-term benefits attributable to services that have been rendered in the period as an expense, unless another IFRS requires or permits the benefits to be included in the cost of an asset. This may particularly be the case under IAS 2 (see Chapter 22 at 3.1) and IAS 16 (see Chapter 18 at 4). Any difference between the amount of cost recognised and cash payments made should be treated as a liability or prepayment as appropriate. [IAS 19.11]. There are further requirements in respect of short-term paid absences and profit-sharing and bonus plans as detailed below. Cost is not defined in IAS 19 and therefore the accounting for such benefits may vary depending on any other standards involved in the recognition of the transaction.

12.2 Short-term paid absences

These include absences for vacation (holiday), sickness and short-term disability, maternity or paternity leave, jury service and military service. These can either be accumulating or non-accumulating absences. [IAS 19.14]. Accumulating absences are those that can be carried forward and used in future periods if the entitlement in the current period is not used in full. They can be either vesting entitlements (which entitle employees to a cash payment in lieu of absences not taken on leaving the entity) or non-vesting entitlements (where no cash compensation is payable). Non-accumulating absences are those where there is no entitlement to carry forward unused days. An obligation arises as employees render service that increases their entitlement to future paid absences. [IAS 19.15].

12.3 Profit-sharing and bonus plans

An entity should recognise the expected cost of profit-sharing and bonus payments when and only when:

• the entity has a present legal or constructive obligation to make such payments as a result of past events; and
• a reliable estimate of the obligation can be made. [IAS 19.19].

The above are discussed in turn at 12.3.1 and 12.3.2 below. Statutory profit-sharing arrangements based on taxable profit are discussed at 12.3.3.

13.1 Meaning of other long-term employee benefits

These are all employee benefits other than post-employment benefits and termination benefits. [IAS 19.8]. They include the following if not expected to be settled wholly before twelve months after the end of the annual reporting period in which the employees rendered the related service:

• long-term paid absences such as long-service or sabbatical leave;
• jubilee or other long-service benefits;
• long-term disability benefits;
• profit-sharing and bonuses; and
• deferred remuneration. [IAS 19.153].

13.2 Recognition and measurement

For such benefits IAS 19 requires a simplified version of the accounting treatment required in respect of defined benefit plans (which is discussed in detail at 5 above). The amount recognised as a liability for other long-term employee benefits should be the net total, at the end of the reporting period, of the present value of the defined benefit obligation and the fair value of plan assets (if any) out of which the obligations are to be settled directly. The net total of the following amounts should be recognised in profit or loss, except to the extent that another IFRS requires or permits their inclusion in the cost of an asset:

1. service cost;
2. net interest on the net defined benefit liability (asset); and
3. remeasurements of the net defined benefit liability (asset).

In other words, all assets, liabilities, income and expenditure relating to such benefits should be accounted for in the same way, and subject to the same restrictions on the recognition of assets and income, as those relating to a defined benefit pension plan (see 8.1 and 8.2 above), except that remeasurements are recognised in profit or loss. [IAS 19.155‑156].

The standard explains the use of this simplified approach by asserting that the measurement of other long-term employee benefits is not usually subject to the same degree of uncertainty as that of post-employment benefits. [IAS 19.154].

An illustration of the methodology to calculate the defined benefit obligation, service and interest costs is given in Example 35.2 at 7.3 above.

14.1 Statutory termination indemnities

Some employee benefits are provided regardless of the reason for the employee's departure. The payment of such benefits is certain (subject to any vesting or minimum service requirements) but the timing of their payment is uncertain. Although such benefits are described in some jurisdictions as termination indemnities or termination gratuities, they are post-employment benefits rather than termination benefits, and an entity accounts for them as post-employment benefits. [IAS 19.164].

14.2 Recognition

An entity should recognise termination benefits as a liability and an expense at the earlier of the following dates:

• when it can no longer withdraw the offer of those benefits; and
• when it recognises costs for a restructuring that is within the scope of IAS 37 and involves the payment of termination benefits (discussed in Chapter 26 at 6.1). [IAS 19.165].

For termination benefits payable as a result of an employee's decision to accept an offer of benefits in exchange for the termination of employment, the time when an entity can no longer withdraw the offer of termination benefits is the earlier of:

• when the employee accepts the offer; and
• when a restriction (e.g. a legal, regulatory or contractual requirement or other restriction) on the entity's ability to withdraw the offer takes effect. This would be when the offer is made, if the restriction existed at the time of the offer. [IAS 19.166].

For termination benefits payable as a result of an entity's decision to terminate an employee's employment, the entity can no longer withdraw the offer when the entity has communicated to the affected employees a plan of termination meeting all of the following criteria:

• actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made;
• the plan identifies the number of employees whose employment is to be terminated, their job classifications or functions and their locations (but the plan need not identify each individual employee) and the expected completion date; and
• the plan establishes the termination benefits that employees will receive in sufficient detail that employees can determine the type and amount of benefits they will receive were their employment to be terminated. [IAS 19.167].

The standard notes that when an entity recognises termination benefits, it may also have to account for a plan amendment or a curtailment of other employee benefits (discussed at 10.2 above). [IAS 19.168].

14.3 Measurement

IAS 19 requires that on initial recognition and subsequent remeasurement, termination benefits should be measured in accordance with the nature of the employee benefit. If the termination benefits are an enhancement to post-employment benefits, the entity applies the requirements for post-employment benefits. Otherwise:

• if the termination benefits are expected to be settled wholly before twelve months after the end of the annual reporting period in which the termination benefit is recognised, the requirements for short-term employee benefits should be applied (discussed at 12 above); and
• if the termination benefits are not expected to be settled wholly before twelve months after the end of the annual reporting period, the requirements for other long-term employee benefits should be applied (discussed at 13 above). [IAS 19.169].

Because termination benefits are not provided in exchange for service, the standard notes that its rules relating to the attribution of the benefit to periods of service are not relevant (discussed at 7.4 above). [IAS 19.170].

IAS 19 illustrates the accounting for termination benefits with an example.

15.1 Defined contribution plans

IAS 19 requires the disclosure of the expense recognised for defined contribution plans. It also notes that IAS 24 requires disclosure of the contributions in respect of key management personnel. [IAS 19.53, 54].

15.2 Defined benefit plans

IAS 19 requires extensive disclosure in relation to defined benefit plans, as set out below.

The standard requires an entity to disclose information that:

1. explains the characteristics of its defined benefit plans and risks associated with them;
2. identifies and explains the amounts in its financial statements arising from its defined benefit plans; and
3. describes how its defined benefit plans may affect the amount, timing and uncertainty of the entity's future cash flows. [IAS 19.135].

To achieve the above, the standard sets out a long and detailed list of narrative and numerical disclosure requirements (considered further below).

The Board also noted that entities must comply with the general materiality requirements of IAS 1 (discussed in Chapter 3 at 4.1.5), including the requirement to disclose additional information if necessary, and that the financial statements need not contain disclosures that are not material. [IAS 19.BC209].

One of the Board's objectives in regard to disclosure was to ensure that financial statements provide relevant information that is not obscured by excessive detail. [IAS 19.BC207].

These references to excessive detail and non-disclosure of immaterial items confirm that entities should apply judgement to determine the appropriate level of detail to be provided rather than giving everything set out in the standard.

To meet the objectives above, the standard requires consideration of all the following:

1. the level of detail necessary to satisfy the disclosure requirements;
2. how much emphasis to place on each of the various requirements;
3. how much aggregation or disaggregation to undertake; and
4. whether users of financial statements need additional information to evaluate the quantitative information disclosed. [IAS 19.136].

If the disclosures provided in accordance with the requirements of IAS 19 and other IFRSs are insufficient to meet the objectives above, an entity should disclose additional information necessary to meet those objectives. For example, an entity may present an analysis of the present value of the defined benefit obligation that distinguishes the nature, characteristics and risks of the obligation. Such a disclosure could distinguish:

1. between amounts owing to active members, deferred members, and pensioners;
2. between vested benefits and accrued but not vested benefits; and
3. between conditional benefits, amounts attributable to future salary increases and other benefits. [IAS 19.137].

An assessment should be made as to whether all or some disclosures should be disaggregated to distinguish plans or groups of plans with materially different risks. For example, an entity may disaggregate disclosure about plans showing one or more of the following features:

1. different geographical locations;
2. different characteristics such as flat salary pension plans, final salary pension plans or post-employment medical plans;
3. different regulatory environments;
4. different reporting segments; and
5. different funding arrangements (e.g. wholly unfunded, wholly funded or partly funded). [IAS 19.138].

15.3 Other employee benefits

IAS 19 has no specific disclosure requirements in respect of other types of employee benefits within its scope (i.e. short-term employee benefits, long-term employee benefits other than post-employment benefits and termination benefits) but contains reminders that:

• IAS 24 requires disclosure of employee benefits for key management personnel (see Chapter 39); and
• IAS 1 requires disclosure of employee benefits expense. [IAS 19.25, 158, 171].

16.1 IASB activities

As noted at 1 above, the IASB published the current version of IAS 19 in June 2011 (with the latest amendments in February 2018). In February 2018, the IASB reviewed its research pipeline and decided to start research on pension benefits that depend on asset returns.¹⁷ Its objective is to assess whether it is feasible to place a cap on asset returns used in estimates of asset-dependent benefits to avoid what is perceived by some to be an anomaly (i.e. benefits being projected based on expected returns that exceed the discount rate, resulting in a liability even though employees will never be paid any amount above the fair value of the reference assets). If the research establishes that this approach would not be feasible the staff expect to recommend no further work on pensions. At the time of writing the Board was conducting outreach activities on this project to decide whether to develop proposals to make a narrow scope amendment to IAS 19. A review of the results is expected in the second half of 2019.

The Board has completed a research project into why different standards require different discount rates to be used with the project summary ‘Discount rates in IFRS Standards’ published in February 2019. The Board intends to use the research findings in existing projects. One of these existing projects is the Primary Financial Statements project which is considering the requirement to present net interest in a single location. IAS 19 currently defers to the requirements of IAS 1 for the presentation of the components of defined benefit cost which allows entities to present net interest on a net defined benefit liability in a variety of ways such as an operating expense or a finance cost (see 10 above). The Primary Financial Statements project proposes that ‘interest’ income or expenses on liabilities that do not arise from financing activities (unwinding of a discount), even though they do not meet the proposed definition of expenses from financing activities, are included in a financing section after the subtotal of profit before financing and income tax.¹⁸

In March 2018, the Board added the Targeted Standards-level Review of Disclosures project to its agenda. The project includes a review of some disclosures relating to present value measures and will cover IAS 19 disclosures. The Board is expecting to issue an exposure draft with amendments to the disclosure requirements in IAS 19, although at the time of writing no date has been set for the publication of this.

16.2 Interpretations Committee activities