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Financial Accounting 2
Lecture 3
Part 1: Employee Benefits
Part 2: Liabilities, Provisions,
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Topic Outline

Employee Benefits

• Understand the concept of employee benefits

and the scope of AASB 119 Employee Benefits

• Calculate the short-term employee benefits and

to account for them correctly in the books of the

Lecture 03 Outline
Liabilities, provisions, contingent liabilities and assets

• Understand the concept of a provision

• Understand how to distinguish provisions from other


• Understand the concept of a contingent liability

• Understand the concept of a contingent asset

• Explain when a provision should be recognised

• Explain how a provision, once recognised, should be
• Apply the definitions, recognition and measurement
criteria for provisions and contingent liabilities to
practical situations


• Chapter 6 and 11 – Understanding Australian

Prescribed Accounting Standards by Loftus et al

• AASB 137 Provisions, Contingent Liabilities and

Contingent Assets
AASBs • AASB 119 Employee Benefits

• Tutorial 03 - Refer Detailed Weekly Schedule for

question numbers

Part 1: Employee Benefits
Scope of AASB 119

• AASB 119 applies to employee benefits

• Prescribes the measurement and recognition of

expenses and liabilities arising from services
AASB119 provided by employers

• Annual (holiday) leave


Short-term employee
• wages, salaries, profit sharing plans and bonuses
• Annual leave and sick leave

• Benefits may be:

• Monetary
$ • Non-monetary

• Liabilities for short term employee benefits are recorded

at their nominal value (or face value), i.e. the amount
Value expected to settle the obligation

Types of salaries and wages
• Gross wages
1. • Tax withheld and payable to government

• Other deductions (salary sacrifice payments)

2. • Net wages

• Salary sacrifice payment may include health

3. insurance premiums, union membership fees

Salaries and wages

• Salary normally paid weekly, fortnightly or monthly


• At period end (or month end) an accrual is

required where the pay date and the reporting
2. date are different

Short-term compensated

• Annual leave and sick leave


• Loading commonly paid on annual leave

* (e.g. 17.5%)

• Applies to leave payments that are

* expected to be settled within 12 months

Short-term compensated
1. • Accumulating vs non-accumulating benefits:

• Accumulating benefits for unused leave can be carried

2. forward to future periods.

• Vesting vs non-vesting benefits:


• Vesting benefits are those where the employer has an

obligation to make a payment to the employee for the
4. sick leave, even if the employee leaves the company.

Short-term compensated
• Accounting treatment for different types of benefits is
1. as follows

2. • Non accumulating – no liability recorded

• Accumulating and vesting – liability recorded at each

3. reporting date.

• Accumulating but non-vesting – liability only

recognised for the portion that is expected to result in
4. additional payment to employees.

Annual leave – example
• ABC has 4 employees who are entitled to 20 days annual leave
per annum.
• Leave loading of 17.5% is paid on the leave when taken.
• The provision for annual leave balance at 1 July 2014 was $7,200
and leave payments of $9,400 have been made during the year.
• At 30 June 2015 a total of 45 days leave was owing to the 4
• The average annual salary is $50,000.
• There are 260 working days in a year.

Annual leave – example
Current balance in provision account = $2,200 DR ($7,200- $9,400DR)
Provision at 30 June 2015
= 45 x ($50,000 x 1.175)/260 days
= $10,168 CR

Adjusting entry required at 30 June 2015

DR Salary and wages expense 12,368

CR Provision for annual leave 12,368

Accumulating sick leave - example

ABC has 200 employees who are entitled to 8 days non-vesting

accumulating sick leave per annum.
At 30 June 2015 30% of employees had taken their full entitlement,
the remaining had an average of 4 days accumulated leave.
An average of 12 days accumulated leave exists at 30 June 2015
for each employee (accumulated over a number of years).
History indicates that employees take an average of 5 days
accumulated sick leave in years subsequent to their accumulation.
The average annual salary is $50,000.
Provision for sick leave at 30 June 2015
200 employees x 5 days x $50,000/260 days = $192,307

Profit-sharing and bonus plans
 Many companies use bonuses in management incentives schemes.
The bonus forms part of the management remuneration package and is
designed to align the interest of managers with the interests of the
equity holders.

 AASB 119 requires an entity to recognise the expected cost of profit-

sharing and bonus arrangements if -
 The entity has a present obligation to make such payments as a
result of past events
 The obligation can be reliably measured

 Legal obligation may arise from employment contract

 Constructive obligation may arise if the entity has an established

practice of paying regular annual bonuses

Post-employment benefits
 AASB 119 prescribes the employer’s accounting treatment for post-
employment benefit plans

 Formal or informal arrangement under which an entity provide post-

employment benefits for one or more employees (AASB 119 Para 8)

 Includes:
 Superannuation plans
 Employee retirement plans
 Pension plans

 Two types of plans

 Defined contribution plan
 Defined benefit plan

Other long-term employee benefits

 Long service leave (LSL) the most common example

 For example, an employee becomes entitled to 3 months of
leave after 10 years of continuing employment
 Steps involved in the measurement of a liability for long
service leave:
 Estimate no. of employees expected to become eligible
 Estimate the projected wages at the time of payment
 Determine the accumulated benefit
 Measure the present value of the accumulated benefit
 Refer Illustrative Example 11.10

Long service leave - example
 Smalltime has 1 employee who is eligible to be paid LSL.
 Her employment contract states that LSL can be taken after 15 years, at
which time she is entitled to 13 weeks of leave.
 After 10 years, pro-rata payment is allowed so that if she leaves after
serving 10 years, she will be entitled to a cash payment in relation to her
pro-rata entitlement to LSL.
 At 30 June 2015 the employee has been employed by Smalltime for 8
 Her current salary is $75,000, which has increased by 5% for each year
since commencing employment. It is anticipated that this annual
increase will continue.
 It is expected that the employee will remain with Smalltime for at least
another 2 years.
 The market yield on corporate bonds with a 2 year period to maturity are

Long service leave - example
The LSL liability for Smalltime as at 30
June 2015 is:
Current salary $75,000
Years of service 8 years
Benefit (%age of annual salary) 13.3%
(8 *(13/15)) =6.93weeks/52weeks
Pro-rata amount (13.3% * 75,000) 9,995
Years until LSL vests 2 years
Salary increase factor (1.05 *1.05) 1.1025
Discount rate 7%
Discount factor (NPV tables) 0.8734
Long service leave liability $9,624

Long service leave
example - alternative calculation
The LSL liability for Smalltime as at 30 June 2015 is:

Current salary $75,000

Estimated salary at end of year 10 75000x1.05 x1.05 82,687.50
Pro rata weeks at year 8 13weeks/15 years x 6.93 weeks
8 years
Long service leave liability 82687.50/52weeks $11 019.70
x 6.93 weeks
Long service leave liability - PV 11019.70/(1.07x1.07 $9,625

Journal entries:
Wages and Salaries Dr 9625.00
Provision for Long Service Leave Cr 9625.00

Part 2: Liabilities, Provisions,
Introduction to AA SB 137
 AASB 137 addresses the recognition, measurement
and presentation of:

 Provisions (excluding those covered by another

AASB – e.g. income taxes, leases, employee

 Contingent assets and liabilities

 Restructuring provisions

 Onerous contracts

Definition of a Provision
• A provision is a subset of
What is it? liabilities

• Definition: A liability of
AASB 137 uncertain timing or amount

• What is a liability?

Definition of a Liability

• Defined in the Framework

What is it?

• A present obligation
• Arising from a past event
• To result in an outflow of economic
Definition resources

What is a ‘’present obligation?”

• A present obligation exists only where

the entity has no reasonable alternative
What is it? but to settle the obligation.

• Legal - arising from a contract

• Equitable - arising from normal business
• Constructive - arising from an established
Types pattern of past practice

Distinguishing provisions from
other liabilities


Restoration Restructuring

Contingent Liabilities
A contingent liability may arise in 2 scenarios:
Scenario 1:

Confirmed only by the occurrence or non-occurrence of

uncertain future events

For example:
A guarantee on a loan for another entity

Contingent Liabilities
A contingent liability may arise in 2 scenarios:
Scenario 2:

A present obligation that fails the recognition criteria


It is not probable an outflow of economic resources will

be required to settle the obligation or

The amount cannot be measured reliably

Contingent Liabilities
A contingent liability may arise in 2 scenarios:
Scenario 2:

For example

A law suit where amount of damages is uncertain

Contingent liabilities are not recognised in the financial statements

but must be disclosed in the notes to the financial statements

Contingent assets
• Possible asset whose existence will be confirmed by the
occurrence/non-occurrence of one or more uncertain
1. future events

• Contingent assets are only disclosed in the notes to the

financial statements where an inflow of benefits is
2. probable

• For example:
• Possible receipt of damages from a court case decided
3. in its favour.

Recognition criteria for
The following 3 criteria must be met:
1. Present obligation as a result of a past event

2. Probable outflow of resources to settle (i.e. more likely

than not)

3. Amount of obligation can be reliably estimated

Refer to figure 6.1 of the readings and figure 6.2

Measurement of provisions
• Estimates should be discounted to present value
1. where material

• Due to the uncertainty involved, caution is

2. required to avoid overstatement

• Account for expected cash outflows only,

3. disregarding any expected cash inflows

• Must review provisions at each end of reporting

4. period

Measurement of provisions -
ABC sells goods with a 3 year warranty attached.
Warranty provisions are calculated as a percentage of annual sales,
based on historical data and are discounted to present value using
the government bond rate.
Relevant data is as follows:

End of year %age of sales $ to be incurred as Discount rate

warranty expenses (incremental)
1 2% 6.0%

2 3% 6.5%

3 5% 6.9%

Total sales for the year ended 30 June 2009 were $2 million

Measurement of provisions -
Required: example
Calculate the total provisions for warranties that should be set
aside in relation to 30 June 2009 financial year sales.

End of Expected cash outflow Discount PV of cash

year rate outflow

1 2% x $2 million = $40,000 6.0% 37,736

2 3% x $2 million = $60,000 6.5% 52,900

3 5% x $2 million = $100,000 6.9% 81,859


Restructuring Provisions
• May occur due to:

 sale or termination of a line of business

 the closure of business locations in a country/region or

relocation of business activities

 changes in the management structure

 fundamental reorganisations

Restructuring Provisions
Necessary conditions to recognise a restructuring provision:

 Must have a present obligation to restructure

 Costs must be directly and necessarily caused by the


 If the restructuring involves the sale of an operation, a

binding sale agreement is needed.

Restructuring provisions
– present obligation
• Present obligation is considered to arise when the entity has a
detailed plan identifying at least:

 The business (or part thereof) concerned

 The locations affected

 The employees affected

 The expenditures that will be undertaken

 The timing of implementation

Restructuring provisions –
qualifying costs
• Costs must be directly and necessarily caused by the
restructuring and should not be associated with the ongoing

• Examples of qualifying costs include:

 The costs of terminating leases and other contracts

 Costs associated with employees & dismantling plant

 Employee redundancy costs

Restructuring provisions –
qualifying costs
• Costs specifically excluded include:

 Employee retraining and relocation costs

 Marketing costs

• Refer to figures 6.4 & 6.5 of text for further examples