Chapter 4: Short-term benefit plans

Recognition and measurement

Short-term employee benefits are defined as “employee benefits (other than termination benefits) that are expected to be settled wholly within twelve months after the end of the annual reporting period in which the employees render the related service”.

Benefits payable in cash

Accounting for wages and salaries is generally straightforward. A liability and an expense, unless capitalisation is appropriate, are recognised when an employee has rendered services. Capitalisation of employee benefits as part of the cost of an asset is dealt with in IAS 2, IAS 16 and IAS 38.

Short-term bonuses and other short-term profit-sharing arrangements are also straightforward. A liability and an expense are recognised when the reporting entity has a present legal or constructive obligation to make payments as a result of past events and a reliable estimate can be made of the amount payable. The considerations are similar to those in IAS 37.

Detailed discussion on treatment of additional service conditions for bonus pay-outs If a bonus has not been paid by the balance sheet date, the amount recognised as a liability should be based on the expected amount payable. Often, an annual bonus is payable sometime after the year end and only to those employees who remain in employment until that time. The amount provided at the balance sheet date should take account of the expected number of leavers, if the amount payable has not been determined by the date on which the financial statements are signed in accordance with IAS 19. However, IAS 19 is unclear as to whether the additional service condition (that is, the requirement to remain in employment until the date on which the bonus is paid) should be taken into account when considering the period over which the bonus expense is recognised. It states that “employees render service that increases the amount to be paid if they remain in service until the end of the specified period”. There are two schools of thought as to how this could be interpreted. The first is that, because the amount of the bonus does not increase after the end of the performance period, the full liability should be recognised at the balance sheet date, with an appropriate adjustment for expected leavers. Thus, the associated expense is recognised over the shorter performance period. The second is that there is another vesting condition to be fulfilled in addition to the performance condition, namely that the employee should remain in employment until the later date and might still forfeit the right to payment by leaving before that date. By analogy with IAS 19, for a plan that pays a lump sum of C1,000 on completion of 10 years of service, an expense of C100 (adjusted to reflect the probability that the employee might leave and ignoring the time value of money for simplicity) should be recognised each year. Thus, the associated expense is recognised over the longer vesting period. Furthermore, IFRS 2 concludes that a liability and an expense should be recognised in respect of a cash-settled share-based payment arrangement, because services are rendered over the entire vesting period. The vesting period is the period until both performance and service conditions are satisfied. Short-term employee benefits within the scope of IAS 19 are outside the scope of IFRS 2, but the IASB considered the standards to be consistent in this area. Hence, recognising an expense over the longer period, until the bonus award vests, is consistent with the treatment for share-based payments under IFRS 2.

Bonus payable to employees three months after the year end An entity has a December year end. It pays a bonus in respect of each year to employees who have provided services during the year and who remain on the payroll at 31 March. The bonus pool is determined as 5% of entity profits, and each employee’s entitlement is determined as at 31 December. There is no reallocation of the bonus entitlement of employees who leave before 31 March. On average, 1% of employees leave the entity each month. The financial statements for the year ended 31 December 20X3 showed a profit, for the purpose of the bonus plan, of C100 million, and they were signed on 28 February 20X4. It is expected that an average of 3% of the employees who worked during the previous year will leave the entity in the period from 1 January to 31 March. The bonus pool for the year ended 31 December 20X3 was C5 million, so the expected amount payable on 31 March 20X4 would be C4.85 million (97% of C5 million). The actual experience in the period up to the date on which the financial statements were signed should be taken into account where it is a confirmation of expectations at the balance sheet date. If 3% of employees actually left during January and February 20X4, but it is still expected that a further 1% will leave during March through the normal course of business, the total amount recognised as an expense would be C4.8 million (96% of C5 million). However, if employees left after the balance sheet, due to a post balance sheet event such as an acquisition or a loss of a major contract or customer, this is likely to be new information arising after the balance sheet date and should not be taken into account. Employees are required to provide services until 31 March. Although an argument can be made for recognition over the shorter 12-month performance period (as discussed above), in our view the expense should be recognised over the longer 15-month vesting period ending on 31 March. Accordingly, a liability of C3.84 million (that is, C4.8 million × 12/15) should be recognised at 31 December 20X3.

The only additional guidance relates to when a reliable estimate can be made of the amount payable. A reliable estimate can be made only when:

• the formal terms of the profit-sharing or bonus plan contain a formula for determining the amount payable;
• the amount payable is determined before the financial statements are authorised for issue; or
• past practice gives clear evidence of the amount of the entity’s constructive obligation.

One-off compensation payment associated with future operations An entity intends to alter the terms and conditions of employment at one factory in such a way that overtime will be paid in future at 1.5 times the normal rate, rather than twice the normal rate as in the past. The entity intends to compensate employees with a one-off payment, and it has put this offer to the union. The employees are also aware of this impending change. No agreement has been reached with the union at the year-end. However, if the offer is not accepted, the entity is likely to switch overtime work to other factories. The entity can withdraw the offer to the union at any time prior to the union’s acceptance. Provision should not be made for the planned expenditure to operate in a particular way in the future, because the entity can avoid that expenditure by changing its method of operation and by withdrawing the offer prior to the union’s acceptance. Therefore, the proposed one-off compensation payment that is associated with the future operations, and that could be avoided by switching overtime production to other factories, should not be provided for, in advance, at the year-end. However, if agreement for the payment had been reached with the unions by the year end and the payment was no longer dependent on future events, a liability should be recognised for the payment at the year-end.

Performance bonus based on sales target A car dealer has a practice of paying a performance bonus to its sales staff. Past evidence indicates that sales staff who meet their sales targets received a bonus of 10% of their current salary package at the year-end. Sales staff who were not in service throughout the whole year received a bonus in proportion to their service period. The bonuses are paid in the first quarter of the following year to the sales staff who are still employed by the entity at the year-end. At the year-end, seven of the sales staff met their sales targets. Two of the seven began their employment halfway through the year, and one of them left the entity before the year end. The car dealer should recognise a liability at the expected cost of the bonuses to be paid in the subsequent year for the following reasons: the dealer created a valid expectation among the sales staff that they would receive bonuses if they met their sales targets and were still in the entity’s service (that is, there is a constructive obligation); and the amount of the payment can be estimated reliably. There are four sales staff who will receive a bonus of 10% of their current salary packages, and two who will receive 5% because their employment commenced halfway through the year. No provision should be recognised for the employee who resigned before the year end, because the employee will not receive a payment.

Cash payments to employee trusts

An entity might establish a trust to act as intermediary in respect of payments to employees. The entity makes a payment to the trust for the benefit of the entity’s employees, and the trust uses the assets accumulated from those payments to pay the entity’s employees for some or all of the services rendered. The key consideration is whether the trust should be consolidated or treated as a long-term employee benefit fund.

Treatment of amounts paid to employee trusts IFRS 10 defines the principle of control, and it establishes control as the basis for determining which entities are consolidated in the consolidated financial statements. IFRS 10 also sets out the accounting requirements for preparing consolidated financial statements. An employee benefit trust that is controlled by a group entity is consolidated in the group financial statements, unless the trust meets the definition of a long-term employee benefit fund. Another consideration is whether an employer’s payment to an employee benefit trust represents an immediate expense. Generally, most expenses are incurred when the related services are received and not when they are paid for. Payments to employee benefit trusts will also need to be analysed in the same way. Further, an immediate expense will occur only if a payment does not result in the acquisition of another asset or the settlement of a liability.

Short-term compensated absences

Compensated absences are periods during which an employee does not provide services to the employer, but employee benefits continue to be paid. Typical examples include:

• Annual leave.
• Sick leave.
• Maternity leave.
• Jury service.
• Military service.

Accumulating absences are those that can be carried forward and used in future periods. Non-accumulating absences lapse if not used in full. Accumulating absences are earned by employees as they provide services, whereas non-accumulating absences are not related to service.

Sick leave, maternity leave and jury service are usually non-accumulating, whereas annual leave entitlements could be accumulating or non-accumulating. An entity should provide for the expected cost of holiday benefit that is accumulating (that is, earned over time and capable of being carried forward).

The reporting entity does not recognise a liability or expense until the absence occurs for a non-accumulating benefit. A non-accumulating benefit that cannot be carried forward over a year end could be an accumulating benefit in an interim reporting period if it can be carried forward for the balance of the year.

Holiday pay carried forward Employees of entity A are entitled to 20 days of paid leave each year. The entitlement accrues evenly throughout the year, and unused leave can be carried forward for one calendar year. This is an example of accumulating compensated absence.

Sick leave entitlement not carried forward Employees of entity B are entitled to 10 days of paid sick leave each year, regardless of how long they have worked for the entity. Unused sick leave cannot be carried forward, and it cannot be used as additional annual leave. This is an example of a non-accumulating compensated absence. Although there is an entitlement to 10 days of paid sick leave each year, employees do not earn this entitlement as the year progresses, and its use cannot be predicted.

Holiday pay while factory is closed An entity has made a provision for holiday pay, accruing three weeks’ pay per worker over the year until the summer holiday, when the factory is closed for three weeks. The holiday year runs until the end of this summer holiday. The employees of this entity accumulate benefit throughout the year, so provision should be made for the expected cost of the holiday pay. The fact that employees might lose the benefit if they leave the entity does not remove the need for a provision, although it might influence the measurement of the provision.

Identifying absences as accumulating or non-accumulating is important, because it will determine the timing of recognising an expense. The expected cost of compensated absences is recognised as follows: In the case of accumulating compensated absences – when the employees render services that increase their entitlement to future compensated absences. In the case of non-accumulating compensated absences – when the absences occur.

Accumulating compensated absences are further categorised as either vesting or non-vesting. Employees with vesting benefits who leave are entitled to cash payment in respect of any unused entitlement. Non-vesting benefits, on the other hand, are lost if an employee leaves without using them. This distinction impacts measurement, but not the existence of a liability. The amount recognised as a liability is the

“Additional amount that the entity expects to pay as a result of the unused entitlement that has accumulated at the balance sheet date”. If benefits are non-vesting, the amount recognised as a liability will take into account the possibility that employees will leave before they utilise their entitlement.

Holiday pay that lapses if employee leaves Employees of entity A are entitled to 20 days of paid leave each year. The entitlement accrues evenly throughout the year, and unused leave can be carried forward to the following year. There is no cash payment in respect of an unused entitlement if an employee leaves the entity. At 31 December 20X3, entity A has 100 employees, and the average unused holiday entitlement per employee is two days. Historically, 10% of employees leave, having never taken their unused holiday entitlement, and management expects this trend to continue. At the balance sheet date (31 December), entity A should recognise a liability representing the number of days of accumulated entitlement that it expects to have to pay in the future. This will be 180 days (that is, 90% of 200 days). If entity A changed its terms and conditions of employment, such that a cash payment was made in respect of unused holiday entitlement when an employee left the entity, the amount provided would be 200 days. This is because it would be irrelevant that 10% of employees never took all of their holiday entitlement, because they would receive a cash payment of equivalent value on leaving the entity.

Unused holiday carried forward for one year only Question: How much should be recognised as a liability in respect of unused holiday entitlement? Solution: Assume the same facts as in previous FAQ, but unused holiday entitlements can be carried forward for only one year. Each year, the current year entitlement is used before any balance brought forward from the previous year. All 100 employees have two days of unused holiday entitlement at 31 December 20X3. Management of entity A expects that 75% of employees will take 22 days of holiday in 20X4 (that is, including two days each brought forward from 20X3), 15% will take 20 days (that is, losing their two days carried forward) and the remainder (10%) will take 18 days (that is, losing their two days carried forward from 20X3 and being eligible to carry forward two days from 20X4’s entitlement at 31 December 20X4). This means that the total expected holiday to be taken in 20X4 is 2,130 days. The liability is calculated at the level of individual employees, and it is based on the additional amount that an entity expects to pay as a result of the unused entitlement. The liability is based on only the 75% of employees who are expected to use their brought forward entitlement. So, the liability recognised at 31 December 20X3 would be 150 days (that is, two days for each of 75 employees).

Financial year different from holiday year Entity A has a March year-end but its holiday year runs to the end of September. Employees of entity A are entitled to 20 days of paid annual leave, all of which should be taken by the end of September or it will be lost. On the basis of past experience, management estimates that staff will take only 95% of their holiday entitlement. Staff do not work at weekends or on national holidays, so there are 253 working days per year. The total annual salary cost for the year ended 31 March 20X4 is C800,000. A pay rise of 4% was awarded with effect from 1 April 20X4, so the total annual salary cost for the year ending 31 March 20X5 will be C832,000. By 31 March 20X4, staff have earned half of their total annual holiday entitlement (that is, 10 days) but have, on average, taken only four days. Hence, the amount of holiday earned but not yet taken at 31 March 20X4 is six days. Although this entitlement would be lost if not taken by the end of September, management believes that most will be taken in line with its overall estimates for the year (that is, cumulatively 95%). Four days have been taken so far, so a provision should be made in respect of the remaining five and a half days expected to be taken (95% × 10 days less 4 days taken). The amount provided should be based on the pay rate at which management expects the leave to be taken. The annual salary cost, with effect from 1 April 20X4, is C832,000, so the amount provided should be C18,087 (that is, 5½/253 × C832,000).

Benefits in kind

The cost of providing non-monetary benefits (including free or subsidised goods or services) should be recognised according to the same principles as benefits payable in cash. The amount recognised as a liability and an expense should be measured at the cost to the employer of providing the benefit. For example, the cost of private medical insurance, for medical benefits provided in the course of employment, would be the amount of premiums paid in the year.

How should benefits in kind in the form of company cars be presented in an income statement presented by nature of expense? Entity A enters into a leasing agreement with a leasing company to lease a car for 36 months, and it recognises a right-of-use asset in accordance with IFRS 16. At the same time, entity A enters into an agreement under which its employee will be permitted to use this car for the same period, provided that he or she is employed on terms that are beneficial to the employee. This is an employee benefit within the scope of IAS 19. Entity A makes a policy election to account for the agreement with the employee by applying only IAS 19. The employee’s monthly salary is presented as personnel expense net of any payments made for the car. How should entity A present the depreciation expense on the right-of-use asset in the income statement? There is no specific guidance on the presentation of the expense in IFRSs. It could be argued that an expense has only one nature and is presented as depreciation. However, it could also be argued that the nature of the expense is not depreciation but employee costs. Both presentations are acceptable, and so the entity has a policy choice for the presentation in accordance with IAS 1. The policy chosen should be consistently applied and disclosed. In either case, the benefit of the company car should be included in key management personnel compensation (if the car is provided to a member of key management personnel). The compensation might be calculated and disclosed, for example, by reference to the depreciation charge or the amount that the employee would have to pay to lease a similar vehicle.