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  1. 1. BA606 FINANCIAL ACCOUNTING Professor Garry Carnegie Lectures 15 & 16
  2. 2. Lectures 15 & 16: Accounting for employee benefits <ul><li>Introduction </li></ul><ul><li>Wages and salaries </li></ul><ul><li>Compensated absences </li></ul><ul><li>Profit sharing and bonus plans </li></ul><ul><li>Termination benefits </li></ul><ul><li>Post-employment benefits </li></ul>
  3. 3. Introduction <ul><li>There are many dimensions to renumerating employees </li></ul><ul><li>It is commonplace to speak of “salary packages” </li></ul><ul><li>A raft of salary packages exist </li></ul><ul><li>Some components of packages provide conditional and/or deferred benefits, such as superannuation (deferred) and long service leave (deferred and conditional) </li></ul>
  4. 4. Introduction <ul><li>Issues in accounting for deferred and conditional benefits relate to measuring and reporting the annual expense and the associated liability </li></ul><ul><li>AASB 119 “Employee Benefits” deals with accounting for employee benefits </li></ul><ul><li>This standard provides general recognition, measurement and disclosure requirements relating to employee benefits </li></ul>
  5. 5. Introduction <ul><li>AASB 119 defines “employee benefits” as “all forms of consideration given by an entity in exchange for service rendered by employees” (para. 7) </li></ul><ul><li>It requires an entity to recognise: </li></ul><ul><li>“ (a) a liability when an employee has provided service in exchange for employee benefits to be paid in the future; and (b) an expense when the entity consumes the economic benefit arising from service provided by an employee in exchange for employee benefits” (Objective) </li></ul>
  6. 6. Introduction <ul><li>AASB 119 specifies two bases for the measurement of liabilities arising from employee benefits: </li></ul><ul><li>- nominal basis of measurement; and </li></ul><ul><li>- present value basis of measurement </li></ul><ul><li>The nominal basis must be used for “short-term employee benefits” (as defined in para. 7) where short-term obligations (such as those specified in para. 8) are measured at undiscounted amounts that will ultimately be paid to settle the obligations (para. 9) </li></ul>
  7. 7. Introduction <ul><li>The present value basis of measurement is required to be used for long-term liabilities, which include: </li></ul><ul><li>- retirement benefits such as pensions </li></ul><ul><li>- other post-employment benefits, such as post-retirement life insurance and post-employment medical care (para. 24) </li></ul><ul><li>- other long-term employee benefits (paras. 126 and 127) </li></ul>
  8. 8. Introduction <ul><li>In addition, “termination benefits” (as defined in para. 7) that fall due more than 12 months after the reporting date are required to be discounted as well (para. 139) </li></ul><ul><li>AASB 119 classifies post-employment benefit arrangements as either “defined contribution plans” or “defined benefit plans” and the relevant accounting and reporting requirements vary accordingly </li></ul>
  9. 9. Wages and salaries <ul><li>Wages and salaries are the base component of employee benefits </li></ul><ul><li>Such benefits have a monetary and a non-monetary component </li></ul><ul><li>Employment agreements are regarded as equally proportionally unperformed at the time wages and salaries are paid </li></ul><ul><li>A liability only arises for accrued wages/salaries payable </li></ul>
  10. 10. Wages and salaries <ul><li>Wages and salaries shall be recognised as an expense and a liability (accrued expense) in accordance with para. 10 </li></ul><ul><li>Accrued wages/salaries are to be measured at nominal amounts (para. 10) </li></ul><ul><li>Non-monetary benefits are to be measured as the net marginal cost, if any, to the employer of the benefits provided </li></ul>
  11. 11. Compensated absences <ul><li>This term relates to circumstances in which employees continue to be paid even though they are absent, such as: </li></ul><ul><li>- annual leave </li></ul><ul><li>- sick leave </li></ul><ul><li>- long service leave </li></ul>
  12. 12. Compensated absences <ul><li>Annual leave </li></ul><ul><li>Annual leave of four weeks per annum is paid in most cases by employers along with, in many cases, an annual leave loading of 17.5 per cent </li></ul><ul><li>Entitlement to annual leave arises as services are provided by employees and is accrued as an expense and a liability on this basis (para. 11) </li></ul><ul><li>Annual leave is paid at wage rates that are current when employees take their annual leave entitlements </li></ul>
  13. 13. Compensated absences <ul><li>Annual leave is a form of “short-term employee benefits” as the leave is expected to be taken within 12 months after the end of the financial period (see definition in para. 7) </li></ul>
  14. 14. Compensated absences <ul><li>Sick leave </li></ul><ul><li>Employees who are unable to work due to illness are entitled to take paid sick leave </li></ul><ul><li>Sick leave may be classified into two forms: </li></ul><ul><li>- non-accumulating sick leave </li></ul><ul><li>- accumulating sick leave </li></ul>
  15. 15. Compensated absences <ul><li>Non-accumulating sick leave is an annual entitlement </li></ul><ul><li>Unused sick leave of this kind cannot be carried forward </li></ul><ul><li>For non-accumulating sick leave, AASB 119 requires the recognition of an expense and a liability only when the sick leave occurs as per para. 11(b) </li></ul>
  16. 16. Compensated absences <ul><li>Accumulating sick leave is where an employee is able to carry forward unused sick leave for use in subsequent periods </li></ul><ul><li>Unused sick leave is “saved” and not “lost” </li></ul><ul><li>As a form of accumulating compensated absences, sick leave of this genre gives rise to the following entitlements: </li></ul><ul><li>- vesting sick leave entitlements </li></ul><ul><li>- non-vesting sick leave entitlements </li></ul>
  17. 17. Compensated absences <ul><li>Vesting entitlements are obligations that will ultimately be paid by the employer </li></ul><ul><li>Vesting sick leave entitlements have the same characteristics as annual leave entitlements and, therefore, should be accounted for in the same way </li></ul><ul><li>Non-vesting entitlements are not unconditional legal obligations of employers and, in the case of sick leave, employees can only benefit when they are sick </li></ul>
  18. 18. Compensated absences <ul><li>For accumulating sick leave, AASB 119 requires a liability to be recognised as employees provide service that increases their entitlement to future paid sick leave [paras. 11 (a) and 13] </li></ul><ul><li>For vesting sick leave, the amount of the entitlement is equal to 100 per cent of the sick leave accumulated </li></ul><ul><li>For non-vesting sick leave, the entitlement is to be estimated, based on past experience, in recognising the accumulated sick leave that is expected to be used by employees in future </li></ul>
  19. 19. Compensated absences <ul><li>Under AASB 119, sick leave is a form of short-term compensated absence </li></ul><ul><li>Any liability for sick leave entitlements is to be measured on a nominal basis at the anticipated pay rates when the leave is expected to be taken (para. 10) </li></ul>
  20. 20. Compensated absences <ul><li>Long service leave </li></ul><ul><li>This genre of leave is provided to employees in recognition of uninterrupted service with the same employer </li></ul><ul><li>For long service leave purposes, employment can be divided into three distinct periods: </li></ul><ul><ul><li>preconditional period </li></ul></ul><ul><ul><li>conditional period </li></ul></ul><ul><ul><li>unconditional period </li></ul></ul>
  21. 21. Compensated absences <ul><li>There are two approaches in accounting for long service leave: </li></ul><ul><li>- direct method </li></ul><ul><li>- liability method </li></ul><ul><li>Under the direct method, long service leave is accounted for on a cash basis, where expenses are recognised on making cash payments, and no liability is recognised for accrued long service leave </li></ul>
  22. 22. Compensated absences <ul><li>Under the liability method, a long service leave expense is recognised as long service leave is earned by employees and a corresponding liability is also recognised </li></ul><ul><li>The liability accrues from the date employment commences as the provision of service by employees gives rise to the entity’s present obligation for long service leave </li></ul><ul><li>The liability should be classified as current and non-current as appropriate </li></ul>
  23. 23. Compensated absences <ul><li>Two key difficulties in applying the liability method are as follows: </li></ul><ul><li>- the leave is paid at the wage rates that are applicable when the leave is taken rather than at the wage rates applying when the leave is earned </li></ul><ul><li>- not all leave earned during a period will be taken </li></ul><ul><li>Read Acme (H,P & H, pp.468-469) </li></ul>
  24. 24. Compensated absences <ul><li>Under AASB 119, long service leave as “other long-term employees benefits” (see definition para. 7) is to be dealt with in accordance with paras. 126 to 131 </li></ul>
  25. 25. Compensated absences <ul><li>Under para. 128, a liability for long service leave is to be recognised at an amount that is equal to the net total of: </li></ul><ul><li>“ (a) the present value of the defined benefit obligation at the reporting date (see paragraph 64); </li></ul><ul><li>(b) minus the fair value at the reporting date of plan assets (if any) out of which the obligations are to be settled directly (see paragraphs 102-104)” </li></ul><ul><li>Plans often do not exist to fund long service leave entitlements </li></ul>
  26. 26. Compensated absences <ul><li>Actuarial assumptions are to be applied in estimating the present value of the long service leave defined benefit obligation </li></ul><ul><li>The “Projected Unit Credit Method” or the “accrual benefit method” is to be applied (para. 64) </li></ul><ul><li>This method views 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 (para. 65) </li></ul>
  27. 27. Compensated absences <ul><li>Under para. 69, the probability that some employees may not satisfy the vesting conditions is to be taken into account when measuring the long service leave obligation </li></ul><ul><li>Accrual of the long service leave liability under AASB 119 is consistent with the liability method, except in two key ways </li></ul>
  28. 28. Compensated absences <ul><li>First, AASB 119 requires the use of amounts of future salaries/wages that will be payable when the leave is taken </li></ul><ul><li>Second, AASB 119 requires future long-service leave obligations to be discounted to their present value </li></ul><ul><li>The effects, however, of incorporating expected wage increases and discounting procedures tend to offset each other </li></ul>
  29. 29. Profit sharing and bonus plans <ul><li>Such arrangements and plans may be equity based or cash-based </li></ul><ul><li>Share-based payments are dealt with by AASB 2 as already addressed </li></ul><ul><li>Cash-based plans are dealt with in AASB 119 (see paras. 17 to 22) </li></ul>
  30. 30. Profit sharing and bonus plans <ul><li>Under para. 17, the recognition criteria for liabilities is specified as follows: </li></ul><ul><li>“ An entity shall recognise the expected cost of profit-sharing and bonus plans under paragraph 10 when, and only when: </li></ul><ul><li>(a) the entity has a present legal or constructive obligation to make such payments as a result of past events; and </li></ul><ul><li>(b) a reliable estimate of the obligation can be made” </li></ul>
  31. 31. Profit sharing and bonus plans <ul><li>In contrast to the recognition criteria in the Framework where future economic benefits are to be “probable”, para. 17 states “a present obligation exists when, and only when, the entity has no realistic alternative but to make the payments” </li></ul><ul><li>A reason for this variation is outlined in paras. 18 and 19 </li></ul>
  32. 32. Profit sharing and bonus plans <ul><li>Such liabilities may be expected to be settled within 12 months of the reporting date (see para. 10) or are otherwise not due to be settled within that period in which case the liability shall be measured at the present value of the estimated future cash outflows to be made by the employer </li></ul>
  33. 33. Termination benefits <ul><li>Termination benefits are described in para. 135 </li></ul><ul><li>The criteria for recognition of termination benefits are specified in para. 133 (also see para. 134) </li></ul><ul><li>In summary, a liability and an expense does not arise unless the entity is “demonstrably committed” to provide termination benefits which, in effect, constitutes what is “virtually certain” </li></ul>
  34. 34. Termination benefits <ul><li>Where termination benefits fall due more than 12 months after the reporting date, the liability shall be measured at the present value of the estimated future cash outflows involved </li></ul>
  35. 35. Post-employment benefits <ul><li>AASB 119 defines “post-employment benefits” as “employee benefits (other than termination benefits) which are payable after the completion of employment” (para. 7) </li></ul><ul><li>There are two key types of plans: </li></ul><ul><ul><li>defined contribution plans </li></ul></ul><ul><ul><li>defined benefit plans </li></ul></ul>
  36. 36. Post-employment benefits <ul><li>These plans are defined in para. 7 </li></ul><ul><li>Defined contribution plans are where the contributions are made to a fund, as specified under an agreement, by an employer and, in many cases, by employees as well. </li></ul><ul><li>Defined benefit plans are those which specify predetermined benefits to be received by an employee on retirement </li></ul>
  37. 37. Post-employment benefits <ul><li>Such plans are to be classified “depending on the economic substance of the plan as derived from its principal terms and conditions” (para. 25) </li></ul><ul><li>Under defined contribution plans, an employer’s legal or constructive obligation is limited to the amount that it agrees to pay into the plan </li></ul>
  38. 38. Post-employment benefits <ul><li>On the other hand, an employer effectively underwrites the actuarial and investment risks of a defined benefit plan </li></ul><ul><li>For defined contribution plans the accounting and reporting requirements paras. 43-47 where the treatment is similar to accounting for salary/wages </li></ul>
  39. 39. Post-employment benefits <ul><li>The management of a defined benefit plan is often entrusted to a specialised financial institution </li></ul><ul><li>As a specialised topic, the accounting and reporting requirements of defined benefit plans will not be subject to detailed examination (see H, P & H, pp. 481-490) </li></ul>