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Chapter 3: Accounting for the closure of a defined benefit pension plan
The term ‘closed’ might be used to describe a pension plan at various stages of its life. The plan might be closed to new members, although existing members continue to earn benefits. Alternatively, there might be no future accrual of benefit, although benefits already earned are preserved; or the plan might be entirely wound up. A pension plan might be wound up and replaced by another plan offering similar benefits. A plan termination where the replacement plan offers benefits that are, in substance, the same is treated as neither a curtailment nor a settlement.
Re-measurements of the net defined benefit liability (asset)
Re-measurements of the net defined benefit liability (asset) comprise:
- actuarial gains and losses;
- the return on plan assets, excluding amounts included in net interest on the net defined benefit liability (asset); and
- any changes in the effect of the asset ceiling, excluding amounts included in net interest on the net defined benefit liability (asset).
Actuarial gains and losses result from increases or decreases in the present value of the defined benefit obligation because of changes in actuarial assumptions and experience adjustments. Causes of actuarial gains and losses include:
- Experience gains and losses arising where actual events during the year differ from the actuarial assumptions in the previous valuation (for example, unexpectedly high or low rates of employee turnover, of early retirement or mortality, or of increases in salaries, benefits or medical costs).
- The effects of changes in actuarial assumptions from one period to the next (for example, to reflect increased life expectancy).
- The effects of changes in the discount rate.
Events that cause actuarial gains or losses Some of the events that result in actuarial gains or losses include (not an exhaustive list):
- Actual or estimated mortality rates, or the proportion of employees taking early retirement, will alter the period for which an entity will be required to make benefit payments. For example, accelerating technological change might cause a manufacturer to reduce its workforce gradually, by offering early retirement to a number of employees.
- Estimated salaries or benefits will alter the amount of each benefit payment. For example, a software developer might decide to increase its salaries by more than the rate of inflation to retain its skilled workforce.
- Estimated employee turnover might alter the number of employees that are expected to transfer their benefits to another pension plan. For example, an unexpected change in tax legislation that makes personal pensions more attractive might lead to a greater number of employees leaving defined benefit plans and making their own pension arrangements.
Actuarial gains and losses do not include changes in the present value of the defined benefit obligations that arise from the introduction, amendment, curtailment or settlement of the defined benefit plan, or changes to the benefits payable under the defined benefit plan. Such changes result in past service costs or gains or losses on settlement.
An entity deducts the costs of managing the plan assets and any tax payable by the plan itself in determining the return on plan assets. Tax excludes any tax included in the actuarial assumptions used to measure the defined benefit obligation. Other administration costs are, likewise, not deducted from the return on plan assets.
Re-measurements should be recognised immediately in full in other comprehensive income (OCI). The re-measurements that have been recognised directly in other comprehensive income are not recycled and are never recognised in the income statement in a subsequent period. However, the entity can transfer these amounts recognised in OCI within equity.
Post-employment benefit plans: multi-employer and state plans
IAS 19 defines a multi-employer plan as a plan, other than a state plan, that:
- pools the assets contributed by various entities that are not under common control; and
- uses those assets to provide benefits to employees of more than one entity, on the basis that contribution and benefit levels are determined without regard to the identity of the employer.
Distinction between multi-employer plans and group administration plans Question:
What is the distinction between multi-employer plans and group administration plans?
Solution:
Multi-employer plans are distinct from group administration plans although, in practice, the terms might be used interchangeably.
A group administration plan, sometimes referred to as a ‘multiple employer’ plan, is merely an aggregation of single employer plans to allow participating employers to pool their assets for investment purposes and reduce investment management and administration costs.
The claims of different employers are segregated for the sole benefit of their own employees. Group administration plans pose no particular accounting problems, because they do not expose the participating entities to actuarial risks associated with the current and former employees of other entities, and information is readily available to treat them in the same way as any other single employer plan.
Industry-wide multi-employer plans Entity A participates in two trustee-administered pension plans that provide centralised pension arrangements for employees throughout the industry. A large number of unrelated employers participate in the plans. Entity A’s employees can be members of either plan, but not both. Entity A contributes to each plan in accordance with the trustees’ instructions.
Plan 1 accumulates the contributions made in respect of each employee in a separate account. The trustees use the accumulated contributions, together with the related investment income, to purchase an annuity for each employee at retirement. Entity A has no obligation to plan 1 beyond its annual contribution.
Plan 2 pays benefits based on final salary and years of service. The employers fund plan 2’s pension obligations by contributing to an independent trust. The trustees estimate the pension funding requirements in order to set the annual contribution. Entity A has an obligation to fund plan 2 based on the decisions made by the trustees, which will take into consideration the actual experience of the plan.
Entity A should classify multi-employer plans as defined benefit plans or defined contribution plans by reference to the economic substance of the arrangements.
Plan 1 is a multi-employer defined contribution plan. The plan pools assets contributed by various unrelated entities and provides benefits to the employees of more than one entity. Entity A has no obligation to plan 1 or its employees beyond its annual contribution. The employees take the actuarial and investment risk.
Plan 2 is a multi-employer defined benefit plan. The plan pools assets contributed by various unrelated entities and provides benefits to the employees of more than one entity.
Entity A has an obligation to plan 2 beyond its annual contribution because, for as long as entity A continues to participate in the plan, the contributions will vary based on the overall experience of the scheme. Entity A is taking some of the actuarial and investment risk, so plan 2 is a defined benefit plan.
Entity A should account for its proportionate share of the defined benefit obligation, plan assets and costs associated with plan 2.
State plans, on the other hand, are established by legislation to cover all entities (or all entities in a particular category, such as a specific industry) and are operated by national or local government or by another body (for example, an autonomous agency created specifically for this purpose) which is not subject to control or influence by the reporting entity.
Employers share risks of a multi-employer plan Entity A participates in an industry-wide pension plan administered by an insurance company. The plan pays benefits based on years of service and final salary. The participating employers fund the plan’s obligations through annual contributions. Entity A should pay a penalty if it withdraws from the plan.
The insurance company does not allocate contributions and employee benefits to separate funds for each participating employer. It does not maintain any detailed records tracking the source of the contributions or which entity employs each member. The employers share the actuarial risks associated with all employees and former employees.
The actuarial valuation of the industry-wide pension shows a small surplus.
Entity A should account for its proportionate share of the defined benefit obligation, plan assets and pension cost in the same way as for any other defined benefit plan in accordance with IAS 19.
The industrywide plan exposes participating employers to the actuarial risks associated with the current and former employees of other participating employers. However, entity A does not have access to the information necessary to apply defined benefit accounting.
Entity A should:
- Account for the pension plan as a defined contribution plan.
- Disclose that the plan is a defined benefit plan and the reasons why insufficient information is available for defined benefit accounting.
- Disclose the extent of any surplus or deficit in the plan that might affect future contributions and any information that is available about the surplus.
Plan in which assets are segregated by employer The facts are the same as in previous FAQ, except that the insurance entity segregates the assets contributed by each employer and uses the assets contributed by entity A, plus the related income and capital appreciation, to pay benefits to entity A’s employees.
Entity A makes cash contributions to the pension plan each year in accordance with an actuary’s recommendations.
Again, entity A has a defined benefit pension plan, because entity A bears the actuarial and investment risk.
However, the insurance company segregates the assets contributed by entity A. The pension arrangements do not expose entity A to actuarial risks associated with other entities’ employees, so these arrangements are not a multi-employer plan.
Such plans could be referred to as ‘group administration’ or ‘multiple employer’ plans, to distinguish them from multi-employer plans.
Entity A should account for its employees’ pension arrangements as a defined benefit plan. The information required to apply defined benefit accounting is readily available, because the assets are segregated.
Multi-employer plans and state plans are accounted for in the same way.
Contractual schedule of contributions to a multi-employer plan Entity A participates in a multi-employer defined benefit plan. It accounts for the plan as if it were a defined contribution plan. The trustees of the plan have agreed with its participants that the current deficit in the plan will be eliminated over the next five years.
A contract has been drawn up, including a schedule of contributions showing that entity A will contribute C10 million in addition to its normal contributions over the next five years.
Accordingly, entity A should recognise a liability and an expense equal to the present value of the C10 million payable. However, this will not affect the entity’s treatment of its normal contributions as if the plan was a defined contribution plan.
Change in accounting for a multiemployer plan from defined contribution to defined benefit plan when information becomes available subsequently Question:
What is the accounting treatment if information becomes available subsequently that indicates a change in accounting from defined contribution plan to defined benefit plan?
Solution:
Sufficient information might become available to an entity after it has applied defined contribution accounting for a number of periods. IAS 19 is clear that, if sufficient information is available, defined benefit accounting has to be applied.
However, IAS 19 does not provide guidance on how to change from defined contribution to defined benefit accounting. The net defined benefit liability (asset) has to be recognised, but it is unclear where the corresponding debit (credit) should be recognised.
We believe that such circumstances should be reflected either as a change in accounting policy (and accounted for with an adjustment to current year opening retained earnings), or as a past service cost (with the change fully recognised in the current period income statement).
An employer that participates in a defined benefit multi-employer plan, including a state plan, should account for its proportionate share of assets, liabilities and costs as for any other defined benefit plan.
Sufficient information might not be available for an entity to account for its participation in a defined benefit multi-employer plan as a defined benefit plan. The entity should account for its participation in the plan as if it were a defined contribution plan where sufficient information is not available.
In this context, ‘is not available’ is considered to mean ‘cannot be obtained. The entity should make every practicable effort to obtain the necessary information in order to apply defined benefit accounting.
A defined benefit multi-employer plan exposes the employer to actuarial risks of the current and former employees of other entities. If this pooling of actuarial risk means that there is no consistent and reliable basis for allocating the obligation, plan assets and cost to individual entities participating in the plan, participating employers would account for the plan as if it were a defined contribution plan.
There might be a contractual agreement between a multi-employer plan and its participants that determines how a surplus in the plan will be distributed or a deficit funded.
A participant in a multi-employer plan that is accounting for that plan as a defined contribution plan should recognise the asset or liability and the resulting income or expense that arises from the contractual agreement. The proportionate share should be determined under IAS 19 rather than on a funding or any other basis.
Group plans
Group pension plans could be considered to be a type of multi-employer plan. Contributions from a number of employers (the members of the group) are pooled, and pension arrangements are administered centrally. However, “defined benefit plans that share risks between entities under common control, for example a parent and its subsidiaries, are not multi-employer plans”. Instead, IAS 19 contains specific rules for group pension plans.
An entity that participates in a defined benefit plan that shares risks between entities under common control should obtain information about the plan as a whole, measured in accordance with IAS 19. The net defined benefit cost should then be allocated among the participating entities as follows:
- If there is a contractual agreement or stated policy for charging the net defined benefit cost for the plan as a whole to participating entities, the entity should recognise the net defined benefit cost that is charged in its separate or individual financial statements.
- If there is no such agreement or policy, the net defined benefit cost for the plan as a whole should be recognised in the separate or individual financial statements of the entity that is legally the sponsoring employer for the plan. The other group entities should recognise a cost, equal to their contribution payable for the period, in their separate or individual financial statements.
Meaning of the term ‘net defined benefit costs’ Question:
IAS 19 requires consideration of the contractual agreement or stated policy for charging the net defined benefit cost for the plan as a whole to individual entities in a group. What is the meaning of the term ‘net defined benefit costs?
Solution:
The accounting for a group plan depends on whether or not there is a contractual agreement or stated policy for sharing the net defined benefit cost amongst the participating employers. However, no definition is provided for the ‘net defined benefit cost’.
IAS 19 outlines the amounts to be recognised in profit or loss. This might suggest that the net defined benefit cost is the net amount recognised in the income statement, thus ignoring any re-measurements recognised outside profit or loss. In our view, the term should not be interpreted in this way.
Instead, it should be considered more broadly, to include the total benefit cost recognised in respect of the pension plan, regardless of whether amounts are recognised within or outside profit or loss (For example, re-measurements).
Factors to be considered to identify the ‘sponsoring employer’ Question:
What are the factors that need to be considered to identify a ‘sponsoring employer’?
Solution:
Where there is no contractual agreement or stated policy for sharing the net defined benefit cost amongst the participating employers, the ‘sponsoring employer’ recognises the net defined benefit cost and the other participating employers recognise their contributions to the plan.
IAS 19 does not define the term ‘sponsoring employer’. The basis for conclusions of the standard provides a limited guidance, stating that “the entity that is the sponsoring employer bears the risk relating to the plan by default”.
Hence, it would appear that any decision as to which entity is the sponsoring employer should be based on a consideration of the risks faced by each participating entity when compared to the others.
Often, the identity of the sponsoring employer will be clear from a plan’s trust deed and rules. However, in the absence of such clarity, we consider that the following factors should be taken into account:
- Which entity’s management is responsible for making decisions concerning the plan and negotiating with its trustees (such as agreeing contribution rates)?
- How are responsibilities that are described in any contribution schedule agreed with the plan trustees?
- Are contributions the responsibility of one entity, with all other participants making payments to that entity, rather than the plan?
- Does one entity guarantee the contributions made by the other group entities?
Judgement involved in recognising net benefit costs Entity B has several trading subsidiaries of similar size. All of the subsidiaries, as well as entity B itself, participate in the ‘entity B group defined benefit plan’. The plan rules do not specify how any surplus or deficit should be allocated amongst participating employers.
However, management has defined a policy for allocating the net defined benefit cost to the individual group entities on the basis of pensionable payroll. Hence, the net defined benefit cost (and the resultant asset or liability) should be recognised on this basis in each of the participating entities’ separate or individual financial statements.
Schedule of contributions agreed with trustees Entity C has several trading subsidiaries of similar size. All of the subsidiaries, as well as entity C itself, participate in the ‘entity C group defined benefit plan’. The plan rules do not specify how any surplus or deficit should be allocated among participating employers.
However, a schedule of contributions has been agreed with the plan trustees. Although this deals with cash payments rather than the net defined benefit cost, it could be argued that a contribution schedule provides evidence as to how the net defined benefit cost (and, hence, the plan surplus or deficit) should be allocated.
So, we believe that, in this example, the net defined benefit cost (and the resultant asset or liability) could be recognised on this basis in each of the participating entities’ separate or individual financial statements. Alternatively, the net defined benefit cost for the plan as a whole could be recognised in the separate or individual financial statements of the entity that is legally the sponsoring employer.
95% of active plan members employed by one entity in the group Entity D has several trading subsidiaries, but one (entity E) is considerably larger than the rest. All of the subsidiaries, as well as entity D itself, participate in the ‘D group defined benefit plan’, but approximately 95% of active members of the plan are employed by entity E.
The plan rules do not specify how any surplus or deficit should be allocated among participating employers, and the entity does not have a stated policy for allocation.
However, in substance, most of the risk in respect of the plan is borne by entity E, because the contribution rate is charged on the salary of active employees, and it is the management of that entity that deals with the plan trustees.
In our view, entity E will be considered to be the sponsoring employer, so the net defined benefit cost (and the resultant asset or liability) should be recognised in full by that entity.
The other entities in the group (including entity D) should treat their participation in the plan as if it was a defined contribution plan (that is, they should recognise a cost equal to their contributions payable for the period).
Employees on the payroll of a separate non-trading service company Entity F, a trading company, has several trading subsidiaries, some of which are overseas. All employees in the ‘entity F group’ are legally employed by a separate non-trading service company subsidiary, entity G, for administrative reasons, but provide services to the trading entities within the group, and not to entity G.
Entity G recharges staff costs, including pension costs, to entity F and its trading subsidiaries. The existence of a recharge arrangement between the group entities is indicative of a stated policy for allocating costs.
Furthermore, the service company is a so-called ‘shell company’ and would be unable to meet the full costs of the pension plan, because it is not trading. The net defined benefit cost (and the resultant asset or liability) should be recognised on the same basis as the costs are recharged in each of the participating trading entities’ separate or individual financial statements.
Insured plans
An employer might pay insurance premiums to fund a post-employment benefit plan. The employer should treat such a plan as a defined contribution plan only where it has no legal or constructive obligation, either directly or indirectly through the plan, to either:
- pay the employee benefits directly when they fall due; or
- pay further amounts if the insurer does not pay all future benefits relating to employee service in the current and prior periods.
The plan is treated as a defined benefit plan, unless the conditions above are met.
Accounting for employer retaining the legal or constructive obligation following purchase of an insurance policy An entity chooses to finance the pension benefits provided for employees through payments to an insurance company. If the insurance company bears all of the actuarial and investment risk and has sole responsibility for paying the benefits, the plan will be treated as a defined contribution plan.
In this situation, the insurance premium costs are, in substance, costs of settling the pension obligation. If the employer, either directly, indirectly through the plan, through a mechanism for setting future premiums, or through a relationship with the insurer, retains a legal or constructive obligation, the payment of the premiums does not settle the pension obligation.
Instead, the plan would be treated as a defined benefit plan, and the insurance policy would be treated as a plan asset or reimbursement right.
Insurance policy against accident and injury compensation Legislation in a particular country requires an entity to provide compensation to employees injured in an accident at work.
The legislation allows employers to cover their obligation with an insurance policy, but makes it clear that employers cannot transfer the legal obligation for making compensation payments to a third party.
A construction entity has a large workforce, and the nature of its business increases the risk of injuries at work. The entity has decided to cover its exposure to injury compensation payments by taking out an insurance policy.
Management believes that the risk that the insurance company will default on its obligations is remote.
The entity should treat its obligations as a defined benefit plan. The legislation does not allow the entity to transfer the obligation for making compensation payments to the insurance entity.
If the insurance company failed to make any payment required by legislation, the company would be required to meet the obligation. The probability of being required to make payments in the future does not affect the accounting treatment. The existence of the legal obligation determines the accounting treatment.