In Defined Benefit Superannuation Plan, the employer pays contributions to the fund, which is a separate entity from the employer. The fund accumulates assets through contributions and returns on investments. The accumulated assets are used to pay post-employment benefits to members (retired employees). The return on investments held by the superannuation fund comprises dividend and interest income and changes in the fair value of investments.
The benefits paid to members are a function of their remuneration levels while employed and the number of years of service. If there is a shortfall in the fund’s capacity to pay benefits to members, the trustee of the fund may need the employer to make additional contributions. Thus, the employer effectively underwrites the actuarial and investment risks of the plan. In other words, the entity bears the risk of the fund being unable to pay benefits.
What are Assets of Defined Benefit Superannuation Plan
The assets of the superannuation plan, which are mostly investments, do not always equal its obligation to pay post-employment benefits to members. The superannuation plan has a deficit to the extent that the present value of the defined benefit obligation (i.e. post-employment benefits that are expected to be paid to employees for their services up to the end of the reporting period) exceeds the fair value of the plan assets. Conversely, a surplus arises when the fair value of the plan assets exceeds the present value of the defined benefit obligation.
Is the Deficit or Surplus of Defined Benefit Superannuation Plan an Asset or a Liability ?
Whether the deficit (surplus) of the defined benefit superannuation plan is a liability (asset) of the sponsoring employer is debatable. Some argue that the surplus in the superannuation plan does not satisfy all of the characteristics of an asset. Arguably, the assets of the plan are not controlled by the employer because they cannot be used for its benefit. For example, the employer may not use the surplus of the defined benefit superannuation plan to pay its debts; the assets of the plan are only used to generate cash flows to pay post-employment benefits to the members of the plan. Although the surplus is expected to result in future cash savings, such as lower contributions in future, it could be argued that the employer has not obtained control over those benefits through a past event where the reduction in superannuation contributions is at the discretion of the trustee of the superannuation fund.
Similarly, it has been argued that a deficit in the defined benefit superannuation fund is not a liability of the sponsoring employer because it does not have a present obligation to make good the shortfall. For instance, the employer may modify the post-employment benefits payable so as to avoid some of the obligation.
The perspective adopted in IAS 19 is that the surplus or deficit of the defined benefit superannuation plan is an asset, or liability, respectively, of the sponsoring employer. In some cases, the entity might not have a legal obligation to make good any shortfall in the fund’s assets. For example, the terms of the trust deed may allow the employer to change or terminate its obligation under the plan. Although the employer might not have a legal obligation to make up any shortfall, it typically has a constructive obligation because terminating its obligations under the plan may make it difficult to retain and recruit staff.
Accordingly, the accounting treatment prescribed by IAS 19 for an entity’s obligations arising from sponsorship of a defined benefit plan assumes that the entity will continue to promise the post-employment benefits over the remaining working lives of its employees. Similarly, the Standard reflects the view that any surplus of the fund represents expected future inflows, in the form of reduced contributions, arising from having contributed more than is needed in the past. The Standard and Basis for Conclusions focus on how to measure the resulting asset rather than justifying whether it meets the definition and recognition criteria.
If adopting the view that a deficit or surplus of the defined benefit superannuation plan is a liability or asset of the sponsoring employer, the next issue to resolve is whether it should be recognized and, if so, how it should be measured. Before looking at how the standard setters resolved these issues, we will consider the possibilities. At one extreme, the deficit or surplus is not recognized in the financial statements of the entity that sponsors the defined benefit superannuation plan. In other words, the superannuation deficit or surplus is ‘off-balance sheet’.
At the other extreme, referred to as ‘net capitalization’, the deficit (surplus) of the fund is recognized as a liability (asset) on the statement of financial position of the entity that sponsors the defined benefit superannuation plan. Under net capitalization, the net superannuation liability or asset is usually measured as the difference between the present value of post-employment benefits earned by employees for services in the current and prior periods and the fair value of plan assets. Between these two extremes are various partial capitalization methods in which some amount of the surplus or deficit of the fund remains off-balance sheet.
For example, the previous version of IAS 19 permitted increments in the defined benefit obligation resulting from prior periods (referred to as past service costs) to be recognized progressively over the average remaining period until they become vested.