Post-employment Benefits

Date recorded:

Feedback from Employee Benefits Working Group Meeting

The first meeting of the Employee Benefits Working Group was on 5 June 2007. The staff informed the Board of the discussions by the Working Group, which had considered the following topics:

  1. the Phase 2 project;
  2. elimination of deferred recognition for defined benefit promises;
  3. presentation alternatives, including three approaches previously discussed by the Board;
  4. definitions of benefit promises; and
  5. the classification of promises with fixed returns.

Topics 2 and 3 were discussed by the Board.

Unvested past service cost — elimination of deferred recognition for defined benefit promises

The staff asked the Board to confirm that in Phase 1, unvested past service cost would be recognised immediately in the period the amendment occurs. There were no objections by the Board.

Presentation of defined benefit costs

The Working Group had discussed the three approaches previously discussed by the Board, favouring approach 3. However, the Board was asked to modify approach three for inclusion in the planned discussion paper so that the following items would be recognised in profit or loss:

  • a. service cost;
  • b. interest cost;
  • c. actuarial gains and losses on the defined benefit obligation except those arising from changes in the discount rate; and
  • d. imputed interest income on plan assets determined using the discount rate determined by reference to market yields at the balance sheet date on high quality corporate bonds.
According to the modified staff proposals, the following items would be recognised outside profit or loss in other comprehensive income:
  • e. Actuarial gains and losses arising from changes in the discount rate; and
  • f. changes in the fair value of plan assets other than those in (d)

There was widespread reluctance by the Board to accept a modified approach three as favoured by some user representatives on the Working Group. The idea of recognising imputed interest based on high quality corporate bonds met with particularly stiff opposition, as many Board members seemed to want to eliminate the use of expected returns on plan assets altogether. One Board member, when asked if he preferred the original approach 3 over the proposed modification, said 'this is like asking me if I prefer to live or die.' There seemed to be general agreement with the chairman's analysis that the discussion paper should contain all three approaches in their original form and that the problems with using each approach should be outlined.

Cash balance and similar plans — Definitions of benefit promises

The staff asked the Board to finalise definitions of the three categories of post-employment benefits that had been discussed during this project and at previous Board meetings:

  • defined benefit;
  • defined contribution; and
  • defined return benefit promises.

The staff had proposed the following revised definitions:

  • defined contribution promise: a post-employment benefit promise that obliges the employer to pay specified contributions to a separate entity (a fund). Payment by the employer of those specified contributions extinguishes the obligation.
  • defined return promise: a post-employment benefit promise, which may be funded or unfunded, that obliges the employer to pay a benefit comprised of:
    • a contribution requirement based on current salary; and
    • a promised return on the specified contributions that is linked to the change in an asset or index.
  • defined benefit promise: a post-employment benefit promise that is neither defined contribution nor defined return.
There was a lengthy discussion about what the default category should be and how to distinguish the different promises, in light of which one Board member even questioned whether the Board would be able to finish the project within the intended timeframe. Some Board members were worried that the proposals would mean that a large number of post-employment benefit plans currently accounted for as defined benefit plans would have to be reclassified as defined return plans. For lump-sum plans, it was argued that this would be artificial. The staff clarified its concept that plans promising lump-sum payments on retirement or generally specified a fixed amount of benefits would constitute defined return promises.

Other Board members criticised the notion that for a plan to qualify as a defined contribution promise, it would have to be funded. Board members noted that in some jurisdictions many defined contribution schemes were unfunded. However, leaving the plan unfunded would introduce a guaranteed return element into the lump-sum (or fixed amount) payment promise, even though that return might be zero per cent, the staff argued. The Board asked the staff to clarify the wording on the importance of the timing of funding for the distinction between defined contribution and defined return promises. The staff agreed to do so. The staff also highlighted that any plan in which the contribution could be expressed in terms of current salary (such as genuine current salary and career average plans) would be classified as defined return promises.

Finally Board members asked if it was possible to collapse defined contribution and defined return promises into a single category. The staff argued that one would have to be very careful with the wording of such a broader category, so as to reassure entities currently making defined contribution promises that nothing would change for them. The chairman asked the staff to revise the definitions, collapsing defined return and defined contribution promises into a single category (which would not be called defined contribution so as to emphasise that there had been a change of definition) and defined benefit promises. In particular, the staff was asked to clarify the wording on funding to emphasise that promised returns related to actual and notional contributions.

Cash Balance and similar plans — Benefit promises with 'higher of' options

The Board discussed staff proposals on how to account for benefit promises that have maximum or minimum limits placed on them (also called 'higher of' options). Under current proposals, such promises would not be classified as either defined contribution or defined return and as such would be accounted for as a defined benefit plan using the projected unit credit method, thus ignoring the value of the 'higher of' option.

The staff had proposed to bifurcate such plans into a defined benefit element to be accounted for under IAS 19 and a 'higher of' option element to be accounted for at fair value. Changes in the liability in respect of the 'higher of' option would be disaggregated into a service cost element equal to the initial recognition of the 'higher of' liability and a fair value gain/loss element equal to the subsequent remeasurement of that liability. Both elements would be presented in profit or loss.

One Board member pointed out that in his home jurisdiction, such plans would be accounted for as two plans: A defined benefit plan accounted for as such and a separate 'higher of' plan measured at the incremental value of the 'higher of' promise. The staff agreed to investigate the accounting of such plans to see whether there was any merit to adopting a similar approach under IFRSs.

The Board discussed the valuation method for 'higher of' options. There was disagreement whether such options should be measured at fair value and what fair value meant in this context. It was suggested that entities should estimate the sum of the present value of future cash flows associated with the option, making assumptions about their potential volatility. No decisions were taken.

Vested benefits payable at the date when an employee leaves the entity

At the Board's June meeting, a Board member raised the question of whether, for defined return promises, an additional liability should be recognised if:

  • vested benefits are payable at the date when an employee leaves the entity; and
  • the amount payable is greater than the amount that would otherwise be recognised in the balance sheet for those benefits.

For defined return benefits, this is likely to occur when the rate of return promised to the employee is less than the discount rate used to determine the present value of the contribution requirement. The staff had recommended the IASB should not require an additional liability to reflect the amount that an employer would have to pay an employee leaving service before retirement, even though this might be considered inconsistent with the requirements of paragraph 49 of IAS 39, which states:

The fair value of a financial liability with a demand feature (eg a demand deposit) is not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid.

However, the staff had argued that such an approach should not be applied in Phase 1 of this project as it would result in different accounting for benefits depending on whether such benefits are vested or unvested and as no additional liability is required for other post-employment benefits.

Some Board members asked the staff to clarify the language in the agenda paper. Moreover, it was suggested that staff should consider whether or not such 'walk away payments' would constitute a liability under IAS 37 Provisions, Contingent Liabilities and Contingent Assets. One Board Member demanded that the staff should undertake further research as to how widespread the problem was in practice. The staff agreed. The chairman proposed going along with the staff's present approach and discuss the issue again at a later stage. Even though no formal vote was taken, there seemed to be agreement among the

Board members to move forward as proposed.

Components of a defined return promise and their measurement

The Board had defined a defined return promise as having two components, comprising:

  • a contribution requirement based on current salary; and
  • a promised return on the specified contributions that is linked to the change in an asset or index.

In terms of measurement, the staff had recommended that the contribution requirement should include both paid and unpaid contributions, with any payments being recognised as plan assets. The contribution element would be measured based on the specified contributions and using the IAS 19 discount rate, while the return element would be measured at fair value, assuming that benefits for past service would not change. The liability for benefits in payment should be measured using the projected unit credit method discounted at the IAS 19 discount rate.

Distinction between contribution and return element

Board members were not united in their assessment of the staff's analysis that to ensure the liability for the contribution requirement is always complete, whatever the funding level, was to consider the plan liabilities and plan assets separately. Some Board members disagreed over whether a difference between the contributions paid and the promised return constituted a contribution liability or a return liability, although the staff seemed to suggest that they regarded such differences as part a return liability.

Performance risk

The Board discussed the staff's proposals on how to account for performance risk, i.e. the risk that the entity defaults on its obligation reflected both the credit risk of the entity and the possibility that the entity will choose not to meet its obligation. It had been argued that that it might sometimes be difficult to distinguish credit risk from other elements of performance risk. Moreover, whether fair value reflects performance risk is an unresolved question in IFRSs. As a consequence, the staff had abandoned its earlier proposal to measure all components of defined return promises at fair value, arguing instead that the contribution element should be measured as outlined above.

The Board discussed the two elements of performance risk outlined by the staff. There was a debate about whether the notion that fair value included the probability of default (credit risk), while excluding the propensity of entities to force employees into accepting lower benefit levels. It was suggested that the staff should undertake more research in respect of whether it was always possible to distinguish credit risk from the risk that entities choose not to meet their obligations.

Benefits in payment

The Board discussed the staff proposal to stop treating the components of defined return promises separately once the plan had reached its payout phase and use the projected unit credit method instead. Even though the staff acknowledged that having three different measurement attributes for defined return plans was not ideal, this was nevertheless necessary to emphasise that there was no essential difference between defined return and defined benefit plans in terms of cash flows during the payout phase.

Where a defined benefit promise and a defined return promise had identical payout streams, the staff had recommended 'resetting' the defined return promise to the same final amount as the defined benefit plan. A defined return promise measured at CU 2,000 on the date of retirement that offered identical payouts compared with a defined return promise valued at CU 2,500 would thus be remeasured CU 2,500. Both plans would then be measured using the projected unit credit method and the IAS 19 discount rate throughout the payout phase. Board members disagreed over whether this was conceptionally superior to the opposite method. Due to the limited time available, the chairman decided to postpone a decision on the matter.

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