• 15 Marks

CR – Nov 2017 – L3 – Q5 – Employee Benefits (IAS 19)

Explain and distinguish between defined contribution and defined benefit plans, providing IAS 19 accounting treatments for two pension plans.

Tinubun Plc., a public limited company, operates two pension plans.

Pension Plan 1
The terms of the plan are as follows:

  1. Employees contribute 6% of their salaries to the plan.
  2. Tinubun Plc. contributes, currently, the same amount to the plan for the benefit of the employees.
  3. On retirement, employees are guaranteed a pension based on the number of years’ service with the company and their final salary.
  4. This plan was closed to new entrants from October 31, 2016, but it remains open for future service accrual for employees already in the scheme.

The following details relate to the plan in the year ending October 31, 2017:

Description Amount (₦’m)
Present value of obligation at Nov 1, 2016 200
Present value of obligation at Oct 31, 2017 240
Fair value of plan assets at Nov 1, 2016 190
Fair value of plan assets at Oct 31, 2017 225
Current service cost 20
Pension benefits paid 19
Total contributions paid to the scheme 17

Actuarial gains and losses are recognized in the Statement of Other Comprehensive Income.

Pension Plan 2
Under the terms of this plan, Tinubun Plc. does not guarantee any return on the contributions paid into the fund. The company’s legal and constructive obligation is limited to the amount contributed to the fund. The following details relate to this scheme:

Description Amount (₦’m)
Fair value of plan assets at Oct 31, 2017 21
Contributions paid by company 10
Contributions paid by employees 10

The discount rates for the two plans are as follows:

Date Discount Rate
October 31, 2017 6%
November 1, 2016 5%

Required:
a. Explain the nature and differences between a defined contribution plan and a defined benefit plan with specific reference to the company’s two schemes.
(7 Marks)

b. Show the accounting treatments for the two Tinubun Plc. pension plans for the year ended October 31, 2017 under IAS 19 ‘Employee Benefits’.
(8 Marks)

Total: 15 Marks

(a) Defined Contribution Plan vs. Defined Benefit Plan

  1. Defined Contribution Plan: This is a post-employment benefit plan where an entity pays fixed contributions into a separate fund. The entity’s obligation is limited to the amount contributed, and it has no obligation to pay further amounts if the fund does not hold sufficient assets to pay all benefits relating to employee service.
  2. Defined Benefit Plan: This includes all other post-employment benefit plans. Under IAS 19, it requires actuarial techniques to estimate the ultimate cost of benefits earned in return for employee service in the current and prior periods.

Differences between the Plans:

  • Actuarial Assumptions: No actuarial assumptions are required in defined contribution plans, whereas defined benefit plans need actuarial assumptions.
  • Financial Position Impact: Defined contribution plans typically do not affect the statement of financial position, but defined benefit plans impact both the financial position and profit or loss.
  • Obligation: Defined contribution plans only obligate the employer to make specific contributions, while defined benefit plans provide specific benefit levels to employees, regardless of fund performance.
  • Risk: Employees bear the investment risk in defined contribution plans; however, employers bear the risk in defined benefit plans.

(b) Accounting Treatment under IAS 19

  1. Pension Plan 1 (Defined Benefit Plan):
    • Financial Position as at October 31, 2017:
      Description 31/10/2017 (₦’m) 1/11/2016 (₦’m)
      Present value of obligation 240 200
      Fair value of plan assets (225) (190)
      Net Liability 15 10
    • Statement of Profit or Loss for the Year Ended October 31, 2017:
      Expense Amount (₦’m)
      Current service cost 20.0
      Net interest expense:
      – Interest expense (5% × ₦200m) 10
      – Interest earned (5% × ₦190m) (9.5)
      Total Expense 20.5
    • Actuarial Gains and Losses:
      • Actuarial Loss on Obligation:
        • Present value as at 01/11/16: ₦200m
        • Interest expense (5% of ₦200m): ₦10m
        • Current service cost: ₦20m
        • Less: Benefits paid (₦19m)
        • Updated value: ₦211m
        • Present value at 31/10/17: ₦240m
        • Actuarial Loss = ₦29m
      • Actuarial Gain on Plan Assets:
        • Fair value as at 01/11/16: ₦190m
        • Interest earned (5% of ₦190m): ₦9.5m
        • Contributions paid: ₦17m
        • Less: Benefits paid (₦19m)
        • Updated fair value: ₦197.5m
        • Fair value at 31/10/17: ₦225m
        • Actuarial Gain = ₦27.5m
    • OCI Analysis:
      • Actuarial loss on obligation: ₦29m
      • Actuarial gain on plan assets: ₦27.5m
      • Net Actuarial Loss = ₦1.5m
    • Movement in Net Liability (as at 31/10/17):
      Description Amount (₦’m)
      Opening liability 10.0
      Expenses 20.5
      Contributions paid (17.0)
      Actuarial loss (Net) 1.5
      Closing Liability 15.0
  2. Pension Plan 2 (Defined Contribution Plan):
    • The entity’s obligation for each period is the amount to be contributed. There are no assets or liabilities recognized; contributions payable (₦10m) are charged to operating profit, reducing cash when paid.
    • Statement of Contribution Paid:
      Description Amount (₦’m)
      Contribution by employer 10
      Contribution by employees 10
      Total Contribution 20
    • Statement of Profit or Loss:
      Description Amount (₦’m)
      Contribution paid by employer 10
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