Employers may offer profit-sharing arrangements and bonuses to their employees. Bonuses may be determined as a lump-sum amount or based on accounting or market-based measures of performance. Many large companies use bonuses in management incentive schemes. For example, the remuneration received by the senior executives of Oxfame International Ltd includes base salary, bonuses linked to performance (incentive-based remuneration) and superannuation benefits.
The components of remuneration for the chief executive officer (CEO) for 2009 to 2011 are shown the decline in total remuneration in 2011 resulted from lower incentive-based remuneration. This occurred because certain performance targets pertaining to the Oxfame Group profit after tax and working capital were not met in that year.
The bonus forms part of a management remuneration package designed to align the interests of the manager with the interests of the entity or its owners. However, the Human Resource and Remuneration Committee of the Board of Directors of Oxfame International Ltd revised the remuneration scheme in response to shareholder concerns.
Para 19 of IAS 19- Employee Benefits requires that an entity have to recognize the expected cost of profit-sharing and bonus payments if:
(a) the entity has a present legal or constructive obligation to make such payments as a result of past events; and
(b) a reliable estimate of the obligation can be made.
A present obligation exists when, and only when, the entity has no realistic alternative but to make the payments.
Although the entity may have no legal obligation to pay the bonus, a constructive obligation arises if the entity has a well-established practice of paying the bonus and it has no realistic alternative but to pay the bonus. For instance, non-payment may be harmful to the entity’s relations with its employees.
Liabilities for short-term profit-sharing arrangements and bonuses are measured at the nominal amount that the entity expects to pay. Thus, if payment under a profit-sharing arrangement is subject to the employee still being employed when the payment is due, the amount recognized as a liability is reduced by the amount that is expected to go unpaid due to staff turnover.
For example, assume an entity has a profit-sharing arrangement in which it is obligated to pay 1% of profit for the period to employees and the amount becomes payable 3 months after the end of the reporting period. Based on staff turnover in prior years, the entity estimates that only 95% of employees will be eligible to receive a share of profit 3 months after the end of the reporting period.
Accordingly, the amount of the liability that should be recognized for the profit-sharing scheme is equal to 0.95% of the entity’s profit for the period. In this simple example it is assumed the bonus is distributed equally among employees.