IAS 19

IAS 19 – Employee Benefits

What are employee benefits and why are they significant?

Employee benefits typically represent a significant portion of the costs borne by reporting entities and may take many diverse forms: from wages, social security contributions and life insurance, paid annual leave, paid sick leave and bonuses, through sabbatical leave and jubilee grants, severance pay, and finally pension payments and other post-employment benefits. Employee benefits are determined by agreements between the employee and the employer, collective agreements and customary practices, as well as by laws and regulations. Many entities also make deposits on behalf of their employees into provident funds, insurance policies, pension funds, and central severance pay funds.

Which IFRS Accounting Standards address employee benefits?

IFRS Accounting Standards devote significant attention to employee benefits in two separate IFRS Accounting Standards. Share-based employee benefits, whether through equity instruments or otherwise (usually cash-settled benefits based on the value of the entity’s equity instruments), are dealt with in IFRS 2 Share-based Payment. All other employee benefits are addressed in IAS 19.

The Standard therefore applies to all benefits granted to employees in exchange for their services, except for share-based benefits (dealt with in IFRS 2), and is not limited to pensions and other post-employment benefits. It prescribes the accounting treatment of employee benefits and the disclosures required in the financial statements of all reporting entities employing workers.

Why is accounting for employee benefits complex?

The provisions of the Standard cover both basic issues, where the accounting treatment is straightforward (such as allocating wages paid to different accounting periods), and the accounting for retirement benefits in financial statements, which generally poses one of the most complex challenges in accounting. The amounts involved are usually very large, the time horizons are typically long, and the estimation process is complex, involving significant uncertainty, assumptions, and judgments. Moreover, applying the accrual basis to allocate costs across different periods of employment is complex and often subject to debate. As a result, it is not surprising that the accounting requirements in this area are complex and frequently revised.

While earlier accounting principles on employee benefits focused on a results-based view — systematically allocating retirement benefit costs to profit or loss — the Standard reflects the modern balance sheet approach, focusing on the statement of financial position rather than on the statement of comprehensive income.

How does IAS 19 classify post-employment benefits?

The most complex accounting treatment under the Standard is for post-employment benefits. These are employee benefits (other than termination benefits) payable after employment ends, such as pensions, other retirement benefits, life insurance, and post-employment medical care. For the accounting treatment of post-employment benefits, the Standard distinguishes between defined contribution plans and defined benefit plans, as follows:

• Defined contribution plans are post-employment benefit plans under which the reporting entity pays fixed contributions to a separate entity (a fund) and has no legal or constructive obligation to pay further amounts if the fund does not hold sufficient assets to pay all benefits relating to current and past service.
• Defined benefit plans are all post-employment benefit plans other than defined contribution plans.

How do defined contribution and defined benefit plans differ in accounting treatment?

The accounting for defined contribution plans is simple, since the liability of the reporting entity in each period is determined by the contribution due for that period. No actuarial assumptions are required, and there is no possibility of actuarial gains or losses. If contributions are unpaid, liabilities are generally measured on an undiscounted basis.

By contrast, the accounting for defined benefit plans is complex: actuarial assumptions are required to measure both the obligation and the expense, and obligations are measured on a discounted basis because they are usually settled many years after the related service was rendered. Consequently, actuarial gains and losses arise from changes in the present value of the obligation due to updated assumptions (including the discount rate) and from differences between past assumptions and actual outcomes.

Defined benefit plans may be funded (wholly or partly, via contributions paid by the entity into a legally separate fund) or unfunded. For example, contributions to a central severance pay fund represent a funded plan, whereas a pay-as-you-go pension represents an unfunded plan. The guiding principle is that, whether funded or not, the reporting entity ultimately bears the risks.

What are the key principles governing defined benefit plans?

The Standard sets out three key principles for accounting for defined benefit plans:

1. Discount rate of the obligation
   The discount rate is one of the most critical parameters in measuring defined benefit obligations. The Standard requires that it does not reflect the reporting entity’s own credit risk and therefore is not based on fair value. Instead, it should be determined using market yields on high-quality corporate bonds (commonly interpreted as AA-rated). Where no deep market exists, government bond yields should be used.
2. Remeasurements
   Remeasurements of the net defined benefit liability generally include actuarial gains and losses and the return on plan assets excluding the interest component. Remeasurements are recognised in other comprehensive income in the period they arise, without subsequent reclassification to profit or loss.
3. Funded defined benefit plans
   The Standard specifies that plan assets are measured at fair value and offset against the obligation in the statement of financial position. Determining whether deposits (such as severance pay contributions to provident funds, insurance policies, or pension funds) qualify as plan assets is critical to the accounting treatment under IAS 19.

How are other employee benefits classified under IAS 19?

For other employee benefits (not post-employment), the Standard divides them into three further categories:

1. Short-term employee benefits
   These are benefits (other than termination benefits) expected to be settled in full within 12 months of the service period. Examples: wages, social contributions, paid annual leave, non-accumulating sick leave, and bonuses. The accounting is simple since no actuarial assumptions are required and the obligations are measured on an undiscounted basis.
2. Termination benefits
   These arise from ending employment before the normal retirement date, rather than from services rendered. The obligating event is the termination itself. Therefore, recognition as a liability and expense occurs only when the entity is demonstrably committed to termination.
3. Other long-term employee benefits
   This is a residual category—benefits not classified as short-term, post-employment, or termination benefits. Examples: long-service leave, sabbatical leave and jubilee awards. Measurement requires actuarial assumptions and using a discount rate but involves less uncertainty than post-employment benefits. Remeasurements (including actuarial gains and losses) are recognised in profit or loss.

Following is a table summarising the key differences between the various categories of employee benefits:

Notes to the Table:

1. Except for non-accumulating paid absences, for which the expected cost of benefits shall be recognised when the absences occur.
2. Except for long-term disability benefits whose amount is not dependent on the number of years of service, for which the expected cost shall be recognised when the event occurs.
3. The event that gives rise to the obligation is the termination itself (the trigger event), not the employee’s service.
4. Except when the contributions are not expected to be settled wholly within twelve months.
5. Except when the benefits are not expected to be settled wholly within twelve months or constitute an addition to post-employment benefits.
6. Except when another IFRS Accounting Standard requires or permits their inclusion in the cost of an asset.