- 20 Marks
Question
Nzema prepares its financial statements in accordance with International Financial Reporting Standards (IFRS) with a financial year end of 31 December 2018. On 1 January 2018, Nzema commenced a defined benefit pension plan for a number of head office employees. Under the pension scheme, Nzema has an obligation to provide these staff with agreed post-employment benefits. Nzema carries the actuarial and investment risk associated with the pension scheme.
The following information has been compiled from workings by Nzema’s accounting staff and actuarial reports for the 2018 financial year:
| GH¢ | |
|---|---|
| Interest income on plan assets | 16,500 |
| Employer contributions to plan | 550,000 |
| Current service cost | 600,000 |
| Interest on plan liability | 18,000 |
| Fair value of plan assets at 31/12/2018 | 580,000 |
| Present value of plan obligation at 31/12/2018 | 620,000 |
The Accountant was not sure which accounting standard to apply when accounting for the pension scheme. The only adjustment made to account for the scheme was to expense the company’s contributions of GH¢550,000 for the 2018 financial year in the Statement of Profit or Loss and Other Comprehensive Income and to credit the ‘Cash’ account.
Required:
Recommend, with appropriate calculations, the necessary accounting treatment for this accounting issue.
Answer
The applicable accounting standard is IAS 19: Employee Benefits. Nzema’s pension plan is a defined benefit plan since Nzema has an obligation to provide agreed post-employment benefits and carries the actuarial and investment risk.
The employer contributions were accounted for incorrectly. Under IAS 19, a defined benefit liability (or asset) is recognized on the balance sheet as the present value of the defined benefit obligation minus the fair value of plan assets.
Workings – Calculation of Actuarial Gain/Loss:
Pension Asset:
| Description | GH¢ |
|---|---|
| Opening balance | 0 |
| Return on assets | 16,500 |
| Employer contributions | 550,000 |
| Remeasurement – Actuarial Gain | 13,500 |
| Closing balance (31/12/2018) | 580,000 |
Pension Liability:
| Description | GH¢ |
|---|---|
| Opening balance | 0 |
| Interest Cost | 18,000 |
| Current Service Cost | 600,000 |
| Remeasurement – Actuarial Loss | 2,000 |
| Closing balance (31/12/2018) | 620,000 |
Net Actuarial Gain:
GH¢13,500 (gain on pension assets) – GH¢2,000 (loss on pension liabilities) = GH¢11,500
Journal Entries:
- Net Interest Expense (Profit or Loss):
Dr Net Interest Expense (Profit or Loss) GH¢1,500
Cr Pension Liability GH¢1,500
(Net interest expense: 18,000 – 16,500) - Current Service Cost (Profit or Loss):
Dr Current Service Cost GH¢600,000
Cr Pension Liability GH¢600,000
(Recognition of current service cost) - Actuarial Gain (Other Comprehensive Income):
Dr Pension Liability GH¢11,500
Cr Remeasurement – Actuarial Gain (Other Comprehensive Income) GH¢11,500
(Recognition of actuarial gain) - Correction of Previous Accounting Treatment:
Dr Pension Liability GH¢550,000
Cr Pension Contribution Expense (Profit or Loss) GH¢550,000
(Correcting previous entry where contributions were expensed) - Identification of the appropriate standard to be applied: 1 mark
Net interest expense to Profit or Loss: 1 mark
Actuarial gain on pension asset: 1 mark
Actuarial loss on pension liability: 1 mark
Net actuarial gain to OCI: 1 mark
Currents service cost: 1 mark
(Total: 20 marks)
- Topic: IAS 19: Employee Benefits
- Series: MAY 2020
- Uploader: Olaoluwa