Accounting

BA606 FINANCIAL BA606 FINANCIAL ACCOUNTINGACCOUNTING

Professor Garry CarnegieProfessor Garry Carnegie

Lectures 15 & 16Lectures 15 & 16

Lectures 15 & 16: Accounting for Lectures 15 & 16: Accounting for employee benefitsemployee benefits

IntroductionIntroduction

Wages and salariesWages and salaries

Compensated absencesCompensated absences

Profit sharing and bonus plansProfit sharing and bonus plans

Termination benefitsTermination benefits

Post-employment benefitsPost-employment benefits


There are many dimensions to There are many dimensions to renumerating employeesrenumerating employeesIt is commonplace to speak of “salary It is commonplace to speak of “salary packages”packages”A raft of salary packages existA raft of salary packages existSome components of packages provide Some components of packages provide conditional and/or deferred benefits, such conditional and/or deferred benefits, such as superannuation (deferred) and long as superannuation (deferred) and long service leave (deferred and conditional)service leave (deferred and conditional)


Issues in accounting for deferred and Issues in accounting for deferred and conditional benefits relate to measuring conditional benefits relate to measuring and reporting the annual expense and the and reporting the annual expense and the associated liabilityassociated liabilityAASB 119 “Employee Benefits” deals with AASB 119 “Employee Benefits” deals with accounting for employee benefitsaccounting for employee benefitsThis standard provides general This standard provides general recognition, measurement and disclosure recognition, measurement and disclosure requirements relating to employee benefitsrequirements relating to employee benefits


AASB 119 defines “employee benefits” as “all AASB 119 defines “employee benefits” as “all forms of consideration given by an entity in forms of consideration given by an entity in exchange for service rendered by employees” exchange for service rendered by employees” (para. 7)(para. 7)It requires an entity to recognise: It requires an entity to recognise: ““(a) a liability when an employee has provided (a) a liability when an employee has provided service in exchange for employee benefits to be service in exchange for employee benefits to be paid in the future; and (b) an expense when the paid in the future; and (b) an expense when the entity consumes the economic benefit arising entity consumes the economic benefit arising from service provided by an employee in from service provided by an employee in exchange for employee benefits” (Objective)exchange for employee benefits” (Objective)


AASB 119 specifies two bases for the AASB 119 specifies two bases for the measurement of liabilities arising from employee measurement of liabilities arising from employee benefits:benefits:- nominal basis of measurement; and- nominal basis of measurement; and- present value basis of measurement- present value basis of measurementThe nominal basis must be used for “short-term The nominal basis must be used for “short-term employee benefits” (as defined in para. 7) where employee benefits” (as defined in para. 7) where short-term obligations (such as those specified short-term obligations (such as those specified in para. 8) are measured at undiscounted in para. 8) are measured at undiscounted amounts that will ultimately be paid to settle the amounts that will ultimately be paid to settle the obligations (para. 9)obligations (para. 9)


The present value basis of measurement The present value basis of measurement is required to be used for long-term is required to be used for long-term liabilities, which include:liabilities, which include:- retirement benefits such as pensions- retirement benefits such as pensions- other post-employment benefits, such as - other post-employment benefits, such as post-retirement life insurance and post-post-retirement life insurance and post-employment medical care (para. 24)employment medical care (para. 24)- other long-term employee benefits - other long-term employee benefits (paras. 126 and 127)(paras. 126 and 127)


In addition, “termination benefits” (as defined in In addition, “termination benefits” (as defined in para. 7) that fall due more than 12 months after para. 7) that fall due more than 12 months after the reporting date are required to be discounted the reporting date are required to be discounted as well (para. 139)as well (para. 139)

AASB 119 classifies post-employment benefit AASB 119 classifies post-employment benefit arrangements as either “defined contribution arrangements as either “defined contribution plans” or “defined benefit plans” and the relevant plans” or “defined benefit plans” and the relevant accounting and reporting requirements vary accounting and reporting requirements vary accordinglyaccordingly


Wages and salaries are the base Wages and salaries are the base component of employee benefitscomponent of employee benefitsSuch benefits have a monetary and a non-Such benefits have a monetary and a non-monetary componentmonetary componentEmployment agreements are regarded as Employment agreements are regarded as equally proportionally unperformed at the equally proportionally unperformed at the time wages and salaries are paidtime wages and salaries are paidA liability only arises for accrued A liability only arises for accrued wages/salaries payablewages/salaries payable


Wages and salaries shall be recognised Wages and salaries shall be recognised as an expense and a liability (accrued as an expense and a liability (accrued expense) in accordance with para. 10 expense) in accordance with para. 10

Accrued wages/salaries are to be Accrued wages/salaries are to be measured at nominal amounts (para. 10)measured at nominal amounts (para. 10)

Non-monetary benefits are to be Non-monetary benefits are to be measured as the net marginal cost, if any, measured as the net marginal cost, if any, to the employer of the benefits providedto the employer of the benefits provided


This term relates to circumstances in This term relates to circumstances in which employees continue to be paid even which employees continue to be paid even though they are absent, such as:though they are absent, such as:

- annual leaveannual leave

- sick leavesick leave

- long service leavelong service leave


Annual leaveAnnual leaveAnnual leave of four weeks per annum is paid in Annual leave of four weeks per annum is paid in most cases by employers along with, in many most cases by employers along with, in many cases, an annual leave loading of 17.5 per centcases, an annual leave loading of 17.5 per centEntitlement to annual leave arises as services Entitlement to annual leave arises as services are provided by employees and is accrued as an are provided by employees and is accrued as an expense and a liability on this basis (para. 11)expense and a liability on this basis (para. 11)Annual leave is paid at wage rates that are Annual leave is paid at wage rates that are current when employees take their annual leave current when employees take their annual leave entitlementsentitlements


Annual leave is a form of “short-term Annual leave is a form of “short-term employee benefits” as the leave is employee benefits” as the leave is expected to be taken within 12 months expected to be taken within 12 months after the end of the financial period (see after the end of the financial period (see definition in para. 7)definition in para. 7)


Sick leaveSick leave

Employees who are unable to work due to Employees who are unable to work due to illness are entitled to take paid sick leaveillness are entitled to take paid sick leave

Sick leave may be classified into two Sick leave may be classified into two forms:forms:

- non-accumulating sick leave- non-accumulating sick leave

- accumulating sick leave- accumulating sick leave


Non-accumulating sick leave is an annual Non-accumulating sick leave is an annual entitlemententitlement

Unused sick leave of this kind cannot be Unused sick leave of this kind cannot be carried forwardcarried forward

For non-accumulating sick leave, AASB For non-accumulating sick leave, AASB 119 requires the recognition of an expense 119 requires the recognition of an expense and a liability only when the sick leave and a liability only when the sick leave occurs as per para. 11(b)occurs as per para. 11(b)


Accumulating sick leave is where an Accumulating sick leave is where an employee is able to carry forward unused employee is able to carry forward unused sick leave for use in subsequent periodssick leave for use in subsequent periodsUnused sick leave is “saved” and not “lost”Unused sick leave is “saved” and not “lost”As a form of accumulating compensated As a form of accumulating compensated absences, sick leave of this genre gives absences, sick leave of this genre gives rise to the following entitlements:rise to the following entitlements:- vesting sick leave entitlements- vesting sick leave entitlements- non-vesting sick leave entitlements- non-vesting sick leave entitlements


Vesting entitlements are obligations that will Vesting entitlements are obligations that will ultimately be paid by the employerultimately be paid by the employerVesting sick leave entitlements have the same Vesting sick leave entitlements have the same characteristics as annual leave entitlements and, characteristics as annual leave entitlements and, therefore, should be accounted for in the same therefore, should be accounted for in the same waywayNon-vesting entitlements are not unconditional Non-vesting entitlements are not unconditional legal obligations of employers and, in the case of legal obligations of employers and, in the case of sick leave, employees can only benefit when sick leave, employees can only benefit when they are sickthey are sick


For accumulating sick leave, AASB 119 requires For accumulating sick leave, AASB 119 requires a liability to be recognised as employees provide a liability to be recognised as employees provide service that increases their entitlement to future service that increases their entitlement to future paid sick leave [paras. 11 (a) and 13]paid sick leave [paras. 11 (a) and 13]For vesting sick leave, the amount of the For vesting sick leave, the amount of the entitlement is equal to 100 per cent of the sick entitlement is equal to 100 per cent of the sick leave accumulatedleave accumulatedFor non-vesting sick leave, the entitlement is to For non-vesting sick leave, the entitlement is to be estimated, based on past experience, in be estimated, based on past experience, in recognising the accumulated sick leave that is recognising the accumulated sick leave that is expected to be used by employees in futureexpected to be used by employees in future


Under AASB 119, sick leave is a form of Under AASB 119, sick leave is a form of short-term compensated absenceshort-term compensated absence

Any liability for sick leave entitlements is to Any liability for sick leave entitlements is to be measured on a nominal basis at the be measured on a nominal basis at the anticipated pay rates when the leave is anticipated pay rates when the leave is expected to be taken (para. 10)expected to be taken (para. 10)


Long service leaveLong service leave

This genre of leave is provided to employees in This genre of leave is provided to employees in recognition of uninterrupted service with the recognition of uninterrupted service with the same employersame employer

For long service leave purposes, employment For long service leave purposes, employment can be divided into three distinct periods:can be divided into three distinct periods:- preconditional periodpreconditional periodconditional periodconditional periodunconditional periodunconditional period


There are two approaches in accounting There are two approaches in accounting for long service leave:for long service leave:- direct method- direct method- liability method- liability methodUnder the direct method, long service Under the direct method, long service leave is accounted for on a cash basis, leave is accounted for on a cash basis, where expenses are recognised on where expenses are recognised on making cash payments, and no liability is making cash payments, and no liability is recognised for accrued long service leaverecognised for accrued long service leave


Under the liability method, a long service leave Under the liability method, a long service leave expense is recognised as long service leave is expense is recognised as long service leave is earned by employees and a corresponding earned by employees and a corresponding liability is also recognisedliability is also recognisedThe liability accrues from the date employment The liability accrues from the date employment commences as the provision of service by commences as the provision of service by employees gives rise to the entity’s present employees gives rise to the entity’s present obligation for long service leaveobligation for long service leaveThe liability should be classified as current and The liability should be classified as current and non-current as appropriatenon-current as appropriate


Two key difficulties in applying the liability Two key difficulties in applying the liability method are as follows:method are as follows:- the leave is paid at the wage rates that - the leave is paid at the wage rates that are applicable when the leave is taken are applicable when the leave is taken rather than at the wage rates applying rather than at the wage rates applying when the leave is earnedwhen the leave is earned- not all leave earned during a period will - not all leave earned during a period will be takenbe takenRead Acme (H,P & H, pp.468-469)Read Acme (H,P & H, pp.468-469)


Under AASB 119, long service leave as Under AASB 119, long service leave as “other long-term employees benefits” (see “other long-term employees benefits” (see definition para. 7) is to be dealt with in definition para. 7) is to be dealt with in accordance with paras. 126 to 131accordance with paras. 126 to 131


Under para. 128, a liability for long service leave Under para. 128, a liability for long service leave is to be recognised at an amount that is equal to is to be recognised at an amount that is equal to the net total of:the net total of:““(a) the present value of the defined benefit (a) the present value of the defined benefit obligation at the reporting date (see paragraph obligation at the reporting date (see paragraph 64);64);(b) minus the fair value at the reporting date of (b) minus the fair value at the reporting date of plan assets (if any) out of which the obligations plan assets (if any) out of which the obligations are to be settled directly (see paragraphs 102-are to be settled directly (see paragraphs 102-104)”104)”Plans often do not exist to fund long service Plans often do not exist to fund long service leave entitlementsleave entitlements


Actuarial assumptions are to be applied in Actuarial assumptions are to be applied in estimating the present value of the long service estimating the present value of the long service leave defined benefit obligationleave defined benefit obligationThe “Projected Unit Credit Method” or the The “Projected Unit Credit Method” or the “accrual benefit method” is to be applied (para. “accrual benefit method” is to be applied (para. 64)64)This method views each period of service as This method views each period of service as giving rise to an additional unit of benefit giving rise to an additional unit of benefit entitlement and measures each unit separately entitlement and measures each unit separately to build up the final obligation (para. 65)to build up the final obligation (para. 65)


Under para. 69, the probability that some Under para. 69, the probability that some employees may not satisfy the vesting employees may not satisfy the vesting conditions is to be taken into account conditions is to be taken into account when measuring the long service leave when measuring the long service leave obligationobligation

Accrual of the long service leave liability Accrual of the long service leave liability under AASB 119 is consistent with the under AASB 119 is consistent with the liability method, except in two key waysliability method, except in two key ways


First, AASB 119 requires the use of First, AASB 119 requires the use of amounts of future salaries/wages that will amounts of future salaries/wages that will be payable when the leave is takenbe payable when the leave is takenSecond, AASB 119 requires future long-Second, AASB 119 requires future long-service leave obligations to be discounted service leave obligations to be discounted to their present valueto their present valueThe effects, however, of incorporating The effects, however, of incorporating expected wage increases and discounting expected wage increases and discounting procedures tend to offset each otherprocedures tend to offset each other


Such arrangements and plans may be Such arrangements and plans may be equity based or cash-basedequity based or cash-based

Share-based payments are dealt with by Share-based payments are dealt with by AASB 2 as already addressedAASB 2 as already addressed

Cash-based plans are dealt with in AASB Cash-based plans are dealt with in AASB 119 (see paras. 17 to 22)119 (see paras. 17 to 22)


Under para. 17, the recognition criteria for Under para. 17, the recognition criteria for liabilities is specified as follows:liabilities is specified as follows:““An entity shall recognise the expected cost of An entity shall recognise the expected cost of profit-sharing and bonus plans under paragraph profit-sharing and bonus plans under paragraph 10 when, and only when:10 when, and only when:(a) the entity has a present legal or constructive (a) the entity has a present legal or constructive obligation to make such payments as a result of obligation to make such payments as a result of past events; andpast events; and(b) a reliable estimate of the obligation can be (b) a reliable estimate of the obligation can be made”made”


In contrast to the recognition criteria in the In contrast to the recognition criteria in the Framework where future economic Framework where future economic benefits are to be “probable”, para. 17 benefits are to be “probable”, para. 17 states “a present obligation exists when, states “a present obligation exists when, and only when, the entity has no realistic and only when, the entity has no realistic alternative but to make the payments” alternative but to make the payments”

A reason for this variation is outlined in A reason for this variation is outlined in paras. 18 and 19paras. 18 and 19


Such liabilities may be expected to be Such liabilities may be expected to be settled within 12 months of the reporting settled within 12 months of the reporting date (see para. 10) or are otherwise not date (see para. 10) or are otherwise not due to be settled within that period in due to be settled within that period in which case the liability shall be measured which case the liability shall be measured at the present value of the estimated at the present value of the estimated future cash outflows to be made by the future cash outflows to be made by the employeremployer


Termination benefits are described in para. 135Termination benefits are described in para. 135

The criteria for recognition of termination The criteria for recognition of termination benefits are specified in para. 133 (also see benefits are specified in para. 133 (also see para. 134)para. 134)

In summary, a liability and an expense does not In summary, a liability and an expense does not arise unless the entity is “demonstrably arise unless the entity is “demonstrably committed” to provide termination benefits committed” to provide termination benefits which, in effect, constitutes what is “virtually which, in effect, constitutes what is “virtually certain”certain”


Where termination benefits fall due more Where termination benefits fall due more than 12 months after the reporting date, than 12 months after the reporting date, the liability shall be measured at the the liability shall be measured at the present value of the estimated future cash present value of the estimated future cash outflows involvedoutflows involved


AASB 119 defines “post-employment AASB 119 defines “post-employment benefits” as “employee benefits (other benefits” as “employee benefits (other than termination benefits) which are than termination benefits) which are payable after the completion of payable after the completion of employment” (para. 7)employment” (para. 7)

There are two key types of plans:There are two key types of plans:

- defined contribution plansdefined contribution plans

- defined benefit plansdefined benefit plans


These plans are defined in para. 7These plans are defined in para. 7Defined contribution plans are where the Defined contribution plans are where the contributions are made to a fund, as contributions are made to a fund, as specified under an agreement, by an specified under an agreement, by an employer and, in many cases, by employer and, in many cases, by employees as well.employees as well.Defined benefit plans are those which Defined benefit plans are those which specify predetermined benefits to be specify predetermined benefits to be received by an employee on retirementreceived by an employee on retirement


Such plans are to be classified “depending Such plans are to be classified “depending on the economic substance of the plan as on the economic substance of the plan as derived from its principal terms and derived from its principal terms and conditions” (para. 25)conditions” (para. 25)

Under defined contribution plans, an Under defined contribution plans, an employer’s legal or constructive obligation employer’s legal or constructive obligation is limited to the amount that it agrees to is limited to the amount that it agrees to pay into the planpay into the plan


On the other hand, an employer effectively On the other hand, an employer effectively underwrites the actuarial and investment underwrites the actuarial and investment risks of a defined benefit planrisks of a defined benefit plan

For defined contribution plans the For defined contribution plans the accounting and reporting requirements accounting and reporting requirements paras. 43-47 where the treatment is similar paras. 43-47 where the treatment is similar to accounting for salary/wagesto accounting for salary/wages


The management of a defined benefit plan The management of a defined benefit plan is often entrusted to a specialised financial is often entrusted to a specialised financial institutioninstitution

As a specialised topic, the accounting and As a specialised topic, the accounting and reporting requirements of defined benefit reporting requirements of defined benefit plans will not be subject to detailed plans will not be subject to detailed examination (see H, P & H, pp. 481-490)examination (see H, P & H, pp. 481-490)

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