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8 September 2005W W W . W A T S O N W Y A T T . C O M
International Seminar on Management of ESOP and other employee benefit Plans
Liyaquat Khan
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HR Heads, Finance Heads & CEOs need to pay immediate heed!
Event – AS 15 (Revised, 2005) issued as mandatory standard
Will change significantly DB scheme expenses for P&L and recognition of liability for B/S – issues take a centre stage
Will mean expense recognition necessarily de-linked from the contribution to the fund?
May mean volatile effect on profits – CEO’s concern!
Greater complexity in budgeting for expensing and profitability – CFO’s concern!
Factoring DB cost in CTC takes a centre stage – HR Head’s concern!
Convergence of issues between Finance and HR
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Pre-Accounting Standard regime
DC – it is fine
DB Schemes: Accounting issues
Benefit cost to relate to the economic value of the employees’ service during the accounting period
Expensing of cost of benefits to conform to principles of:
Prudence – provision to be made for all known liabilities
Going concern – Reporting entity to continue its business unless known otherwise
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Actuary sets assumptions
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Actuarial Practices Standard (Guidance Note) - GN 12 of Actuarial Society of India
Discount rate ≤ yield on 20-year Central Government bonds + 2%
Salary growth ≥ (Discount rate – 4%)
ASI Guidance Note on assumption setting – Actuarial responsibility
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Start of year
End of year
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Expensing vis-à-vis Funding
Many employers mistakenly believe that contribution paid to life insurer is an expense for P&L!
Many employers mistakenly believe that contribution to life insurer is a premium for the risk transfer!
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What does AS 15 (Revised, 2005) mean?
Fair value accounting for scheme assets as against book value so far
Demonstrable consistency with the four principles of prudential accounting
Enable better comparability of expense and liability between employers
Greater public disclosure of expensing and liability
Prescriptive, Less “Wriggle” Room
Applicability of AS15 (Revised, 2005)
Mandatory for accounting periods commencing on or after 1 April 2006 for:
Listed companies or companies in the process of listing
Banks
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All Employee Benefits
Short term benefits (e.g. salaries, paid leave, housing) – immediate recognition of costs
Post employment benefits (e.g. retirement benefits, gratuity, leave encashment)
Other long term benefits (e.g. long-term disability) – immediate recognition of costs
Employer initiated termination benefits – immediate recognition of costs
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Balance Sheet
Income Statement
Disclosure requirements
Extensive items
Best estimates:
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Financial Assumptions
Discount Rate:
Volatility: Discount rate will change from year to year as market based
Discounts projected benefits
Term of bond consistent with term of liabilities
Lower discount rate will increase expense
Discount rates not related to return on assets
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Based on company expectation over expected future service life
Include inflation, promotion, seniority and market-based salary review
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Net amount recognised
Fair value of assets
plus
(“Interest Cost”)
plus/(less)
Variation in actual experience vs. previous assumption (e.g. salary growth higher/lower than expected)
Change of assumptions
Change in market value of assets over accounting period due to:
Actual market return different from assumed, (e.g. actual return 5%, expected 8%)
Gains/loss recognized immediately
Year End Expected
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Assumptions:
Not specified in AS15 (1995): Actuary’s decision
GN 12 requires discount rate to be equal to market yield on 20-year gilts plus 2% margin
AS15 (Revised, 2005): Discount rate prescribed as responsibility of employer but on actuarial advice
P+L Expense
Disclosure requirements
FAS 87 (US)
Amortized using 10% corridor over average future working lifetime of active members
FRS 17 (UK)
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IAS19
Full and immediate recognition through P&L
Amortization using 10% corridor over average future working lifetime of active members
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