IFRS Conversion Considerations: Employee Benefits

Organizations considering a conversion to the International Financial Reporting Standards (IFRS) from U.S. Generally Accepted Accounting Policies (U.S. GAAP) should note that there are differences surrounding employee benefit plans. This could result in a significant impact to the financial statements, particularly for organizations with large defined benefit plans. This article is the part of a series covering considerations for organizations contemplating a conversion from U.S. GAAP to IFRS.

The U.S. GAAP guidance is discussed in Sections 710, 712 and 715 of the Codification, while the guidance under IFRS is primarily found within International Accounting Standard (IAS) 19, Employee Benefits. Defined contribution plans are treated in a similar manner between two standards. The cost for these plans is recognized in each period based on the contribution due from the employer. Defined benefit plans are similar in principle between the two standards. Both standards require the defined benefit obligations accounted for based on actuarial methods and measured at the present value of the benefits employees had accrued at the reporting date. Both plans require the funded status to be recognized on the balance sheet as the difference between the present value of the benefit obligation and the fair value of the plan assets and disclosure surrounding these amounts.

Actuarial Methods

U.S. GAAP provides multiple methods for calculating the plan’s benefit formula based on the characteristics of the plan. U.S. GAAP permits the use of the traditional unit credit method, which estimates the employee’s actual cost of compensation to date as well as the projected unit credit method, which also estimates the employee’s future compensation levels. Flat-benefit plans and plans not tied to pay thresholds generally use the traditional unit credit method, while final-pay and career-average plans generally use the projected credit method.  IFRS requires the projected unit credit method for all plans.

Under U.S. GAAP, actuarial gains and losses may be recognized into net income as they occur or deferred into other comprehensive income (OCI) and then subsequently amortized into in net income over time. Actuarial gains and losses under IFRS must be recognized immediately into OCI and are not subsequently recognized into net income.

Discount rate for some U.S. plans are specifically calculated by the actuary based on the plan’s high-quality bond holdings. However, under IFRS this rate is deemed to be biased to a particular plan and must instead utilize third-party market yields for their discount rate. In addition, under IFRS if a market for bonds does not exist in the currency dominated by the benefit obligation, then the yield from government bonds dominated in that currency should be used. This assessment should be performed at the currency level rather than on an entity or country basis. Therefore, there could be significant difference in the calculated benefit obligation in countries without a deep market for high-quality corporate bonds.

Service Costs

Under U.S. GAAP, the service cost component of the net periodic benefit cost should now be presented on the same line of the income statement as other compensation costs relating to that employee. IAS 19 does not specify where these costs must be presented on the income statement other than amounts that should be recorded to OCI. A portion of service can be capitalized into inventory under U.S. GAAP, while IFRS permits a proportion of all component costs for capitalization.

Plan Assets

U.S. GAAP utilizes an expected long-term rate of return on invested assets; however, this concept does not exist under IFRS. Instead, IAS 19 requires the recognition of a net interest expense or income on the net defined benefit liability or asset as a component of the defined benefit cost. Net interest represents the change in the deferred obligation or asset as a result of the passage of time and incorporates the discount rate used in determining the benefit obligation.

Plans in a net asset position under U.S. GAAP measure the surplus of the fair value of the present value of plan assets over the present value of the defined benefit obligation. U.S. GAAP does not limit the size of the defined benefit asset that can be recognized on the balance sheet. IAS 19 limits the measurement of the net defined benefit asset or surplus to the present value of the economic benefits available as cash refunds from the plan or reductions to future contributions to the plan. This limitation is known as the “asset ceiling” and could have a significant impact to plans with large net defined benefit asset positions.

Plan Revisions

Under U.S. GAAP, prior service costs or credits from plan amendments are initially recognized into OCI and then subsequently recognized into income over the average service period of active participants or the average life expectancy of plan participants, based on the nature of the revision. Under IFRS, these amounts are immediately recognized in net income.

Settlement gains or losses are recognized in net income when the obligation is settled under U.S. GAAP, but when it occurs under IFRS. Under U.S. GAAP, benefit curtailment loss is recognized into net income when the curtailment is probable, and the amount can be estimated, while curtailment gains are recognized when they occur. Under IFRS, changes in the defined benefit plan obligation from curtailment are recognized immediately into income at the earlier of its occurrence or when the related restructuring costs or termination benefits are recognized.

Plans with More Than One Employer

The transition to IFRS could have a significant impact to entities participating in a multiemployer plan. Under U.S. GAAP, a multiemployer plan is accounted for in a similar manner to a defined contribution plan. Under IFRS, these plans are accounted for as either a defined contribution plan or as a proportionate share of a defined benefit plan, based on the substantive nature of the plan. If recognized as a defined benefit plan, the entity would record its proportionate share of the fair value of plan assets, defined benefit obligations and costs associated with the plan.

Most multiple employer plans are already accounted for as defined benefit plans under U.S. GAAP, with each entity recognizing its proportionate share of the plan. Therefore, the treatment will generally be similar under IFRS.

First-Time IFRS Adopters

In connection with IFRS 1, First-Time Adoption of International Financial Reporting Standards, a first-time adopter must recognize the benefit obligation or asset for each plan at the adoption date. Any revisions to the recorded asset or liability on the balance sheet should be recorded against retained earnings.

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