International Accounting Standard 19 Employee Benefits Katelijne Simeons 4 November 2002

1. International Accounting Standard 19Employee BenefitsKatelijne Simeons4 November 2002

2. Agenda (1) • Introduction: international financial reporting standards • Objective and scope of IAS19 • Short-term employee benefits • Post-employment benefits • Other long-term employee benefits • Termination benefits • Equity compensation benefits

3. Agenda (2) Post-employment benefits: • Defined contribution plan • Defined benefit plan • Actuarial assumptions and actuarial methods • Liabilities and plan assets • Accounting • Actuarial Gain/Loss • Past Service Cost • Implementation • Illustrative example • Curtailment and settlement • Disclosures requirements

4. International financial reporting standards • International financial reporting standards • New standards will be known as IFRS • Previous standards continue to be designated “ International Accounting Standards” (IAS)

5. International financial reporting standards • Reminder: June 2000 communication from the Commission to the Council • Proposal requiring all listed companies within the EU to prepare their consolidated financial statements under IAS (deadline: 2005) • Option for member states to either encourage or require • earlier adoption • adoption by non listed companies • adoption for the entity (i.e. non consolidated) financial statements • Option for member states to authorize the use of other GAAP during all or part of transitory period - not thereafter

6. Objective of IAS19 • Objective: prescribe the accounting and disclosure for employee benefits • Requires the enterprise to recognise: • A liability when an employee has provided service in exchange for employee benefits to be paid in the future • An expense when the enterprise consumes the economic benefit arising from service provided by an employee in exchange for employee benefits

7. Scope of IAS19 • Applies to all employee benefits, including: • formal plans and other formal agreements between the enterprise and employees, groups or representatives • legislative requirements or industry arrangements • informal practice that give rise to a constructive obligation • Constructive obligation: when the enterprise has no realistic alternative but to pay employee benefits

8. Scope of IAS19 • Scope – all employee benefits • Short term employee benefits • Post employment benefits • Other long term employee benefits • Termination benefits • Equity compensation benefits • Applicable since 1/1/1999

9. Short-term employee benefits • Employee benefits (other than termination and equity compensation) within 12 months after the employee rendered the related service • Salaries, social security contributions, short-term compensated absence (annual or sick leave), bonuses …and non-monetary benefits (medical care, car, …)

10. Short-term employee benefits • Accounting is generally straightforward as: • No actuarial assumptions • No gain/loss • No discounting • Expense = undiscounted amount of benefits payable during the accounting period

11. Post-employment benefits • Employee benefits (other than termination and equity compensation) payable after the completion of service • Retirement benefits, such as pensions, and other post-employment benefits, such as life insurance and medical care, … • Either Defined Benefit or Defined Contribution plan • Specific guidance on classification of multi-employer plans, state plans and plans with insured benefits

12. Other long-term employee benefits • Long-service leave, jubilee or other long-service benefits, long-term disability benefits, bonus if payable after 12 months, … • Simplified method of accounting: • Actuarial gain/loss are recognized immediately • All past service cost is recognized immediately • Liability recognised = • Present value of the liabilities (based on Projected Unit Credit method) • Minus fair value of plan assets – if any -

13. Termination benefits • Employee benefits payable as a result of either: • Enterprise’s decision to terminate an employment before the normal date • Employee’s decision to accept voluntary redundancy in exchange of such benefits • Event= termination rather than employee service

14. Termination benefits • Recognition of a liability and a cost if the employer is demonstrably committed to: • Terminate the employment of an employee or group of employees, or • Provide termination benefits as a result of an offer made in order to encourage voluntary redundancy

15. Termination benefits • Demonstrably committed when: • the enterprise has a detailed formal plan including: • location, function, and approximate number of employees concerned; • termination benefits for each job classification or function; and • time at which the plan will be implemented. • without realistic possibility of withdrawal.

16. Termination benefits • Typically lump-sum payments, but may also include: • enhancement of retirement benefits • salary until the end of a specified notice period • Immediate recognition as an expense as do not provide an enterprise with future economic benefits • Discounting if benefits payable within more than 12 months

17. Equity compensation benefits • Equity compensation benefits include: • shares, share options, and other equity instruments, issued to employees at less than the fair value at which those instruments would be issued to a third party; and • cash payments, the amount of which will depend on the future market price of the reporting enterprise's shares.

18. Equity compensation benefits • IAS19 does not specify recognition and measurement requirements for equity compensation benefits • Requires detailed disclosures intended to give information on the enterprise’s financial position, performance and cash flows.

19. Equity compensation benefits • Disclosures must include: • the nature, terms and characteristics of equity compensation plans (including the accounting policy); • the number and terms of the equity financial instruments which are held, issued and lapsed by equity compensation plans at the beginning and end of the period;

20. Equity compensation benefits • Disclosures must also include: • the fair value, at the beginning and end of the period, of the enterprise's own equity financial instruments (other than share options) held by equity compensation plans; and • the fair value, at the date of issue, of the enterprise's own equity financial instruments (other than share options) issued by the enterprise to equity compensation plans or to employees, or by equity compensation plans to employees, during the period. • If it is not practicable to determine the fair value, it should be disclosed. • As no consensus exists on the determination of the fair value of share option, there is no requirement to disclose this value.

21. Post-employment benefits • Benefits: • Retirement benefits, such as pensions, and • Other post-employment benefits, such as life insurance and medical care, … • Plan is classified as: • Defined Benefit or • Defined Contribution

22. Post-employment Benefits: Defined Contribution Plan • Defined contribution plans are post-employment benefit plans under which an enterprise 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.

23. Post-employment Benefits: Defined Contribution Plan • Defined Contribution Plan: • The contributions or premiums are defined in the rules of the plan • Ex. Annual premium = 5% of salary • The benefit is the result of the total contributions paid and the return on investments obtained

24. Post-employment Benefits: Defined Contribution Plan • Defined Contribution Plan: • The enterprise's legal or constructive obligation is limited to the amount that it agrees to contribute to the fund • Actuarial risk (that benefits will be less than expected) and investment risk (that assets invested will be insufficient to meet expected benefits) fall on the employee

25. Post-employment Benefits: Defined Contribution Plan • Accounting is straightforward because: • Obligation for each period is determined by the amounts to be contributed • So, no actuarial assumptions • No possibility for gain or loss • Undiscounted basis, except if after 12 months • Disclosure: amount recognized as expense

26. Post-employment Benefits: Defined Benefit Plan • Defined Benefit Plan: • Post-employment benefits plans other than defined contribution plans • The actuarial risk (benefits are more than expected) fall on the enterprise.

27. Post-employment Benefits: Defined Benefit Plan • Defined Benefit Plan: • The benefit is defined in the rules of the plan • The retirement benefit is determined by reference to a formula usually based on an employee’s remuneration (salary and other benefits), years of service, or other factors • Ex. Pension = 70 % of final salary less State pension

28. Post-employment Benefits: Defined Benefit Plan • Accounting involves following steps: • determining estimate of the benefit relative to service rendered, based on actuarial assumptions about demographic and financial variables; • discounting that benefit based on actuarial method, to determine the present value of the defined benefit obligation and the current service cost; • determining the fair value of any plan assets; • determining the total amount of actuarial gains and losses and the amount that should be recognised; • if the plan has changed, determining the past service cost; • in case of curtailment or settlement, determining the resulting gain or loss

29. Post-employment Benefits:Defined Benefit Plan • Basic principles • liability to be recognized in employer’s balance sheet • cost to be accounted for through P&L • Determination of the expense requires • actuarial method • actuarial assumptions

30. Post-employment Benefits:Defined Benefit Plan • Actuarial Method required by IAS19 is the Projected Unit Credit method • The Defined Benefit Obligation (DBO) = • the present value of the benefit payable at due date (retirement) • based upon projected salary • based on past service

31. Post-employment Benefits:Defined Benefit Plan – actuarial assumptions presentvalue of a benefit at retirement = probability x interest x benefit at of the event factor retirement- withdrawal - discount rate - inflation - mortality - future salary increase - disability - retirement age

32. Post-employment Benefits:Defined Benefit Plan - actuarial assumptions • Demographic assumptions • mortality in service and after retirement • rates of withdrawal • age at retirement • disability • …

33. Post-employment Benefits:Defined Benefit Plan - actuarial assumptions • Financial assumptions • discount rate • expected long term return on plan assets • salary increase • salary scale • social security increase • inflation • …

34. Post-employment Benefits:Defined Benefit Plan - actuarial assumptions • Actuarial assumptions: • employer is responsible • unbiased and mutually compatible • financial assumptions based on market expectations at the balance sheet date • discount rate by reference to • high quality corporate bonds • government bonds where no deep market in corporate bonds

35. Post-employment Benefits:Defined Benefit Plan - actuarial method presentvalue of a benefit at retirement = probability x interest x benefit at of the event factor retirement- withdrawal - discount rate - inflation - mortality - future salary increase - disability - retirement age

36. Post-employment Benefits:Defined Benefit Plan - actuarial method • Some actuarial methods and typical financing for pension plans: • Successive single premiums • Level annual premiums • Projected Unit Credit Method

37. Post-employment Benefits:Defined Benefit Plan - actuarial method Financing methods: Illustration: Constitution of a retirement lump sum of 100 over 4 periods of 10 years 100 25 25 25 25 Age IN =25 10 y 20 y 30 y 40 y Retirement age Basic Principle : “IN” = “OUT”:  4 x 25 = 100

38. Post-employment Benefits:Defined Benefit Plan - actuarial method 1st method: financing based on successive single premiums 100 25 25 25 25 interest interest interest premium premium premium premium X=25 10 y 20 y 30 y 40 y Retirement age

39. Post-employment Benefits:Defined Benefit Plan - actuarial method 2nd method: financing based on level annual premiums 100 Average = level annual => premium 25 25 25 25 interest interest premium premium premium premium X=25 10 y 20 y 30 y 40 y Retirement age

40. Post-employment Benefits:Defined Benefit Plan - actuarial method Overfunding at the beginning 100 25 interest interest interest premium premium premium premium X=25 10 y 20 y 30 y 40 y Retirement age

41. Post-employment Benefits:Defined Benefit Plan - actuarial method 208 Snow-ball effect!! 100 100 (x=25) 100 (x=35) 100 (x=45) 100 (x=55) 108 50 50 58 33 33 33 25 25 25 25 25 X=25 10 y 20 y 30 y 40 y Retirement age Early Leave : Underfunding

42. Post-employment Benefits:Defined Benefit Plan - actuarial method Conclusion for plan financed through level annual premium: • beginning : overfunding (effect 1) • later : underfunding (effect 2) • & snowball effect - effect 2 + effect 1 Contrary to International Accounting Principles

43. Post-employment Benefits:Defined Benefit Plan - actuarial method 3rd method: financing based on Projected Unit Credit Method 400 100 (25y) 100 (35y) 100 (45y) 100 (55y) 10/40 x 400 = 20/40 x 400 - 100 = 100 30/40 x 400 - 200 = 100 40/40 x 400 - 300 = 100 100 X=25 10 y 20 y 30 y 40 y retirement age Proportional accrual of projected lump sum

44. Post-employment Benefits:Defined Benefit Plan - actuarial method • Defined Benefit Obligation (DBO) is the present value of the employer’s liability at any point in time Based on the past service Based on the projected salaries • Service Cost (SC) is the cost of the benefit for one year Under normal (Belgian) circumstances: • Service cost = Accrued Liability / length of past service

45. Post-employment Benefits:Defined Benefit Plan – actuarial method DBO: Defined Benefit Obligation Last Year Now DBO Projected Salary Projection Service cost Current Salary Last year’s salary 25 Last Year Now Retirement age discounting

46. Post-employment Benefits:Defined Benefit Plan – actuarial method As compared to an insured plan Projected salary DBO Projection Unfunded DBO Current salary Assets (reserve) 25 Retirement age discounting

47. Post-employment Benefits:Defined Benefit Plan – Plan Assets • Plan assets comprise: • (1) assets held by a long-term employee benefit fund; and • (2) qualifying insurance policies. • (1) Assets held by a long-term employee benefit fund are assets that: • are held by an entity (a fund) that is legally separate from the reporting enterprise and exists solely to pay or fund employee benefits; and • are available to be used only to pay or fund employee benefits, are not available to the reporting enterprise's own creditors (even in bankruptcy), and cannot be returned to the reporting enterprise Plan assets measured at market value or at fair value

48. Post-employment Benefits:Defined Benefit Plan – Plan Assets • (2) A qualifying insurance policy is an insurance policy issued by an insurer that is not a related party, if the proceeds of the policy: • can be used only to pay or fund employee benefits under a defined benefit plan; • are not available to the reporting enterprise's own creditors (even in bankruptcy) and cannot be paid to the reporting enterprise • When it is certain that another party will reimburse some expenditure required, a reimbursement of rights may be recognised and treated as plan assets

49. Post-employment Benefits:Defined Benefit Plan - Accounting • Basic principles Accrued Projected Past Service Liability (DBO) at any point in time to be reflected in employer’s balance sheet • Overfunded DBO is recorded as a prepaid asset (attention to recoverability test) • Unfunded DBO is recorded as a liability

50. Post-employment Benefits:Defined Benefit Plan - Accounting • The liability in the balance sheet comprises: Defined Benefit Obligation (DBO) - fair value of assets • unrecognised past service cost • unrecognised actuarial losses (gains) • unrecognised transitional liability (if any) • In case of an asset (fair value of assets exceeding DBO), pay attention to recoverability test