Accounting implications of the abolition of the MPF-LSP offsetting mechanism
In June 2022, the Hong Kong Legislative Council passed the Employment and Retirement Schemes Legislation (Offsetting Arrangement) (Amendment) Bill 2022, marking a significant change in the handling of Long Service Payment (LSP). This bill abolishes the practice of using Mandatory Provident Fund (MPF) contributions to offset LSP liabilities, effective from 1 May 2025.
Timeline of Key Events:
Jun 2022: The Legislative Council passed the bill, which sets in motion the abolition of the MPF offset mechanism for LSP, strengthening employee protection.
Feb 2023: The Hong Kong Institute of Certified Public Accountants (HKICPA) published Financial Reporting Alert 44, highlighting the potential accounting implications for businesses regarding LSP obligations due to this legislative change.
Apr 2023: The Hong Kong government confirmed that the abolition will take effect on 1 May 2025, marking the Transition Date.
Jul 2023: HKICPA issued updated guidance for making provisions for LSP obligations, helping companies prepare for the upcoming changes in accounting practices.
The abolition of the Mandatory Provident Fund (MPF) offsetting mechanism for Long Service Payment (LSP) in Hong Kong, effective from May 1, 2025, necessitates significant adjustments in accounting practices for employers. Historically, employers could use accrued MPF benefits to offset LSP liabilities, reducing the reported LSP obligation. With the offsetting mechanism abolished, employers must now recognize the full LSP liability, potentially leading to a substantial increase in reported liabilities.
Accounting Approaches Post-Abolition
The Hong Kong Institute of Certified Public Accountants (HKICPA) has outlined two acceptable accounting approaches:
- Net Basis Approach: Treats the offsetable MPF accrued benefits as a deemed employee contribution towards LSP, resulting in a reduction of the LSP liability. The abolition leads to a one-off catch-up adjustment, increasing the LSP obligation.
- Gross Basis Approach: Recognizes the LSP obligation without offsetting MPF accrued benefits. Employers record a separate asset (reimbursement asset) for the expected MPF contributions to be used for LSP payments. The abolition necessitates adjustments to the LSP obligation and the reimbursement asset.
Implementation Considerations
Employers should assess the impact of the abolition on their financial statements, considering factors such as workforce demographics and existing LSP provisions. Actuarial valuations may be required to determine the full LSP liability. Additionally, maintaining detailed wage and employment records is essential for accurate calculation of pre-transition LSP portions.
Early engagement with auditors and valuers is advisable to ensure compliance with the new accounting requirements and to manage the financial implications effectively.
For comprehensive guidance, refer to the HKICPA’s educational guidance on the accounting implications of the abolition of the MPF-LSP offsetting mechanism.
The Projected Unit Credit (PUC) method is an actuarial valuation approach mandated by Hong Kong Accounting Standard 19 (HKAS 19) for assessing long service payment (LSP) obligations. This method systematically allocates the total LSP benefit over an employee’s entire service period, ensuring that each year of service contributes proportionally to the accrued benefit.
Key Steps in Applying the Projected Unit Credit Method:
- Determine the Total Benefit: Establish the full LSP amount an employee is entitled to upon retirement or termination, based on the company’s benefit formula.
- Project Future Benefits: Estimate the future value of the LSP, considering factors such as salary growth, inflation, and potential changes in the benefit formula.
- Allocate Benefits Over Service Period: Distribute the projected benefits across the employee’s service years, attributing a portion to each year worked.
- Discount to Present Value: Apply an appropriate discount rate to calculate the present value of the total LSP obligation, reflecting the time value of money.
- Recognize Service Costs: Determine the annual service cost, representing the increase in the LSP obligation due to an additional year of service.
Assumptions in the Valuation Process:
- Employee Turnover: Probabilities of employees leaving the company before becoming eligible for LSP.
- Mortality Rates: Expected rates of employee death, affecting the timing of benefit payments.
- Retirement Age: Anticipated age at which employees will retire and claim their LSP.
- Discount Rate: Reflects the time value of money, typically based on market yields of high-quality corporate or government bonds.
- Salary Growth Rate: Projected annual increase in employee salaries, influencing the future value of LSP benefits.
- Investment Return Rate: Assumed rate of return on plan assets, if the LSP is funded. This rate should align with the expected long-term returns of the plan’s investment portfolio.
Valuation Approach:
The PUC method treats each year of service as generating an additional unit of benefit entitlement. The total LSP obligation is the sum of the present values of these units, calculated by discounting each unit to its present value using the discount rate. This approach ensures that the LSP liability recognized in the financial statements accurately reflects the company’s future obligations to its employees.
Employers are advised to engage qualified valuers to perform LSP valuations, as the process involves complex assumptions and calculations. Our LSP 360 can provide detailed reports and guidance on the financial implications of LSP obligations, ensuring compliance with HKAS 19 and assisting in effective financial planning.
Understanding the implications of the abolition of the MPF offsetting mechanism for Long Service Payment (LSP) in Hong Kong is crucial for employers. This change necessitates a comprehensive valuation of LSP obligations to ensure accurate financial reporting and strategic planning.
Key Considerations for LSP Valuation:
- Accounting Implications: Employers must recognize the full LSP liability without offsetting MPF contributions, potentially leading to increased liabilities on the balance sheet and higher service costs in the income statement.
- Actuarial Valuation: The Projected Unit Credit method, as outlined in HKAS 19, is commonly used for LSP valuation. This method involves the gradual accumulation of the defined benefit obligation throughout the service period.
- Data Requirements: Accurate employee data, including demographics, employment history, and salary information, are essential for precise valuation.
- Assumptions: Key assumptions include discount rates, salary growth rates, employee turnover, mortality rates, and retirement age.
Recommended Actions for Employers:
- Engage Professional Services: Consult with valuers, actuaries or contact ValuAct to conduct a thorough LSP valuation, ensuring compliance with accounting standards and accurate financial reporting.
- Keeping wage records: Comply with Employment Ordinance, keep the 12 months immediately preceding the transition date until six months after the employee ceases to be employed
- Prepare for Financial Impact: Anticipate and plan for the financial implications of increased LSP liabilities, including potential adjustments to financial forecasts and budgets.
Employers should account for the full LSP liability from the financial year that includes June 2022, the date of the Amendment Ordinance’s enactment.
Employers should initiate an actuarial valuation of LSP obligations promptly, as the abolition of the MPF offsetting mechanism is set to take effect on May 1, 2025. This proactive approach allows for early identification and management of the financial impact on the company’s balance sheet and income statement.
Effective May 1, 2025, the use of accrued benefits from employers’ mandatory MPF contributions to offset LSP liabilities will be abolished.
mployers must recognize the full LSP liability without offsetting MPF contributions, potentially leading to an increase in reported liabilities.
The Hong Kong Institute of Certified Public Accountants (HKICPA) recommends using the Projected Unit Credit method under HKAS 19 for LSP valuation.
Approach 1 (Net Basis) is generally recommended unless there are specific circumstances that necessitate Approach 2 (Gross Basis). This preference is due to the simplicity of Approach 1, which does not require consideration of the reimbursement asset, thereby streamlining the accounting process.
Key assumptions include discount rates, salary growth rates, employee turnover, mortality rates, and retirement age.
Employers may experience increased liabilities on the balance sheet and higher service costs in the income statement due to the full recognition of LSP obligations.
Yes, the Hong Kong government has introduced a 25-year subsidy scheme totaling $33.2 billion to assist employers with the additional LSP costs post-abolition.
HR departments should review and update LSP policies, communicate changes to employees, and collaborate with finance teams to ensure compliance with new accounting standards.
Finance departments should conduct actuarial valuations, adjust financial forecasts, and implement strategies to manage the increased LSP liabilities effectively.
Employers should consult with tax advisors to understand the tax treatment of LSP provisions and related expenses under the new regulations.
Challenges include recalculating LSP liabilities, updating financial reporting systems, and ensuring compliance with new accounting standards.
The abolition applies to all employers and employees, with no exceptions.
Companies with existing LSP provisions must adjust their financial statements to reflect the full LSP liability, potentially leading to increased liabilities and expenses.
Companies should monitor updates from the Hong Kong Institute of Certified Public Accountants (HKICPA), engage with professional advisors, and participate in industry seminars to stay informed about developments related to LSP and the abolition of the offsetting mechanism.
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