THE INSTITUTE OF

CHARTERED ACCOUNTANTS
OF SCOTLAND
FINANCIAL REPORTING

CONTENTS
Page
EMPLOYEE BENEFITS...............................................................................................1
10.1 INTRODUCTION................................................................................................1
10.2 OBJECTIVES.......................................................................................................1
10.3 SHORT-TERM EMPLOYEE BENEFITS............................................................2
10.3.1 Accounting treatment all short-term benefits.............................................2
10.3.2 Profit sharing and bonus plans.....................................................................2
10.4 POST-RETIREMENT BENEFITS: AN OVERVIEW........................................4
10.4.1 Types of plans................................................................................................5
10.5 ACCOUNTING FOR DEFINED CONTRIBUTION PLANS.............................7
10.6 ACCOUNTING FOR DEFINED BENEFIT PLANS..........................................8
10.6.1 Measurement of assets and liabilities...........................................................8
10.6.2 Recognition in profit and loss and balance sheet..........................................9
10.6.3 Disclosure....................................................................................................14
10.6.4 Alternative to the corridor...........................................................................17
10.7 IFRS 2 SHARE BASED PAYMENT.................................................................19
10.7.1 Scope of IFRS 2...........................................................................................20
10.7.2 Types of share-based payment transactions................................................20
10.7.3 Recognition..................................................................................................20
10.7.4 Equity-settled share-based transactions (para 10 29).............................20
10.7.5 Cash-settled share-based payment transactions (para 30 33).................26
10.7.6 Share-based payment transactions with cash alternatives (para 34 43). 27
10.7.7 Disclosure....................................................................................................29
10.8 FINANCIAL REPORTING STANDARDS.......................................................30
10.9 SUMMARY........................................................................................................31

ICAS 7

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EMPLOYEE BENEFITS
10.1 INTRODUCTION
Employees receive a variety of benefits in return for providing
services to their employer. Some benefits are received from
the employer almost immediately the services are performed
eg wages and salaries. Some, such as an annual bonus, are
determined and paid after the year-end. Others, such as
pensions, are not paid until many years in the future when the
employee retires.
One thing these benefits have in common is that they are a
cost to the employer and this cost should be recognised as the
benefits are earned or accumulated by the employee.
IAS 19, Employee Benefits, addresses the above issues.
Employee benefits are included in the syllabus at level 2. As a
result some parts of IAS 19 are omitted. These include:
Short-term compensated absences (paras 11-16).
Post-employment benefits
: multi-employer plans (paras
29-33)
: state plans (paras 36-38)
: insured benefits (paras 39-42)
: attributing benefit to periods of service
(paras 67-71)
: business combinations (para 108)
: transitional provisions (paras 153-156)
: defined benefit plans that share risks
(para 34, 34A and B)
: defined benefit plans that share risks
(para 34, 34A and B).
Most benefits are paid by companies in cash. Payment of some
benefits in shares of the company is also quite common. IFRS
2 Share based payments addresses the accounting issues
involved. It also covers situations where the shares of the
company are used to pay for other goods and services. The
module covers these aspects of IFRS 2.

10.2 OBJECTIVES
On completing this module you should be able to:
1. apply the provisions of IAS 19 in accounting for short-term
employee benefits;
2. identify the key features of defined contribution and
defined benefit pension plans;
3. apply the provisions of IAS 19 in accounting for defined
contribution and defined benefit plans;

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notes

4. describe the principal disclosure requirements relating to

post-employment benefit plans;
5. describe the principal differences between IAS 19 and FRS
17.
6. describe and apply the requirements of IFRS 2.
This will help you meet the second, third and sixth learning
objective of the FR syllabus.

10.3 SHORT-TERM EMPLOYEE BENEFITS

Short-term employee benefits include such items as:
(a)

wages, salaries and social security (NI) contributions;

(b)

short-term compensated absences eg annual paid leave;

(c)

profit sharing and bonuses payable within 12 months of

the period end of giving the related services; and

(d)

non-monetary benefits (benefits in kind).

10.3.1 Accounting treatment all short-term

benefits

When an employee has given service during a period the

employer should recognise the benefits expected to be
paid:
(a)

as a liability to the extent they have not been paid at the

year-end;

(b)

as an expense (unless it is treated as part of the cost of

a fixed asset, stock or construction contract etc).

Due to the short-term nature of the payments the amounts

should be undiscounted.

10.3.2 Profit sharing and bonus plans

Almost all short-term benefits are paid as the services are

provided or shortly afterwards eg most employees are
paid at the end of each month. Profit share and
bonuses may not be known until some time after the
year-end and this raises questions about when they
should be recognised and how much should be
accrued.
Amounts for these should be recognised only when:
(a)

the company has a present legal or constructive

obligation to make such payments as a result of past
events; and

(b)

a reliable estimate can be made of the amount.

A present obligation exists when, and only when, the

enterprise has no realistic alternative but to make the
payments. When the right to a bonus is in a contract
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of employment this will give a legal obligation

assuming other conditions (eg relating to performance
or profitability) are met. Where a bonus is not in a
contract of employment but a company has an
established practice of paying bonuses then a
constructive obligation will exist.

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notes

In

measuring the amount to include in the financial

statements, the details of bonus arrangements need to
be looked at.
If the payment of the bonus is
conditional on employees still being with the firm at
some date in the future, allowance should be made for
likely departures before that date.

You should assume that employers NI will arise on the

payment of any bonus being recognised and this
should also be accrued.
Example 1
Nairn plc includes a bonus system in its contracts of employment
of all staff. Key terms are:
(i)

if profits increase by more than 10% in any one year a bonus

equivalent to 2% of gross wages and salaries (excluding
employers NI) is payable to staff;

(ii) the bonus is payable at the end of month 6 of the following

year to all employees who worked in the year and are still
employed by the company on the date the bonus is payable.
In the year to 31 December 2005 gross wages and salaries
totalled 14m and employers NI was 1.5m.
PAYE and
employees NI average 32% of payroll. Payments to the Revenue
are paid one month in arrears. Profits in 2004 and 2005 equalled
6.3m and 7.1m respectively.
Staff details are as follows:
Date
At 31.12.05
Of which left between 1.1.06 and 30.6.06

Number
610
12

The accounts for the year to 31 December 2005 are being

completed in July 2006.
Employers NI is 12.8%.
Required:
(a) assuming those that left earned the average wage, calculate the
total short-term employment cost for Nairn plc for the year to
31 December 2005; and
(b) calculate the liability relating to employee benefits as at
31 December 2005.

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Solution
(a) Total short-term employment cost

notes

000
14,000
1,500
309
15,809

Wages and salaries

Employers NI on wages and salaries
Annual bonus
Annual bonus

There is a legal obligation to pay a bonus if the

conditions are met.
% increase in profits = 12.7%, therefore bonus will be
paid.
Number of staff eligible

=
=

610 12
598

Bonus = 2% x 598/610 x 14m =

274,000
NI on bonus (12.8%)

274,491 = approx

=
35,135
35,000

approx
309,000

(b)

Liability at 31 December 2005

Annual bonus
309
PAYE and NI (32% x 14m/12 + 1.5/12)
(= 373,333 + 125,000)
498
807

You should now be able to achieve the first learning objective

of the module.

10.4 POST-RETIREMENT BENEFITS: AN OVERVIEW

These include:
(a)
(b)

pensions; and
other post-retirement benefits (eg medical care).

As pensions are by far the most common type of postretirement benefits in the UK we will concentrate on
these. Pensions often are part of the remuneration
package offered by companies to their employees.
While the pension will not be paid until an employee
retires, normally contributions are made towards the
cost of providing the future pension throughout the
working life of the employee.
Pension schemes can be either contributory (both the
employee and the employer contribute to the pension) or noncontributory (the employee makes no contribution).

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notes

The employees contribution is a deduction from gross salary

and is accounted for in the same way as other deductions eg
PAYE and NI. The main accounting problem is with the
employers contribution which is a cost to the company
in addition to the gross salary of the employee.

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10.4.1 Types of plans

There are two types of pension plan: defined contribution and
defined benefit.
Defined contribution plans (or money purchase schemes)
require the company to make an agreed level of contributions
to the scheme. The pensioners will enjoy the full benefits of all
returns generated from the subsequent investments, although
they also run the risk of a poor pension if the schemes
investments are unsuccessful. The principal risks lie with the
employee as, once the employer has paid its contribution, it
has no further obligation.
These plans are increasingly
popular with employers.
Defined benefit plans (or final salary schemes) require the
plan to pay an agreed pension on retirement for the remainder
of the pensioners life. The amount of the pension will usually
be based on a formula taking account of length of service and
salary at the time of retirement. The actual amount to be paid
as a pension will not be known until retirement. Employees
pay a fixed contribution to the plan. Employers are required
to pay contributions to the scheme to meet the projected
pension liability. This is obviously less risky for the employees,
but it leaves the risk with the employer. These plans are
becoming less common
Defined benefit schemes create pension liabilities which are
related to a variety of unknown factors: salaries at time of
retirement, length of retirement, probability of death in
service, etc. This makes the liability extremely difficult to
measure. Pension assets are usually accumulated to meet
these liabilities. Assessing how much should be put into a
pension scheme each year to build up the necessary assets is
also a difficult task. Estimates need to be made of investment
returns and decisions made as to which assets to invest in.
One of the roles of the actuarial profession is to make such
assessments of liabilities and assets. Actuaries collect and
analyse detailed statistics about past events and use these to
predict the future.
While this is not an exact science,
experience suggests that it is possible to make predictions
which are sufficiently accurate for planning and accounting
purposes.
The following example may help to identify the range of
variables.
Example 2
An employee joins a non-contributory scheme on his 50 th birthday.
It is assumed he will retire in ten years when he will receive a
pension based on 1/50 of salary for each year worked. He earns
30,000 pa. It is estimated that the employee will live for 15 years
after retirement. The pension will not increase during retirement.
Assume inflation and salary increases are zero and return on
investments is 12% and contributions are made at the end of each
year.

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notes

The actuarial problem is to build up a fund by age 60 sufficient to

fund an annuity of 30,000 x 10/50 = 6,000 per annum. The
obligation to fund the pension is a pension liability

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What fund of assets is required at retirement?

The assets at retirement must be able to fund payments of
6,000 per annum for 15 years ie an annuity of 6,000
for 15 years.
Using PV tables assuming a 12%
discount rate (return on investments) gives:
6,000 x 6.8109 = 40,865
For each years service 4,086 (40,865/10) requires to be
available to fund the pension when the employee
retires.
What annual contributions are required to build up the fund?
For each year of pension entitlement 4,086 must be
accumulated by the time of retirement. The PV of
4,086 in ten years time is:
4,086/(1.12)10 = 1,316
What percentage of salary should the employer contribute in
the first year?
1,316/30,000 = 4.39%
On the above assumptions this would be the total contribution
rate.
If the scheme was contributory the employer would contribute
the balance to give a total contribution of 4.39% eg if
the employee contributes 2%, the companys share
would be 2.39% or 717.
This should ensure that the pension assets (contributions paid
in to the fund) keep pace with the liabilities (the
obligation to pay pensions).
Note that the above example is for illustration. You will
not be expected to calculate required pension
contributions.
Consider some of the simplifications that have been made in
this example:

inflation zero
salary increases zero ie no annual increases or promotion
known life of pensioner
investment returns constant at 12%
no increase in pension over the 15 years (by law pensions
must be increased by the lower of 5% and RPI)
no dependants pension rights
worker does not die in service or seek early retirement.

It is not surprising that calculating a contribution rate is

difficult and that past estimates will require to be

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notes

reviewed and changed in the future.

You should now be able to achieve the second learning
objective of the module.

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10.5 ACCOUNTING FOR DEFINED CONTRIBUTION PLANS

Accounting for defined contribution plans is straightforward as
the companys obligation is determined by the amounts
to be contributed for the period. Once the company
pays this there is no further liability. The main points
are:

any contribution by the employee is deducted from their

salary as part of the salaries system and is paid over to the
pension scheme. Any amount deducted but not paid over to
the pension scheme at the year end is a liability of the
company.

any unpaid or pre-paid part of the

contribution is an accrual or prepayment.

the company charges its share of the contribution to the

pension scheme to the profit and loss account (unless it is
to be included in the cost of fixed assets, stock etc.).

companys

Example 3
Pitcher plc operates a defined contribution plan under which
employees pay 5% of gross salary and the employer 13%.
Payments are made to the pension scheme and the Revenue 14
days after the end of each month.
Gross salaries for November 2004 were 500,000. PAYE and NI
deductions were 100,000. Employers NI equalled 56,000 for
the month.
Required:
(a) calculate the total employment cost for November 2004;
(b) prepare journal entries to record the relevant transactions.

Solution
(a)

Employment cost

Gross salary
500,000
Employers NI
56,000
Employers pension contribution (13% x 500,000)
65,000
621,000

(b)

Journal entries
30 November 2004
Dr Wages and salaries
621,000
Cr Inland Revenue
Pension liability
Bank
being payroll for November 2004
14 December 2004
Dr Inland Revenue

156,000

156,000
90,000
375,000

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notes

12

Pension liability
90,000
Cr Bank
being payment of deductions

246,000

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Note:
(i)
Total payments (375,000 + 246,000) equal the total
wages and salaries expense.
The net salary paid to employees is:
Gross salaries
less: PAYE and NI
: pension (5%)
(ii)

500,000
(100,000)
(25,000)
375,000

If 30 November 2004 was the company year-end there

would be liabilities of 246,000:
Inland Revenue (100,000 + 56,000) 156,000
Pension scheme (65,000 + 25,000) 90,000

(iii)

Under a defined contribution plan, payment of 90,000

to the pension scheme removes all the liability the
company has for pensions.

10.6 ACCOUNTING FOR DEFINED BENEFIT PLANS

As described in 10.4 defined benefit plans are more complex
than defined contributions plans and the company,
rather than the employee, is exposed to the principal
risks.
As a result the accounting and disclosure
requirements are more detailed.
The approach adopted is that although the pension assets and
liabilities are normally held by a separate legal entity
(usually a trust) they should appear in the companys
balance sheet as the company bears the ultimate risks
and rewards of the performance of the plans
investments, through higher or lower levels of
contributions.
The accounting entries are mainly based on details supplied by
actuaries.

10.6.1 Measurement of assets and liabilities

Measurement of defined benefit scheme assets and liabilities:
(a)

assets are measured at fair value (FV) at the balance

sheet date;

(b)

liabilities are measured at an approximation of fair

value, using a particular actuarial method (the projected
unit credit method);

(c)

liabilities are discounted to present value (PV) at the

current rate of return on a high quality corporate bond
of equivalent terms and currency of the liability;

(d)

PV of liabilities and FV of assets should be determined

regularly so that amounts in the financial statements
approximate to the amounts at the year-end.

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notes

10.6.2 Recognition in profit and loss account and

balance sheet
The following example will be used to illustrate the required
amounts to be recognised in the profit and loss account and
balance sheet.
Example 4
Fitzroy Ltd has a defined benefit pension plan for its employees.
The scheme assets and liabilities were as follows:

Assets market value

Liabilities actuarial value

31.12.05
m
395
355

31.12.04
m
300
250

The expected rate of return on assets is 7.2% and the discount

rate is 5.5%. Contributions of 20m were paid at the year-end
and the current service cost was 23m.
Payments of 5m to pensioners were made in the year.
Assume any pension asset is recoverable.
The average remaining working lives of staff in the plan is ten
years as at 1 January 2005.
Unrecognised actuarial gains at 31 December 2004 were 40m.
There was a pension asset of 10m at that date.
During 2005 Fitzroy improved the benefits under the plan and
backdated these for existing members of the scheme. The cost of
this was estimated by the actuary at 12m. No payments had
been made into the plan in relation to this at 31 December 2005.
In August 2005 Fitzroy closed one of its operating plants. As a
result of redundancies a significant number of members will earn
no future benefits the actuary estimates that this will reduce the
total liabilities of the plan by 6m. There is no affect on assets.
Fitzroy Ltd adopts the corridor approach in recognising actuarial
gains and losses.
Required:
Calculate the amounts to be included in the profit and loss account and
balance sheet of Fitzroy Ltd for the year to 31 December 2005 and
prepare relevant journal entries.

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(i)

Profit and loss account

notes

There are six items that can arise. The first four are
periodic costs and the last two are non-periodic costs.
(a)

the current service cost (the increase in the

actuarial liability expected to arise from employee
service in the current period). This represents the
net cost to the employer of providing an extra
years benefits to employees.
The journal is:
Dr

Staff costs
Cr
Pension account

For Fitzroy the current service cost is 23m.

Therefore:
Dr
(b)

Staff costs
Cr
Pension account

m
23

m
23

the interest cost (the expected increase during

the period in the present value of the liability
because the benefits are one period closer to be
being paid). The interest cost represents the
unwinding of the discount.
The journal is:
Dr

Staff costs
Cr
Pension account

For Fitzroy the interest cost is:

discount rate x opening liability
ie 5.5% x 250m = 13.75m
Dr
(c)

Staff costs
Cr
Pension account

13.75
13.75

the expected return on assets (the expected

rate of return multiplied by the market value of
the plan assets).
It represents the long-term
return expected on the assets in the plan. It also
reflects the effect of contributions paid into the
fund and benefits paid out during the year.
The journal is:
Dr

Pension account
Cr
Staff costs

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The expected return for Fitzroy is:

notes

return % x opening assets

ie 7.2% x 300m = 21.6m
Dr
(d)

Pension account
Cr
Staff account

21.6
21.6

actuarial gains and losses can arise on plan

assets when expected and actual returns differ
and can arise on scheme liabilities when there are
differences between actuarial assumptions and
actual experience and from changes in actuarial
assumptions.
A company need not recognise all of its actuarial
gains and losses immediately. None of the gains
or losses need be recognised if they fall within a
10% corridor. The boundaries of the corridor
are the greater of:
(a)

10% of PV of plan liabilities at the last

balance sheet date; and

(b)

10% of FV of plan assets at that date.

If the net cumulative unrecognised actuarial gains

and losses at the last balance sheet date exceed
the corridor a portion should be recognised as
income or expense. The portion is the excess
over the corridor divided by the expected average
remaining working lives of employees who are
members of the plan. A systematic method of
faster recognition is acceptable if applied
consistently (10.6.4).
If an actuarial gain or loss is being recognised the
journal entry will be either:
Gain
Dr
Pension account
Cr
Staff costs
Loss
Dr
Staff costs
Cr
Pension account
Fitzroy has 40m of unrecognised gains at
1.1.05.
At 1.1.05
less: greater of
10% of liabilities (10% of 250m)25
10% of assets (10% of 300m) 30
Excess gain
16

40

30
10

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Recognise in year (1/10)

The actuarial gain recognised for Fitzroy is:

Dr
(e)

Pension account
1
Cr
Staff costs
1
past service costs (increases or decreases in
pension liabilities related to employee service in
earlier periods arising in the current period as a
result of the introduction of, or changes to, postretirement benefits) should be recognised as an
expense immediately.
The journal is:
Dr

Staff costs
Cr
Pension account

For Fitzroy the cost is 12m, therefore the journal

is:
Dr
(f)

Staff costs
Cr
Pension account

12
12

gains and losses on settlements and

curtailments (settlement is the removal of the
obligation by, for example, a lump sum cash
payment to a member or transfer to another
scheme; curtailment is a material reduction in the
number of employees covered by a plan or a
reduction of benefits for some or all of employees
future service) should be included in the profit
and loss account. These may involve reductions
in both pension assets and liabilities.
The journal is:
Dr

Pension account (reduction in liability)

Cr
Pension account (reduction in asset)
Staff costs (if a gain, otherwise debit)

Fitzroy has had a curtailment that has led to a

gain due to a reduction in liabilities with no
change in assets. The entry is:
Dr

Pension account
Cr
Staff costs

6
6

Profit and loss summary

Amounts recognised in staff costs relating to
defined benefit pension costs are:
current service cost
interest cost
expected return on plan assets

23.0
13.7
(21.6)

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notes

18

net actuarial gain recognised

past service cost
curtailment
Net expense

(1.0)
12.0
( 6.0)
20.1

TPS FINANCIAL REPORTING

(ii)

Contributions and benefit payments

notes

Contributions paid to the pension plan increase the

pension assets. The actual contribution paid in a period
will depend on a number of factors including actuarial
advice and the cash flow of the company.
The
contribution paid in a year will not necessarily equal the
current service cost.
Contributions paid will be
recorded as
Dr

Pension account
Cr
Bank

X
X

The purpose of a pension plan is to provide benefits to

members when they retire. Benefits paid by the pension
plan will reduce both pension assets (as money is paid
out by the pension plan) and pension liabilities (paying
benefits settles an obligation and therefore obligations
reduce). There will be no net effect on the pension fund.
The entry will be:
Dr

Pension account (liability)

Cr
Pension account (asset)

In the Fitzroy case contributions of 20m were paid and

payments to pensioners totalled 5m. Required entries
are:
Dr

Pension account
Cr
Bank

20
20

and
Dr
(iii)

Pension account (L)

5
Cr
Pension account (A)

Balance sheet
There is a formal and informal way of calculating the
amount to appear in the balance sheet. We will deal
with the informal (quicker) method here and leave the
formal (more detailed) method until we look at
disclosure.
The informal method relies on the journals that have
been produced and works as follows:
Opening pension asset (debit) or liability (credit)
adjusted by net debit or credit to pension account from
(i)
(ii)

profit and loss entries

contributions and benefit payments

equals closing pension asset or liability.

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In the case of Fitzroy this gives:

notes

m
10

opening asset

Dr

net credit to pension account from profit

and loss entries
20.1 Cr
net debit to pension account from
contributions and benefit payments

20

closing asset

Dr

9.9 Dr

Always use this approach unless you are required to

produce a disclosure note in which case you will have to
use the formal approach.

10.6.3 Disclosure
Defined contribution plans
The expense for the year should be disclosed (para 46).
Defined benefit plans
Due to the more complex nature of these plans there are
significant disclosure requirements.
These are
detailed in paragraph 120A. The more important ones
are as follows.
Note that the references below are consistent with those in
paragraph 120. There appear to be gaps in the sequence
below but this is when the item is omitted because it is either
of less significance or is outwith the scope of the syllabus.
Illustrative disclosures in Appendix B to IAS 19 are useful.
An entity should disclose the following information about
defined benefit plans:
(a)

the enterprises accounting

actuarial gains and losses;

(b)

a general description of the type of plan;

(c)

a reconciliation of opening and closing balances of the

present value of the defined benefit obligation showing
separately, if applicable, the effects during the period
attributable to each of the following:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)

20

current service cost,

interest cost,
actuarial gains and losses,
benefits paid,
past service cost,
curtailments and
settlements.

policy

for

recognising

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(e)

a reconciliation of the opening and closing balances of the

fair value of the plan assets showing separately, if
applicable, the effects during the period attributable to
each of the following:
(i)
(ii)
(iii)
(iv)
(v)
(vi)

expected return on plan assets,

actuarial gains and losses,
contributions by the employer,
contributions by plan participants,
benefits paid and
settlements.

(f)

a reconciliation of the present value of the defined benefit

obligation in (c) and the fair value of the plan assets in (e)
to the assets and liabilities recognised in the balance
sheet, showing the net actuarial gains or losses not
recognised in the balance sheet (see paragraph 92). This
is the formal presentation and calculation of the balance
sheet total.

(g)

the total expense recognised in profit or loss for each of

the following, and the line item(s) in which they are
included:
(i)
(ii)
(iii)
(iv)
(v)
(vi)

current service cost;

interest cost;
expected return on plan assets;
actuarial gains and losses;
past service cost; and
the effect of any curtailment or settlement.

(h)

the total amount recognised in the statement of

recognised income and expense for actuarial gains and
losses.

(i)

for entities that recognise actuarial gains and losses in

the statement of recognised income and expense in
accordance with paragraph 93A, the cumulative amount
of actuarial gains and losses recognised in the statement
of recognised income and expense.

(m) the actual return on plan assets.

(n)

the principal actuarial assumptions used as the balance

sheet date, including, when applicable:
(i)
(ii)

the discount rates;

the expected rates of return on any plan assets for
the periods presented in the financial statements;
(iii) the expected rates of salary increases (and of
changes in an index or other variable specified in the
formal or constructive terms of a plan as the basis
for future benefit increases);
(iv) medical cost trend rates; and
(v) any other material actuarial assumptions used.

notes

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notes

An entity shall disclose each actuarial assumption in

absolute terms (for example, as an absolute percentage)
and not just as a margin between different percentages or
other variables.
You should now be able to achieve the third and fourth
learning objectives of the module.

22

TPS FINANCIAL REPORTING

Assume in Example 4 that a disclosure note was also required.

Accounting policy for recognising actuarial gains and losses
Actuarial gains and losses that exceed 10% of the greater of
plan liabilities and plan assets are amortised over the expected
average remaining service lives of employees in the plan. Past
service costs are recognised immediately.
General description of the plan
The company operates a defined benefit pension plan on behalf
of its employees.
Changes in the present value of defined benefit obligation and
fair value of plan assets are as follows:

Opening amount
Service cost
Interest cost
Expected return
Actuarial gains/(losses)
Past service costs
Curtailment
Contributions paid
Benefits paid

Obligation
m
(250)
(23)
(13.7)
(67.3)
(12.0)
6.0
5.0
(355.0)

Assets
m
300
21.6
58.4
20.0
(5.0)
395.0

Notes:
1.

The figures, except for actuarial gains/losses are all

derived from the journals created earlier.

2.

The actuarial gains or loss is a balancing figure. In this

case there is a loss on the obligations (liabilities) and a
gain on assets.

3.

In Appendix B of IAS 19 there are separate tables for

obligations and assets. They have been combined here
for speed.

The amount recognised in the balance sheet

m
355.0
395.0
(40.0)
Unrecognised actuarial gains (see working) 30.1
Present value of obligations
Fair value of plan assets

Net pension asset at 31 December 2005

Notes:

(9.9)

1. The way in which the calculation is illustrated in

IAS 19 a negative figure represents an asset.

2. This is the formal way of arriving at the balance

sheet total. This is much slower than the informal

notes

MODULE 10

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notes

24

way described earlier and should only be done when

a disclosure note is required in the question.

TPS FINANCIAL REPORTING

notes

Total expenses recognised in profit or loss

This has been detailed earlier (see page 12)
Actual return on plan assets
Expected return on assets
Actuarial gain on plan assets
Principal actuarial assumptions
Discount rate applied to plan obligations
Expected return on plan assets

21.6
58.4
80.0
5.5%
7.2%

Working
Unrecognised gains or losses have to be calculated as follows:
Unrecognised amount at start of the period 40 gain
Actuarial gain/(loss) on liabilities
(67.3)
Actuarial gain/(loss) on assets
58.4
Recognised in year (from corridor working) (1.0)
30.1

10.6.4 Alternative to the corridor

An amendment to IAS 19 introduced, from UK GAAP, an

alternative approach to actuarial gains and losses
(para 93A-D). This permits a company to recognise all
actuarial gains and losses immediately in the period in
which they arise. The following conditions must be
met:

it must be applied to all of its defined benefit plans;

it must include all actuarial gains and losses as at the
current balance sheet date;
presentation must be through the statement of recognised
income and expense ie a company must produce this
statement. It cannot be reported through the full changes
in equity statement;
it must recognise the actuarial gains and losses in profit
and loss reserve and not a separate reserve.

The journal entries will be:

Gain
Dr
Loss
Dr

Pension account
Cr Profit and loss reserve
Profit and loss reserve
Cr Pension account

When this method is adopted there will be no unrecognised

gains and losses.

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notes

Example 5
Assume that Fitzroy does not apply the corridor method but adopts
the alternative approach outlined above. All the data is the same
as in Example 4 except that in using the alternative approach the
full difference between assets and liabilities at 31 December 2004
would have been recognised ie a 50m asset.
Required:
(a) calculate the amounts that would appear in the profit and loss
account and statement of recognised income and expense of Fitzroy
for the year to 31 December 2005 and the balance sheet as at that
date; and
(b) prepare disclosure notes.

Solution
(a)

Profit and loss account

The only difference is that there will be no figure for
actuarial gain or loss as these are reported through the
SORIE. All the other figures will be exactly the same.
This gives:
Current service cost
Interest cost
Expected return on assets
Past service cost
Curtailment

m
23
13.7
(21.6)
12.0
(6.0)
21.1

Statement of recognised income and expense

Actuarial loss on liabilities
Actuarial gain on assets
Net actuarial loss presented

(67.3)
58.4)
(8.9)

Balance sheet
Non-current assets
Net pension asset

40

Note: the pension asset is the net of pension assets and

liabilities.
(b)

Disclosure note
The disclosure would be identical to that for the original
Example 4 except for the following:
Accounting policy for recognising actuarial gains and
losses
All actuarial gains and losses are recognised

26

TPS FINANCIAL REPORTING

immediately through the statement of recognised

income and expense. Past service costs are recognised
through profit and loss immediately.

notes

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notes

The amount recognised in the balance sheet

Present value of obligations
355
Fair value of plan assets
(385)
Net pension asset at 31 December 2005 (40)
Note: under this approach all gains and losses are
recognised
immediately
therefore
none
are
unrecognised.
Total expense recognised in profits or loss
As indicated in (a) this would now exclude the 1m
actuarial gain.
You should now be able to achieve the forth learning outcome
of the module.

10.7 IFRS 2 SHARE BASED PAYMENT

It is quite common for companies to make payments in the
form of shares or share options or to base a cash payment on
the value of shares or share options. This is particularly the
case with payments to employees where part of the
remuneration package may be in the form of shares or options.
The company is issuing or granting these shares and options in
return for goods and services received.
Example 6
X Ltd pays a bonus to its staff in the form of share options. Under
this scheme a total of 50,000 options to acquire ordinary 1 shares
were granted in the year to 31 December 2005. The options had
an average fair value of 75p each and an average exercise price of
1.05. They can be exercised on 31 December 2006 but not
before that date.
The accountant of X Ltd is unsure how to deal with these in the
financial statements for the year to 31 December 2005 and has
asked three colleagues - A, B and C.
Their suggestions are:
A
As the options have not been exercised at 31 December 2005
there is nothing to record at that date. If the options are exercised
they should be recorded at 31 December 2006.
B
As the options have been granted and may be exercised 52,500
should be recognised as a debtor and added to ordinary share
capital.
C
As the options issued are to employees in return for services
rendered 37,500 (the fair value of the options) should be
recognised as an expense and credited to reserves.
28

TPS FINANCIAL REPORTING

Required:
How should X Ltd account for the shares issued and options granted?

notes

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notes

Solution
Prior to the issue of IFRS 2 there was no accounting standard
in this area and many companies adopted the suggestion of A.
After prolonged review and extensive lobbying by companies
that make extensive use of options for the status quo, IFRS 2
was issued. As we shall see it requires the approach suggested
by C.

10.7.1 Scope and definitions

IFRS 2 applies to all share-based payment transactions with
limited exceptions.
The main exception is accounting for the issue of shares in a
takeover. Module 22 deals with this situation.
Two definitions are important:
grant date the date at which the entity and another party
(including an employee) agree to a share-based payment
arrangement.
vesting period the period during which all the specified
vesting conditions of a share-based payment arrangement are
to be satisfied.

10.7.2 Types of share-based payment transactions

The standard identifies three types of transaction (para 2).
Equity-settled share based transactions
The company gives shares or options in return for goods and
services received.
Cash-settled share-based payment transactions
The company gives an amount of cash, based on the value of
the companys shares, in return for goods and services
received. For example, employees may receive a bonus paid in
cash based on the increase in the share price of the company
over a particular period of time.
Cash or share-settled transactions
The company or the other party can either settle in cash or
shares (or options) in return for goods and services given or
received. For example, a company or its employees may have a
choice as to whether part of the remuneration package is
given in cash or shares.

10.7.3 Recognition
A company should (paras 7 & 8):
(a) recognise the goods or services received or acquired in a
share-based transaction when the goods and services are
received (ie not when payments are made or shares are
actually issued). If the goods and services do not qualify to be
recognised as assets they should be written-off to profit and
loss as expenses. Most payments to employees will be
expenses as no future benefit is to come; and
30

TPS FINANCIAL REPORTING

(b) recognise a liability if payment is to be in cash or as an

increase in equity if it is to be equity-settled.

10.7.4 Equity-settled share-based transactions (para

10 29)
The amount to record is the fair value of the goods and
services received unless the fair value cannot be estimated
reliably in which case the fair value of the equity instruments
granted should be used.

notes

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notes

It is presumed that the fair value of services provided by

employees cannot be estimated reliably and therefore
the value of the shares given has to be used.
If the equity instruments vest immediately (ie the employees
become unconditionally entitled to the shares) it is presumed
that the company has already received the benefit of the
services and the full amount is recognised on the grant date of
the equity instrument.
If the equity instruments do not vest immediately the company
should assume that the benefits received in return for the
equity will be received over the vesting period. They should be
accounted for as services received over the vesting period
(normally debited to profit and loss) with a corresponding
increase in equity.
If the vesting condition is merely the passing of time the
company should assume that the benefits are received from
the grant date to the vesting date.
If the vesting condition is based on the market price of the
shares of the company (eg an employee is granted 1,000 share
options that will vest when and if the share price of the
company exceeds 5 per share) the company estimates the
vesting period and does not change that estimate.
If the vesting condition is not based on the market price of the
shares (eg on when a particular sales target is met) the
company also should estimate the vesting period but change
the estimate when new information becomes available.
For transactions that are measured by reference to the fair
value of the equity granted the fair value should be calculated
at the measurement date based on market prices or, where
these are not available, an acceptable valuation technique eg
an option pricing model.
For transactions with employees measurement date is grant
date. For others it is the date of receipt of the goods and
services involved.
If the situation changes during the vesting period the
estimated number of shares to be issued is adjusted not the
fair value so that on final vesting the total amount charged for
goods and services received equals the final number of shares
issued at vesting date valued at the fair value at the
measurement date.
Assuming an employee remuneration arrangement the entry
each year would be:
Dr Staff costs
Cr Other reserves
Example 7

32

X
X

TPS FINANCIAL REPORTING

A company has granted share options to its 1,000 employees on

the following basis. Each employee will be entitled to 500 options if
they remain with the company for 3 years. At the date of grant each
option is estimated to have a value at 3.50 each.
At the end of year one 50 staff have left and the company
estimates a total of 100 will leave over the next two years.

notes

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notes

During year two 60 staff leave and it is now estimated that 55 will
leave in year three.
During year three 45 staff leave.
Required:
Calculate the amounts that should appear in the financial statements in
each of the three years.

34

TPS FINANCIAL REPORTING

Solution
As the options vest over a three year period it is assumed that
the options relate to services provided by the employees over
the three year period. The cost of these services should be
recognised over the three years with estimates revised based
on new information. This gives the following figures:
Staff costs

Cumulative increase
in equity

Year 1
(1,000 150) x 3.50 x 500 x 1/3495,833

495,833

Year 2
(1,000 165) x 3.50 x 500 x 2/3
less 495,833
478,333

974,166

Year 3
(1,000 155) x 3.50 x 500
less 974,166
504,584

1,478,750

Example 8
A company grants a total of 100,000 share options to its 4
executive directors on 1 January 2003 conditional upon the
directors remaining in office for the next 3 years. The exercise
price of the options is:
5 if the earnings of the company grow by an average of less than
15% per annum over the 3 years
4 if earnings grow by more than 15% per annum.
On grant date it is estimated that the options have the following
values:
5 option - 1
4 option - 1.60.
In the year to 31 December 2003 earnings grew by 16% and the
company expected this level of growth to be maintained over the
next two years.
During 2004 due to the loss of a major customer earnings grew by
only 9%. The expected growth over the next year was estimated to
be less than 15% per annum.
During 2005 growth was 13%.
At each date the company expected all directors to be in service at
the end of the third year. This was the case. The options must be
exercised during 2006.
Required:
Calculate the amounts that would appear in the financial statements for
2003 to 2005.

notes

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notes

Solution
At 31 December 2003 it is anticipated that the earnings target
of more than 15% over the three years will be met and
therefore the share options will have an exercise price of 4
and a value at grant date of 1.60.
At 31 December 2004 earnings have dipped and are not
expected to average over 15% during the three year period.
The options would therefore be expected to be issued at 5
with a value of 1 each.
At 31 December 2005 it is confirmed that the growth rate in
earnings is less than 15%.
The amounts to appear in the accounts for each year are as
follows:
Year

Staff cost

2003
(100,000 x 1.60) x 1/3

Cumulative increase
in equity

53,333

53,333

2004
(100,000 x 1) x 2/3 53,33313,334

66,667

2005
(100,000 x 1) x 3/3 66,66733,333

100,000

Example 9
A company acquired a property on the 31 March 2005.
Consideration was 1m ordinary 50p shares. The property had an
estimated market value of 3.5m at the date of acquisition. At that
date the ordinary shares of the company were trading at 3.55.
Required:
Prepare the journal entry to record the acquisition of the property.

Solution
Dr Property cost 3,500,000
Cr Share capital
500,000
Share premium
3,000,000
being purchase of property
IFRS 2 requires that the fair value of the goods received is
used as the basis of measuring the transaction unless no
reliable estimate of fair value is available. There is no
indication that the figure of 3.5m is not reliable therefore it
should be used.

36

TPS FINANCIAL REPORTING

The above treatment will ensure that the goods and services
received are recognised over the period to vesting.
Irrespective of what happens after the vesting date no change
is made to total equity. Transfers within equity are permitted
and may be appropriate. For example, if shares are issued on
settlement the entry will be:
Dr

Other reserves
Cr
Share premium
X

If share options are not exercised any balance on other

reserves should be transferred to profit and loss reserve by:
Dr

Other reserves
Cr
Profit and loss reserve
Example 10
Referring to example 8 the directors were issued with a total
100,000 5 options. The directors exercised 40,000 of the options
in early 2006. However due to a decline in the share price to below
5 none of the other options were exercised and they lapsed on 31
December 2006.
The options were in respect of the companys 25p ordinary shares.
Required:
Prepare journal entries to record the above events.

Solution
Exercised options
Dr Other reserves
(40% x 100,000)
Cr Share premium

40,000
40,000

being issue of shares on exercise of options

Issue of shares
Dr Bank
200,000
Cr Share capital
Share premium
being issue of shares of 5 each

10,000
190,000

Unexercised options
Dr Other reserves
60,000
Cr Profit and loss reserve
being transfer of share options on lapse

60,000

The exercised options become capital and should be recorded

as such in the usual manner.

notes

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notes

38

TPS FINANCIAL REPORTING

The lapsed options should be removed from other reserves.

Profit and loss reserve can be credited as the company has no
obligation to issue equity instruments.

10.7.5 Cash-settled share-based payment

transactions (para 30 33)
With these transactions the amount to be paid for the goods
and services is based on the value of the companys shares but
is paid in cash. The standard refers to these as share
appreciation rights (SARs). If payment is not made at the date
of the transaction (the normal situation) a liability exists. The
initial cost of the goods and services is the fair value of the
liability. The entries are as follows.
At date of transaction
Dr Goods/services
Cr Creditors

X
X

At date of payment
Dr Creditors
Cr Bank

X
X

As the liability varies with the value of the companys

shares it should be re-measured at each balance sheet
date until settlement. Any change is taken to the profit and
loss account. The SARs should be measured using an option
pricing model.
Example 11
Part of the contract of employment of the staff of a company is the
right to receive payment in cash equivalent to 75% of the increase
in value of a notional number of the companys shares during the
year. On average each of the companys 250 employees receive
75% of the increase on 1,000 shares.
During the year to 31 December 2005 the share price increased
from 450p per share to 520p.
Payment is made on 31 March 2006.
Required:
Calculate the amount to appear in the accounts of the company for the
year to 31 December 2005.

Solution
Amount payable
250 x 1,000 x 75% x (5.20 4.50)

131,250

This would appear as an employment cost and would be a

liability at the year-end as payment was not until 31 March
2006.

notes

MODULE 10

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notes

40

If the rights to a cash-settled amount vest over a period of time

the same approach as to equity-settled transactions applies.

TPS FINANCIAL REPORTING

notes

Example 12
A company grants 500 SARs to each of its 300 employees, on
condition that the employees remain with the company for the next
two years. The SARs must be exercised at the start of year 3.
During year one 10 staff leave and the company estimates that
another 12 will leave in year 2. During year two 15 staff leave the
company. At the end of year 2 the SARs of those remaining in
employment vest.
The estimates of the fair value of the SARs for each year a liability
exists are as follows:
Fair value

Year 1
Year 2

12.00
14.30

Required:
Calculate the amounts to appear in the profit and loss account and the
balance sheet of the company for years 1 and 2.

Solution
Staff costs

Liability

Year 1
(300 22) x 500 x 12 x 1/2834,000

834,000

Year 2
(300 25) x 500 x 14.30
less 834,000
1,132,250

1,966,250

10.7.6 Share-based payment transactions with cash

alternatives (para 34 43)
These are transactions where either the counterparty or the
company has the choice whether the transaction is settled in
cash or equity instruments. Cash refers to cash and other
assets. Transactions with employees are by far the most
common and only these are covered.
These should be treated as cash-settled share-based
transaction if the company has incurred a liability to settle in
cash or other assets, otherwise as an equity-settled share
based payment transaction.
The company has an obligation if either:
(a) the counterparty has the choice, or

MODULE 10

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notes

42

(b) the company has the choice but the settlement in equity
option has no commercial substance or the company has
a past practice or stated policy of settling in cash.

TPS FINANCIAL REPORTING

Situation where an obligation exists

The accounting treatment where an obligation exists is the
same as a cash-settled share-based payment transaction as in
10.7.5 above.
One difference is that the counterparty might choose not to
receive cash on the date of settlement. If this is the case the
liability built up is transferred to equity as it represents the
consideration received for the equity. For settlement in shares
the entry would be:
Dr Creditors
Cr Share capital
Share premium

X
X
X

Example 13
A company grants employees the choice of 500 50p ordinary
shares each or the cash equivalent. The rights vest on the
completion of 2 years service. Any employee leaving within the two
year period forfeits the right to receive cash or shares.
During the two year period a liability of 639,400 is built up in
relation to 278 eligible staff, being 278 x 500 x 4.60 (4.60 was
the share price at 31 December 2005).
On the settlement date of day 1 of year 3, 200 of the eligible staff
opt for payment in cash. The remaining opt for shares.
Required:
Prepare journal entries to record the settlement on day 1 of year 3.

Solution
Two hundred staff opt for cash and 78 for payment in shares.
The cash payments reduce the liability by 460,000 (200 x 500
x 4.60). The remaining 179,400 (639,400 less 460,000) of
the liability is effectively the proceeds form the issue of 39,000
(78 x 500) 50p ordinary shares. The required journal entries
are:
Dr Liability
460,000
CR Bank
being payment of share-based payment liability

460,000

Dr Liability
179,400
Cr Share capital
19,500
Share premium
159,900
being transfer of shares to employees under share-based
payment arrangement
Note that the two journals could have been combined into one.

notes

MODULE 10

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notes

Situation where no obligation exists

The transaction should be accounted for as an equity-settled
share-based payment transaction as in 10.7.4 above.
If the company chooses to settle in cash then no new equity
arises and the amount built up over the period has to be
removed. The accounting entry is:
Dr Other reserves
Cr Bank

X
X

If settlement is in shares there will be a transfer within equity

from other reserves to share capital and share premium.
Example 14
A company has created a reserve of 1,000,000 within Other
reserves in relation to a share-based payment scheme where the
company had the choice of settling in cash or shares. As the
company had intended to settle in shares this reserve has been
built up over the vesting period.
At the settlement date the company decided to settle one-quarter
of the amount in cash and the remainder through the issue of 1
ordinary shares that were worth 5 at that date.
Required:
Prepare the journal entries on settlement.

Solution
Dr Other reserves
250,000
Cr Bank
being cash settlement of share-based payment
Dr Other reserves
750,000
Cr Share capital
Share premium
being capitalisation of reserves in issue of shares

250,000

150,000
600,000

10.7.7 Disclosure
Paragraphs 44 to 52 of the standard cover disclosure. There
are three broad areas covered:
(a) information about the nature and scope of share-based
payment arrangements that existed during the period
(paras 44 and 45). A description of the arrangements
and detail of share options outstanding, granted,
exercised etc during the period.
(b) How any fair values were determined (paras 46 49).
Information about the use of fair values and how these
were arrived at need to be given.
(c) Effect on the profit and loss account and balance sheet
(paras 50 52). The total expense (with the total for
equity-settled
share-based
payment
transactions
44

TPS FINANCIAL REPORTING

separately identified) and the total lability and how

much of this is vested at the year-end.

notes

MODULE 10

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notes

10.8 FINANCIAL REPORTING STANDARDS

IAS 19 and FRS 17 Retirement Benefits adopt the same
approach to post-retirement benefits with one major exception.
FRS 17 requires all actuarial gains and losses to be taken
through the STRGL immediately. The balance sheet reflects
the net pension asset or liability. No corridor or delayed
recognition over the remaining lives of the employees is
applied.
FRS 17 applies to retirement benefits only. There is no
equivalent standard dealing with short-term or other long-term
benefits.
The UK has adopted IFRS 2 as FRS 20.
You should now be able to achieve the fifth and sixth learning
objective of the module.

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TPS FINANCIAL REPORTING

10.9 SUMMARY
1.

2.

notes

Short-term benefits

any amounts unpaid liability

charge as expense in P/L unless included in cost of an asset

profit sharing and bonus plans: accrue when obligation arises.

Post retirement benefits

a.

Defined contribution
P/L charge for year
B/S any unpaid/prepaid amount

b.

Defined benefit

(1) Profit and loss

Current service cost
Dr P/L - staff costs
Cr Pension a/c
Interest cost
Dr P/L staff costs
Cr Pension a/c
Expected return on assets
Dr Pension a/c
Cr P/L staff costs
Actuarial gain on assets
Dr Pension a/c
Cr P/L (gain)
(opposite for loss)
Actuarial gain on liabilities
Dr Pension a/c
Cr P/L (gain)
(opposite for loss)

X
X
X
X
X
X
X
X

Amount at last balance

sheet date falling
outside 10% corridor.
Spread over average
remaining working lives.

X
X

OR
Take all actuarial gains/(losses) to P/L reserve and
report through statement of recognised income and
expense.
Past service costs
Dr P/L staff costs
Cr Pension a/c

Settlements/curtailments
Dr Pension a/c
X
Cr P/L operating income
Cr Pension asset
(opposite for net cost)

X
X

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notes

(2) Contribution paid

Dr Pension a/c
Cr Bank

X
X

Benefit paid reduce both assets and liabilities

(3) Balance sheet
Balance at start of year
Effect of P/L entries
Contributions paid
= balance at end of year
(4) Disclosure
Defined contribution

Cost for period

Defined benefit

description and accounting policy

reconciliation of assets and liabilities

reconciliation of recognised gains/losses

analysis of total expense

actual return of plan assets

principal assumptions
3.

Share-based payment
Most relate to employee benefit packages
Equity-settled share-based payment transactions
Measure at FV of goods and services received
If no reliable FV use FV of shares given
Spread cost over vesting period using appropriate estimates
JE on recognition:
Dr P/L cost
Cr other reserves
If shares issued on settlement:
Dr Other reserves
Cr Share capital
Share premium
Cash-settled share-based payments
Based on value of share but paid in cash
JE on recognition
Dr P/L cost
Cr Creditors
On payment:
Dr Creditors
Cr Bank

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TPS FINANCIAL REPORTING

Share-based payment transactions with cash alternatives.

Treat as cash-settled share-based transaction if the
company has an obligation.
Otherwise treat as equity-settled share-based payment
transaction.
4.

FRS 17

deals with retirement benefits only

defined benefit plans similar approach but

all actuarial gains and losses recognised immediately

through STRGL.

No corridor is applied

notes

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notes

50