FAS 112: Accounting for Postemployment Benefits

Statement of Financial Accounting Standards No. 112, or FAS 112, established rules for how companies account for benefits provided to former or inactive employees. Its principles are now part of the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) under Topic 712, Compensation—Nonretirement Postemployment Benefits. The guidance ensures that the cost of these benefits is recorded as an expense during the periods in which employees render the service to earn them. This matches the expense with the revenue generated by the employees’ work, rather than waiting until the benefits are paid.

Scope of Postemployment Benefits

Postemployment benefits are arrangements provided to former or inactive employees after their employment has ended but before their formal retirement begins. These benefits are distinct from pensions or other postretirement benefit plans. The guidance covers a range of benefits an employer might offer, including:

• Severance pay offered to employees whose jobs are eliminated.
• Supplemental unemployment benefits that augment state-provided compensation.
• Disability-related benefits for employees who can no longer work, such as long-term disability payments.
• Job counseling and outplacement services to help former employees find new work.
• Continuation of health insurance under COBRA or life insurance coverage.

Criteria for Accruing a Liability

A company can only record a liability for postemployment benefits when four specific conditions are met. All criteria must be satisfied to accrue the obligation in the financial statements. The four conditions are:

• The employer’s obligation to provide the benefits is attributable to services already rendered by the employees.
• The employees’ rights to receive these benefits accumulate or vest. Accumulate means the benefits build up over time, while vesting is when the employee has an unconditional right to the benefit.
• The payment of the benefit is probable, meaning it is likely to occur.
• The amount of the benefit payment is reasonably estimable.

If any of these conditions are not met, the company cannot accrue the liability. For instance, if a company has a well-defined severance plan based on years of service and a layoff is probable, all conditions would be met. In contrast, if a company has no history of paying such benefits, it may be difficult to prove an amount is estimable or that a payment is probable.

Measuring the Postemployment Benefit Obligation

Once a company determines that all four criteria for accrual have been satisfied, it must calculate the amount of the liability. The measurement should represent the company’s best estimate of the future payments it will make to its former employees under the benefit plan.

The starting point for this measurement is a formal, written benefit plan that details the payments and eligibility. If no written plan exists, a company may look to its historical practice of making such payments. For example, if a business has consistently paid two weeks of severance for every year of service during past layoffs, that history can serve as a basis for estimating the obligation.

In situations where benefits are paid over an extended period, such as with long-term disability, the measurement is more complex. Accounting principles require that future cash flows be discounted to their present value. This means the liability recorded on the balance sheet is the value of those payments in today’s dollars, not the total sum of all future payments, reflecting the time value of money.

Required Financial Statement Disclosures

A company must provide specific information about its postemployment benefit obligation in the notes to its financial statements. These disclosures are for investors, creditors, and other stakeholders.

The company is required to disclose a description of its postemployment benefit plans, including the types of benefits provided and the employee groups covered. The disclosures must also report the amount of the liability accrued. If an obligation is not accrued because the amount cannot be reasonably estimated, that fact must be disclosed.