Shikkiah Corp. (which is a private enterprise) tries to attract the most knowledgeable and creative employees

Shikkiah Corp. (which is a private enterprise) tries to attract the most knowledgeable and creative employees it can find. To help accomplish this, the company offers a special group of technology employees the right to a fully paid sabbatical leave after every five years of continuous service. It is the company’s objective that the employees will come back renewed and with fresh ideas, but there are no restrictions on what they do during the sabbatical year. Shikkiah hired three employees in early 2011 who were entitled to this benefit. Each new hire agreed to a starting salary of $80,000 per year.

Instruction

(a) Explain generally how this employee benefit should be accounted for by Shikkiah Corp. under PE GAAP and IFRS.

(b) Assume that you are the assistant to the company controller. In response to the controller’s request, list all the information you need in order to calculate the amounts and prepare the adjusting entry that is required at December 31, 2011, relative to this plan under ASPE and IFRS.

(c) Assume that the employees’ activities during the sixth (the sabbatical) year are specified by the company: the employees must work on research and promotion activities that will benefit the company. Would your answer to (a) change?

If yes, explain why and how it would be accounted for. If not, explain why not.

(a) This benefit relates to a compensated absence.  It is a defined benefit plan which is service related (the benefit is earned by the employee over a five-year period and then vests in the employee).  Under both PE GAAP and IFRS, the company should accrue the cost of the benefit and the related liability over the five years in which the employee obtains full eligibility for benefits. Under PE GAAP, the company can use the immediate recognition method that measures the accrued benefit obligation using the funding valuation method.  All past service costs and actuarial gains and losses are immediately recognized, as well as the actual return on any plan assets. 

   

    As an alternative, PE GAAP also allows the deferral and amortization method similar to IFRS.  Under this approach, the accrued benefit obligation is estimated using the projected benefits valuation method which is an accounting specified approach.  Under this method, for PE GAAP, any past service costs that arise can be deferred and amortized over the remaining period to full eligibility for the sabbatical or a shorter period.  Actuarial gains and losses related to these plans are also deferred and amortized over some reasonable period (EARSL or some shorter period).

    Under IFRS, which requires that the defer-and-amortize method be used, past service costs and actuarial gains and losses that would relate to the sabbatical leave (if any) are recognized immediately to income. 

(b) The accountant must have the following information or make assumptions about them:

-     Employee turnover data: i.e., probability that some employees will not satisfy the minimum five year service requirement. This information would not be required for the immediate recognition alternative allowed under PE GAAP.

-     Projected salary in the sabbatical year. Again, under the immediate recognition alternative, this information would not be required.

-     Appropriate discount rate to use in discounting benefits to their present value (market rates).  Under PE GAAP, this discount rate can either be the current yield on high quality corporate bonds, or the settlement date rate.  IFRS requires that the current yield on high quality corporate bonds be used.

-     Valuation of the accrued benefit obligation at the report date (or within 3 months under PE GAAP if applying the defer-and-amortize approach) expected earnings rates on plan assets, if any, required only for the defer-and-amortize methods under PE GAAP and IFRS.

-     Actual return on any plan assets supporting the obligation.  Fair value of the plan assets (or an option under PE GAAP is the market-related value).

(c)   Yes, the answer to part (a) could change. The accounting method described in (a) is based on the assumption that the employees are receiving compensation in the sixth year based on past services and that in the sixth year they are not providing active service to the company. If the company dictates their activities during the sabbatical year and the activities benefit the company, this would be considered active service. The sabbatical year would then not be a compensated absence, but rather a salary for active service even if the service is in alternative activities such as research and promotion. The company would then not need to accrue the compensated absence in the preceding years, and it would account for the payments in the sabbatical year in the same way as for regular salary payments.  This treatment is the same under both IFRS and PE GAAP.