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Plain‑English explainer of HKAS 26 / IAS 26 for students, junior accountants and non‑specialists who find official standards too dense to read.
This article is based on Hong Kong Accounting Standards (HKAS / HKFRS), which are fully aligned with IAS / IFRS except for minor local tweaks, so the same principles generally apply under IAS / IFRS unless noted otherwise. The goal is to unpack HKAS 26 Accounting and Reporting by Retirement Benefit Plans (equivalent to IAS 26) using plain English and practical, real‑life examples instead of technical jargon. It is written for students, junior accountants, audit juniors and finance professionals who want to understand not just “what the standard says” but how to actually read and prepare financial statements in line with it.
When you see “the company” or “the entity” below, you can think of any entity that prepares general purpose financial statements under HKFRS / IFRS.
Why defined benefit plans under HKAS 26 feel so “technical”
In a defined benefit plan, the plan does more than collect contributions and invest them. It also promises retirement benefits determined by a formula that usually depends on salary and years of service, and those future payments must be quantified using actuarial techniques. HKAS 26 requires the plan to present, side by side, the net assets available for benefits and the actuarial present value of promised retirement benefits, then explain how these two numbers relate. How you connect, present and explain these figures is exactly what this article focuses on.
In real life, when you open the financial statements of a defined benefit plan, you often see a mix of “very actuarial‑looking” numbers and assumptions: present values based on current salary and projected salary, discount rates and salary growth assumptions, plus a portfolio of investments measured at fair value. HKAS 26 gives you the framework to turn this collection of numbers into a coherent story for users of the financial statements.
What You Should Be Able To Do After Reading?
By the end, you should be able to:
- Clearly state the reporting objective of HKAS 26 for defined benefit plans: not just showing net assets, but also the actuarial present value of promised benefits and the relationship between the two.
- Distinguish between actuarial present values based on current salary and projected salary, and explain the assumptions, uses and limitations of each.
- Understand the logic of dual disclosure – why providing both present values can help users see both the “if we stop now” and the “if we carry on as planned” views of the obligation.
- Explain HKAS 26’s requirement to measure plan assets at fair value, and the special treatment allowed for certain fixed‑return investments held specifically to match known obligations.
- Read the main disclosures in a defined benefit plan financial report: statement of changes in net assets, asset breakdown and valuation bases, major individual investments, exposure to the sponsoring employer, and funding policy / sufficiency explanations.
1. Reporting objectives for defined benefit plans under HKAS 26
For a defined benefit plan, HKAS 26 is not satisfied with “how big is the plan’s asset pool?”. The standard wants users to see three things together:
- The net assets available for benefits at the reporting date.
- The actuarial present value of promised retirement benefits (often split into vested and non‑vested benefits).
- Whether there is a surplus or deficit and how the funding policy responds to that position.
HKAS 26 offers three presentation “layouts” for this information, which you can think of as different page designs telling the same story:
- Version A: A single statement that shows net assets available for benefits, the actuarial present value of promised benefits (with vested and non‑vested separated), and the resulting surplus or deficit.
- Version B: The primary statements show net assets available for benefits only; the actuarial present value of promised benefits is disclosed in the notes, again with a clear explanation of its relationship to the assets.
- Version C: The financial statements present net assets available for benefits, while the actuarial present value of promised benefits is contained in a separate actuarial report that is clearly cross‑referenced.
In practice, when you audit or review a defined benefit plan’s financial statements, the first questions you usually ask are:
- Has an actuarial valuation been prepared, and if so, on what date, using what methods and assumptions?
- Is the actuarial present value of promised benefits based on current salary, projected salary, or both?
- Which of the three HKAS 26 presentation versions is being used, and is there enough explanation linking the assets, the promised benefits and the funding policy?
If you keep the “two lines” idea in mind – net assets and actuarial present value of promised benefits – the technical details later in the standard have a clear place to attach to.
2. Actuarial present value of promised benefits: current salary vs projected salary
HKAS 26 allows the actuarial present value of promised retirement benefits to be calculated and reported using either of two salary bases:
- Current salary levels.
- Projected salary levels, i.e. expected salary levels at or close to retirement.
The difference comes from how defined benefit formulas usually work: benefits are commonly linked to salary (final or average) and years of service.
Current salary basis – closer to an “immediate termination” view
Using current salary as the basis has some clear advantages:
- It requires fewer assumptions, because you do not need to forecast future salary growth, so the calculation is often more objective and stable.
- Additional benefits arising from future salary increases become obligations only when those increases actually occur, so a current salary basis focuses more on obligations that have arisen by the reporting date.
- If the plan were terminated or frozen at the reporting date, the current salary basis present value is often closer to the amount that would be payable in that scenario.
In a common real‑world scenario, if the employer is considering closing a defined benefit plan, regulators or members will focus heavily on whether existing assets are sufficient to cover vested benefits calculated on current salary levels. In that context, a current salary‑based actuarial present value is highly relevant.
Projected salary basis – reflects the long‑term commitment under going concern
Using projected salary levels also has strong logic:
- Many defined benefit formulas are based on final salary or average salary, so if the plan is assumed to continue, the benefits members ultimately receive will be much closer to a projected salary basis result.
- From a going concern perspective, both employer and members care about the size of obligations if the plan continues and salaries increase as expected over time.
- Funding policies (for example, contribution rates and funding targets) are often designed using projected salary information, so the projected salary basis aligns better with funding adequacy assessments.
Take a typical formula such as “pension = final salary × years of service × 1.5%”. If you only look at current salary for a young employee whose salary is expected to grow significantly, you will seriously underestimate that employee’s ultimate benefit. A projected salary basis fills this blind spot.
In practice, HKAS 26 does not force plans to use one basis over the other. What it requires is clear disclosure of which basis has been used and an explanation of the meaning and limitations of that basis. For exams and work, the key is to understand that the two bases are not in conflict; they simply reflect different perspectives on the obligation under different scenarios.
3. Dual disclosure: why show two different present values?
Some defined benefit plans choose to disclose both:
- The actuarial present value of promised benefits based on current salary.
- The actuarial present value of promised benefits based on projected salary.
At first glance, this “dual disclosure” can look unnecessarily complicated. In reality, it is meant to help users understand two different views of the obligation:
- Current salary view – roughly, “How large would the obligation be if the plan were terminated or frozen at the reporting date?”.
- Projected salary view – “Assuming the plan continues and salaries increase as expected, how large are the obligations likely to be in the long run?”.
This is especially useful in real‑life situations such as:
- When employers and unions are negotiating changes to the plan and want to see the gap between the “now” obligation and the “long‑term” obligation.
- When regulators or trustees review the funding policy and need to know whether the current contribution rate looks adequate under different long‑term assumptions.
However, dual disclosure is easy to misread. A user might glance at net assets and then compare them only with the larger projected salary‑based present value, concluding that the plan is heavily underfunded in the long term. That conclusion may ignore the fact that the figure is built on long‑term assumptions and that the funding policy might be designed to fill the gap gradually.
For this reason, HKAS 26 emphasises that disclosures about the actuarial present value of promised benefits should include enough explanation to give users the right context, for example:
- How the funding policy is set (for example, the target funding level and time horizon).
- The main actuarial assumptions used (discount rate, salary growth, expected investment return, mortality and other demographic assumptions).
- Whether there are plans to adjust contribution rates or benefit terms in response to actuarial findings.
A very practical question to put in your working papers or explanatory notes is:
“What scenario does this actuarial present value describe, and do my notes make that scenario clear to users?”
4. Valuing plan assets: fair value and special cases
The other technical pillar of defined benefit plan reporting is how to measure the plan assets themselves. HKAS 26 applies a straightforward principle to all retirement benefit plans:
Plan investments are measured at fair value; for market‑traded securities, fair value is normally their market value at the reporting date.
The logic is simple:
- Fair value reflects the real economic resources the plan controls at the reporting date.
- It provides more useful information for assessing investment performance, risk and funding sufficiency than historical cost.
Fixed redemption investments held to match specific obligations
HKAS 26 also recognises that some plans deliberately hold fixed‑return investments, with a clear maturity and redemption amount, specifically to match known obligations. Typical examples are long‑term bonds or deposits held to fund fixed annuity payments for retirees. In these cases, the standard allows a special treatment:
- Such investments may be measured based on the ultimate redemption value, assuming they are held to maturity at a fixed rate of return, rather than simply using short‑term market prices.
- The idea is that this measurement better reflects the purpose and economic substance of the investment, which is to lock in cash flows to meet specific obligations.
In practice, if a plan holds long‑dated bonds whose market price fluctuates in the short term, but the plan clearly intends to hold them to maturity to pay annuities over the next 10 or 20 years, measuring them at ultimate redemption value can produce a more stable and obligation‑aligned pattern of returns.
Investments that cannot be reliably measured at fair value
Sometimes a plan may hold assets that are difficult to value, such as:
- A controlling stake in a private company.
- Complex financial instruments with no active market quotes.
HKAS 26 sets a minimum transparency requirement for these situations:
- If fair value cannot be measured reliably, the plan must disclose the reasons and explain the alternative measurement basis used.
- Where possible, the notes should still provide fair value information or an indicative range to help users assess risk.
From a practical standpoint, as an accountant or auditor, the key question to ask is:
“Does our chosen measurement approach faithfully represent the economic resources the plan actually has, and have we clearly told users why we are using this figure?”
5. Core disclosures: what defined benefit plan statements should show
Whether a plan is defined contribution or defined benefit, HKAS 26 requires a basic set of disclosures in the financial statements. For defined benefit plans, these “general” disclosures are then supplemented by more detailed requirements.
General disclosures for all retirement benefit plans
All plans should provide at least:
- A statement of changes in net assets available for benefits, showing opening net assets, contributions, investment income, benefit payments, expenses and closing net assets.
- The principal accounting policies, including asset valuation bases, income recognition policies and the basics of actuarial valuation methods.
- A description of the plan, covering eligibility, benefit formula, contribution arrangements and significant changes during the period.
Additional detail for defined benefit plans
HKAS 26 then asks for more granular information to improve transparency:
- Asset classification: for example, by class (equities, bonds, property, cash and so on) and by valuation basis.
- Explanation of valuation bases: whether assets are measured at quoted market prices, using fair value models or at ultimate redemption value.
- Major individual investments: disclosures where a single investment exceeds a specified percentage (commonly 5%) of net assets or of a particular asset class.
- Investments in the sponsoring employer: including direct and indirect exposures to the employer or related parties, so users can see any concentration risk in the employer’s securities.
In everyday audit work, these requirements often show up as a checklist in your file:
- Have we clearly broken down assets by type and valuation basis?
- Have we highlighted any investments that exceed 5% of total net assets or 5% of an asset class?
- Have we disclosed and explained the plan’s exposure to the sponsoring employer?
- Are the actuarial present value, the key assumptions and the funding policy explained clearly?
When you design or review defined benefit plan financial statements, you can treat this section of HKAS 26 as a map of the minimum content needed. Even if you do not memorise paragraph numbers, keep asking yourself:
“Can a reader see where the money comes from, where it is invested, how much needs to be paid in future and how much of the risk is tied to the employer?”
6. The tension between actuarial measurements and accounting measurements
One easily overlooked but crucial concept is that:
The actuarial present value of promised benefits and the fair value of plan assets come from two very different “worlds” of assumptions, so comparing the two figures directly can sometimes mislead users.
The actuarial present value is driven by long‑term assumptions, including:
- Salary growth.
- Discount rates (often linked to long‑term bond yields).
- Expected investment returns.
- Demographic assumptions such as mortality, turnover and retirement age.
By contrast, the fair value of plan assets is measured based on market conditions at the reporting date. Short‑term market volatility flows straight through to the asset numbers.
As a result:
- In a year of significant market decline, net assets may drop sharply, while the actuarial present value changes only modestly as assumptions are tweaked, making the plan suddenly look severely underfunded.
- When interest rates move sharply, changes in the discount rate can cause large swings in the actuarial present value, even if asset values move by a different magnitude or direction.
HKAS 26 is aware of this tension. It therefore requires:
- Disclosure of the main actuarial assumptions and the major impacts of changes in those assumptions on the actuarial present value.
- Explanation of the relationship between the actuarial present value and net assets, together with the plan’s funding strategy.
- When there is an apparent deficit, disclosure of strategies to improve funding, such as higher contribution rates, longer funding periods or benefit changes, so that users see how “underfunding” is being managed rather than just comparing two raw numbers.
For beginners, a common misunderstanding is:
“Net assets < projected salary‑based actuarial present value” = “the deficit must be filled immediately”.
In reality, this comparison is more like a distance indicator between a long‑term target and current resources. Whether contributions must increase immediately depends on the funding policy, actuarial recommendations and regulatory requirements. HKAS 26’s disclosure requirements are designed to give readers enough context to avoid this oversimplified interpretation.
7. Bringing it all together: reading defined benefit plan reports like a pro
When you next pick up the financial statements of a defined benefit retirement plan, you can use a simple four‑step reading approach:
- Start with the net assets and the statement of changes in net assets to understand the plan’s size and how its investments are allocated.
- Locate the actuarial present value of promised benefits and note whether it is based on current salary, projected salary, or both.
- Review the key actuarial assumptions and funding policy, and consider whether they make sense in light of the current market environment and the plan’s features.
- Pay special attention to investments in the sponsoring employer and major single investments to assess how concentrated the plan’s risk is.
In your working papers, adding a few short explanatory sentences can be extremely helpful, for example: “The projected salary basis present value reflects obligations under a going concern scenario, while the current salary basis is closer to obligations on immediate plan termination.” This kind of wording is far more helpful to reviewers than leaving them with raw numbers only.
Once you can weave together the actuarial present value, the fair value of plan assets and the key disclosures into a narrative, the defined benefit part of HKAS 26 stops being “the actuary’s territory only”. It becomes a reporting language that you, as an accountant or auditor, can understand and explain confidently to others.
Key takeaways for students and junior accountants
- Always identify whether you are looking at the employer’s accounting (HKAS 19 / IAS 19) or the plan’s own statements (HKAS 26 / IAS 26) before you start analysing pension information.
- When reading defined benefit plan reports, consciously separate the two main lines: net assets available for benefits and the actuarial present value of promised benefits, then ask how the funding policy bridges the gap between them.
- In exams and at work, common pitfalls include mixing up current vs projected salary bases and treating any gap between assets and the projected salary‑based present value as if it must be filled immediately.
- When reviewing contracts, actuarial reports or plan rules, highlight who bears the investment and benefit risk and what salary basis is used; this will shape the assumptions and disclosures you expect to see.
- In working papers, explicitly document the measurement bases for plan assets and promised benefits, key actuarial assumptions and how they link to the funding strategy; this turns a pile of numbers into a coherent story that other team members (and exam markers) can actually follow.
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