Chapter 5: Other long-term benefits

Long-term employee benefits are employee benefits (excluding post-employment and termination benefits) that are not expected to be settled wholly before 12 months after the end of the annual reporting period in which the employees render the service that gives rise to the benefit.

A bonus granted with a three-year vesting period is long term in nature, even though the bonus is paid shortly after completion of the three-year vesting period, because the benefit is considered as being earned over three or four annual accounting periods rather than over one three-year period.

Classification of short- and long-term benefits Question How should an entity classify a benefit as a short-term or other long-term benefit? Answer The example below illustrates the classification of a ‘short-term employee benefit’ and an ‘other long-term benefit’. Employees accrue a 20-day holiday entitlement rateably over the year. Unused entitlement can be carried forward indefinitely, but it is lost with no cash settlement if not used before the employee leaves the company. Entitlement is utilised on a ‘first in first out’ basis. Entity A has past experience that indicates that employees often carry forward their entitlement for a number of years, building up balances greater than 20 days. Entity B has past experience that indicates that employees utilise their entitlement such that they do not build up balances in excess of 10 days, and they typically use any carried-forward entitlement in the next year. Entity A concludes that the holiday accrual is accounted for as an ‘other long-term benefit’, because it does not expect to settle all of the benefit wholly before 12 months after the end of the period in which it has been earned. Entity B concludes that the holiday accrual is accounted for as a ‘short-term benefit’, because it expects to settle the benefit wholly before 12 months after the end of the period in which it has been earned. Note that the guidance above addresses the accounting for the benefits, but it does not address the classification of the benefits as current or non-current liabilities, which is determined in accordance with IAS 1.

Long-term employee benefits, such as long-term bonuses, long-term incentive plans and long service awards, share many of the characteristics of the short-term benefits discussed above.

However, long-term employee benefits are accounted for in the same way as defined benefit pension benefits, with the exception that re-measurements are recognised immediately through profit or loss.

The complexity and length of some long-term benefit arrangements will require the use of actuarial assumptions, such as salary increases and inflation, in order to calculate the obligation using the projected unit credit method.

Bonus on completion of five years’ service Entity A operates a long-term bonus scheme, whereby employees receive a bonus on completion of five years’ service. The bonus is calculated as 1% of each year’s salary. Salaries are expected to increase by 5% per annum and the discount rate is 8%. The following table illustrates how the liability for the bonus would build up over the five years for an employee that joins the company in year 1. It is assumed that the employee will reach five years’ service and that there are no changes in actuarial assumptions. The employee’s salary in year 1 is C40,000. Year 1 2 3 4 5 Current year benefit (1% of current year salary) 400 420 441 463 486 Cumulative bonus payable 400 820 1,261 1,724 2,210 Opening obligation – 325 702 1,137 1,637 Interest at 8% – 26 56 91 131 Current service cost 325 351 379 409 442 Closing obligation 325 702 1,137 1,637 2,210 In the above table, the current service cost is the present value of the benefit attributed to the current year. The benefit attributed to the current year is the overall benefit payable of C2,210 divided by five, being C442 each year. So, in year 3, for example, the current service cost is C379 (that is, C442 discounted to the current period). In this example, the straight-line attribution method is used rather than an attribution based on the scheme’s benefit formula.

Non-contractual bonus paid after 10 years’ service Entity A has traditionally awarded an anniversary bonus to employees on completion of 10 years’ service. This entitlement is not part of their employment contract, but the payment is established common practice, and so entity A will record a provision for the anticipated bonus. Long-term employee benefits, such as long service awards, are recognised and measured in a similar way to pensions and other post-retirement benefits. IAS 19 requires a provision to be built up, by spreading the charge over the 10 years’ service using the projected unit credit method.

Accounting for service conditions relating to bonus Employees might be awarded specified cash bonuses that are conditional on additional employment. For example, employees might be awarded bonuses where the amount is based on performance in a specific year, but where terms of the bonus arrangement require the employees to remain in employment for an additional one, two or three years. As discussed, we consider that the bonus is provided for service over the whole vesting period. We consider that these arrangements are long-term in nature and should be accounted for in the same way as defined benefit pension plans. Significant actuarial calculations are generally not necessary, because certain assumptions (For example, mortality, life expectancy, asset return, etc) might not be relevant or material. In practice, the liability to be accrued would generally reflect the present value of expected cash outflows, with any unwind in the discount reflected in the income statement. The liability should be assessed and trued up at each reporting date for any changes in expected cash flows.

Treatment of long-term benefit plans which vest in instalments In some situations, long-term benefit plans might vest in instalments over the vesting period. We believe that there are two approaches to recognise the expense. The most appropriate approach will depend on the specific facts and circumstances. One approach is to recognise the expense according to the plan’s benefit formula based on the principle in IAS 19. An entity attributes an expense to separate periods of service. However, where benefits are materially higher in later years, the expense should be recognised over the vesting period on a straight-line basis. The second approach is to view the bonus arrangement as multiple awards with different service periods. The plan’s benefit formula is based on each award’s individual service period. This means that the expense is recognised for each instalment over the respective service periods in a manner similar to staged-vesting (or tranche vesting) for share-based payment transactions. The period of service is the period for which the employee is required to be employed by the entity before being unconditionally entitled to the bonus payments. An entity will need to consider the specific terms and conditions to determine which approach is appropriate. For example, if an entity grants an annual recurring bonus as part of an employment agreement (for example, C10,000 payable at the end of each year for the next three years), this might indicate that the first approach is more appropriate, because this arrangement is similar to accounting for wages and salaries. However, if an entity otherwise grants a bonus that vests and is payable in three future instalments, this might indicate that a staged-vesting approach is more appropriate, because employees could be viewed as providing services for each instalment of the bonus until payment.

Deferred bonus arrangements over disproportional service periods Entity A awards its employees a cash bonus of C100, based on the performance of the employee and the entity in 20X1. Half of the bonus will be paid in February 20X2, and the other half will be paid at the end of 20X3, provided that the employee remains working for the entity at the payment date. An entity could use the staged-vesting approach in this scenario because, in substance, the employee is working for two awards with different service periods. The bonus expense should be recognised for each instalment. This means that 50% of the bonus should be spread from 1 January 20X1 to 28 February 20X2, and the other 50% of the bonus should be spread from 1 January 20X1 to 31 December 20X3. Alternatively, it might be appropriate to recognise the expense based on the bonus plan’s benefit formula. This means that 50% of the bonus should be spread from 1 January 20X1 to 28 February 20X2 (14 months), and the other 50% of the bonus should be spread from 1 March 20X2 to 31 December 20X3 (22 months).

Deferred bonus arrangements with three rateable instalments Entity A awards its employees a cash bonus of C100. A third of the bonus will be paid at the end of year 1, a third paid at the end of year 2, and a third paid at the end of year 3, provided that the employee in question is in employment with the entity on each payment date. An entity could use the staged-vesting approach in this scenario because, in substance, the employee is working for three awards with different service periods. This means that a third of the bonus should be spread over year 1, a third spread over years 1 and 2, and the remaining third spread over years 1, 2 and 3. This will result in front-loading the charge. Alternatively, it might be appropriate to recognise the expense based on the bonus plan’s benefit formula. This means that a third of the bonus expense would be recognised in each year, which is similar to straight-line attribution in this scenario.

Deferred bonus with a material instalment at end of vesting period The facts are the same as in previous FAQ, except that 25% of the bonus will vest and be paid in February 20X2, and the remaining 75% will vest and be paid at the end of 20X3, provided that the employee remains working for the entity. An entity could use the staged-vesting approach in this scenario because, in substance, the employee is working for two awards with different service periods. The bonus expense should be recognised for each instalment. This means that 25% of the bonus should be spread from 1 January 20X1 to 28 February 20X2, and the other 75% of the bonus should be spread from 1 January 20X1 to 31 December 20X3. Alternatively, it might be appropriate to recognise the expense based on the bonus plan’s benefit formula. However, as mentioned, where benefits are materially higher in later years, the expense should be recognised over the vesting period on a straight-line basis. Because the employees will receive 75% of their award at the end of year 3, this is considered materially higher in later years, and so the bonus expense should be recognised on a straight-line basis over the vesting period.

Deferred bonus arrangement that is recurring Entity A grants members of its senior management a bonus of C20,000, payable at the end of each year for three years, as part of their annual benefits package and contract of employment. The only condition is that the senior manager remains in employment. New joiners to senior management might be invited to participate in the bonus arrangement during the period. In our view, it is more appropriate to recognise the expense according to the plan’s benefit formula. This is because the bonus is part of the senior managers’ annual benefits package and should be treated in a similar way to short-term benefits. Therefore, C20,000 should be recognised each year for three years. Alternatively, an entity could recognise a bonus expense based on a staged vesting approach. This would mean that C20,000 is recognised in year 1, C20,000 is recognised over years 1 and 2, and the remaining C20,000 is spread over years 1, 2 and 3.

Long-term disability

Long-term disability is not a termination benefit. Long-term disability benefits that pay out the same level of benefit for all employees, irrespective of their length of service, are only recognised at the point when the disability arises.

Lump sum disability payments Entity A pays, in accordance with a trade union agreement, a lump sum of C10,000 to an employee who becomes disabled as a result of an accident. This payment is the same, regardless of the length of service. Entity B pays, in accordance with its trade union agreement, a lump sum of C10,000 to an employee who becomes disabled as a result of an accident within the first five years of employment, and C20,000 if the employee becomes disabled after more than five years of employment. The future cash outflow of entity A does not depend on past employee service. No accruals should be made by entity A until the occurrence of an accident that causes the disability of an employee. The level of benefits of entity B’s employees depends on the length of employee service. An obligation arises when service is rendered. Entity B’s obligation should be measured using the projected unit credit method. It should reflect the probability that payments will be required and the length of service (that is affecting the amount) for which payments are expected to be made. The focus of the guidance in IAS 19 is on length of service. If the level of benefit varies depending on other parameters excluding length of service, this does not affect the assessment. For example, if beneficiaries receive a cash payment amounting to a percentage of salary or a fixed amount of cash per age, regardless of length of service, benefits are recognised at the date when disability arises.

Disability payments covered by an insurance policy Legislation requires an entity to provide compensation to employees whose disability was caused by injuries at work. Entity A, a construction group, has decided to cover its exposure to disability compensation payments by taking out an insurance policy with one of the world’s largest insurance entities. The insurance premium is payable monthly. The amount of disability payment does not vary based on years of service and is paid out to the employee as an annuity rather than a lump sum. The insurance policy can only be used to pay the disability benefits, and it is not available to the entity’s own creditors, even in the event of bankruptcy. The proceeds from the policy cannot be paid to the entity unless they represent surplus assets. Entity A recognises the insurance premium as an expense when incurred. When an event occurs that causes a long-term disability, entity A recognises an expense for the disability payments. Since the level of benefit does not vary based on years of service, the obligation only arises when the disability occurs. Entity A also recognises income from the claim due under the insurance policy. The net impact on profit or loss will be the insurance premium expense.

Death-in-service benefits

A benefit that is earned if an employee dies during the employee’s working life can be recognised and measured under the same principles as a defined benefit pension plan.

The cost of benefits is attributed over the period from the date when service by the employee first leads to benefits under the plan until the date when further service by the employee does not result in a material amount of further benefits, other than those arising from further salary increases.

The date of death is the point at which no further benefit arises for the employee.

Detailed discussion on death-in-service benefits Sometimes, employers insure their death-in-service and disability obligations. Where an employer has transferred all risks and obligations to the insurer, the cost of providing benefits is represented by the payment of insurance premiums. In substance, such death-in-service and disability arrangements are treated as defined contribution pension plans. However, insurance for death in-service benefits is typically only for a limited period (For example, one year), and the employer or plan trustees (and insurers) have a choice at each renewal date whether or not to continue to insure the benefit. The decision whether to continue insuring is an investment choice each time the policy is up for renewal. In such circumstances, the employer will not have transferred all risks and obligations to the insurer. So, entities that ensure their death-Inservice liabilities will typically not have extinguished the liability, but they will have insured that risk only for the duration of the insurance policy (For example, for the following year). IAS 19 does not address the accounting for death-in-service benefits in detail. Where these benefits are not part of a defined benefit pension plan, it might be acceptable for an entity to account for such benefits in a manner that is consistent with other defined benefit obligations, unless such arrangements meet the conditions of an insured benefit and the definition of a defined contribution plan. This was confirmed by the IFRS Interpretations Committee (IC) in January 2008, which considered a request for guidance on how such benefits should be attributed to periods of service. The IFRS IC did not add the request to its agenda, but it stated in its agenda decision that divergence of practice in this area was unlikely to be significant, and that any further guidance would only be around the use of the projected unit credit method. Accordingly, an entity providing such benefits would recognise a defined benefit liability and a related plan asset representing the insurance cover for the duration of the policy, where the benefits are insured but not all of the risk and rewards are transferred to the insurer. This reflects the fact that the long-term liability has not been extinguished, and the insurance asset covers only pay-outs that arise from death-in-service that occurs during the coverage period. In line with the projected unit credit method, the defined benefit liability would be accrued over the estimated employee service period, and it would be presented net of any plan asset. IAS 19 requires attribution of the cost of the benefits until the date “when further service by the employee will lead to no material amount of further benefits under the plan, other than from further salary increases”. The IFRS IC noted that: The anticipated date of death (that is, the date assumed for actuarial purposes) would be the date at which no material amount of further benefit would arise from the plan. Using different mortality assumptions for a defined pension plan and an associated death-in-service benefit would not comply with the requirement in IAS 19 to use actuarial assumptions that are mutually compatible. If the conditions in IAS 19 were met, accounting for death-in-service benefits on a defined contribution basis would be appropriate. Nevertheless, death-in-service benefits that are not part of a defined benefit pensions plan are other long-term employee benefits and are similar to long- term disability benefits in various ways. Where the level of death-in-service benefit is the same, regardless of years of service, it might also be acceptable for an entity to analogise to the accounting for long-term disability benefits in accordance with IAS 19. By analogy, an entity does not recognise death-in-service benefits until death occurs. Where death-in-service benefits form part of a defined benefit pension plan, it is our view that they should be measured as part of the actuarial assumptions (and, hence, factored into the valuation of the defined benefit plan liabilities) and attributed to periods of service using the projected unit credit method. They cannot be separated from the plan of which they are a part.