ACCOUNTING FOR COMPENSATED ABSENCES UNDER IAS 19

ll companies are statutorily required to grant employees the right to take leave in one form or another. IAS 19 – Employee Benefits requires companies to recognise a liability for “compensated absences” if various requirements are met. The purpose of this article is to examine the accounting requirements for providing for leave pay under IFRSs in the financial statements, and briefly review how they have been applied in practice.

IAS 19 requires an entity to recognise a liability for compensated absences if the following conditions are met:

1. The employer has an obligation to compensate employees for future absences attributable to employees’ services already rendered.
2. The obligation relates to rights that accumulate from period to period.
3. It is probable that the amount will be paid.
4. A reliable estimate can be made of the amount of the obligation.

Each of the above requirements is discussed separately:

1. Obligation to compensate employees for future absences

IAS 19 works under the premise that the underlying economics of accumulated leave pay is that the employer entity is obligated to compensate the employee for no services to be rendered. It requires the entity to accrue a liability for future compensated absences in the period in which the employee’s services were rendered. Consequently, the right that the employee has to be compensated for no services is an obligation for the employer entity, which must be recognised in the period in which the employee’s rights crystallise.

2. Leave pay rights accumulate from period to period

The obligation to accrue for compensated absences under IAS 19 arises only for compensated absences that can be carried forward to the next period (accumulating absences). In other words, only compensated absences that are earned in the current year and can be used in the following financial period are to be accounted for as a liability in the period in which they are earned. However, compensated absences that are non-accumulating and do not carry forward to the next period are not recognised as a liability at period end. This is because the entity has no further obligation to the employee for unused leave entitlement beyond the current period. Consequently, compensated absences with respect to maternity or paternity leave, jury service or military service leave would not need to be included as part of a company’s provision for compensated absences.

3. It is probable that the amount will be paid

In most cases, the employee’s rights to accumulated leave will either be paid directly with cash when the employee leaves the entity or indirectly when the employee is paid whilst he is on leave and renders no services.

4. A reliable estimate can be made of the amount of
   the obligation

As mentioned above, the timing of the recognition liability for accumulated leave pay is a function of the work that the employee renders giving rise to the accumulated benefit. However, the measurement of the liability is driven by whether the obligation is vesting or not as follows:

• A vesting obligation is where employees are entitled to a cash payment for unused leave entitled upon leaving the entity. The amount of the obligation will therefore be equal to the number of unused leave multiplied by the relevant employee’s gross salary at the reporting date.
• A non-vesting obligation is where employees are not entitled to a cash payment for unused leave entitlement on leaving the employer. The amount of the obligation will need to be adjusted by the expected staff turnover rate (or forfeiture rate) to take into account unused leave which will lapse and will not need to be settled.

IAS 19 requires entities initially to recognise the obligation during the vesting period (if any) based on the best available estimate of the accumulated leave expected to vest. The estimate must be revised each period end if subsequent information indicates that the accumulated leave expected to vest differs from previous estimates. On vesting date, the entity revises its estimate to equal the accumulated leave that ultimately vested. The above calculation would best be achieved by computing an overall forfeiture rate per class of employee and adjusting it each period end based on expected staff turnover. The procedures under IAS 19 are similar to IFRS 2 – Share-based payment, which requires entities to estimate the number of employee share options expected to vest in computing a share-based payment expense.

IAS 19 states that short-term employee benefits must not be discounted. However, IAS 19 does not provide specific guidance as to how the employer should measure the liability for compensated absences in terms of:

1. whether the liability should be based on current or future rates of pay; and
2. whether the effect of scheduled salary increases should be included.

It will therefore be up to the company and its auditors to determine how they compute the liability for compensated absences, and their accounting policy should disclose this accordingly.

Presentation and disclosure

IAS 37 – Provisions, Contingent Liabilities and Contingent Assets (para. 5(d)) excludes employee benefits from its scope and there are some who feel that the liability arising from accumulated leave pay should be recognised as an accrual in the accounts and not as a provision. In this case there would be no specific disclosure requirements necessary for the leave pay accrual, which would be included as part of “trade and other payables” on the balance sheet

However, it can also be argued that the definition of a “provision” under IFRSs is a liability of uncertain timing or amount. This definition does not preclude liabilities that fall within the scope of IAS 37. Thus even though leave pay is a liability of uncertain timing or amount that is scoped out of IAS 37, it is still a “provision” albeit measurable under IAS 19. IAS 1 – Presentation of Financial Statements para. 68(k) requires presentation of provisions separately on the balance sheet and is not restrictive to those measured in terms of IAS 37. To ensure consistency of presentation and disclosure, the following disclosure and presentation requirements of IAS 37, with respect to leave pay provisions should be complied with:

• A reconciliation between the opening and closing balance of the provision (comparatives are not required)
• A description of the nature of the obligation and the expected timing of its settlement.

In all cases, the debit leg of the movements in the provision/accrual account would be disclosed as part of staff costs and need not be shown separately. Finally, the company’s accounting policy with respect to accumulated compensated absences must be shown.

Implications for SA companies

In order to review compliance with the IAS 19 requirements on accumulated compensated absences, a random sample of 10 FTSE 100 companies and 10 JSE Main Board companies were selected. The results are summarised in the tables opposite: see Tables 1 & 2.

 

Table 1: Sample of 10 FTSE 100 Companies

Company	Accounts Reviewed	Separate Accounting Policy	Separate Provision Note
3i Group plc	2007	No	No
Admiral Group plc	2007	No	No
Anglo American plc	2007	No	No
Amec plc	2007	No	No
BT Group plc	2007	No	No
Tesco plc	2007	No	No
Diageo plc	2007	No	No
Rio Tinto plc	2007	No	Yes
ABI plc	2007	No	No
Lloyds TSB	2007	No	No

 

Table 2: Sample of 10 JSE Main Board Companies

Company	Accounts Reviewed	Separate Accounting Policy	Separate Provision Note
Telkom SA Limited	2007	Yes	Yes
Pick ‘n Pay Stores Limited	2007	Yes	No
Johnic Holdings Limited	2007	No	Yes
Bidvest Group Limited	2007	Yes	Yes
ABSA Bank Limited	2007	Yes	Yes
Illovo Sugar Limited	2007	No	Yes
Kumba Iron Ore Limited	2007	No	Yes
Naspers Limited	2007	No	Yes
Sasol Limited	2007	Yes	No
Caxton & CTP Publishers Limited	2007	Yes	Yes

 

The results of the sample of FTSE 100 companies reveal an apparent lack of disclosure of the relevant company’s compensated absences accounting policy. Furthermore, there was no separate note to the balance sheet disclosing the provision for compensated absences recognised. The only exception to this was Rio Tinto plc, which disclosed a provision for long service leave of $107 million. It would appear that the other FTSE 100 companies may have chosen to present the leave pay liability as part of accruals rather than provisions. Consequently, no separate disclosure of the accrual would have been shown as the amount would have been included in “trade and other payables” on the balance sheet. However, the lack of a separate accounting policy for compensated absences in the sampled UK companies is a point of concern.

By contrast, a review of JSE companies that have been applying IAS 19 for the past 10 years reveals that these companies either disclosed an accounting policy and a leave pay provision note, or no accounting policy note was disclosed but a separate leave pay provision was shown or included as part of “other provisions” in the notes to the accounts. This suggests that, in the main, South African compliance with IAS 19 has been on target apart from a few omissions of the leave pay accounting policy and/or the provision note.

Zwi Sacho CA(SA), Bcompt (Hons), MCompt, ACA(UK), is a corporate finance executive at Lopian Gross Barnett & Co.