ANNUAL IFRS WEEK

1. ANNUAL IFRS WEEK Employee Benefits ( IAS 19) 1

2. Objectives and scope • Accounting and disclosure of Post employment benefits Short term employee benefits Termination benefits Other long term employee benefits

3. The Objective of IAS 19 • The objective of this Standard is to prescribe: (a) the accounting; and (b) disclosure for employee benefits. • The Standard requires an entity to recognise: (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.

4. The Scope of IAS 19 • Applied by an employer in accounting for all employee benefits, except • those to which IFRS 2 Share-based Payment applies. • An employee may provide services to an entity on a full time, part time, permanent, casual or temporary basis. For the purpose of this Standard, employees include directors and other management personnel (Para 6). • The issuance of shares or rights to shares requires an increase in a • component of equity. IFRS 2 requires the offsetting debit entry to be expensed • when the payment for goods or services does not represent an asset. • Employee benefits are all forms of consideration given by an entity in exchange • for service rendered by employees.

5. Employee benefits include: • short-term employee benefits, such as wages, salaries and social security contributions, paid annual leave and paid sick leave, profit-sharing and bonuses (if payable within twelve months of the end of the period) and non-monetary benefits (such as medical care, housing, cars and free or subsidised goods or services) for current employees; (b) post-employment benefits such as pensions, other retirement benefits, post- employment life insurance and post-employment medical care; (c) other long-term employee benefits, including long-service leave or sabbatical leave, jubilee or other long-service benefits, long-term disability benefits and, if they are not payable wholly within twelve months after the end of the period, profit-sharing, bonuses and deferred compensation; and (d) termination benefits: payable because of a decision to terminate an employee’s employment before the normal retirement date or an employee’s decision to accept voluntary redundancy in exchange for those benefits.

6. Short term employee benefits Examples Accounting treatment Definition

7. Recognition and measurement: All short-term employee benefits Short-term employee benefits are employee benefits (other than termination benefits) which fall due wholly within twelve months after the end of the period in which the employees render the related service. When an employee has rendered service to an entity during an accounting period, the entity shall recognise the undiscounted amount of short-term employee benefits expected to be paid in exchange for that service: (a) as a liability (accrued expense), after deducting any amount already paid. If the amount already paid exceeds the undiscounted amount of the benefits, an entity shall recognise that excess as an asset (prepaid expense) to the extent that the prepayment will lead to, for example, a reduction in future payments or a cash refund; and (b) as an expense, unless another Standard requires or permits the inclusion of the benefits in the cost of an asset (see, for example, IAS 2 Inventories and IAS 16 Property, Plant and Equipment).

8. Definitions Accumulating Short term compensated absences Non-accumulating

9. Accumulating compensated absences • Accumulating absences relate to, for example, paid holiday allowances that can be carried over into the next accounting year. • These should be expensed in the years they are earned by the employee and the expected cost of any unused amount that has been accumulated at the balance sheet date should be shown as a liability.

10. Non Accumulating compensated absences • Non accumulating absences are things such as holiday that employees can take during the year, but lose if they have not taken it by the accounting year end, or to a compensated sick leave allowance per year, where the employee has not used the full allowance (and it cannot be carried over). • These short term compensated allowances are expensed as they arise, and no liability is created at the year end. • Where, however, the company’s accounting year and benefit year do not coincide, such that, at the accounting year end employees can carry forward the leave, it is treated as ‘Accumulating absence’.

11. Profit sharing and bonus plans IAS 19 - EMPLOYEE BENEFITS An entity shall recognise the cost of profit sharing and bonus payments when a legal or constructive obligation arises, and when a reliable estimate of the obligation can be made. An obligation arises when the employer has no realistic alternative to making the payments. Even if an entity has no legal obligation to pay, if it has a history of such payments it is under a constructive obligation to pay. Profit sharing and bonus payments which are not fully payable within twelve months of the accounting year end are treated as long term employee benefits

12. Expected cost of profit-sharing and bonus payments • A profit-sharing plan requires K Ltd. to pay a specified proportion of its profit for the year to employees who serve throughout the year. If no employees leave during the year, the total profit-sharing payments for the year will be 3% of profit. The entity estimates that staff turnover will reduce the payments to 2.5% of profit. • The entity recognises a liability and an expense of 2.5% of profit.

13. Post employment benefits Defined benefit plans Defined contribution plans

14. Post employment benefits • Post employment benefits include pensions and any other post employment benefits such as post employment life insurance and post employment health care. • Post employment benefit plans are classed as either defined benefit or defined contribution. Under defined contribution plans the entity agrees to contribute to a fund that is separate from the company (a rate usually specified in the scheme rules) and the amount of post retirement benefits the employee receives is determined by these contributions and the return made on them. • The employer must have no contractual or constructive obligation to make further contributions to the fund. Risks, therefore, lie with the employee, not the employer. IAS 19 - EMPLOYEE BENEFITS

15. Post employment benefits • Defined benefit plans are defined as post employment plans other than defined contribution plans. • Under defined benefit plans, the employer is obliged to provide the agreed benefits to current and former employees. The risks lie with the entity, in particular the risk that the benefits will cost more than the entity expected. All unfunded post employment benefits are ‘defined benefit’. IAS 19 - EMPLOYEE BENEFITS

16. Accounting Treatment Expense when due Disclosure Defined contribution plans

17. Defined contribution plans Accounting for defined contribution schemes is relatively straight forward. An expense is recognised for the contributions when due, and any unpaid expense shown as a liability, any overpayment an asset. The amount recognised as an expense for defined contribution plans in the period should be disclosed, as should, where required by IAS 24 ‘Related party transactions’, information about contributions into a defined contribution plan for key management personnel. IAS 19 - EMPLOYEE BENEFITS

18. Post retirement benefits-defined benefit plans Value on balance sheet FV of scheme assets X PV of liabilities (X) Actuarial gains/losses not yet recognised (X)/X Past service costs not yet recognised X X Components of change in value accounted for separately

19. Post retirement benefits-defined benefit plans IAS 19 - EMPLOYEE BENEFITS Under a defined benefit scheme the (net) surplus or deficit on the pension fund is shown on the entity’s balance sheet. If there is an excess of liabilities over assets a deficit is recognised, vice versa a surplus. The carrying value of the surplus or deficit is the fair value of the schemes’ assets, less the present value of the schemes’ liabilities, plus or minus the actuarial gains/losses and past service costs not yet recognised. We will look at each of these components separately.

20. Fair value? No market price?Use estimate Market price if available Determining the value of plan assets

21. Benefits earned - Projected Unit Credit Method • Example A new employee has current salary of Ksh. 50,000, expected to increase at a rate of 4% per annum over the next 5 years. The employee is a member of the firm’s defined benefit scheme, and is entitled to a lump sum on retirement (expected to be in 5 years) of 2% of final salary for each year of service. A discount rate of 5% is applied. • Calculate the obligation at the end of each year

22. Calculations Salary at end of year 5 Ksh. 50,000 x 1.045=Ksh. 60,833 Benefit attributable to each year Ksh. 60,833 x 2%=Ksh.1,217

23. Calculations (continued) • Benefits attributable to years 1-5

24. Calculations (continued) Year 3 example Present value of obligation at end of year 3 Ksh3,6511.053 Ksh.3,154 = Ksh.2,4341.052 Present value of obligation at end of year 2 Ksh.2,208Ksh.946Ksh.110Ksh.836 = Movement Interest cost Service cost (balance)

25. Recognition in the income statement • Current service cost • Net Interest on the Net Defined Benefit Liability (Asset) • Past service costs Other comprehensive income • Actuarial gains and losses (to the extent they are recognised)

26. Service cost CurrentDue to employee working extra year PastDue to change in benefits

27. Net Interest on the Net Defined Benefit Liability (Asset) Expected return Interest cost High yield interest rate High yield interest rate

28. Actuarial gains and losses • Experience adjustments • Changes in assumptions • Recognition

29. Disclosure for defined benefit schemes • Accounting policy • Description of plan • Reconciliation of assets and liabilities in the balance sheet • Fair value of plan assets • Reconciliation of movement in liabilities • Breakdown of income statement expense • Actual return on plan assets • Actuarial assumptions

30. Multi-employer plans • Defined benefit • Defined contribution • Disclosures

31. Other long term employee benefits Recognition and measurement Examples Disclosure

32. Termination benefits • Termination benefits are treated separately from other employee benefits, as the obligation to pay them arises from an employee’s termination of employment rather than service. • Termination benefits should be recognised as an expense and a liability when the entity is demonstrably committed to either terminating the employment or providing termination benefits as a result of an offer made to encourage voluntary redundancies. This demonstrable commitment is evidenced by a detailed formal plan from which the entity has no realistic option of withdrawing. • If the benefits are to be paid more than twelve months after the balance sheet date the liability should be discounted back using a discount rate determined by reference to market yields on high quality bonds. • Disclosure of termination benefits should be in accordance with IAS 1, 37 and 24.

33. General Changes made by IAS 19 Full Recognition of Deficit (Surplus) on Balance Sheet -1/3 Under IAS 19 some of the effect of actuarial gains and losses can be excluded from the net defined benefit liability (asset) by using the corridor approach and the effect of unvested past service costs is recognized on the average vesting period. Under IAS 19 (Revised) all such items to be recognized immediately (actuarial gains and losses in other comprehensive income for retirement benefits and in profit or loss for other long term employee benefit and past service cost in profit or loss within service cost) Therefore, the net defined benefit (liability) recognized on the balance sheet will equal the actual deficit (surplus) in an entity’s defined benefit plan. 33

34. General Changes made by IAS 19 Full Recognition of Deficit (Surplus) on Balance Sheet – 2/3 The application of IAS 19 (Revised) will impact the current equity position and future profit or loss of entities currently using the corridor approach Due to declining financial markets, decreasing discount rates and changing mortality rates in recent years, in general most companies using the corridor approach have disclosed unrecognized actuarial losses. These entities therefore present smaller balance sheet liability (or larger balance sheet asset) than the actual deficit or surplus in the defined benefit plan On application of IAS 19 (revised), all cumulative unrecognized actuarial gains and losses will be recognized in retained earnings 34

35. General Changes made by IAS 19 Full Recognition of Deficit (Surplus) on Balance Sheet – 3/3 If unrecognized actuarial losses are in place, application of IAS 19 (Revised) will decrease the equity position of the entity, leading to possible knock on effects such as issues with loan covenants or potential credit granting to the entity. Also, OCI and profit or loss will become more volatile due to immediate recognition of actuarial gains and losses and past service cost when compared to IAS 19. 35

36. General Changes made by IAS 19 Introduction of Net Interest on the Net Defined Benefit Liability (Asset) – 1/2 Under IAS 19 the expected return on plan assets recognized in profit or loss is determined based on the expected rate of return on investment over the entire life of the underlying obligation. Under IAS 19 (Revised) the net interest income is introduced as the equivalent of the expected return on the plan assets under IAS 19. The net interest income is included in the net interest on the defined benefit liability (asset) which is the counterpart under IAS 19 revised of the interest cost and the expected return on plan assets (IAS 19) The expected return under IAS 19,depends on the actual investment portfolio and is typically not equal to the discount rate applied for the determination of scheme liabilities. 36

37. General Changes made by IAS 19 Introduction of Net Interest on the Net Defined Benefit Liability (Asset) – 2/2 In addition, while under IAS 19 all administration costs were deducted from expected return (in profit or loss), under IAS 19 (Revised) only the (administration) costs relating to managing plan assets are deducted from actual return in OCI and all other administration costs should be recognized in profit or loss when they occur. 37

38. General Changes made by IAS 19 Change in the Presentation of the Defined Benefit Cost – 1/2 Under IAS 19, the pension expense recognized in profit or loss consists of several components, such as current service cost, interest cost and expected return on plan assets, as well as the recognition of actuarial gains and losses. IAS 19 (Revised) is more prescriptive and introduces the term “defined benefit cost”. The defined benefit cost comprises all cost (income) during a reporting period that lead to the development of the net defined liability (asset) excluding contributions paid. 38

39. General Changes made by IAS 19 Change in the Presentation of the Defined Benefit Cost – 2/2 Service cost (current and past service cost and gains and losses on curtailments and settlements ) and net interests are recognized in profit or loss Re-measurements (actuarial gains and losses, any changes in the effect of the assets ceiling and difference between the expected net interest income and the actual return) are recognized in other comprehensive income for retirement benefits and in profit or loss for other long term employee benefits. 39

40. General Changes made by IAS 19 Introduction of More extensive disclosure requirements in Financial Statements – 1/3 IAS 19 (Revised) reporting entities should disclose information that: Explains the characteristics of and risks associated with its defined benefit plans; Identifies and explains the amounts in its financial statements arising from its defined benefit plans; and Describes how its defined benefit plans may affect the amount, timing and uncertainty of the entity’s future cash flows. 40

41. General Changes made by IAS 19 Introduction of More extensive disclosure requirements in Financial Statements – 2/3 The disclosure requirements are more extensive than the disclosure requirements in IAS 19 and will provide additional insight into the pension situation at the entity. Narrative descriptions of e.g. the regulatory framework, funding arrangements, potential (non-) financial risks and/or asset ceiling tests should be included in the financial statements according to IAS 19 (revised) 41

42. General Changes made by IAS 19 Introduction of More extensive disclosure requirements in Financial Statements – 3/3 Examples of these more extensive disclosure requirements are: The disclosure of the nature of the benefits A description of the risks to which the employee benefit plan exposes the entity The results of a sensitivity analysis that indicates the influence of certain assumptions on the outcome of the pension valuation A narrative description of funding arrangements Information about the maturity profile including the duration of the pension liabilities Entities that participate in a multi-employer defined benefit plan should for example disclose: The extent to which the entity is liable for other entities’ obligations; qualitative information about agreed deficit/ surplus allocation on wind –up or withdrawal. 42

43. THANK YOU Q & A 43