Actuarial Valuation of Employment Benefits: A Comprehensive Overview
- What is Actuarial Valuation of Employment Benefits?
Actuarial valuation is the process of calculating the present value of an employer’s future obligations related to employee benefits using actuarial assumptions like salary growth, employee turnover, mortality rates, and discount rates.
Why is it Needed?
Ensures financial transparency in reporting long-term employee benefit liabilities.
Helps in estimating future cash flows related to employee benefits.
Required for financial reporting compliance under IFRS, NFRS, and local regulations.
Actuarial assumptions are key estimates used to calculate employee benefit obligations under IFRS 19/NFRS 19, categorized into demographic assumptions (mortality, employee turnover, retirement age, salary growth) and financial assumptions (discount rate, inflation, expected return on plan assets). These assumptions impact the balance sheet (liabilities/assets), income statement (expense recognition), and cash flows (funding obligations). A higher discount rate reduces liabilities, while higher salary growth and inflation increase them. Companies must carefully review these assumptions annually to ensure accurate financial reporting, regulatory compliance, and risk management, as small changes can significantly affect financial statements.
Types of Employee Benefits Requiring Actuarial Valuation:
Defined Benefit Plans (DBPs) – e.g., Pension plans, Gratuity, Post-employment benefits.
Other Long-Term Employee Benefits – e.g., Leave encashment, Long service awards.
Termination Benefits – Compensation for early retirement or layoffs.
Other Post-Employment Benefits – e.g., Medical benefits for retirees.
- What Do IFRS and NFRS Say About Actuarial Valuation?
IFRS Standards (IAS 19 - Employee Benefits)
IFRS (IAS 19) requires companies to recognize and disclose employee benefit obligations based on actuarial valuation.
Defined Contribution Plans → Expense is recognized when contributions are made.
Defined Benefit Plans → Obligation is calculated using the Projected Unit Credit Method (PUCM) and recognized on the balance sheet.
Actuarial Gains & Losses → Recognized in Other Comprehensive Income (OCI) (for post-employment benefits) or Profit & Loss (P&L) (for long-term benefits).
NFRS (Nepal Financial Reporting Standards) Alignment with IFRS
NFRS 19 is aligned with IAS 19 and requires actuarial valuation for gratuity, pensions, and long-term employee benefits.
Employers in Nepal must ensure actuarial valuations are conducted annually to meet compliance requirements.
Impact on Financial Statements
Balance Sheet (Statement of Financial Position)
Recognition of a Liability: The present value of future benefits is recorded as a liability if obligations exceed plan assets.
Recognition of an Asset: If the plan is overfunded, it is recorded as an asset.
- Income Statement (Statement of Profit & Loss - P&L)
Current Service Cost → Expense related to employee benefits for the year.
Interest Cost → Cost of carrying the liability (based on discount rate).
Actuarial Gains & Losses → Can be part of Other Comprehensive Income (OCI) instead of P&L.
- Cash Flow Statement
Employer Contributions are reported as cash outflows from operating or financing activities.
Accounting Treatment (Journal Entries as per IFRS 19/NFRS 19)
Initial Recognition of Defined Benefit Obligation (DBO)
Dr. Employee Benefit Expense (P&L)
Cr. Employee Benefit Liability (Balance Sheet)
- Recognition of Actuarial Gains & Losses (OCI Treatment)
Dr. Other Comprehensive Income (OCI)
Cr. Employee Benefit Liability
- Employer Contributions to Fund (if applicable)
Dr. Employee Benefit Liability
Cr. Bank/Cash
- Settlement of Benefits (Payment to Employees)
Dr. Employee Benefit Liability
Cr. Bank/Cash
- Benefits and Challenges of Actuarial Valuation
Benefits:
✅ Accurate Financial Planning – Helps businesses set aside funds for future employee liabilities. ✅ Compliance with IFRS/NFRS – Ensures companies meet legal and regulatory requirements. ✅ Transparency in Reporting – Investors get a clearer view of long-term obligations. ✅ Better Risk Management – Reduces unexpected financial shocks due to employee benefits.
Challenges:
⚠️ Complex Calculations – Requires specialized actuarial expertise. ⚠️ Assumption Risks – Small changes in discount rates, salary growth, or mortality rates can significantly impact liabilities. ⚠️ Impact on Profitability – Higher liabilities can reduce profits and affect investor confidence. ⚠️ Cash Flow Strain – Companies may struggle to fund long-term benefits while managing short-term cash needs.
- Conclusion
Actuarial valuation under IFRS 19/NFRS 19 is critical for financial transparency and long-term sustainability of employee benefit plans. While it presents accounting and cash flow challenges, it ensures that businesses properly recognize and plan for their employee obligations.
Actuarial Assumptions: Meaning, Types, and Impact
- What are Actuarial Assumptions?
Actuarial assumptions are estimates and projections used by actuaries to calculate the present value of future employee benefit obligations, such as pensions, gratuities, and long-term benefits. These assumptions are critical in determining the Defined Benefit Obligation (DBO) under IFRS 19/NFRS 19.
Actuarial assumptions are divided into two categories:
Demographic Assumptions – Related to employee behavior and life expectancy.
Financial Assumptions – Related to economic and financial factors affecting liabilities.
- Types of Actuarial Assumptions
A. Demographic Assumptions (Employee-Related)
These assumptions estimate how employees behave over time, impacting the company’s long-term liability.
- Mortality Rate
Estimates how long employees (or pensioners) will live after retirement.
Higher life expectancy increases pension liabilities.
Based on national/international mortality tables (e.g., WHO Life Tables).
- Employee Turnover Rate (Attrition Rate)
Probability of employees leaving the company before retirement.
Higher turnover reduces liabilities (fewer employees qualify for benefits).
- Disability Rate
Estimates employees leaving due to disability before retirement.
Higher disability rates can increase liabilities (if disability benefits exist).
- Retirement Age
The assumed age at which employees will retire.
A later retirement age means more salary growth and higher liabilities.
- Future Salary Growth Rate
Annual salary increase percentage, impacting future benefit payouts.
Higher salary growth increases benefit obligations.
B. Financial Assumptions (Economic Factors)
These assumptions deal with interest rates, inflation, and other financial factors affecting benefit calculations.
- Discount Rate
The interest rate used to convert future obligations into present value.
IFRS 19/NFRS 19 requires companies to use the rate of high-quality corporate bonds or government bonds.
A higher discount rate reduces present liability, while a lower discount rate increases it.
- Inflation Rate
The expected increase in the cost of living over time.
Higher inflation impacts salary growth and pension benefits, increasing liabilities.
- Expected Return on Plan Assets (For Funded Plans)
The estimated investment return on pension/gratuity funds.
A higher expected return reduces the employer’s required contributions.
- Impact of Actuarial Assumptions on Financial Statements
Balance Sheet (Statement of Financial Position):
Changes in assumptions impact the Defined Benefit Liability/Asset.
Example:
If salary growth increases, the liability on the balance sheet increases.
If discount rate increases, the liability decreases.
Income Statement (P&L Statement):
Service Cost (current and past) and Interest Cost affect expenses.
Actuarial Gains & Losses due to assumption changes may go to Other Comprehensive Income (OCI).
Cash Flow Statement:
Employer contributions to funded plans affect operating or financing cash flows.
- Challenges in Setting Actuarial Assumptions
✅ Estimation Errors – Small changes in assumptions (e.g., discount rate ±0.5%) can significantly impact liabilities. ✅ Regulatory Compliance – IFRS/NFRS require assumptions to be realistic and unbiased. ✅ Economic Uncertainty – Inflation, interest rates, and market returns fluctuate. ✅ Industry-Specific Factors – Some industries have higher employee turnover than others.
- Conclusion
Actuarial assumptions are critical in valuing employee benefits and must be reviewed annually. Companies need to work with actuaries and financial experts to ensure compliance with IFRS 19/NFRS 19 and minimize risks.
