Contents -
1. Provisions of Accounting for Retirement Benefits in the Financial Statement of Employers.
2. Provisions for Accounting for Derivatives.
a) Definition
b) Accounting for Derivatives as per FAS 133
c) Derivatives Used as Hedging Instrument.
d) Hedge Recognition.
Accounting Standard 15 :
Accounting for retirement benefits in the financial statement of employers are as follows :
1. Gratuity -
For gratuity and other defined benefit schemes, accounting treatment will depend on the type of arrangements, which the employer has entered into.
2. Provident Fund -
Excess payment be treated as pre-payment. For retirement benefits of provident fund and other defined contribution schemes, contribution payable by employer and any shortfall on collection from employees if any for a year be charged to profit and loss account.
3. Employers Fund -
If payment for retirement benefits out of employers funds, appropriated charged to profit and loss to be made through a provision for accuruing liability, calculated according to actuarial valuation.
4. Certificate of Confirmation -
The excess/shortfall of the contribution paid against the amount required to meet accrued liability as certified by actuary or confirmed by insurer should be treated as pre-payment or charged to profit and loss account. If liability for retirement benefits is funded through a scheme administered by an insurers, an actuarial certificate or confirmation from insurer to be obtained.
5. Determination of Cost Incurred -
Excess/shortfall of contribution paid against amount required to meet accrued liability as certified by actuary be treated as pre-payment or charged to profit and loss account. If liability for retirement benefit funded through the creation of trust, cost incurred be determined actuarially.
6. Disclosure of Method of Determining -
Financial statements to disclose method by which retirement benefit cost have been determined.
7. Retirement Benefit -
Accounting standard 15 - Employee benefits - Effective from accounting period commencing on or after 1st April, 2006.
8. Disclosure about Alteration -
Any alteration in the retirement benefit cost should be charged or credited to profit and loss account and change in actuarial method should be disclosed as per Accounting Standard 5.
9. Method of Accural -
For Enterprises employing less than 50 persons any method of accrual for accounting long-term employee benefits liability is allowed.
10. Number of Applications of Employees -
Application to level II and III Enterprises (subject to certain relaxation provided), if number of persons employed is 50 or more.
11. Short-Term Employee Benefits -
Short term employee benefits should be recognised as an expenses without discounting, unless permitted by other accounting standard to be included as a cost of an asset.
12. Contents in Employee Benefits -
Employee benefits include those provided under formal plan or as per informal practices which give rise to an obligation or required as per legislative requirements. Employee benefit are all forms of consideration given in exchange of services rendered by employees. These include performance bonus and non monetary benefits such as housing, car or subsidized goods or services to current employees, post employment benefits, deferred compensation and termination benefits. Benefits provided to employees spouse, children, dependents, nominees are also covered.
13. Accounting for Cost of Profit Sharing and Bonus Plans -
While estimating, probability of payment at a future date is considered. Cost of profit sharing and bonus plans are accounted as an expense when the enterprise has a present application to make such payments as a result of past events and a reliable estimate of the obligation can be made.
14. Cost of Accumulating Compensated Absences -
Cost of accumulating compensated absences is accounted on accrual basis and cost of non accumulating compensated absences is accounted when the absences occur.
15. Accounting in Respect of Multi-Employer Plans -
In case of a multi-employer plans and enterprise should recognise its proportionate share of the obligation. If defined benefit cost can not be reliably estimated it should recognise cost as if it were a defined contribution plan, with certain disclosures (in para 30).
16. Post Employment Benefits -
Under the later plans if actuarial or investment experience are worse than expected, obligation of the enterprise may get increased at subsequent dates. Post employment benefits can either be defined contribution plans under which enterprises obligation is limited to contribution agreed to be made and investment returns arising from such contribution or defined benefit plan under which the enterprise's obligation is to provide the agreed benefits.
17. Accounting for Cost of Defined Contribution plan -
Cost of defined contribution plan should be accounted as an expense on accrual basis. In case contribution does not fall due within 12 months from the balance sheet date, expense should be recognised for discounted liabilities.
18. Contribution Plan -
State plants and insured benefits are generally defined contribution plan.
19. Accounting for Balance Sheet Purpose -
An enterprise should determine the present value of defined benefit obligation and the fair value of plan assets (on each balance sheet date) so that amount recognised in the financial statement do not differ materially from the liability required. In case of fair value of plan asset is higher than liability required, the present value of excess should be treated as an asset. For balance sheet purpose, the amount to be recognised as a defined benefit liability is the present value of the defined benefit obligation reduced by Past services cost not recognised and The fair value of the plan asset.
20. Accounting for Obligation -
The obligation that arises from the enterprises informal practices should also be accounted with its obligation under the formal defined benefit plan.
21. ActuarialAssumption -
Actuarial assumptions comprise of following :
i) Employee turnover.
ii) Mortality during and after employment.
iii) Claim rate under medical plans.
iv) Plan members eligible for benefits.
v) The discount rate, based on market yields on Government Bonds of relevant maturity.
22. Consideration in the Profit and Loss Account -
For determining cost to be recognised in the profit and loss account for the defined benefit plan, following should be considered :
i) Interest cost.
ii) Current service cost.
iii) Past service cost.
iv) Effect of any curtailment or settlement.
v) Expected return of any plan assets.
vi) Actuarial gains and losses.
vii) Surplus arising out of present value of plan asset being higher than obligation under the plan.
23. Past Service Cost -
Past service cost arises due to introduction for changes in the defined benefit plan. It should be recognised in the profit and loss account over the period of vesting. Similarly, surplus on curtailment is recognised over the vesting period. However, for other long term employee benefits, past service cost is recognised immediately.
24. Actuarial Gains / Losses -
Actuarial gains / losses should be recognised in profit and loss account as income / expenses.
25. Future Salary and Benefits Levels -
i) Rate of return expectation on plan assets.
ii) In case of medical benefits, future medical cost (Including administration cost, if material).
26. Transitional Provisions -
When enterprise adopt the revised standard for the first time, additional charge on account of change in a liability, compared to pre-revised Accounting Standard - 15, should be adjusted against revenue reserve and surplus.
27. Expected Return -
An enterprise should disclose information by which users can evaluate the nature of its defined benefit plans and the financial effects of changes in those plans during the period. The expected return on plan assets in a component of current service cost. The difference between expected return and the actual return on plan assets is treated as an actuarial gain/loss, which is also recognised in the profit and loss account.
28. Termination Benefit -
Termination benefits are accounted as a liability and expense only when the enterprise has a present obligation as a result of a past event, outflow of resources will be required to settle the obligation and a reliable estimate of it can be made. If termination benefit amount is material, it should be disclosed separately as per Accounting Standard-5 requirements. As per the transitional provision expenses on termination benefits incurred up to 31st March, 2009 can be deferred over the pay back period, not beyond 1st April, 2010. When termination benefit fall due behind 12 months period, the present value of liability needs to be worked out using the discount rate.
Accounting for Derivatives
Provisions for Accounting for Derivatives -
Introduction -
Statement of Financial Accounting Standard No. 133 issued by the Financial Accounting Standard Board, US defines the criteria/attributes which an instrument should have to be called as derivative and also provides guidance for accounting of derivatives. The Standard is facing tough opposition and services from the US business and industry.
Definition -
The standard defines a derivative as an instrument having following characteristics :
i) The contract can be readily settled by net cash payment.
ii) A derivatives cash flows for fair value must fluctuate or vary based on the changes in an underlying variable.
iii) The contract must be based on a notional amount of quantity. The notional amount is the fixed amount or quantity that determines the size of change caused by the movement of the underlying.
Accounting for Derivatives as per FAS 133 -
The standard requires that every derivative instrument should be recorded in the balance sheet as asset or liability at fair value and changes in fair value should be recognised in the year in which it takes place.
It is important to understand the purpose of the enterprise while entering into the transaction relating to the derivative instrument. The derivative instrument could be used as a tool for hedging or could be a trading transaction unrelated to hedging. If it is not used as a hedging instrument, the gain or loss on a derivative instrument is required to be recognised as profit or loss in current earning. The standard also calls for accounting the gains and losses arising from derivatives contracts.
Derivatives Used as Hedging Instrument -
Derivative instruments used for hedging the fair value of a recognised asset or liability, are called Fair Value Hedges. The gain or loss on such derivative instruments as well as the off setting loss or gain on the hedged item shall be recognised currently in income.
Example -
An individual having a portfolio consisting of share of infosys and BSES, may decide to hedge this portfolio using the Sensex futures contract. The gain or loss on the index futures contract would compensate the loss or gain on the portfolio. Both the gains and losses will be recognised in the profit and loss statement. If the hedge is perfect, gains and losses will offset each other and hence will not have any impact on the current earnings. However, if the hedge is not a perfect hedge, there would be a different between the gain and the compensating loss. This would affect the current reported earnings of the individual.
If the derivative instrument hedges risks of variations in cash flow on a recognised asset and liability, it is called Cash Flow Hedge. The gain or loss on such derivative instruments will be transferred to current earnings of the same period or the periods during which the forecasted transaction affects the earnings. The remaining gain or loss on the derivative instrument if any shall be recognised currently in earnings.
Similarly, if the derivative instrument hedges risk of exposures arising out of foreign currency transactions or investments overseas or in subsidiaries, it is called Foreign Currency Hedge.
Hedge Recognition -
Accounting treatment for trading and hedging is completely different. In order to qualify as a hedge transaction, the company should at the inception of the transaction.
i) Document such relationship.
ii) Designate the hedge relationship.
iii) Expect hedge to be highly effective.
iv) Lay down reasonable basis for assessment effectiveness. Ineffectiveness may be reported in the current financial statement earnings.
v) Identifying hedge item, hedge instrument and risks being hedged.
Earlier there was no concept of partial effectiveness of hedge. However, FASB recognised that not all hedging transaction can be perfect. There can be a degree of ineffectiveness which should be recognised. The statement requires that the assessment of effectiveness must be consistent with risk management strategies documented for that particular hedge relationship. Further the assessment of effectiveness is required whenever financial statements or earnings are reported.
Conclusion -
The international trend is moving towards marking the underlying securities as well as associated derivative instrument to market. The Indian Accounting guidelines in this area need to be carefully reviewed. Such a practice would bring into the accounts a clear picture of the impact of derivatives related operations. Indian accounting is based on traditional prudence where profit are not recognised till realisation. This practice, though sound in general appears to be inconsistent with reality in a highly liquid and vibrant area like derivatives.
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