Amendments To AASB 119 – Employee Benefits The .

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Amendments to AASB 119 – Employee BenefitsThe implications for employersActuaries & ConsultantsSee the unforeseenMay 2012

Implementation of therevised AASB 119 is likelyto increase the call for areassessment of whetherAustralia has a deep, highquality corporate bondmarketOn 16 June 2011, the InternationalAccounting Standards Board (IASB)published a revised version of IAS 19Employee Benefits.Australian Accounting Standard AASB 119 –Employee BenefitsThe objective of AASB 119 is to prescribe theaccounting and disclosure for employee benefits byemployers. The standard identifies four categoriesof employee benefits with distinct requirements foreach of: Short-term employee benefitsThe same changes were reflected bythe Australian Accounting StandardsBoard (AASB) in the revised version ofAASB 119 Employee Benefits, issuedon 5 September 2011, replacing thesuperseded requirements of AASB 119(December 2004, as amended) Post-employment benefits Other long-term employee benefits and Termination benefits.In this paper, we describe the changes made by therevised AASB 119 to the requirements of the supersededstandard, starting with a generic description. The mostimportant changes made by the revised AASB 119 andthe potential impacts for Australian employers are thendiscussed in more detail. We also include some questionsfollowing the Brief Summary of Changes section thatemployers should consider now regarding the applicationof AASB 119 in their organisation.The revisions to AASB 119 are expected to have the mostimpact on employers in relation to the measurement ofannual leave liabilities in respect of employees, as wellas for the measurement and recognition of definedbenefit superannuation obligations in the case of thoseemployers who provide defined benefit superannuationto their employees (including former employees,where applicable).2

Brief summary of changesAASB 119 (September 2011) is applicable for reportingperiods starting on or after 1 January 2013 (unlessadopted early). The most significant changes requiredon application of the standard are highlighted belowFull recognition of deficit (surplus) on thebalance sheetUnder the superseded AASB 119, some of the effectof actuarial gains and losses can be excluded fromthe net defined benefit liability (asset) by using the‘corridor approach’, and the effect of unvested pastservice costs is recognised over the average vestingperiod. The revised AASB 119 requires all such itemsto be recognised immediately: Actuarial gains and losses to be recognised in othercomprehensive income (OCI) for retirement benefits Actuarial gains and losses to be recognised in profit orloss for other long-term employee benefits and Past service cost to be recognised in profit or losswithin service cost.Therefore, the net defined benefit liability (asset)recognised on the balance sheet will equal the actualdeficit (surplus) in an entity’s defined benefit plan.Few Australian entities currently use the‘corridor approach’ for recognising actuarial gains orlosses – the ones who do tend to do so for consistencywith U.S. GAAP reporting, typically where they havea U.S. parent. This means that most companies inAustralia already fully recognise actuarial gains or losseseither through OCI (i.e. below the net profit line) orthrough their profit and loss statement. Therefore,the change to require immediate recognition throughOCI is not expected to affect most Australian entities’balance sheets.Introduction of net interest on the net definedbenefit liability (asset)Under the superseded AASB 119, the expected returnon plan assets recognised in profit or loss is determinedbased on the expected rate of return on investments overthe entire life of the underlying obligation. Under therevised AASB 119, the net interest income is introducedas the equivalent of the expected return on plan assetsunder the superseded AASB 119. The net interestincome is included in the net interest on the definedbenefit liability (asset), which is the counterpart underthe superseded AASB 119 of the interest cost and theexpected return on plan assets.The expected return under the superseded AASB 119depends on the actual investment portfolio and istypically not equal to the discount rate applied for thedetermination of scheme liabilities. The net interestincome under the revised AASB 119 is determined basedon the discount rate applied to liabilities rather than theexpected rate of return on assets. When the discountrate is lower than the expected return, application of therevised AASB 119 will increase the defined benefit costrecognised in profit or loss. The difference between the(expected) net interest income and the actual return isrecognised in OCI.The impact of this amendment will be more significantfor Australian entities which currently use the governmentbond rate for the measurement of liabilities underAASB 119 rather than the high quality corporatebond rate which is used in most other jurisdictions.Implementation of the revised AASB 119 is thereforelikely to increase the call for a reassessment of whetherAustralia has a deep, high-quality corporate bond market.Change in the presentation of the definedbenefit costUnder the revised AASB 119, the defined benefit costcomprises service cost, net interest and remeasurements.Service cost (current and past service cost and gains andlosses on curtailments and settlements) and net interestare recognised in profit or loss, while remeasurements(actuarial gains and losses, any changes in the effectof the asset ceiling and the difference between the(expected) net interest income and the actual return)are recognised in OCI for retirement benefits and in profitor loss for other long-term employee benefits.Introduction of more extensive disclosurerequirements in the financial statementsThe revised AASB 119 introduces more extensivedisclosure requirements relating to the characteristics,risks and amounts in the financial statements regardingdefined benefit plans, as well as the effect of definedbenefit plans on the amount, timing and uncertainty ofthe entity’s future cash flows.3

Change in the definition of short-termemployee benefitsThe revised AASB 119 changes the definition of shortterm employee benefits. Short-term employee benefitsunder the superseded AASB 119 were benefits that aredue to be settled within 12 months after the end of theperiod in which the employees render the related service.In contrast, under the revised AASB 119, only benefitsthat are expected to be settled wholly within 12 monthsafter the end of the annual reporting period in whichthe employees render the related service are classified asshort-term employee benefits. The inclusion of ‘expected’and ‘wholly’ in the definition of short-term employeebenefits might lead to a change of classification.For example, for annual leave in Australia it is generallynot required (or ‘expected’) that the accrued annualleave is wholly used (settled) before the end of the nextannual reporting period. Due to the adjusted definition,similar benefits classified as short-term employee benefitsunder the superseded standard would be classified aslong-term employee benefits under the revised AASB 119.The impact of this would be that annual leave classifiedas long term would need to be discounted allowing forexpected salary levels in the future period when the leaveis expected to be taken.Taxation in defined benefit plansIn Australia, taxation applies to both investmentearnings on plan assets, and employer contributions(also known as concessional contributions) paid into thedefined benefit plan. Under the superseded AASB 119,there was uncertainty regarding how investments tax andcontributions tax should be allowed for in determiningthe defined benefit disclosures.The revised AASB 119 standard resolves some of thisuncertainty in relation to allowance for contributionstax, which should result in more consistency of financialstatement disclosures, as entities are generally expectedto allow for contributions tax in the calculation ofdefined benefit obligation. However, the revised AASB119 has not provided any clarification on investment taxcompared to the superseded standard.Questions for employers to consider now Should the employer adopt the revised AASB 119earlier than the first reporting period starting in2013?4 What implications would early adoption have(e.g. the treatment of any unrecognised actuarialgains and losses on transition to the newstandard)? For employer sponsors of defined benefitplans, what is the estimated impact on thesuperannuation expense disclosed in theemployer’s income statement? What will be theimpact on the retained profits position of theentity, given full recognition of deficit/surplus inthe balance sheet under the revised standard? Will the nature of annual leave liabilities changefrom short-term to long-term employee benefitsunder the revised standard? If so, what impact willthis have on the value of liabilities disclosed, andwhat assistance may the employer need to makethis calculation? For employers considering a restructuring of theirdefined benefit arrangements, such as a definedbenefit to accumulation transfer, will this be moreor less attractive under the revised standard? As aresult, should the employer bring forward or deferany benefit restructure?

The important changes in more detailIn this section, the changesmade by the revised AASB119 – Employee Benefits arediscussed in more detail,with particular focus on theitems expected to have mostimpact for Australian entitiesThe changes discussed in this section are:Deferred recognition of actuarial gains and losses Full recognition of deficit (surplus) on thebalance sheetActuarial gains and losses arise due to differencesbetween expected and actual experience during thereporting period. As actuarial gains and losses can beeither positive or negative, and depend on marketconditions as well as entity-specific developments,the impact on the net defined benefit liability (asset) canchange from year to year. In order to decrease volatilityin profit or loss, the superseded AASB 119 permitteddeferred recognition through the ‘corridor approach’.Under the corridor approach, the cumulativeunrecognised amount at the start of the reporting periodwas tested against a certain limit (corridor). Only theamount exceeding this limit was recognised in profit orloss, amortised over (at most) the expected future serviceyears of the active participants. Introduction of net interest on the net defined benefitliability (asset) Change in the presentation of the defined benefit cost Introduction of more extensive disclosurerequirements in the financial statements Change in the definition of short-termemployee benefits Taxation in defined benefit plans.The revised AASB 119 clarified the definitionand recognition of termination benefits, but thisis not expected to have a significant impact forAustralian entities and therefore it is not discussed furtherin this paper.Full recognition of deficit (surplus) on thebalance sheetThe deficit (surplus) in an entity’s defined benefit planunder AASB 119 is equal to the difference between thepresent value of the defined benefit obligation (‘DBO’)and the fair value of plan assets. Under the revisedAASB119, the net defined benefit liability (asset) recordedon the balance sheet is equal to the deficit (surplus)in the defined benefit plan and the possible effect ofthe asset ceiling.Under the superseded AASB 119, this was not necessarilythe case due to the possibility of deferring actuarialgains and losses using the ‘corridor approach’ and therequirement to recognise unvested past service costsover the average vesting period rather than immediatelyin the reporting period in which these occur. Deferredrecognition leads to less volatile financial statements,which is the main reason why this treatment waspermitted in the superseded AASB 119.Therefore, a two-step deferral mechanism was in placewhen using the corridor approach, decreasing impact onprofit or loss but, therefore, also distorting the balancesheet position.The superseded AASB 119 also permitted directrecognition either in profit or loss or in OCI, as a resultof which all actuarial gains and losses are included inthe net defined benefit liability (asset). Under the revisedAASB 119, all actuarial gains and losses will be recognisedin OCI in the reporting period in which they occur.Therefore, recognition of actuarial gains and losses inprofit or loss, either on a deferred or immediate basis,will not be possible under the revised AASB 119.Few Australian entities currently use the‘corridor approach’ for recognising actuarial gains orlosses – the ones who do tend to do so for consistencywith U.S. GAAP reporting, typically where they havea U.S. parent. This means that most companies inAustralia either recognise actuarial gains or lossesthrough OCI or through their profit and loss statement.Therefore, the change to require immediate recognitionof actuarial gains and losses is not expected to be anissue for most Australian entities’ balance sheets.5

The fact that the planassets will be multipliedby the discount raterather than the expectedrate of return can havea significant impact onprofit or loss of the entityFor those Australian entities which do use a‘corridor approach’ at present, the impact of the revisedAASB 119 will be that any unrecognised gains and losseson transition to the revised standard will be adjusted forthrough retained profits (i.e. equity).The application of the revised AASB 119 will affectthe current equity position and future profit or loss ofentities currently using the corridor approach. Due topoor investment performance, decreasing discountrates, and changing mortality rates in recent years,most companies using the corridor approach havegenerally disclosed unrecognised actuarial losses.These entities, therefore, present a smaller balancesheet liability (or larger balance sheet asset) than theactual deficit or surplus in the defined benefit plan.On application of the revised AASB 119, all cumulativeunrecognised actuarial gains and losses at the start of theearliest comparative period will be recognised in retainedearnings. If unrecognised actuarial losses are in place,application of the revised AASB 119 will decrease theequity position of the entity, leading to possible knock-oneffects, such as issues with loan covenants or potentialcredit granting to the entity. Also, OCI will becomemore volatile in future years, as all changes of marketrelated assumptions (such as the discount rate) will berecognised in OCI. The balance sheet will, however,reflect the actual net defined benefit liability (asset) basedon the revised AASB 119, which increases comparabilitybetween entities.Deferred recognition of past service costPast service costs arise in case of a change of theemployee benefit plan. Under the superseded AASB 119,when vesting requirements are in place with regard tothe change of the defined benefit plan, past servicecost (or a part of it) should be deferred when unvested.This results in an unrecognised amount which isamortised in profit or loss over the vesting period,typically based on a fixed amortisation schedule.6Under the revised AASB 119, all past service costsare recognised in profit or loss as they occur.Therefore, no unrecognised amount will exist relatingto (unvested) past service cost after application of therevised AASB 119.ConcludingThe revised AASB 119 prohibits delayed recognitionof actuarial gains and losses and past service cost.Therefore, the actual net defined benefit liability (asset)is reflected on the balance sheet. Also, OCI and profitor loss will become more volatile due to immediaterecognition of actuarial gains and losses and past servicecost when compared to the superseded AASB 119.Introduction of net interest on the net definedbenefit liability (asset)Under the superseded AASB 119, the financing costof defined benefit plans recognised in profit or loss aredetermined by the interest cost on the DBO and theexpected return on plan assets. The discount rate bywhich the interest cost is determined is based on marketyields on high-quality corporate bonds (or on governmentbonds in countries where there is no deep market insuch bonds), while the expected return on plan assetsis determined based on the expected rate of returnson investments over the entire life of the underlyingobligation. The rate of return depends on the actualinvestment portfolio and is typically not equal to thediscount rate. In general, the expected return on planassets exceeds the discount rate due to investmentsin assets with a higher level of risk than high-qualitycorporate bonds (e.g. equities or property).The revised AASB 119 introduces the net interest onthe net defined benefit liability (asset), which will berecognised in profit or loss. The net interest on the netdefined benefit liability (asset) is defined as the changeof the net defined benefit liability (asset) during thereporting period that arises from passage of time and isdetermined by multiplying the net defined benefit liability(asset) by the discount rate, taking into account actualcontributions and benefits paid during the reportingperiod. Effectively, this means that the DBO as well as theplan assets are both multiplied by the same discount rate.

Defined benefit costService costProfit or lossNet interestProfit or lossRemeasurementsWith regard to AASB 119, the fact that the plan assetswill be multiplied by the discount rate rather than theexpected rate of return can have a significant impact onprofit or loss of the entity.When the actual return is equal to the expected return,based on superseded AASB 119 this has no impact oneither profit or loss or OCI, as the actuarial gains orlosses on plan assets equals zero. However, based on therevised AASB 119, the return on plan assets excluding theamount included in interest income will be recognised inOCI as part of remeasurements.Although this change gives less room for interpretationby entities of the expected return assumption and willtherefore improve comparability, in general the employeebenefit cost of the entity recognised in profit and losswill increase. Also, effective asset management is notreflected in profit or loss but rather in OCI, which mightbe regarded by companies as a negative effect of therevised AASB 119. This change is implemented in orderto exclude the reward for asset management risks run byentities from profit or loss.In addition, while under the superseded AASB 119 alladministration costs were deducted from the expectedreturn (in profit or loss), under the revised AASB 119 onlythe (administration) costs relating to managing plan assetsare deducted from the actual return (in OCI) and all otheradministration costs should be recognised in profit or losswhen they occur.Change in the presentation of the definedbenefit costUnder the superseded AASB 119, the pensionexpense recognised in profit or loss consists ofseveral components, such as current service cost,interest cost and expected return on plan assets,as well as (depending on the entity’s accountingpolicy) the recognition of actuarial gains and losses.The superseded standard had little guidance on thepresentation of these items within profit or loss and inpractice a number of presentations were used.OCIThe revised AASB 119 is more prescriptive and introducesthe term ‘defined benefit cost’. The defined benefit costcomprises all costs (incomes) during a reporting periodthat lead to the development of the net defined liability(asset), excluding contributions paid.As shown in the diagram above, the defined benefit costis disaggregated in the following components: Service cost, which comprises-- Current service cost-- Past service cost-- Curtailment and settlement gains and losses Net interest on the net defined benefit liability (asset) Remeasurements of the net defined ben

Australia has a deep, high-quality corporate bond market Australian Accounting Standard AASB 119 – Employee Benefits The objective of AASB 119 is to prescribe the accounting and disclosure for employee benefits by employers. The standard identifies four categories of employee benefits with distinct requirements for each of:

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