Explanation of IAS 19 International Accounting Standard: Employee Benefits

IAS 19 International Accounting Standard, “Employee Benefits,” is an important International Financial Reporting Standard (IFRS) that addresses how to account for and present the costs and benefits related to an entity’s employees. IAS 19 International Accounting Standard covers all forms of benefits provided by an entity to its employees, whether short-term or long-term, including termination benefits and retirement plans. In this article, we will provide a detailed explanation of IAS 19 International Accounting Standard, discussing its objectives, scope, and key requirements, with a focus on classifying employee benefits and how to recognize and measure their various types, as well as highlighting the importance of this standard and its impact on financial statements.

What are Employee Benefits?

Employee benefits are all forms of consideration given by an entity in exchange for services rendered by its employees. These benefits include:

• Short-term Employee Benefits: Benefits (other than termination benefits) that are expected to be settled wholly before twelve months after the end of the annual reporting period in which the employees render the related service, such as salaries and wages, social security contributions, paid annual leave, paid sick leave, and profit-sharing and bonuses.  
• Post-employment Benefits: Benefits (other than termination benefits) that are payable after the completion of employment, such as retirement pensions, post-employment life insurance, and post-employment medical care.
• Other Long-term Employee Benefits: All employee benefits other than short-term employee benefits, post-employment benefits, and termination benefits, such as long-service leave, jubilee benefits, and long-term disability benefits.  
• Termination Benefits: Benefits payable as a result of either an entity’s 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.  

What is IAS 19 International Accounting Standard: Employee Benefits?

IAS 19 International Accounting Standard is an international accounting standard that specifies how to account for and disclose employee benefits in the financial statements. The standard aims to ensure that liabilities related to employee benefits are properly recognized, the cost of these benefits is reliably measured, and they are presented in the financial statements in a way that reflects their impact on the entity’s financial position and financial performance.

Objectives of IAS 19 International Accounting Standard:

• Determine How to Account for Employee Benefits: IAS 19 International Accounting Standard provides guidance on how to recognize, measure, present, and disclose the various types of employee benefits.
• Ensure Recognition of Liabilities Related to Employee Benefits: IAS 19 International Accounting Standard requires entities to recognize liabilities related to employee benefits in their financial statements, providing a more complete picture of their financial position.
• Measure the Cost of Employee Benefits Reliably: IAS 19 International Accounting Standard specifies how to measure the cost of employee benefits, including the cost of pension plans, reliably.
• Improve the Quality of Disclosures: IAS 19 International Accounting Standard imposes specific disclosure requirements aimed at improving the transparency and reliability of information related to employee benefits in the financial statements.
• Enhance Comparability: IAS 19 International Accounting Standard contributes to improving the comparability of financial statements of companies that provide different benefits to their employees.

Scope of IAS 19 International Accounting Standard:

IAS 19 International Accounting Standard applies to all employee benefits, except for those that fall within the scope of IFRS 2, “Share-based Payment.”

Classification of Employee Benefits:

IAS 19 International Accounting Standard classifies employee benefits into four main types:

1. Short-term Employee Benefits:
   • Definition: Benefits (other than termination benefits) that are expected to be settled wholly before twelve months after the end of the annual reporting period in which the employees render the related service.  
   • Examples: Salaries and wages, social security contributions, paid annual leave, paid sick leave, profit-sharing and bonuses.
   • Recognition and Measurement: Benefits due to employees in exchange for their services during the period are recognized as an expense in profit or loss, unless another accounting standard permits or requires their inclusion in the cost of an asset (such as inventory or property, plant, and equipment according to IAS 16 International Accounting Standard).
   • Disclosure: The accounting policy used in measuring these liabilities and the total amount of the liability and expense recognized.
2. Post-employment Benefits:
   • Definition: Benefits (other than termination benefits) that are payable after the completion of employment.
   • Examples: Retirement pensions, post-employment life insurance, post-employment medical care.
   • Classification of Post-employment Benefit Plans: Post-employment benefit plans are classified as either defined contribution plans or defined benefit plans.
     • Defined Contribution Plans: Under these plans, the entity pays fixed contributions into a separate fund (an independent entity), and it has 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.
       • Accounting Treatment: The entity’s contributions to defined contribution plans are recognized as an expense in the period to which the employee’s contribution relates. It is relatively simpler than accounting for defined benefit plans.  
     • Defined Benefit Plans: All post-employment benefit plans other than defined contribution plans. Under these plans, the entity’s obligation is to provide the agreed benefits to current and former employees, and the risks of achieving these benefits (actuarial risk and investment risk) fall on the entity.
       • Accounting Treatment: Accounting for defined benefit plans requires the use of actuarial methods to estimate the present value of the defined benefit obligation and the current service cost. This method requires the use of an appropriate discount rate, in addition to a set of demographic and financial assumptions.
       • Recognition and Measurement:
         • The net defined benefit liability (or asset) is recognized in the statement of financial position.
         • Components of defined benefit cost are recognized in profit or loss (such as current service cost, and net interest on the net defined benefit liability) or in other comprehensive income (such as remeasurements of the net defined benefit liability).
3. Other Long-term Employee Benefits:
   • Definition: All employee benefits other than short-term employee benefits, post-employment benefits, and termination benefits.
   • Examples: Long-service leave (such as sabbatical leave), jubilee benefits, and long-term disability benefits.  
   • Recognition and Measurement: These benefits are recognized and measured in the same way as post-employment benefits according to defined benefit plans, but they are not discounted over the service period. All components of the cost of other long-term employee benefits are recognized in profit or loss, unless another standard requires their recognition in other comprehensive income.
4. Termination Benefits:
   • Definition: Benefits payable as a result of either an entity’s 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.  
   • Recognition and Measurement: Termination benefits are recognized as an expense and a liability at the earlier of the date the entity can no longer withdraw the offer of those benefits and the date the entity recognizes costs for a restructuring that is within the scope of IAS 37 and involves the payment of termination benefits.  
   • Measurement: Termination benefits are measured according to the best estimate of the amount required to settle the obligation at the reporting date.

Actuarial Valuation and the Projected Unit Credit Method:

Accounting for defined benefit plans and other long-term employee benefits requires using the projected unit credit method to measure the obligation and expense. This method involves:

• Performing an Actuarial Valuation: The actuary estimates the present value of the defined benefit obligations using actuarial assumptions, such as mortality rates, employee turnover rates, salary increase rates, and the discount rate.
• Determining the Discount Rate: The discount rate used should reflect the time value of money and should be determined by reference to market yields on high-quality corporate bonds, or government bonds if there is no deep market in corporate bonds.
• Allocating the Cost of Benefits over the Employees’ Service Period: The cost of benefits is allocated over the employees’ service period using an appropriate method, such as the straight-line method or the constant yield method.
• Actuarial assumptions: Actuarial assumptions should be unbiased and not imprudent, and should reflect the entity’s best estimates of future experience.

Disclosure Requirements under IAS 19 International Accounting Standard:

IAS 19 International Accounting Standard requires entities to disclose information about:

• The characteristics of its defined benefit plans and any risks associated with them.
• The accounting policies used for employee benefits.
• The amounts of employee benefits recognized in the financial statements.
• The key actuarial assumptions used in measuring defined benefit obligations.
• A reconciliation between the opening and closing balance of defined benefit obligations, showing the changes during the period.
• A description of the post-employment benefit plan, including the nature of the benefits and the regulatory framework in which the plan operates.
• Information about the assets designated to fund defined benefit plans (if any).
• The impact of employee benefits on the entity’s future cash flows.
• Sensitivity analysis for the key actuarial assumptions.
• Information about any multi-employer plans or group plans in which the entity participates.
• The amounts of other long-term employee benefit costs recognized during the period.
• A description of the nature of other long-term employee benefits.
• The amount of termination benefits recognized as an expense during the period.
• A description of the nature of termination benefits.

Importance of IAS 19 International Accounting Standard for Companies:

IAS 19 International Accounting Standard is an important IFRS that helps companies to:

• Comply with IFRS: IAS 19 International Accounting Standard ensures that companies account for employee benefits consistently with IFRS.
• Improve the Quality of Financial Reporting: Applying IAS 19 International Accounting Standard leads to improved quality, relevance, and reliability of financial information related to employee benefits.
• Enhance Investor Confidence: IAS 19 International Accounting Standard helps build investor confidence by providing more accurate and transparent information about an entity’s obligations to its employees.
• Better Manage Employee Benefit Costs: IAS 19 International Accounting Standard provides a clear accounting framework for employee benefits, helping companies manage these costs more effectively.
• Make Better Decisions: IAS 19 International Accounting Standard helps management make better decisions about designing and managing employee benefit plans.

Challenges in Applying IAS 19 International Accounting Standard:

• Complexity of the Standard: IAS 19 International Accounting Standard is a relatively complex standard, especially concerning accounting for defined benefit plans.
• Actuarial Valuations: Accounting for defined benefit plans requires complex actuarial valuations, which may pose a challenge for companies that do not have the necessary expertise. This often necessitates hiring external actuarial experts.
• Actuarial Assumptions: Actuarial valuations rely on a set of assumptions about the future, such as mortality rates and investment return rates, which may be uncertain and require significant judgment. Small changes in assumptions can have a large impact on the calculated liability.
• Need for Detailed Data: Applying IAS 19 International Accounting Standard requires the availability of detailed data about employee benefit plans and the benefiting employees.
• Changes in Accounting Standards: Companies must keep up with any changes or updates to IAS 19 International Accounting Standard to ensure compliance with the latest requirements.

Role of Technology in Applying IAS 19 International Accounting Standard:

Accounting software and Enterprise Resource Planning (ERP) systems, as well as specialized actuarial software, help in applying IAS 19 International Accounting Standard more efficiently and accurately by:

• Automating complex calculations, such as calculating the present value of defined benefit obligations.
• Managing data related to employee benefits.
• Performing the analyses necessary to assess the impact of different actuarial assumptions (sensitivity analysis).
• Generating the reports necessary to comply with disclosure requirements.
• Improving the accuracy and comprehensiveness of financial information related to employee benefits.
• Facilitating the audit process by providing a clear and accurate audit trail of all calculations and estimates.
• Supporting decision-making by providing analytical tools that help management better understand employee benefit costs and design more effective benefit plans.

Detailed Examples of Applying IAS 19 International Accounting Standard:

Example (1) Short-term Employee Benefits:

• Situation: Company “A” has 100 employees, each earning a monthly salary of 5,000 Riyals. The company also offers an annual bonus equivalent to 10% of total annual salaries if the company achieves its specified performance targets.
• Accounting Treatment:
  • Company “A” will recognize a monthly salary expense of 500,000 Riyals (100 employees × 5,000 Riyals) in profit or loss.
  • If it is probable that the company will achieve its performance targets, it will estimate the expected annual bonus amount and accrue for this amount throughout the year.
  • The bonus will be recognized as an expense in profit or loss when it becomes due.

Example (2): Defined Contribution Plan:

• Situation: Company “B” contributes 5% of each employee’s monthly salary to a defined contribution plan. The company’s total monthly salaries are 200,000 Riyals.
• Accounting Treatment:
  • Company “B” will recognize a monthly pension contribution expense of 10,000 Riyals (200,000 × 5%) in profit or loss.
  • This amount will be transferred to the separate fund designated for the defined contribution plan.

Example (3): Defined Benefit Plan:

• Situation: Company “C” operates a defined benefit plan for its employees. At the end of 2023, the actuary assessed the present value of the defined benefit obligation at 2,000,000 Riyals. The fair value of the plan assets was 1,700,000 Riyals. The current service cost was 150,000 Riyals, and the discount rate used was 6%.
• Accounting Treatment:
  • Recognition of Net Defined Benefit Liability: Company “C” will recognize a net defined benefit liability in the statement of financial position of 300,000 Riyals (2,000,000 – 1,700,000).
  • Recognition of Current Service Cost: Company “C” will recognize 150,000 Riyals as an expense in profit or loss.
  • Calculate Net Interest on Net Defined Benefit Liability:
    • Net Interest = Discount Rate × Net Defined Benefit Liability at the Beginning of the Period.
    • Note: To calculate the net defined benefit liability at the beginning of the period, we will assume it was 250,000 Riyals (for illustrative purposes only).
    • Net Interest = 6% × 250,000 = 15,000 Riyals
  • Journal Entry to recognise current service cost and net interest:
    • Debit: Current Service Cost Expense 150,000 Riyals
    • Debit: Net Interest Expense 15,000 Riyals
    • Credit: Net Defined Benefit Liability 165,000 Riyals
  • Remeasurement of Net Defined Benefit Liability: Company “C” will remeasure the net defined benefit liability at the end of each reporting period, and any changes in value (due to changes in actuarial assumptions or returns on plan assets) will be recognized in other comprehensive income.

Example (4): Other Long-term Employee Benefits:

• Situation: Company “D” offers a 6-month paid sabbatical leave to its employees who complete 20 years of service.
• Accounting Treatment: Company “D” will estimate the present value of the sabbatical leave obligation using an actuarial valuation method, taking into account employee turnover and discount rates. The company will recognize the liability in the statement of financial position and the related expense in profit or loss over the employees’ service period.

Example (5): Termination Benefits:

• Situation: Company “E” decided to terminate the employment of 50 employees as part of a restructuring plan. The company offers termination benefits of 25,000 Riyals per employee.
• Accounting Treatment:
  • Company “E” will recognize a termination benefit expense of 1,250,000 Riyals (50 employees × 25,000 Riyals) in profit or loss.
  • Company “E” will recognize a termination benefit liability of the same amount (1,250,000 Riyals) in the statement of financial position.

Impact of IAS 19 International Accounting Standard on Financial Statements:

• Statement of Financial Position: IAS 19 International Accounting Standard affects the statement of financial position through the recognition of employee benefit liabilities, especially defined benefit plan liabilities. The entity may also recognize assets related to employee benefits if there is a surplus in funding defined benefit plans.
• Statement of Profit or Loss: IAS 19 International Accounting Standard affects the statement of profit or loss through the recognition of employee benefit expense, which includes current service cost, net interest on the defined benefit liability, the cost of other short-term and long-term employee benefits, and termination benefits.
• Statement of Comprehensive Income: IAS 19 International Accounting Standard affects the statement of comprehensive income through the recognition of remeasurements of defined benefit obligations (changes in actuarial assumptions and returns on plan assets).
• Disclosures: IAS 19 International Accounting Standard imposes comprehensive disclosure requirements aimed at enabling users of financial statements to understand the nature and impact of employee benefits on the entity’s financial position, financial performance, and cash flows.

Importance of Compliance with IAS 19 International Accounting Standard:

Compliance with IAS 19 International Accounting Standard is crucial for several reasons:

• Compliance with International Standards: Applying IAS 19 International Accounting Standard ensures that the company complies with IFRS, which is essential for companies listed on international stock exchanges or seeking to attract foreign investment.

• Transparency and Credibility: Applying IAS 19 International Accounting Standard enhances the transparency and credibility of financial statements by fully disclosing the entity’s obligations to its employees.
• Better Assessment of the Company: IAS 19 International Accounting Standard enables investors and analysts to assess the company’s financial position more accurately by taking employee benefit obligations into account.
• Avoiding Legal Violations: Failure to comply with IAS 19 International Accounting Standard may expose the company to violations and fines by regulatory authorities.

Conclusion:

IAS 19 International Accounting Standard, “Employee Benefits,” is an important standard that affects many companies, especially those that offer pension plans or other long-term benefits to their employees. IAS 19 International Accounting Standard provides a comprehensive framework for accounting for all forms of employee benefits, from salaries and wages to complex retirement plans. Understanding IAS 19 International Accounting Standard and applying it correctly is essential for accountants, auditors, investors, and anyone seeking to understand how employee benefits affect an entity’s financial position and financial performance.

Applying IAS 19 International Accounting Standard requires a deep understanding of its requirements, especially with regard to defined benefit plans that require complex actuarial valuations. Therefore, preparing adequately for IAS 19 International Accounting Standard ensures that accurate and transparent financial reports are prepared that meet the needs of all stakeholders and effectively reflect the economic reality of the company. Finally, technological developments and the use of specialized accounting software can significantly contribute to the efficient and effective application of IAS 19 International Accounting Standard.