Intermediate Accounting — Employee Benefits: Defined Contribution and Defined Benefit Plans

Employee benefits are all forms of consideration given in exchange for service rendered by employees. K-IFRS 1019 (IAS 19) divides them into short-term employee benefits, post-employment benefits, other long-term employee benefits and termination benefits. The hardest to account for are defined benefit post-employment benefits payable far in the future.

1. Short-term employee benefits

These are benefits expected to be settled wholly within twelve months after the end of the reporting period in which the service is rendered: salaries, bonuses and paid leave. They are not discounted and are expensed in the period the service is rendered.

Paid leave comes in two kinds. Accumulating paid absences, where unused leave can be carried forward, give rise to expense and a liability as employees render service that increases their entitlement. Non-accumulating paid absences (such as sick leave) are recognized when the absence occurs.

2. Post-employment benefits: DC and DB

Defined contribution and defined benefit plans
Item	Defined contribution (DC)	Defined benefit (DB)
The entity's obligation	Ends once the agreed contributions are paid	An obligation to pay the promised benefits
Who bears the risk	The employee (benefits vary with investment performance)	The entity (bears investment losses and salary increases)
Accounting	Contributions recognized as an expense	Defined benefit obligation − plan assets recognized as a net liability
Korean examples	DC-type retirement pension	DB-type retirement pension, statutory severance pay

DC plans are simple: the contribution of ₩3 million due for the year is expensed, with any unpaid amount shown as an accrual. The rest of this chapter concerns DB plans.

3. Defined benefit obligation and plan assets

Defined benefit obligation (DBO): the post-employment benefits to be paid in future for service rendered to date, estimated by the projected unit credit method and discounted to present value. The discount rate is the market yield on high-quality corporate bonds at the end of the reporting period (or government bond yields where there is no deep market).
Plan assets: assets held in a form that the entity’s creditors cannot reach, such as a retirement pension account. They are measured at fair value.

The statement of financial position shows the difference, the net defined benefit liability (asset). A net asset is limited to the economic benefits available as refunds or reductions in future contributions (the asset ceiling).

4. The three components of cost

Defined benefit cost

\underbrace{\text{Service cost}}_{\text{profit or loss}} + \underbrace{\text{Net defined benefit liability} \times \text{Discount rate}}_{\text{net interest, profit or loss}} + \underbrace{\text{Remeasurements}}_{\text{OCI}}

Service cost is current service cost, past service cost (plan amendments) and settlement gains or losses. Remeasurements are actuarial gains and losses and the return on plan assets in excess of net interest.

Remeasurements are recognized in other comprehensive income and never reclassified to profit or loss. The aim is to keep changes in discount rate or salary growth assumptions from shaking profit for the year.

5. Worked example

Company II’s figures for 20X1 (unit: ₩10,000): opening DBO 1,000, opening plan assets 800, discount rate 5%, current service cost 150, benefits of 100 paid to retirees from plan assets, employer contribution 200 (paid at year-end). The closing actuarial valuation of the DBO is 1,120 and the fair value of plan assets 960.

Movements in the DBO and plan assets (unit: ₩10,000)
Item	DBO	Plan assets
Opening	1,000	800
Current service cost	+150
Interest cost / interest income (5%)	+50	+40
Benefits paid	−100	−100
Contributions		+200
Closing before remeasurement	1,100	940
Remeasurements	+20 (actuarial loss)	+20 (excess return)
Closing	1,120	960

The post-employment benefit expense in profit or loss is service cost of 150 plus net interest of $(1{,}000 - 800) \times 5\% = 10$ , or ₩1.6 million. In OCI, the actuarial loss of 20 and the excess return on plan assets of 20 offset, giving 0. The closing net defined benefit liability is $1{,}120 - 960 = 160$ , equal to the opening 200 plus the expense of 160 less contributions of 200.

Check your understanding

Company JJ’s opening DBO is ₩20 million, plan assets ₩15 million and the discount rate 6%. Current service cost was ₩2.5 million, the year-end contribution ₩3 million, and benefits of ₩2 million were paid from plan assets. The closing DBO valuation is ₩22 million and the fair value of plan assets ₩16.5 million. What are the post-employment expense in profit or loss, the remeasurements in OCI and the closing net defined benefit liability?

Net interest is $(2{,}000 - 1{,}500) \times 6\% = 30$ (₩10,000), so the expense in profit or loss is $250 + 30 = 280$ . The DBO before remeasurement is $2{,}000 + 250 + 120 - 200 = 2{,}170$ , an actuarial loss of 30. Plan assets before remeasurement are $1{,}500 + 90 + 300 - 200 = 1{,}690$ , so the actual return is 40 less than interest income. Remeasurements total $-30 - 40 = -70$ (a loss in OCI). The closing net defined benefit liability is $2{,}200 - 1{,}650 = 550$ , equal to the opening 500 plus 280 and 70 less contributions of 300.

References

Korea Accounting Standards Board, K-IFRS 1019 Employee Benefits
Employee Retirement Benefit Security Act — National Law Information Center
Donald Kieso, Jerry Weygandt and Terry Warfield, Intermediate Accounting: IFRS Edition, ch. 20