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This purpose of this report is to give advice on the development of an accounting standard for employee benefits. Five different problems regarding employee benefits will be examined and each problem will be related to an accounting concept. Recommendations will be suggested for these problems as well.
All employees work in expectation of being rewarded afterwards, or in advance in some cases. Beam and Mcfadden (2001) define employee benefits as "all benefits and services, other than wages for time worked that are provided to employees in whole or in part by their employers". These benefits include sick leaves, medical expenses, holiday bonuses and many others. Therefore, it is necessary that there are certain rules regarding these benefits that will maintain the rights of the employees. In the developing country of Aquilealand, we do not have our own conceptual framework, and therefore we adopt the IASB's framework. Aquilealand Accounting Standards Board should apply a new standard for employee benefits and this will be used by all companies in Aquilealand. There are several problems concerning employee benefits which need to be looked into in depth, some of them will be discussed in the following paragraphs.
Problem (1): Recognition of profits and losses arising from plan assets
One of the problems mentioned during the creating the accounting standard for Aquilealand is the recognition of expected return of plan assets. In the approach v IASB expected return should be recognized and excluded from the assets service cost. However, prediction of any future return involves a big amount of uncertainty (Pastor, 2001). According to Pastor it is very hard to predict expected return even using mathematical models objectively. The reason is that subjectivity and judgement have a big impact on this process (Pastor, 2001). This fact is breaking the objectivity concept of the Regulatory Framework. According to this concept, accounts should be free of judgement and should be measured by all people in the same way (Alexander et al). In addition, recognition of expected return, which is unrealized return, may be misleading information for the users of financial statements.
As it is not possible to eliminate the judgement factor in the process of calculation of expected return, companies should not recognise the expected return on plan assets until it is really gained. That will prevent the breaking of the objectivity concept. This may also help to provide more accurate information about the financial situation of the company to the users of financial statements. Only realized return on plan assets should be recognized. In addition, companies should be required to disclose the information about change of plan asset in the annual report; not as the part of the statement of comprehensive income but as a separate section.
Problem (2): Disclosures
There are three basic matters that can be important to be disclosed in financial statements. Firstly, explain in details the features and risks connected with its defined benefit plans. Next, demonstrate the effect of defined benefit plans on the entity's future cash flow and which related to timing, doubt and amounts. Finally, explain the numerical information that is involved in the financial statements generating from its defined benefits plan (PWC, 2011). However, there are many requirements for disclosures which might be difficult to apply.
A company has to provide detailed information about the financial events in order to meet three things because the users of financial statements need to evaluate numerical information (KPMG, 2011). Furthermore, sensitivity analysis disclosure is given merely on the defined benefit obligation, although IASB states that, 'sensitivity analysis on the net defined benefit liability (assets)' can be more useful. However, it is far more difficult and complicated to carry out (ibid.). Moreover, disclosures for multi-employer plans are currently extended because more information linked with multi- employer should be disclosed such as funding arrangement (PWC, 2011).
According to the materiality concept, financial statements are prepared to serve the users to make the right decision. Therefore, all information that may impact their decision should be involved in financial statements. As a result, disclosure principle is significantly associated with materiality because all the quantitative and qualitative information should be involved in financial statement such as accounting policies and significant events (Jan, O., 2010).
As mentioned before, there are some recommendations that should be considered for employee benefits disclosure. Firstly, the companies required to disclosing the important information involved in financial statements to satisfy the external users and help them to understand information and make right decision (PWC, 2013). In addition, the companies should use narrative description of financial information such as liabilities matching so the readers can understand written information.
Problem (3): Termination benefits
Based on the definition in IAS 19, termination benefits are the benefits for those employees whose employments are voluntarily or involuntarily terminated before the normal retirement date. Therefore, termination benefits should be recognized as a liability and an expense in entity's financial report. For instance, voluntary termination benefits should be recognized when they are provided as 'a result of an offer made in order to encourage voluntary redundancy' (Alexander, Britton & Jorissen, 2011: 525). On the other hand, as the name implies, involuntary termination benefits should be recognized when the employment is terminated involuntarily, such as dismissal.
However, for recognition in financial accounting, it is essential to firstly decide when and how much it should be recognized. Therefore, the expense of the termination benefits should be able to be expressed in money, which is also known as one of the financial accounting conventions named 'monetary measurement' (Alexander, Britton & Jorissen, 2011). Furthermore, besides the amount to recognize, it is also necessary to determine the time to recognize. For instance, to recognize the involuntary termination benefits as soon as the employees are aware of the termination or at the time they leave the entity should be regulated.
Based on the guidance of financial accounting conventions, the amount and the time for the recognition could be easily determined. Firstly, taking account of the monetary measurement convention, entity should ensure the termination benefits in its dismissal plan could be measured. Similarly, the benefits included in the offer that entity provides for voluntary termination should also be measurable. Moreover, according to the accruals convention, the expense of the entity should be recognized and recorded as soon as the usage of the expense is determined (Alexander, Britton & Jorissen, 2011). Therefore, involuntary termination benefits should be recognized at the time when entity formally notice the employees affected in its dismissal plan. However, for those who have exchanged their termination benefits for future services, the liability of their benefits should be recognized over the future period. At last, voluntary termination benefits should be recognized when the employees accept the offer made in other to encourage voluntary redundancy.
Problem (4): Post-employment benefits
Post-employment benefits means the staff begin receiving retirement benefits, for example, retirement benefits and other post-employment benefits after completed an employment relationship (BDO, 2013). Besides, there are two categories of post-employment benefits plans. One is defined contribution plans, another is defined benefit plans (ibid.). In general, DCP (which stand for defined contribution plans) means employees' retirement plan benefits was reserved funds from the company's annual profit (Investopedia, n.d.). Accounting treatment is relatively simple. But the obligations undertaken of the employee is not quite clear. Therefore, the detail of the handling is the employer ought to make the contribution towards the present service and have no obligation to give extra contribution for past service (Towers Watson, n.d.). For DBP (which stand for defined benefit plans), it is a retirement plan that employee benefits are classified according to a formula using factors such as length of service and salary history, which was sponsored by the employer (Investopedia, n.d.). According to Towers Watson [n.d.], owing to actuarial gains and losses and prior service costs are deferred, resulting in the pension liability that are not actually required to bear the obligations. The solution is immediately recognition of actuarial gains and losses and prior service cost. The following specific practices are: deleting actuarial gains and losses using the corridor approach, remove actuarial gains and losses that are recognized in profit and loss provisions and require all actuarial gains and losses should be recognized immediately in other comprehensive income (OCI). Moreover, past service cost should not be deferred amortization and also need to be recognized immediately when incurred (ibid.). Also IAS 19 changes in the method of expression, service cost and net interest income or expense recognized in profit or loss, Re-measurable portion recognized in OCI (BDO, 2013).
Problem (5): Immediate recognition
Immediate recognition in other comprehensive income will have an impact on organizations which recognizes gains and losses simultaneously in profit and loss. The standard requires recognition of defined benefit obligation and plan assets in the statement of comprehensive income and in the statement of financial position. According to IASB, 'immediate recognition provides more relevant information to users of financial statements and provides more faithful representation of the financial effect of defined benefit plans' (KPMG 2011, p 5).
There are some expressions of immediate recognition which eliminated by AASB as the standard of employee benefits. Among them are past service cost and administration costs and other expenses. As an example of immediate recognition problems, past service costs will be explained in detail.
Past service costs used to describe service costs different from current service costs and gains or losses on the settlement. It is defined as 'the change in the present value of the defined benefit obligation for the employee service provided in prior periods (KPMG, 2011: 18).
We should define whether past service costs is positive or negative. When the changes improve employee benefits, it is positive (Deloitte, 2011). While it is negative if the change results in reduction of the existing benefits (ibid). The next step is to recognize them into the entities' financial statements.
According to the prudence concept basis, it is also necessary to report the accounting transactions. Therefore, the method used to recognize a vested past service costs should differ from the one used to recognize an unvested past service costs. Based on the consistency concept basis, it states that 'accounting methods once adopted must be applied consistently in future' (Jan, I., 2012). Therefore, the accounting treatment for both vested and unvested past service costs should be respectively kept the same in several accounting periods.
As it has been shown in the previous paragraph, we recommend that the methods used to recognize vested and unvested past service cost should be different. Vested past service costs should be recognized immediately while 'unvested past service costs should be recognized on a straight-line basis over the remaining vesting period' (Ernst and Young, 2011: 4). Moreover, the methods used to recognize past service costs should follow a consistency basis.
To conclude, the Aquilealand Accounting Standard Board examined problems regarding employee benefits such as: recognition of profits and loss arising from plan assets, disclosures, termination benefits, post employment benefits, and immediate recognition. Each of these problems relates to an accounting concept, and recommendations were suggested in order to create a suitable standard that fit a country which has an active stock market.