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FRS 102: Employee benefits reporting changes

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20th May 2014
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Steve Collings highlights some of the issues surrounding employee benefits in section 28 of the new financial reporting standard coming into play in January.

FRS 102 'The Financial Reporting Standard applicable in the UK and Republic of Ireland' essentially modernises the way in which financial reporting in the UK will take place. This article will take a look at the technical content relating to employee benefits and consider some additional areas that accountants using the standard will need to take on board for accounting periods commencing on or after 1 January 2015.

Section 28 on employee benefits deals with all forms of consideration given by an entity to its employees and directors in exchange for services rendered. Section 28 does not, however, deal with share-based payment transactions as these are covered by section 26 of the standard.

Section 28 deals with the following types of employee benefits:

  • Short-term employee benefits (excluding termination benefits) that are expected to be settled before 12 months after the end of the reporting period in which the employee renders the service
  • Post-employment benefits payable to employees after completion of employment
  • Other long-term employee benefits other than short-term employee benefits, post-employment benefits and termination benefits; or
  • Termination benefits as a result of 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.

‘Other long-term employee benefits’ could include:

  • Long-term paid absences such as long-service or sabbatical leave
  • Other long-service benefits
  • Long-term disability benefits
  • Profit-sharing and bonuses; and
  • Deferred remuneration.

The phrase ‘short-term employee benefits’ means those benefits which the entity expects to settle within 12 months after the year-/period-end. Paragraph 28.4 outlines four examples of short-term employee benefits as follows:

  • Wages, salaries and social security contributions
  • Paid annual leave and paid sick leave
  • Profit-sharing and bonuses; and
  • Non-monetary benefits (such as medical care, housing, cars and free or subsidised goods or services) for current employees.

Example - holiday pay

A company has a year-end of 31 December 2015 and is mandated to report under FRS 102 for its accounting year commencing on 1 January 2015. The holiday year runs from 1 October to 30 September each year and as at 31 December 2015 its employees have accrued holiday entitlement which will be paid to them in the following financial year.

Section 28 at paragraph 28.6 requires companies to make accruals for unpaid holiday pay at the year-end. Under current UK GAAP there is no explicit requirement to make such accruals - although FRS 12 'Provisions, Contingent Liabilities and Contingent Assets' at paragraph 11(b) does cite an example of accrued holiday pay meeting the definition of an accrual (ie a liability).

Holiday pay may prove problematic for some companies - particularly larger companies which do not maintain a central record of such information. In addition, as FRS 102 is retrospective, the previous year’s financial statements should also include an accrual for holiday pay accrued by the employee(s) but not paid until the subsequent accounting period.

Profit-sharing and bonus plans

Some companies operate profit-sharing and bonus arrangements for their employees. When such arrangements are in place the entity must make provision for such amounts, but only when:

  • There is a present legal or constructive obligation to make such payments as a result of past events; and
  • A reliable estimate of the obligation can be made.

These two above may seem familiar to many as they relate to the provisions and contingencies section. Essentially, such amounts should only be provided if the entity has an obligation at the balance sheet date to make such payments and these payments are made in the subsequent accounting period.

The term ‘constructive obligation’ can prove very subjective and such an obligation arises on the part of the entity when its past practices or policies create an expectation in the mind-sets of those affected (for example, stating to employees before the balance sheet date that the directors will pay a bonus after the year-end based on actual pre-tax profit. This will create an expectation by the employees that they will receive a bonus and hence create an obligation on the part of the company).

Pensions

Section 28 includes guidance relating to defined contribution and defined benefit pension plans. These are currently the subject of FRS 17 ‘Retirement Benefits’ and there are some subtle changes to section 28 as a result of the changes to the international equivalent, IAS 19 ‘Employee Benefits’.

There are no changes to the way in which a defined contribution pension plan will be accounted for in section 28. In essence, as actuarial risk and investment risk do not, in substance, fall on the part of the entity (even where the plan has insufficient assets to pay all employee benefits), companies will simply charge the contributions to profit and loss as they arise.

Defined benefit plans are inherently more complex to account for. As investment risk and actuarial risk do, in substance, fall on the part of the entity then the company must account for the defined benefit plan in the financial statements. There are some occasions, however, when a defined benefit plan is accounted for as a defined contribution plan.

Example - defined benefit plan accounted for as a defined contribution plan

A school converted to an academy in 2013 and has two forms of pensions: the Teachers’ Pension Scheme (TPS) and the Local Government Pension Scheme (LGPS). The LGPS is a defined benefit pension plan and the academy receives actuarial valuations each year in order that the accounting input and relevant disclosures can be made in the financial statements.

The TPS is a multi-employer scheme and the academy is not able to identify its share of the underlying assets and liabilities of the scheme.

Under paragraph 28.11 of FRS 102, multi-employer plans and state plans are classified as defined contributions plans or defined benefit plans on the basis of the terms of the plan. In this case, however, there is insufficient information available for the academy to identify its share of assets and liabilities in the TPS and therefore the academy must account for the TPS as if it were a defined contribution plan and make the disclosures required under paragraphs 28.40 and 28.40A.

Another point to note where such plans are concerned is in relation to agreements that the entity has entered into which determine how the entity will fund a deficit. Under FRS 17, reporting entities are currently not required to make provision for a liability where there is an agreement in place between the entity and the multi-employer plan stipulating how the entity will fund a deficit arising on the pension plan. Section 28 was amended immediately prior to the publication of FRS 102 which now requires a reporting entity to recognise a liability on the balance sheet representing the contributions payable that arise from an agreement determining how the entity will fund a deficit to the extent that the liability relates to the deficit.

Actuaries

Paragraph 35 to FRS 17 says that “full actuarial valuations by a professionally qualified actuary should be obtained for a defined benefit scheme at intervals not exceeding three years. The actuary should review the most recent actuarial valuation at the balance sheet date and update it to reflect current conditions.”

Paragraph 35 essentially mandates the company to use a qualified actuary. In contrast, paragraph 28.20 in FRS 102 takes a slightly more relaxed approach and does not specifically require an entity to engage an independent actuary to perform the actuarial valuation needed to calculate the defined benefit obligation.

In addition, paragraph 28.20 does not require a comprehensive valuation to be done annually provided the actuarial assumptions have not changed significantly. This paragraph recognises that where no significant changes have occurred, the defined benefit obligation can be measured by adjusting the prior period measurement for changes in employee demographics (for example employee numbers and salary levels).

Annual expense for defined benefit plans

The requirements in FRS 102 relating to the annual expense are based on the revisions to IAS 19 ‘Employee Benefits’ which occurred in 2011. Paragraph 28.23 (a) to (d) says that the cost that should be included in profit or loss will be made up of:

  • The change in the net defined benefit liability arising from employee service rendered during the reporting period in profit or loss;
  • Net interest on the net defined benefit liability during the reporting period in profit or loss;
  • The cost of plan introductions, benefit changes, curtailments and settlements in profit or loss; and
  • Remeasurement of the net defined benefit liability in other comprehensive income.

Paragraph 28.24 says that the net interest on the net defined benefit liability is calculated by multiplying the net defined benefit liability by the discount rate as determined at the start of the accounting period. In doing this calculation, the entity must consider any changes in the net defined benefit liability during the period as a result of contribution and benefit payments. This revised treatment, which replaces the finance charge and expected return on plan assets, where income is credited with the expected long-term yield on the assets in the fund, may increase the annual benefit expense and have a potential impact on earnings.

Presentational differences

Section 28 does not include the same requirement to present the surplus or deficit in a defined benefit pension plan on the face of the balance sheet after ‘other net assets’ as FRS 17 currently does. As a consequence, a deficit in a defined benefit pension plan could be included within ‘provisions’ and surpluses could go within ‘other assets’.

In addition, FRS 17 currently requires a reporting entity to show the defined benefit pension plan net of any related deferred tax considerations. FRS 102 makes no explicit requirement for this to be done and as such a company could include deferred tax in relation to a defined benefit pension plan within other deferred tax.

Conclusion

Employee benefits will largely continue to be accounted for in much the same way under FRS 102. However, clients should be aware of the need to calculate unpaid holiday entitlements at the year-end for inclusion in the financial statements where these are material. In addition, the changes to the way in which defined benefit pension plans are calculated may also have an impact on client’s financial statements.

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