for Accounting Professionals
IAS 26 Accounting and reporting by retirement benefit plans
2011
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Retirement Benefit Plans
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Retirement Benefit Plans
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TACIS project partners included Rosexpertiza (Russia), ACCA (UK), Agriconsulting (Italy), FBK (Russia), and European Savings Bank Group (Brussels). The help of Philip W. Smith (editor of the third edition) and Allan Gamborg, project managers and Ekaterina Nekrasova, Director of PricewaterhouseCoopers, who managed the production of the Russian version (2008-9) is gratefully acknowledged. Glyn R. Phillips, manager of the first two projects conceived the idea, designed the workbooks and edited the first two versions. We are proud to realise his vision.
Robin Joyce
Professor of the Chair of
International Banking and Finance
Financial University
under the Government of the Russian Federation
Visiting Professor of the Siberian Academy of Finance and Banking Moscow, Russia 2011 Reviewed
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Retirement Benefit Plans
CONTENTS
1. Retirement benefit plans- Introduction 3
2. Definitions 4
3. Defined Contribution Plans 5
4. Defined Benefit Plans 6
5. All Plans 9
6. Disclosure 9
7. Multiple choice questions 13
8. Answers to multiple choice questions 14
Note: Material from the following PricewaterhouseCoopers publications has been used in this workbook:
-Applying IFRS
-IFRS News
-Accounting Solutions
1. Retirement Benefit Plans- Introduction
OVERVIEW
Aim
The aim of this workbook is to assist the individual in understanding IAS 26, Retirement Benefit Plans according to IFRS.
IAS 26 is short as most of the work relating to pension schemes is carried out by actuaries, rather than accountants.
Scope
IAS 26 should be applied in the reports of retirement benefit (pension) plans where such reports are prepared.
Retirement benefit plans are sometimes referred to by various other names, such as ‘pension schemes’, ‘superannuation schemes’ or ‘retirement benefit schemes’. IAS 26 regards a retirement benefit plan as a reporting undertaking separate from the employers of the participants in the plan.
All other IFRS apply to the reports of retirement benefit plans unless superseded by IAS 26.
IAS 26 deals reporting by the plan to all participants as a group. It does not deal with reports to individual participants about their retirement benefit rights.
IAS 19 Employee Benefits is concerned with the calculation of the cost of retirement benefits in the financial statements of employers. IAS 26 complements IAS 19.
Retirement benefit plans may be defined contribution plans, or defined benefit plans. (Some plans have characteristics of both. These hybrid plans are considered to be defined benefit plans for the purposes of IAS 26.)
Many require the creation of separate funds, which may or may not have separate legal identity and may or may not have trustees, to which contributions are made, and from which retirement benefits are paid. IAS 26 applies to all.
Retirement benefit plans with assets invested with insurance companies are subject to the same accounting and funding requirements as privately invested arrangements. They are within the scope of IAS 26, unless the contract with the insurance company is in the name of a specified participant, or a group of participants, and the retirement benefit obligation is solely the responsibility of the insurance company.
IAS 26 does not deal with other forms of staff benefits such as:
-employment termination indemnities,
-deferred compensation arrangements,
- long-service leave benefits,
-special early retirement or redundancy plans,
-health and welfare plans or
-bonus plans.
Government pensions are also excluded from the scope of IAS 26.
2. Definitions
Retirement benefit (pension) plans are arrangements whereby an undertaking provides benefits for its staff on, or after, termination of service (either in the form of an annual income, or as a lump sum) when such benefits, or the employer’s contributions towards them, can be determined (or estimated) in advance of retirement from the provisions of a document, or from the undertaking’s practices.
Defined contribution plans are pension plans under which amounts to be paid as pensions are determined by contributions to a fund together with investment earnings thereon.
Defined benefit plans are pension plans under which amounts to be paid as pensions are determined by reference to a formula usually based on staff members’ earnings and/or years of service.
Funding is the transfer of assets to an undertaking (the fund) separate from the employer’s undertaking to meet future obligations for the payment of pensions.
Participants are those who are entitled to benefits under the plan.
Net assets available for benefits are the assets of a plan less liabilities, other than the actuarial present value of promised pensions.
Actuarial present value of promised pensions is the present value of the expected payments by a pension plan to existing and past staff, attributable to the service already rendered.
Vested benefits are benefits, the rights to which are not conditional on continued employment.
EXAMPLES-vested and non-vested benefits
1.You have worked 5 years for your firm. You will work another 10 years then retire. Even if you leave today, you will receive a pension based on the 5 years already worked.
The pension relating to the 5 years’ service is a vested benefit. The pension relating to the remaining 10 years are non-vested, as they will only be paid if you continue to work for the firm until you retire.
2. Your pension plan will only pay pensions to staff which work for the firm until they retire. The only vested benefits relate to those who are pensioners, who receive pensions. Future pensions relating to existing staff are non-vested, as they are conditional on continued employment.
Some pension plans have sponsors other than employers; IAS 26 also applies to the reports of such plans.
EXAMPLE- Sponsors other than employers
Some trade unions provide pensions to members. IAS 26 applies to such plans.
Most pension plans are based on formal agreements. Some plans are informal, but have an obligation as a result of employers’ practices.
EXAMPLE-Informal plans
Your employer provides pensions according to salary and years worked for the firm. Although there is no formal document, staff expect to receive this pension on retirement. The employer has an obligation, as non-payment of pensions would incite problems with both existing and former staff.
While some plans permit employers to limit their obligations under the plans, it is usually difficult for an employer to cancel a plan if staff are to be retained. The same basis of reporting applies to an informal plan as to a formal plan.
Some pension plans provide for separate funds into which contributions are made, and out of which benefits are paid. Such funds may be administered by parties who act independently in managing fund assets. Those parties are called trustees in some countries. The term trustee is used in IAS 26 to describe such parties, regardless of whether a trust has been formed.
EXAMPLE-Separate funds, independently managed
Your firm has various pension funds for different levels of management. These funds are administered by a merchant bank. The funds include only pension money.
3. Defined Contribution Plans
The report of a defined contribution plan should contain:
- a statement of net assets available for benefits and
- a description of the funding policy.
Under a defined contribution plan, the amount of a participant’s future benefits is determined by the contributions paid by the employer, the participant, or both, and the operating efficiency and investment earnings of the fund.
EXAMPLE- Defined contribution plan
Your pension fund is a defined contribution plan. Your firm contributes 10% of your salary and you contribute 5% of your salary to the fund. (These are the defined contributions.) These amounts are invested on your behalf, and build up to a pension that you will receive when you retire.
The firm has no further obligation. Whether or not the investments are profitable, no further money will be paid by the firm.
An employer’s obligation is usually discharged by contributions to the fund. An actuary’s advice is not normally required, except to estimate benefits based on present contributions, and varying levels of future contributions and investment earnings.
The participants are interested in the activities of the plan because they directly affect the level of their future benefits.
Participants are interested in knowing whether contributions have been received and proper control has been exercised to protect the rights of beneficiaries.
An employer is interested in the efficient and fair operation of the plan. The employer wishes to see low administration costs. Good returns from the funds motivate staff, and reduce pressure to increase contributions.
EXAMPLE-Employer’s interest
A firm contributes 10% of its payroll costs to an in-house fund, which costs another 4% of payroll to administer. Poor performance of the fund has led to miniscule pensions. A staff survey shows that staff consider the pension to be of no value. The firm is paying a considerable sum for no benefit.
The objective of reporting by a defined contribution plan is periodically to provide information about the performance of its investments. Such a report should include:
(i) a description of significant activities for the period and the effect of any changes relating to the plan, and its membership and terms and conditions;
(ii) statements reporting on the transactions and investment performance for the period and the financial position of the plan at the end of the period; and
(iii) a description of the investment policies.
4. Defined Benefit Plans
A defined benefit plan is more complicated than a defined contribution plan. Under a defined benefit plan, the participant is promised a specific pension, based on the time worked with the firm, and the salary earned (either in the final year, or an average of the last 3 years).
EXAMPLE-Defined benefit plan
Your firm offers a pension based on your final year’s salary. Each year worked entitles you to 1/60 multiplied by your final salary.
Your final year’s salary was $12.000. You have worked 40 years for the company.
Your annual pension will be $8.000 (40/60*$12.000).
The firm is promising a pension in the future. The calculation of its contributions into the fund are extremely complex and require a specialist (an actuary) to advise on the levels of the contribution.
To calculate the liability to the future pensioner, estimates are needed of:
- the time that each member of staff will work at the firm,
- the age of retirement,
- the final salary figure
- the length of the post-retirement life of the pensioner.
Further calculation is needed if the spouse will receive a pension, after the death of the pensioner.
To calculate the contributions, assumptions must be made of the profits that will be made on the contributions. These comprise the returns on the investments made by the plan.
From these estimates, the actuary calculates whether the fund of contributions will be sufficient to pay the promised pension, or whether contributions need to be increased if the fund is in deficit (or decreased, if the fund is in surplus). An example of assumptions made is included in Sample Note 2 at the end of this workbook.
The report of a defined benefit plan should contain either:
(1) a statement that shows:
(i) the net assets available for benefits;
(ii) the actuarial present value of promised pensions, distinguishing between vested benefits and non-vested benefits; and
(iii) the resulting excess or deficit; or
(2) a statement of net assets available for benefits including either:
(i) a note disclosing the actuarial present value of promised pensions, distinguishing between vested benefits and non-vested benefits; or
(ii) a reference to this information in an accompanying actuarial report.
If an actuarial valuation has not been prepared at the date of the report, the most recent valuation should be used as a base, and the date of the valuation disclosed.
The actuarial present value of promised pensions should be based on service rendered to date, using either:
- current salary levels or
- projected salary levels, with disclosure of the basis used.
The effect of any changes in actuarial assumptions that have had a significant effect on the actuarial present value should also be disclosed.
EXAMPLE- Changes in actuarial assumptions
Your actuary tells you that past pension calculations were based on your recent staff turnover figures. These have been very high over the last few years due to major restructuring of the group. The latest figures assume that staff will stay longer, thereby building larger pensions.
This change in assumption should be disclosed.