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MODULE 3 PACKET
ELEC 2 – Valuation Concepts and Methods
MODULE 3 EMPLOYEE BENEFITS

Welcome to Module 3
In this module, we will discuss post-employement benefits and defined benefit plan

CONSULTATION HOURS:
Virtual time: During your class schedule (either Monday or Tuesday)
Phone or Messenger: Every Thursday from 8am to 11am and 1pm to 4pm

MODULE 3 LEARNING OBJECTIVES:

By the end of this module, the students will be able to:
1. Distinguish defined contribution plan and defined benefit plan
2. Know the recognition of defined contribution plan, current service cost, past service cost and net
interest, and actuarial gains and losses
3. Define plan assets and return on plan assets
4. Understand the relationship between fair value of plan assets and projected benefit obligation
5. Compute employee benefit expense, remeasurements of plan assets, projected benefit obligation and
effect of asset ceiling
6. Understand plan settlement and treatment of asset ceiling
7. Identify, recognize and measure short-term and long-term employee benefits
8. Know the recognition and measurement of termination benefits

COURSE CONTENT FOR MODULE 3:

ACTIVITY DESCRIPTION TIME TO COMPLETE

Assigned Reading Post-employment Benefits 1 hour
Lecture Discussion Defined Benefit Plan 1 hour
Other Employee Benefits 1 hour
Activity Problem Solving 2 hours
Quiz Summative quiz for module 3 (to be announced) 1 hour

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ASSIGNED READING

Employee benefits are all forms of consideration given by an entity in exchange for services rendered by
employees or for the termination of employment.

Post-employment benefits or employee benefits, other than termination benefits and short term employee
benefits, which are payable after completion of employment.

Under a contributory plan, the employer and employee make contributions to the retirement benefit plan
but they do not necessarily contribute equal amounts. Both the employer and employee share in the
retirement benefit cost. While in a non-contributory plan, only the employer makes contributions to the
retirement benefit plan.

Funding is the transfer of assets to an entity, called the retirement fund, which is separate from the reporting
entity for the purpose of meeting obligations arising from a retirement benefit plan.

Under a funded plan, the entity sets aside funds for future retirement benefits by making payments to
funding agency, such as a trustee bank or insurance company. The funding agency is responsible for the
accumulation of funds and making payments to retired employees with the benefits become due.

In an unfunded plan, the entity retains the obligation for the payment of retirement benefits without the
establishment of a separate fund.

A defined contribution plan is a postemployment benefit plan under which an entity pays fixed contributions
into a separate entity known as the fund. The retirement benefit to be received by the employee is not
specified. This means the contribution is definite but the benefit is indefinite. Once the defined contribution
is paid, the employer has no more obligation under the plan and the employee bears the investment risk.

Defined benefit plan is a postemployment plan other than a defined contribution plan. An entity is obligated
to provide the agreed benefits to employees. The benefit is definite but the contribution is indefinite. The
entity must make contributions such that the contributions plus earnings would be sufficient to cover future
retirement benefits. The entity assumes the investment risk.

LECTURE DISCUSSIONS

Accounting for Defined Contribution Plan

1. The contribution shall be recognized as expense in the period it is payable

2. Any unpaid contribution at the end of the period shall be recognized as accrued expense.
3. Any excess contribution should be recognized as prepaid expense but only to the extent that the
prepayment will lead to a reduction in future payments or a cash refund.

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Illustration 1

An employee earned P300,000 during the current year. He Employee benefit exp 24,000
was covered by a defined contribution plan which requires Cash 24,000
his employer to contribute 8% of the employee’s salary.

Upon retirement, the trustee shall pay large or small benefit greatly depending on the investment
performance of the trust or pension fund.

Illustration 2

On Jan 2021, an entity paid P80,000 to a defined 12/20 Employee benefit exp 80,000
contribution plan for services performed by the Accrued benefit payable 80,000
employees in Dec 2020. Entries to record the 01/21 Accrued benefit payable 80,000
accrual benefit and subsequent payment are made. Cash 80,000

Illustration 3

An entity paid P300,000 contribution to a defined 2020 entry:

contribution plan. P225,000 is for services performed Employee benefit exp 225,000
by the employees in 2020 and the balance of Prepaid benefit exp 75,000
P75,000 for services to be performed 2021. Cash 300,000

Accounting for Defined Benefit Plan

Under a defined benefit plan, the expense recognized is not necessarily the amount of contribution for the
period.

An entity shall recognize the following components of defined benefit cost:

1. Service cost: current service cost, past service cost, any gain or loss on settlement
2. Net interest: interest expense on defined benefit obligation, interest income on plan assets, interest
expense on effect of asset ceiling
3. Remeasurements of plan assets, of projected benefit obligation, of the effect of asset ceiling

Service cost and net interest are included in profit or loss as component of employee benefit expense.
All the remeasurements are fully recognized through other comprehensive income. Remeasurements
are transferred within equity or reclassified to retained earnings.

The defined benefit cost is partly profit or loss representing service cost and net interest, and partly other
comprehensive income representing the remeasurements.

Current service cost is the increase in the present value of the defined benefit obligation resulting from
employee service in the current period. It increases expense and defined benefit obligation.

Net interest on defined benefit liability or asset is the change in the defined benefit obligation, plan assets
and effect of asset ceiling as a result of the passage of time.

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Interest expense on defined benefit liability Defined benefit obligation, beg. X discount rate
Interest income Fair value of plan assets, beg. X discount rate
Interest expense on effect of asset ceiling Effect of asset ceiling, beg. X discount rate

Net interest expense or income is the difference between the interest expense of the defined benefit
obligation, interest expense on effect of asset ceiling and interest income on the plan assets.

Illustration. At the beginning of the current year, the records showed the following:

Given data Computation

Fair value of plan assets 2,000,000 Interest exp on DBL 300,000
Defined benefit obligation 3,000,000 Interest income on plan assets 200,000
Discount rate 10% Net interest expense 100,000
Expected return on plan assets 8% Included in computation of total employee benefit expense

Past service cost is the change in the present value of defined benefit obligation for employee service in
prior periods resulting from a plan amendment or curtailment due to closing of a plant, discontinuance of
an operation or termination or suspension of a plan. Past service cost is an expense at the earlier of the
following dates: when the plan amendment or curtailment occurs or when the entity recognizes related
restructuring costs or termination benefits. Thus, whether vested or unvested, all past service costs shall
be recognized as an expense immediately, added to the defined benefit obligation.

Plan assets comprise assets held by a long-term benefit fund and qualifying insurance policies. These
are assets held by an entity, the fund itself, that is legally separate from the reporting entity. The assets
are available to pay only employee benefits and are not available to the reporting entity’s own creditors
even in bankruptcy. The assets cannot be returned to the reporting entity or can be returned to the reporting
entity if the remaining assets of the fund are sufficient to meet all employee benefit obligations or the assets
are returned to the reporting entity to reimburse it for employee benefits already paid.

A qualifying insurance policy is issued by an insurer that is not a related party under reporting entity. The
proceeds of the policy can be used to only to pay employee benefits and are not available to the reporting
entity’s own creditors even in bankruptcy. The proceeds of the policy cannot be made paid to the reporting
entity, except: when the proceeds represent a surplus assets not needed to pay employee benefits and
when the proceeds are returned to the reporting entity to reimburse it for employee benefits already paid.

Plan assets are measured at fair value. They exclude unpaid contributions due from the reporting entity to
the fund, as well as any non-transferable financial instruments issued by the entity and held by the fund.
They are reduced by any liabilities of the fund that do not relate to employee benefits.

Return on plan assets include interest, dividend and other income derived from the plan assets, as well as
realized and unrealized gains and losses on the plan assets.

The following are deducted to compute return on plan assets: any costs of managing the plan assets or
costs of managing investments, and any tax payable by the plan itself or any tax on investment income.

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Remeasurement of plan assets

The return on plan assets is fully recognized as a remeasurement and accounted for as component of
other comprehensive income without any subsequent recycling or reclassification to profit or loss. The
remeasurement is reclassified through equity or retained earnings.

Actual return on plan assets

MINUS Interest income on the fair value of the plan assets at the beginning of the reporting period
Equals Remeasurement GAIN (LOSS)

Illustration. Entity provided the following data for the current year related to a defined benefit plan:

Projected benefit obligation is the actuarial present value of all benefits attributed by the pension benefit
formula employee service rendered before a specified date based on future compensation level or future
salary increases. If the benefit obligation is based on current salary level, it is known as accumulated benefit
obligation.
PBO = PBO, beginning PLUS current service cost PLUS interest expense

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Actuarial gains and losses are changes in the present value of the projected benefit obligation resulting
from experience adjustments and the effects of changes in actuarial assumptions. They are usually caused
by an expected high or low rate of employee turnover, early retirement or mortality and increases in salary;
change in assumptions concerning benefit payment options; and change in discount rate.

Remeasurement of projected benefit obligation

Projected benefit obligation - actual 800,000 Projected benefit obligation - actual 800,000
Projected benefit obligation - estimated 700,000 Projected benefit obligation - estimated 980,000
Actuarial LOSS 100,000 Actuarial GAIN 180,000

These are recognized in other comprehensive income. Actuarial gain and loss are not subsequently
reclassified to profit or loss but transferred to retained earnings.

DEFINED BENEFIT PLAN

The benefit plan should be viewed as a sub-entity separate and distinct from the primary entity, which is
the employer entity. The sub-entity maintains information that does not appear in the financial statements
of the primary entity. It is kept only by means of memorandum records and therefore not reflected in the
general ledger accounts of the primary entity.

The information contained in the memorandum records contains the following:

a. Fair value of plan assets (FVPA) – the source of funds set aside in meeting future benefit payments.
b. Projected benefit obligation (PBO) – the present value of expected future payments required to
settle the obligation arising from employee service in the current and prior periods.

FVPA or contribution
Less: PBO or cost
Equals: Prepaid benefit cost – overfunded (accrued benefit cost – underfunded)

Noncurrent asset Noncurrent liability

Overfunding
Current service cost is P300,000. The entity Employee benefit expense 300,000
made a P400,000 contribution to the defined Prepaid/accrued benefit cost 100,000
benefit plan for the current year. Cash 400,000

Underfunding
Current service cost is P300,000. The entity Employee benefit expense 300,000
made a P220,000 contribution to the defined Prepaid/accrued benefit cost 80,000
benefit plan for the current year. Cash 220,000

The prepaid/accrued benefit cost account is the balancing figure. This account builds up and may have
debit (prepaid benefit cost) or credit (accrued benefit cost) balance at the end of current reporting period.

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Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

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Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

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A settlement is a transaction that eliminates all further legal or constructive obligations for part or all of the
benefits provided under a defined benefit plan. PAS 19 provides that an entity shall recognize gain or loss
on the settlement of a defined benefit plan when the settlement occurs.

Present Value of the Defined Benefit Obligation on date of settlement

LESS: Settlement Price
Equals SETTLEMENT GAIN (LOSS)

The settlement price includes any plan assets transferred and any payments made directly by the entity in
connection with the settlement. Any gain or loss on settlement is fully recognized and included in service
cost in the computation of employee benefit expense.

Illustration. At the beginning of the year, the memorandum records of a defined benefit plan show:

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Prepaid Benefit Cost aka Surplus – occurs when FVPA > PBO = surplus must not exceed the asset
ceiling. Assume that at year-end, a defined benefit plan had the following data:

Fair value of plan assets 5,000,000 The surplus does not exceed the asset
Projected benefit obligation 4,000,000 ceiling.
Prepaid benefit cost - surplus 1,000,000 Therefore, a prepaid benefit cost or surplus
The asset ceiling or the PV of available future refunds asset of P1,000,000 shall be reported in the
and reduction in future contributions is P1,200,000. statement of financial position at year-end.

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OTHER EMPLOYEE BENEFITS

Short-term employee benefits

Short-term employee benefits are employee benefits other than termination benefits which are expected to
be settled wholly within 12 months after the annual reporting period in which the employees render the
related service. They include the following:

a. Salaries, wages and social security contributions

b. Short-term compensated or paid absences such as paid annual leave and paid sick leave
c. Profit sharing and bonuses payable within 12 months
d. Nonmonetary benefits, such as medical care, housing, car and free or subsidized goods

Accounting for short-term employee benefits is fairly straightforward because there are no actuarial
assumptions. There is no requirement to discount future benefits because such benefits are all payable
not later than 12 months after the end of the current reporting period.

Short-term employee benefits are measured on an undiscounted basis hence there is no possibility of
actuarial gain or loss.

Rules for short-term employee benefits:

a. Unpaid short-term employee benefits at the end of the accounting period shall be recognized as
accrued expense.
b. Any short-term benefits paid in advance shall be recognized as a prepayment, to the extent, that it
will lead to a reduction in future payments or a cash refund.
c. The cost of short-term benefits shall be recognized as expense in the period when the economic
benefit is given, except when such cost may be included within the cost of an asset like PPE.

Illustration. Employees are entitled to 2 weeks of paid vacation leave. During the year, the employees
earned 100 weeks of vacation leave and used 60 weeks. Current salary of the employees is on the average
P2,000 per week and the salary is expected to increase by P200 per week.

Accumulating paid vacation leave Non-accumulating paid vacation leave

(unused portion are carried forward and can be used in the future (benefits lapse if the current period’s entitlement is
periods) not used)
Record the used Vacation pay exp 120,000 Vacation pay exp 120,000
vacation leave Cash 120,000 Cash 120,000
Accrue the Vacation pay exp 88,000 No accrual is necessary because non-
unused vacation Cash 88,000 accumulating paid absences are recognized
weeks (40 weeks x P2,200) when the absences occur and lapse when
the entitlement is not used in full.
Vacation expense = used and unused Vacation pay expense = used portion only

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Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

If the employee can take the unused sick leave anytime in the future, the formula will be simplified:

Total vacation days earned (add up all days in given years)

Less: vacation days taken (based on year/s taken)
Vacation days not taken (these days will usually come from the later years)

Accrued liability = Vacation days not taken * # of employees * hours * rate per hour

the rates to be applied correspond to that year except if the problem requires the accrued liability to be
based on the wage rate of a particular year only

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Profit-sharing and bonus plans

In profit sharing plans, employees shall receive a share of the profit only if they remain with the entity for
a specified period.

An entity shall recognize the expected cost of profit-sharing and bonus payment when the entity has a
present legal or constructive obligation to make such payments as a result of past events and when a
reliable estimate of the obligation can be made. A present obligation exists when the entity has no realistic
alternative but to make the payment.

Illustration 1. A profit-sharing bonus plan requires an entity to pay employees 5% of income for the year.
The entity reported income of P10million for the current year. The bonus payment is to be made at the end
of the following year.

To record the bonus in the current year Bonus expense 500,000

(10 million x 5%) Bonus payable 500,000
To record the bonus payment at the end Bonus payable 500,000
of the following year Cash 500,000

Illustration 2. A profit-sharing bonus plan requires an entity to pay employees 10% of income for the year
to employees who serve throughout the current year and who will continue to serve throughout the following
year. The entity reported income of P2million for the current year. The entity expects to save 5% of the
maximum bonus payment through staff turnover. The bonus payment is to be made at the end of the
following year. Any difference between the estimated liability and actual payment is accounted for as
change in accounting estimate and included in profit or loss.

To record the bonus in the current year. Bonus expense 190,000

Maximum bonus (10% x 2million) 200,000 Bonus payable 190,000
Saving through staff turnover (5% x 200,000) (10,000)
To record the bonus payment at the end of the following Bonus payable 190,000
year with no change in estimated liability Cash 190,000

Long-term employee benefits

Long-term employee benefits are benefits not expected to be settled wholly within 12 months after the end
of annual reporting period in which the employees render the related service.

Recognition and measurement of liability for other long-term employee benefits are the same as the
recognition and measurement of the defined benefit obligation. It is also the excess of the present value
of the liability over the fair value of the plan assets at the end of the reporting period. However,
remeasurements are recognized fully through other comprehensive income under a defined benefit plan
whereas for other long-term employee benefits, these are recognized in profit or loss.

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Termination benefits

These are employee benefits provided in exchange for the termination of an employee’s employment as a
result of either an entity’s decision to terminate an employee’s employment before the normal retirement
date or an employee’s decision to accept an offer of benefits in exchange for the termination of employment.

Termination benefits are usually lump sum payment but sometimes also include enhancement of
postemployment benefits OR salary until the end of a specified period if the employee renders no further
service.

The fundamental principles in relation to termination benefits are: not conditional on future service being
provided OR short period between offer of termination and actual termination.

An entity shall recognize an expense and a liability for termination benefits at the earlier of the following
dates:
a. The entity can no longer withdraw the offer of the termination benefits (when the plan of termination
is already communicated to affected employees).
b. When the entity recognizes the cost of restructuring that involves the payment of termination
benefits.

Restructuring costs are expenditures that are necessarily incurred for the restructuring and not associated
with ongoing activities of the entity.

Measurement of termination benefits

If the termination benefits are expected to be settled wholly within 12 months, they are measured at the
undiscounted amount. If they are expected not to be settled wholly within 12 months, they are measured
at discounted amount using the applicable discount rate.

Illustration. An entity is committed to close a factory in 8 months and at that time, shall terminate the
employment of all the remaining employees of the factory.
• An employee leaving before closure of the factory shall receive P20,000
• Each employee that renders service and get the closure of the factory shall receive on the
termination date a cash payment of P50,000
• There are 100 employees at the factory
• Entity expects 20 employees to leave before closure and 80 employees to render service until
closure.
• The total expected cash outflow under the plan is determined as follows:

Employees leaving before closure (20 x P20,000) 400,000

Employees leaving until closure (80 x P50,0000) 4,000,000 P4,400,000

accounted for as partly termination benefits and partly short-term employee benefits

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The amount that the entity would have to pay for terminating employment without future service known as
termination benefits:

Termination benefit P20,000 Shall be paid regardless of whether the

Multiply by the total number of employees 100 employees leave before closure or
Liability for termination benefits 2,000,000 render service until closure

The incremental benefits that employees receive if they render service for the full 8 months are
recognized as short-term employee benefits:

Total payment for 8-month period P50,000

Termination benefit 20,000 The short-term employee benefit may
Short-term employee benefit 30,000 be accrued monthly over 8 months
Multiply by employees until closure 80 equal to a monthly expense and liability
Short-term employee benefit 2,400,000 of P300,000

Let’s try

How much is total liability for termination benefits?

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ACTIVITY

1.

2.

3.

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6.

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7.

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