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IFRS Interpretations Committee issues — IAS 19 (IASB only)

Date recorded:

IAS 19 Employee Benefits: Discount rate

In October 2012, the Committee received a request for guidance on the determination of the rate used to discount post-employment obligations.  The main concerns of the submitter were that:

  1. according to paragraph 83 of IAS 19 the discount rate should be determined by reference to market yields at the end of the reporting period on high quality corporate bonds (HQCB);
  2. IAS 19 did not specify which corporate bonds qualify to be HQCB;
  3. listed corporate bonds were considered to be HQCB if they received one of the two highest ratings given by an internationally recognised rating agency (e.g. ‘AAA’ and ‘AA’ from Standard and Poor’s); and
  4. because of the financial crisis, the number of corporate bonds rated ‘AAA’ or ‘AA’ (AA-Bonds) had decreased significantly and were traded less frequently.  It was therefore considered that single trades could influence market yield more significantly than in the past and eventually distort the observable market rate, which would in turn distort the discount rate.

In particular, the submitter asked the Committee whether corporate bonds with an internationally recognised rating lower than “AA” could be considered to be high quality corporate bonds (HQCB).  The submitter noted that two views existed in practice:

  1. only AA bonds were considered HQCB
  2. corporate bonds with a rating lower than AA could be considered HQCB

In its January 2013 meeting the Interpretations Committee:

  • requested the staff to consult with the IASB:
    1. to confirm that the underlying principle for the determination of the discount rate is set out in paragraph 84 of IAS 19 (2011), and is described as “the discount rate reflects the time value of money but not the actuarial or investment risk”;
    2. to provide clarity about this sentence in paragraph 84;
    3. to ask whether this sentence in paragraph 84 means that the objective for the discount rate for post-employment benefit obligations should be a risk-free rate; and
    4. to confirm that IAS 19 should be amended to clarify that when government bonds are used to establish the discount rate in the absence of HQCBs, those government bonds used must themselves be high quality.

In the February 2013 IASB meeting, the Staff asked the Board members for their views on these four consultation areas.  The Staff noted that the objective of the meeting was to get the Board observations on the four consultation areas so that the Staff could go back to the Interpretations Committee so that they could provide the Board with recommendations to amend IAS 19.

Underlying principle

The Staff provided their analysis to the Board.  The Staff noted that paragraphs 83 and 84 of IAS 19 stated:

  • The rate used to discount post-employment benefit obligations (both funded and unfunded) shall be determined by reference to market yields at the end of the reporting period on high quality corporate bonds. In countries where there is no deep market in such bonds, the market yields (at the end of the reporting period) on government bonds shall be used. The currency and term of the corporate bonds or government bonds shall be consistent with the currency and estimated term of the post-employment benefit obligations (paragraph 83)
  • One actuarial assumption that has a material effect is the discount rate. The discount rate reflects the time value of money but not the actuarial or investment risk. Furthermore, the discount rate does not reflect the entity-specific credit risk borne by the entity's creditors, nor does it reflect the risk that future experience may differ from actuarial assumptions (paragraph 84)

The Staff noted that it was their opinion that the underlying principle for the determination of the discount rate was that it reflected the time value of money but not actuarial or investment risk.  They considered that paragraph 83 was then intended to explain the best way to achieve this objective.

The Staff asked the Board whether:

  • they agreed that the objective for the determination of the discount rate is within paragraph 84 (i.e. “the discount rate reflects the time value of money but not the actuarial or investment risk.
  • They agreed that the intention of IAS 19 was that the discount rate would not reflect the entity-specific credit risk borne by the entity's creditors, nor would it reflect the risk that future experience may differ from actuarial assumptions.”)
  • They agreed that paragraph 83 explained the best way to achieve this objective in paragraph 84

The majority of Board members tentatively agreed to the Staff’s proposals.  One Board member did not tentatively agree with the Staff proposals.

Clarity within paragraph 84

The Staff highlighted to the Board that if they agreed that the objective of paragraph 19 was within paragraph 84, then the sentence “the discount rate reflects the time value of money but not the actuarial or investment risk” should be clarified by the Board.  The Staff noted that some view this rate as being risk free and noted that many Interpretations Committee members supported this view.  The Staff also noted that some perceive this rate as not being risk free as it would be in conflict with the requirement to use yields on HQCB to determine the discount rate as noted in paragraph 83 of IAS 19.  The Staff were of the view that the rate should not be risk free and should reflect the time value of money and the credit risk reflected in HQCB issued in the currency in which the employment benefits are to be paid.  The Staff noted to the Board that they thought that the exclusion of investment risk within paragraph 84 was not intended to exclude the credit risk in HQCB (and hence they viewed IAS 19 as requiring HQCB to be used to determine the discount rate).

The Staff asked the Board whether:

  • They agreed that the sentence “the discount rate reflects the time value of money but not the actuarial or investment risk” should be clarified.
  • The agreed that this sentence did not imply that the discount rate should be risk free.

A discussion was held as to what the objective of paragraphs 83 and 84 of IAS 19 were – did they imply that a risk free rate was required or some other rate that was not risk free.  The Staff highlighted to the Board that these were the two choices that the Board had to deliberate over.  Once a choice was made the Interpretations Committee could then develop further guidance as to how one would achieve that rate.

One Board member asked what the Staff were trying to achieve by asking the questions.  It was clarified that the Interpretations Committee were unsure what the Board’s objective for the discount rate in IAS 19 was.  It was noted to the Boards that there were practical situations where there was not a deep market for AA and AAA corporate bonds, hence the question as to whether bonds of a lower quality could be used in the determination of the discount rate.  It was noted that if it was the Board’s view that where there are lower rated bonds a rate of AA or AAA was still required in determining the discount rate, then the Interpretations Committee were trying to establish what the Board perceive as a technique to achieving these ratings.

One Board member agreed that paragraph 84 should not be read to imply that a risk free rate is used.  This was agreed by another Board member who noted that although paragraph 84 did imply a risk free rate, the guidance in paragraph 83 (i.e. to look to HQCB) moved one away from a pure risk free rate.

Another Board member was of the opinion that the sentence in paragraph 84 intended that the discount rate was risk free – he asked that if one removed investment and credit risk then this must imply risk free.  He suggested deleting the paragraph within IAS 19 as there was no other way to interpret it than risk free so any further clarification would have no purpose.  This Board member commented that paragraph 84 was inconsistent with paragraph 83 (one implied risk free and the other, through providing guidance did not).  A number of other Board members agreed that there was an inconsistency between paragraphs 83 and 84 but did not feel so strong to remove paragraph 84.  One noted that the Interpretations Committee should work within the confines of the standard noting that there is an inconsistency but still providing additional guidance in line with paragraph 83 (i.e. the objective of paragraph 84 should not form a precedent over paragraph 83 and the discount rate would therefore not be risk free).

Notwithstanding the above Board comments, the majority of Board members tentatively agreed with the Staff proposals.  Board members tentatively agreed that it would be up to the Interpretations Committee to determine the level of risk that would be accepted in the discount rate.

The Staff noted to the Board that if they agreed that the discount rate should not be risk free then the Board should clarify what risk should be included within the discount rate.  The Staff noted that they felt that HCQB could be corporate bonds with minimal or very low credit risk and that the Interpretations Committee could develop proposals that would clarify the meaning of HQCB.

The Staff asked the Board whether:

  • They agreed that the discount rate should reflect the credit risk of HQCB and that a reasonable interpretation of HQCB could be corporate bonds with minimal or very low credit risk
  • They agreed that the Interpretations Committee should develop proposals to clarify the meaning of HQCB.

The Board members agreed that paragraph 83 required that HQCB be used in the determination of the discount rate (which would imply non risk free in contradiction to paragraph 84).  They tentatively agreed that the Interpretations Committee would need to determine the level of quality of the bond for use in determining the discount rate.

The majority of Board members tentatively agreed with the Staff proposals.

Government bonds

The Staff highlighted that paragraph 83 of IAS 19 required that government bonds be used to determine the discount rate where there was no deep market in HQCB.  The Staff noted to the Board that the Interpretations Committee did not intend for government “junk” bonds to be used in these situations to determine the discount rate.  The Staff noted that only high quality government bonds should be used.  They noted that where government bonds are not of high quality then an entity should risk adjust the low quality government bonds.

The Staff asked the Board whether they agreed that the Interpretations Committee should propose amendments to IAS 19 to specify that when government bonds are used to determine the discount rate those bonds should be high quality.

One Board member asked whether there was an opportunity to do an Annual Improvement in IAS 19 to reorder paragraphs 83 and 84. Another Board member asked how one would determine whether government bonds were of high quality.  Another member noted that this could be determined by looking at the interest rates carried by some government bonds.  Where the government bonds carried significantly high interest rates one could make a judgement that this would not represent high quality.

The Staff noted to the Board that it was not anticipating amendments to IAS 19 but interpretations to clarify the requirements of IAS 19.

Generally the Board members were supportive of the Staff proposals.  They acknowledged the inconsistency within IAS 19 and tentatively agreed that due to inherent problems with application, the Interpretations Committee should develop guidance that it sees fit to address some of the issues identified with the discount rate within the confines of the IASBs views.

Notwithstanding the above comments, the majority of Board members tentatively agreed with the Staff proposals.  The Board members tentatively agreed that government bonds should be high quality and junk government bonds should not be a substitute for HQCB.  The Board members tentatively agreed that the Interpretations Committee should develop some proposals that defined HQCB.

IAS 19: Narrow-scope amendments

The IFRS Interpretations Committee (the Interpretations Committee) received two requests, in May and September 2012 respectively, seeking clarification of paragraph 93 of IAS 19 Employee Benefits. That paragraph refers to the accounting for employee contributions set out in the formal terms of a defined benefit plan. The submitters specifically requested guidance on the accounting of employee contributions in respect of service.  The question was whether employee contributions were a reduction in cost to the entity of the short term benefit (e.g. salary) or a reduction in the post-employment benefit cost.

The accounting for the two alternative views results in a different pattern of recognition of cost to the entity.  If the employee contributions are classified as a reduction in short term employee benefits the net benefits (i.e., reduced salary) will be measured at the undiscounted amount of the benefits expected to be paid and recognised in the period of service in accordance with paragraph 11 of IAS 19. If the employee contributions are classified as part of post-employment benefits the obligations for the cost of the benefits including (net of) employee contributions will be measured on a discounted basis, and attributed to periods of service as a negative benefit in accordance with the steps identified in paragraph 57 of IAS 19 that describes recognition and measurement for defined benefit plans.

The Interpretations Committee discussed this issue in its September, November and January meetings.  At its January 2013 meeting, the Interpretations Committee observed that the wording of paragraph 93 of IAS 19 seemed to suggest that all employee contributions in respect of service should be attributed to periods of service as a negative benefit in accordance with paragraph 93 of IAS 19.  However the Interpretations Committee also observed that contributions that are linked solely to the employee’s service rendered in the same period in which they are paid (e.g. if the contributions are a fixed percentage of salary throughout the entire period of employment) might also be considered to reduce the cost of short term employee benefits.  It was noted that the existing wording in paragraph 93 of IAS 19 did not make this clear and hence should be addressed through a narrow scope amendment.

In the February IASB meeting, the Staff presented proposed amended wording for paragraph 93 of IAS 19.  Under their proposed wording, contributions from employees or third parties that were linked to the employee’s service would be attributed to periods of service as a negative post-employment benefit except when the contributions were linked solely to the employee’s service rendered in the same period in which they are paid.  The Staff proposed that if contributions from employees or third parties are linked solely to the employee’s service rendered in the same period in which they are paid then the contributions would be treated as a reduction in short term employee benefit cost and accounted for in that same period.

The Staff also presented another amendment that they proposed to IAS 19.  The Staff noted that they proposed removing the statements that refer to the net benefit from paragraph 93 and BC 150(a).  This is because there is currently confusion in that paragraph 93 is unclear whether the back-end loading test in paragraph 70 should be performed on the net benefit or on the gross benefit and the negative benefit separately, while paragraph BC150(a) explicitly states that the back-end loading test and attribution in paragraph 70 should be based on the net benefit.

The Staff noted to the Board that they also proposed to specify in paragraph 93 that the negative benefit from employee contributions is attributed to periods of service consistently with the application of the gross benefit in accordance with paragraph 70 in order to ensure consistent attribution of the net benefit.

The Staff noted that they did not think that it was necessary to add a disclosure requirement related to the proposed amendments and that the amendments should apply retrospectively.  The Staff proposed that the comment period be 120 days.

The Staff asked the IASB members:

  • Whether they agreed with the Interpretation Committee’s proposal to make a narrow scope amendment to IAS 19;
  • Whether they agreed with the wording of the proposed amendment;
  • Whether they agreed that it was not necessary to add a disclosure requirement related with the proposed amendment;
  • Whether they agreed that amendments should apply retrospectively; and
  • Whether they agreed that the comment period should be no less than 120 days.

One Board member agreed with the direction of the Interpretation Committee’s amendment.  However this Board member noted that where the contributions from employees or third parties are linked solely to the employee’s service rendered in the same period in which they are paid, the contributions should be treated as a reduction in service cost rather than a reduction in short term employee benefits (i.e. salary).  This view was shared by a number of other Board members.

With the above change to reduce service cost as opposed to short term employee benefit cost, all of the Board members tentatively agreed to the Staff proposals.