Introduction

End of Service Benefits (EOSB) are a key component of employee compensation, particularly in Saudi Arabia and other neighbouring countries. Under IAS 19 – Employee Benefits, EOSB schemes are typically classified as defined benefit plans, requiring companies to recognise their obligations using the Projected Unit Credit (PUC) method. However, in certain cases, IAS 19 mandates the use of a straight-line approach for attributing benefits over the employee’s service period.

It is important to note that the straight-line approach is not an alternative for PUC method. Instead, it is one of the approaches under PUC method, the other approach being accrued service approach. Straight-line method is also known by the name service pro-rated approach. For a general discussion on actuarial valuations, including the PUC method, refer to this guide.

This article explores when and how to apply the straight-line approach in EOSB actuarial valuations, with practical examples to illustrate its application.

1. The basis for EOSB valuation under IAS 19

Under IAS 19, an entity must calculate its defined benefit obligation (DBO) for EOSB schemes by:

• Estimating future benefits payable to employees.
• Projecting these benefits to account for future salary increases.
• Discounting future payments to present value using an appropriate discount rate.

Generally, under the PUC method, you would use the benefit formula to calculate and project the accured benefits. E.g. if an employee has had 2 years of service, you would just consider 2 years of service in the calculation of the benefit at retirement. This is called the accrued service approach. However, IAS 19, paragraph 73, states that if benefits accrue disproportionately towards later years, then a straight-line approach must be used instead of directly following the plan’s benefit formula. You can refer to the relevant section of IAS 19 here.

2. When to use the straight-line approach

The straight-line approach is required when a plan’s benefit formula leads to back-loaded accruals, meaning that benefits increase at a higher rate in later years. This is usually the case in many EOSB plans in the Middle-East region. For example, the Saudi EOSB plan has the following provisions:

Saudi EOSB: Grants 15 days’ salary per year for the first 5 years, and 30 days’ salary per year thereafter.

• Issue: Benefits accumulate more rapidly in later years.
• Required treatment: Instead of recognising benefits based on the step-up formula, an entity should smooth the accrual over the employee’s total period of service.

3. Practical implementation of the straight-line approach

To apply the straight-line method, follow these steps:

• Determine total benefit entitlement:
  • Calculate the projected EOSB payable at retirement or expected exit date.
• Allocate benefit over the service period:
  • Divide the total benefit by the total years of service.
  • Assign equal portions of the benefit to each year of service.
  • In practice, this is achieved by approtioning the total projected benefit by t / T, where t is the accrued service and T is the projected total service till exit.
• Discount to present value:
  • Apply an appropriate discount rate to reflect the time value of money.
• Recognise expense in P&L:
  • The straight-line service cost is recognised annually as an employee expense.

4. Example calculation

Let’s consider an employee earning SAR 225,000 per year with a step-up EOSB scheme offering 15 days’ salary per year for the first 5 years and 30 days’ salary per year thereafter:

• Expected tenure: 20 years
• Final salary projection: SAR 500,000
• Total EOSB entitlement: (5 × 15 × (500,000 ÷ 365) + 15 × 30 × (500,000 ÷ 365))
• Straight-line allocation per year: Total EOSB ÷ 20
• Discounting applies for present value calculations

Under the straight-line method, rather than back-loading costs, the company would recognise the same EOSB cost per year throughout the employee’s tenure.

5. When straight-line should not apply

The straight-line approach must not be used when the plan’s benefit formula does not result in higher accruals over time. Examples include:

• Flat accrual EOSB schemes: Where benefits are based on a simple formula such as one month’s salary per year of service. E.g. Indian gratuity plans
• Schemes with a benefit ceiling: Where a scheme specifies a monetary maximum amount, then the benefit accrual would reduce in the later years of service.

You should use the accrued service approach in such instances.

6. Implications of using straight-line vs accued service

The difference in DBO (liability) calculated using straight-line approach compared to accrued service approach will vary depending on the level of accrued service:

• For employees will little accrued service (e.g. 0-2 years), the straight-line approach will produce a much higher DBO than the accrued service approach.
• For employees close to retirement, the two approaches will produce nearly identical DBO.

Therefore, you can expect that the straight-line method will produce an overall higher DBO. The difference will be higher for new companies compared to mature companies.

7. Key takeaways

• The Projected Unit Credit (PUC) method is always used for EOSB actuarial valuation under IAS 19.
• If benefits accumulate disproportionately in later years, IAS 19 requires a straight-line approach.
• Straight-line approach is a branch of PUC method, not it’s replacement.
• Step-up schemes commonly require straight-line allocation.
• The straight-line approach is not needed for EOSB plans with uniform benefit accruals.
• Straight-line approach produces higher liability estimates.
• Actuaries must ensure compliance by recognising EOSB expenses consistently over service periods.