Chapter 13 Accounting for employee benefits Objectives



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Chapter 13

Objectives

  • Understand the various forms of benefits that employees can receive from their employers
  • Be able to account for the various forms of employee benefits
  • Understand whether particular employee entitlement obligations should be recorded at their nominal value or at their discounted present value
  • Be able to provide the necessary disclosures in conformity with AASB 119 ‘Employee Entitlements’

Overview of employee benefits

  • Employment agreement with employer results in employees receiving various benefits (entitlements) in return for services
  • Accounting for employee benefits governed by AASB 119
  • ‘Employee’ not actually defined in standard, but refers to
    • a natural person appointed or engaged under a contract of service, whether on a full-time, part-time, permanent, casual or temporary basis
  • ‘Employee benefits’ according to AASB 119 (par. 7)
    • all forms of consideration given by an entity in exchange for service rendered by employees

Overview of employee benefits (cont.)

  • Examples of employee benefits
  • Employee benefits can relate to such items as
    • wages and salaries
    • annual leave
    • sick leave
    • long-service leave
    • superannuation
    • share entitlements
    • bonuses
    • other entitlements

Overview of employee benefits (cont.)

  • Other entitlements
  • AASB 119 divides employee benefits into categories
    • short-term employee benefits
    • post-employment benefits
    • termination benefits
    • other long-term employee benefits (e.g. superannuation)
  • Short-term employee benefits
    • wages, salaries, social security contributions
    • annual leave and sick leave to the extent that they are paid within 12 months of the period in which the employee renders the services
    • benefits measured on an undiscounted basis—present values not used
    • refer to AASB 119 (par. 10)

Overview of employee benefits (cont.)

  • Other entitlements (cont.)
  • Salaries and wages, social security contributions, and other employee benefits (e.g. termination payments, post-employment benefits and other long-term employment benefits) that do not fall due wholly within 12 months of the end of the period in which the employee renders service
    • related obligations to be discounted to present value
    • discount rate used to be determined by reference to market yields at the reporting date on high quality corporate bonds

Salaries and wages

  • For short-term employee benefits such as salaries and wages payable within 12 months of the end of the reporting period no requirement to discount any outstanding obligations to present value
  • For salaries and wages payable more than 12 months after the end of the reporting period any outstanding obligation should be discounted to its present value
  • Liabilities arise only where the services have already been rendered by the employee but the associated entitlements have not been paid as at the reporting date
  • Salaries and wages may be treated as an expense in the same period in which the obligation to make the payment is recorded

Salaries and wages (cont.)

  • May be carried forward as an asset in certain circumstances (e.g. when labour cost relates to inventories)
  • Initially recorded as work in progress, transferred to finished goods and then expensed as part of cost of goods sold
  • Cost of employee benefits can also be included in cost of property, plant and equipment (refer to AASB 116 ‘Property, Plant and Equipment’, par. 17)

Salaries and wages (cont.)

  • Salaries and wages expenses may include
    • wages and salaries
    • PAYG tax
    • medical benefits
  • Salaries and wages— Accounting entry at balance date
  • Dr Wages and salaries expense
  • Cr PAYG tax payable
  • Cr Medical benefits payable
  • Cr Wages and salaries payable

Salaries and wages (cont.)

  • Salaries and wages—Entry paid after balance date
  • Dr Salaries and wages expense (incurred since balance date)
  • Dr Salaries and wages payable (owing at balance date)
  • Cr PAYG tax payable
  • Cr Medical benefits payable (both incurred since balance date)
  • Cr Cash (payment to employees)

Salaries and wages (cont.)

  • Salaries and wages—Remittance to Tax Office and medical fund
  • Dr PAYG tax payable
  • Dr Medical benefits payable
  • Cr Cash
  • Refer to Worked Example 13.1 on page 454—Accounting for salaries and wages

Annual leave

  • Typical in Australia for employees to be granted four weeks’ annual leave entitlement each year
  • May also receive annual leave loading (17.5%)
  • To the extent that the obligation is payable within 12 months of the balance sheet date, there is no need to discount the obligation to its present value

Annual leave (cont.)

  • Accounting for annual leave (cont.)
  • To recognise annual leave obligation throughout the year
  • Dr Annual leave expense
  • Cr Provision for annual leave
  • When annual leave taken
  • Dr Provision for annual leave
  • Cr PAYG tax payable
  • Cr Cash at bank
  • Refer to Worked Example 13.2 on pp. 456—Accounting for annual leave

On costs

  • ‘On-costs’ also to be considered when calculating employer’s obligations for employee benefits
  • ‘On-costs’ include
    • payroll tax
    • workers’ compensation insurance
    • superannuation contributions

Sick leave

  • Necessary to divide sick leave into two types of entitlements

Vesting sick leave

  • Accounting for vesting sick-leave entitlements
    • ‘vesting’—employee has a right to receive the calculated amount in cash, even if the employee leaves the employer
    • accounted for in the same manner as annual leave

Non-vesting sick leave

  • Accounting for non-vesting sick-leave entitlements
    • only paid upon a valid claim for sick leave by the employee
    • only that part which has accumulated through past service and which is expected to be taken should be recognised as a liability and then only when it is capable of being reliably measured

Non-vesting sick leave (cont.)

  • Accounting for non-vesting sick-leave entitlements (cont.)
  • \

Non-vesting sick leave (cont.)

  • Accounting for non-vesting sick-leave entitlements (cont.)
    • if employees are sick, their entitlements are charged to sick leave instead of salaries and wages:
    • Dr Provision for sick leave (wages during sick leave)
    • Dr Salaries and wages (wages for rest of period)
    • Cr PAYG tax payable
    • Cr Cash at bank
  • Refer to Worked Example 13.3 on page 457—Accounting for non-vesting sick leave

Long service leave

  • Employees within Australia typically receive an entitlement to take an extended amount of leave after working for an employer for a specific number of years
  • Although no long-service leave may actually be paid in a given year, the employer must recognise an expense and an associated liability
  • Long-service liabilities must be accrued and the liability measured at its present value to the extent that the obligation is payable beyond 12 months after balance sheet date
  • Guidance to be found in AASB 119 ‘Australian Guidance’ (pars G4 to G8)

Long service leave (cont.)

  • Three common long-service leave entitlement categories (in terms of par. G4)
    • preconditional period
    • conditional period
    • unconditional period

Long service leave

  • Many judgments required in determining long-service leave liability
  • Consideration given to such factors as
      • - probability employee will stay until such time as they have a LSL entitlement
      • - salary being earned at the time of receiving the LSL entitlement (inflation, promotion prospects, etc.)

Long service leave (cont.)

    • Recall
    • - AASB 119 requires estimated future cash flows to be discounted to present value when measuring benefits to be paid beyond 12 months from the balance sheet date
    • Discount rate for entitlements
    • to be based on rates generated by high quality bonds
    • bond rates selected must generally match the expected timing of the long-service leave entitlements

Long service leave (cont.)

  • Calculating long-service leave liability
  • Need to calculate
    • projected salary
      • current salary × (1 + inflation rate)n
    • accumulated LSL benefit
      • years of employment / total no. of periods required to be served before leave can be taken × weeks of LSL entitlement available after conditional period has been served / 52 × projected salary

Long service leave (cont.)

  • Calculating long-service leave liability (cont.)
    • Present value of LSL obligation
      • accumulated LSL benefit/(1 + appropriate government bond rate)n
    • Probability that LSL will be paid
      • determined by reference to prior experience within the organisation and industry

Long service leave (cont.)

  • Accounting entries for long-service leave
  • Entry to recognise the LSL expense
  • Dr Long-service leave expense
  • Cr Provision for long-service leave
    • provision broken up into current and non-current portion
  • Entry when LSL is subsequently taken
  • Dr Provision for long-service leave
  • Cr Cash at bank
  • Refer to Worked Example 13.4 on pp. 459—Accounting for long-service leave

Superannuation

  • AASB 119 addresses how a reporting entity is to account for the superannuation entitlements of its employees, as well as other post-employment benefits such as post-employment life insurance and post-employment health care
  • AAS 25 ‘Financial Reporting by Superannuation Funds’ outlines how a superannuation plan itself should account for the plan’s assets, liabilities, revenues, and expenses (covered in Chapter 23)
  • Focus in this chapter on contributions of employers and not how superannuation funds account for their resources
  • Where an entity provides post-employment benefits (e.g. superannuation) considered to be ‘post-employment benefit plan’

Superannuation (cont.)

  • Post-employment benefit plans classified as either
  • defined contribution plans
  • defined benefit plans
  • Defined contribution plan
  • A superannuation benefit scheme under which amounts to be paid as retirement benefits are determined by contributions made to the fund together with investment earnings on those contributions
  • Defined benefit plan
  • A superannuation benefit scheme under which amounts to be paid as retirement benefits are paid from an aggregated fund by reference to a member’s annual salary or are paid as a specified amount regardless of contributions made by the employee

Superannuation (cont.)

  • Overview of defined contribution plans
  • Employer’s contribution to a plan is set at a specified amount
  • Employee’s final payout depends on factors such as earnings generated by contributions
  • Employer therefore does not specify final payment to employee
  • Refer to AASB 119 (par. 23)

Superannuation (cont.)

  • Overview of defined contribution plans (cont.)
  • Accounting relatively straightforward (refer to AASB 119, par. 44)
    • contribution recognised as an expense (unless part of cost of inventory or property, plant and equipment)
    • associated liability limited to amount of obligation unpaid by employer at end of year
    • obligations are measured on an undiscounted basis, except where they do not fall due wholly within 12 months after the end of the period in which the employees render the related service (under AASB 119, par. 43)
    • where contributions to a defined contribution plan do not fall wholly within 12 months after the end of the period in which the employees render the related service, they are to be discounted using the discount rate specified in paragraph 78 (under AASB 119, par. 45)
    • entity to disclose the amount recognised as an expense for defined contribution plans (under AASB 119, par. 46)
  • Refer to Worked Example 13.5 on page 462—Accounting for contributions to a defined contribution plan

Superannuation (cont.)

  • Accounting for employer’s obligation to a defined contribution superannuation plan
  • Dr Employee benefits cost—superannuation
  • Cr Employee benefits payable
  • When amount paid
  • Dr Employee benefits payable
  • Cr Cash at bank

Superannuation (cont.)

  • Overview of defined benefit plans
  • More complex accounting issues involved than with defined contribution plans
  • Defined benefit superannuation plan established by employer to (for example) provide employees with a pension of 40% of their final salary after reaching age of 60
  • Employers need to determine amount to contribute to fund so as to ensure obligation is met taking into account
    • projected final salary, earnings rates of the fund, costs associated with managing fund, probability employee will stay until retirement
  • Employer effectively bears the risks associated with the earnings of the fund vs a defined contribution plan where employer pays a set amount and employee receives whatever the plan has earned

Superannuation (cont.)

  • Overview of defined benefit plans (cont.)
  • Large proportion of AASB 119 dedicated to defined benefit plans
  • Need to know whether the fund (possibly externally managed) accepts the risks of unexpected changes in earnings or whether employer retains associated risks

Superannuation (cont.)

  • Overview of defined benefit plans (cont.)
  • Refer to AASB 119 (par. 49)
  • Defined benefits plans may be unfunded, or they may be wholly or partly funded by contributions by an entity, and sometimes its employees, to an entity or fund that is legally separate from the entity and from which the employee benefits are paid
  • The payment of funded benefits when they fall due depends not only on the financial position and the investment performance of the fund but also on an entity’s ability (and willingness) to make good any shortfall in the fund’s assets
  • Therefore, the entity is, in substance, underwriting the actuarial and investment risks associated with the plan
  • Consequently, the expense recognised for a defined benefit plan is not necessarily the amount of contributions for the period

Superannuation (cont.)

  • Steps in accounting for defined benefit plans
  • Estimate of benefits that an employee has earned
  • Assumes knowledge of formula used to determine benefits to be provided to the employer
  • Obligations of the entity require consideration of whether
    • - benefits have vested in employee (ultimate payment of the benefit earned in the current period is not conditional on satisfying any further service requirements)—probability of payment then 100%
    • benefits have not vested—use of probabilities of satisfying service required and will reduce the expense recognised by entity in current period
    • If obligations fall due beyond 12 months after balance sheet date they are required to be discounted to their present value

Superannuation (cont.)

  • Steps in accounting for defined benefit plans (cont.)
  • Determine the present value of the defined benefit obligation
  • If obligations fall due beyond 12 months after balance sheet date they are required to be discounted to their present value
  • Discount rate to be used (funded and non-funded) to be determined by reference to market yields at the reporting date on high quality corporate bonds (AASB 119, par. 78)
  • Par. 78 also provides that “in countries where there is no deep market in such bonds, the market yields (at reporting date) on government bonds shall be used. The currency and term of the corporate bonds or government bonds shall be consistent with the currency and estimated term of the post-employment benefit obligation”

Superannuation (cont.)

  • Steps in accounting for defined benefit plans (cont.)
  • Determine the fair value of the plan’s assets
  • Need to assess whether the employer has any outstanding obligation for superannuation at year end by comparing the closing obligation for superannuation entitlements (refer to (b)) with the fair value of the plan’s assets
  • If fair value of plan’s assets matches expected payout to employees then no further liabilities exist
  • If fair value exceeds the obligation then an asset would exist

Superannuation (cont.)

  • Steps in accounting for defined benefit plans (cont.)
  • (c) Determine the fair value of the plan’s assets (cont.)
  • Fair value of plan’s assets (AASB 119, par. 102)
  • Fair value of any plan assets is deducted in determining the amount recognised in the balance sheet
  • When no market price is available, the fair value of the plan is estimated, i.e. discounting expected future cash flows using a discount rate that reflects both the risk associated with the plan assets and maturity or expected disposal date of those assets
  • If the assets have not attained maturity, the expected period until the settlement of the related obligation

Superannuation (cont.)

  • Steps in accounting for defined benefit plans (cont.)
  • (d) Determine the amount of the actuarial gains and losses (cont.)
  • When determining accounting entries to be made in relation to the defined benefit liability of an entity, actuarial gains and losses must be recognised as part of the income or expense of the period
  • AASB 110 (par. 94)
  • Actuarial gains and losses may result from increases or decreases in either the present value of a defined benefit obligation or the fair value of any related plan assets

Superannuation (cont.)

  • Steps in accounting for defined benefit plans (cont.)
  • (d) Determine the amount of the actuarial gains and losses (cont.)
  • Causes of actuarial gains and losses include
    • unexpected 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
    • 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
    • the effect of changes in the discount rate; and
    • the differences between the actual return on plan assets and the expected return on plan assets (refer to pars 105–107)

Superannuation (cont.)

  • Steps in accounting for defined benefit plans (cont.)
  • (d) Determine the amount of the actuarial gains and losses (cont.)
  • AASB 119 (par. 105)
  • Expected return on the plan’s assets is one component of the expense recognised in the income statement
  • The difference between the expected rate of return on plan assets and the actual rate of return on plan assets is an actuarial gain or loss
  • Differences between the expected and actual returns on high quality corporate bonds will lead to actuarial gains and losses

Superannuation (cont.)

  • Steps in accounting for defined benefit plans (cont.)
  • Determination of the closing liability for each period
  • Need to assess the difference between the present value of the obligation to the employees and the fair value of the plan’s assets that are available to meet the obligation to the employees

Superannuation (cont.)

  • Steps in accounting for defined benefit plans (cont.)
  • To determine the total expenses to be recognised in relation to the defined benefit plan often involves consideration of
  • - current service costs
  • - interest costs
  • - expected return on assets
  • - net actuarial gain or loss
  • Disclosure requirements
  • - outlined in AASB 119 (par. 120)

Accrued employee benefits and corporate collapses

  • The mere act of making an accrual does not guarantee cash reserves available to make payment should the employer become insolvent
  • Under law employees have some preferential access to payment
    • Amount available is affected by
      • existence of secured creditors
      • amount of assets available
  • Calls for establishment of central funds to protect claims of employees

Summary

  • Purpose of the chapter to discuss accounting for employee benefits (entitlements), including application of the relevant accounting standard, AASB 119 ‘Employee Benefits’
  • Examples of benefits include
    • wages and salaries
    • annual leave
    • sick leave
    • long-service leave
    • superannuation
    • share entitlements
    • bonuses

Summary (cont.)

  • Wages and salaries payable within 12 months of balance sheet date are to be recorded at their nominal amount, and liabilities are to be recognised where salaries have been incurred but employees have not been fully paid at balance date
  • Annual leave liabilities payable within 12 months of balance sheet date are to be recognised at the nominal amount of the entitlement. At year end there will generally be a provision for vesting
  • Obligations for employee benefits, inclusive of salaries and wages, that are payable beyond 12 months after balance sheet date are to be recorded at their present value
  • The discount rate to be used to determine present values is determined by reference to market yields at the reporting date on high quality corporate bonds. The currency and term of the bonds are to be consistent with the currency and estimated term of the post-employment benefit obligations

Summary (cont.)

  • Sick leave is to be divided into vesting and non-vesting entitlements. For accounting purposes, vesting sick leave can be treated in the same manner as annual leave. With non-vesting sick leave entitlements, only the part of the entitlement that is accumulated through past service and that is expected to be taken should be recognised as a liability within the financial statements
  • Long-service leave (LSL) entitlements are to be accrued and the liability is to be measured at its present value. The determination of the obligation and the expense for LSL will require various assumptions, including assumptions about future pay levels, promotion prospects, inflation rates and the likelihood of LSL entitlements ultimately vesting. Failure to recognise LSL obligations can lead to a significant understatement of recorded liabilities
  • Post-employment benefit plans are classified as either defined contribution plans or defined benefit plans. The accounting treatments for defined benefit plans are a great deal more complex than the requirements relating to defined contribution plans


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