Defined contribution or defined benefit fund?
How to tell whether a client's retirement fund is a defined contribution or a defined benefit plan under IAS 19, and what each means for the statements.
By Achekam · · 4 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
A client hands over its retirement fund's annual benefit statement and asks what goes in the financial statements. The answer depends on a question the fund's name rarely answers: if the fund runs short, does the employer have to make up the difference?
That question sorts every post-employment plan into one of two categories under IAS 19, and the accounting for each could hardly be more different.
The test: is there any further obligation?
IAS 19 Employee Benefits prescribes the accounting for all types of employee benefits except share-based payment, to which IFRS 2 applies. It describes employee benefits as all forms of consideration given by an entity in exchange for service rendered by employees or for the termination of employment.
For retirement benefits, IAS 19 defines a defined contribution plan as a post-employment benefit plan under which an entity pays fixed contributions into a separate entity, a fund, and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods. IAS 19 defines a defined benefit plan as any post-employment benefit plan other than a defined contribution plan.
Notice that the second definition is a remainder. A plan is defined contribution only if the employer's obligation stops at the fixed contribution. If anything more could fall back on the employer, the plan is defined benefit.
Defined contribution: an expense and an accrual
Under IAS 19, when an employee has rendered service during a period, the entity recognises the contribution payable to a defined contribution plan in exchange for that service as a liability (an accrued expense) and as an expense, unless another standard requires or permits the contribution to be included in the cost of an asset.
In practice that is straightforward:
- the contributions for the year go to staff costs;
- contributions for the final month, still unpaid at year end, are accrued;
- contributions for staff who were building an asset may form part of that asset's cost.
There is no actuary, no fund assets on the employer's balance sheet and no annual remeasurement. Confirm the category from the fund's rules, though, rather than from its name.
Defined benefit: actuarial measurement
For defined benefit plans, IAS 19 requires an actuarial technique, the projected unit credit method, to estimate the ultimate cost of the benefits employees have earned, discount it to find the present value of the defined benefit obligation and the current service cost, and deduct the fair value of any plan assets. Those measurements are updated each period.
That is not a calculation a preparer can make from a trial balance. A client with a defined benefit plan needs an actuarial valuation prepared for IAS 19 purposes as at its reporting date. A valuation prepared for the fund's own purposes may use different assumptions, so ask the actuary which basis was used before relying on it.
Signs that an actuary is needed:
- the employer promises a pension or lump sum based on salary and years of service;
- the employer underwrites a minimum return on members' savings;
- the employer has promised to pay medical aid contributions for retired staff;
- the rules, or the employer's past behaviour, suggest it would top up the fund if it fell short.
Reading the fund rules a client hands over
Clients rarely know which kind of plan they have, but the rules will tell you. Look for:
- How the benefit is defined. A benefit equal to the member's accumulated contributions plus investment returns points to defined contribution. A benefit based on salary and service points to defined benefit.
- Who carries the investment risk. If poor returns reduce members' benefits, the members carry it. If the employer must top up, the employer does.
- Deficit clauses. Any clause requiring the employer to contribute to make good a shortfall.
- Promises outside the fund. Medical aid, housing or other benefits promised to pensioners directly by the employer.
- Past practice. Has the employer ever paid a special contribution to cover a shortfall? A pattern can create a constructive obligation.
Statutory schemes need the same reading. Where a law requires an employer to pay fixed contributions and nothing more, the scheme behaves like defined contribution for that employer. Where the employer could be called on to cover a shortfall, it does not.
Notes to complete in the Studio
In Achekam's Financials Studio, the draft set is built from the mapped trial balance with every figure calculated in code, including the policies and notes. The standard policy wording is based on IFRS for SMEs and labelled for review before issue, and staff can write their own policies. Notes take their figures from the mapped trial balance, and anything it does not hold is left as "[to be completed]".
For a defined contribution plan that is usually enough: the contributions expense and any accrual come straight from the ledger, and the preparer completes the description of the plan. For a defined benefit plan, the actuarial figures must be posted to the ledger first, and the disclosures IAS 19 asks for will draw heavily on the actuary's report.
Contributions also appear in the staff costs note; see the staff costs note from payroll. Other year-end staff accruals are covered in leave pay and bonus accruals.
The IFRS Foundation's IAS 19 summary explains how IAS 19 accounts for employee benefits, including contributions to defined contribution plans.
Ask for the rules, not the brochure. The marketing material describes what members can expect; the rules say who pays if it goes wrong, and that is the only question that decides the accounting.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
