Long Service Payment Valuation

Long Service Payment Valuation after Abolition of MPF Offsetting Mechanism

HKICPA recently issued comprehensive guidance for the accounting for the impact arising from the abolition of the Mandatory Provident Fund (MPF)-Long Service Payment (LSP) offsetting mechanism (the “Abolition”) on entities in Hong Kong.

https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-and-regulation/SSD/gMPFLSP.pdf

It should be noted that the Government Subsidy does not yet meet the recognition criteria of any element of the financial statements based on an assessment of relevant facts and circumstances at the time of writing of the above publication.

Long Service Payment Valuation Services

Past service cost should be recorded in the year of enactment of the Amendment Ordinance. Valtech’s LSP valuation model can incorporate acturaial assumptions and calculate the LSP including the anticipated effects of the Abolition. The calculation process can be adjusted no matter the Company chooses Approach 1 or Approach 2 in the guidance. Valtech can provide similar services on severance payment (SP) and gratuity payment’s valuation.

Methodology: Projected Unit Credit Method

Why are many sizeable companies appoint Valtech to conduct the long service payment valuation?

Valtech Valuation has been appointed by many multinational corporations and prominent employers in Hong Kong. Currently Valtech Valuation is actively helping clients with several thousands of employees in quantifying their LSP obligation under the new legislation in a truly detailed manner. It is far more complicated than one can expect in handling a lot of different possibilities in a sizable workforce. Appointment of specialist is highly recommended. Valtech also appoints qualified actuary (fellow) for continuous improvement of our actuarial model. Our core actuarial valuation programme used in valuation has recently been certified by a qualified actuary (fellow).

In the sector of long service payment valuation, Valtech is truly professional and experienced. All of the track records we share with our clients are directly related to LSP valuaition but not valuation of other nature.

Case References of Valtech’s Actuarial Model for HKAS 19 Employee Benefits Regarding Long Service Payment or Severance Payment

  1. Multinational corporation’s (MNC’s) Hong Kong office in publication sector
  2. MNC’s Hong Kong office in production sector
  3. MNC’s Hong Kong office in telecommunication sector
  4. An international law firm’s Hong Kong office
  5. A company with approximately ten thousands of staff in Hong Kong
  6. A famous medical group in Hong Kong
  7. MNC’s Hong Kong business in clothing and baby products
  8. MNC’s Hong Kong business in building product
  9. The Hong Kong office of a MNC, with headquartered in USA
  10. A MNC headquartered in Austria in electronics trading industry
  11. A hotel group in Hong Kong
  12. An organisation with both MPF and ORSO scheme
  13. The list above is non-exhaustive.

Why are you encouraged to hire a valuation specialist to perform the calculation?

The calculation is not too complicated for one single employee. Following the practical example provided by HKICPA, you can calculate the result and project the impact for a single employee under simplified assumptions using a single worksheet of a spreadsheet program. However, when the number of employees increase from 1 to hundreds or even to thousands, the complexity will increase significantly. Programming technique will be required to handle massive data. On the other hand, according to HKAS 19, actuarial assumptions should be used. For example, staff turnover rate should be considered and turnover rate should be different for staff in different age groups. Combining the impact of actuarial assumptions and the large pool of employees, involvement of valuation specialist can support company in using a proper framework and perform a level review on the input data.

Can I Use Excel Spreadsheet to Calculate LSP?

The projected unit credit method is an actuarial valuation method that views each period of service as giving rise to an additional “unit” of LSP and measures each unit separately to build up the final obligation. In HKICPA’s guidance note, the example is based on a predefined year of service for a particlar employee, that would give you a complete table of each unit that sum up to the total LSP. In practice, we have a lot of employees. Also an employee may leave before they retire and he/she may be dismissed such that LSP may be paid before his/her retirement. In our opinion, unless a company has only less than 10 employees, otherwise, calculating by excel is not a feasible solution. Programme will be required to calculate for a larger workforce.

Valtech have conducted telephone interview with over 20 employers in Hong Kong including public and private companies. We understand that some companies have been using simple excel template in estimating LSP obligation. Some excel template or simple estimation method make use of “time to retirement” concept by assuming that all existing employees will not resign or be dismissed until 65 years ago, then a discount or probability adjustment is applied to consider many employees would leave before retirement. Before enactment of the new legislation, the error caused by such simple estimation will be less material given the overall exposure is much less significant with MPF offsetting machanism. Many simple excel template is not applying the projected unit credit method as suggested by the accounting standard. Some excel templates try to apply “prudence first” approach, which also cannot provide a fair or comprehensive estimate of SP and LSP.

Experience Really Matters in LSP and SP Valuation

Many employers have volantary contribution and some even have a vesting scheme for the volantary contribution. Since volantary contribution can still be used to offset LSP or SP, such contribution should be considered carefully in the actuarial model. Some companies may have experienced volatilte turnover in the past few years, posting a challenge in LSP estimation. Experienced valuer and actuary will be able to provider a fairer estimate.

Hong Kong Accounting Standard 19 (HKAS 19) requires businesses to compute and report their defined benefit obligations (DBO) and related expenses. Thus, Hong Kong companies need to have fair value assessments on DBO. The most commonly adopted method in valuation of DBO is the projected unit credit method.

The projected unit credit method is a valuation method using actuarial assumptions that considers each period of service as generating an additional unit of benefit entitlement and measures each unit separately to build up the final obligation.

  1. Mortality rate
  2. Employee turnover rate
  3. Average salary incremental rate
  4. The probability that employees resign or retire early due to health reasons
  5. Discount rate
  6. Current year’s DBO accumulation and related payments
  1. The probability that employees live until the statutory retirement age
  2. The probability that employees stay in position in retirement year
  3. The impact brought by the new abolition of MPF offsetting arrangement

Under the new legislations, significant differences could be found in the calculations of MPF offsetting arrangement. Overall, the related obligations will increase. In the calculation process, the related issues rise from pre- and post-transition have to be solved.

The Hong Kong Government will put in place two supporting measures to assist businesses to adapt to the new policy. The first measure is a 25-year refined subsidy scheme. The Government will subsidize a certain proportion of the total amount of severance payments (SP) and LSP payable by employers under this scheme, in order to lower the burden of employers brought by rising obligations.

The second measure is the Designated Saving Accounts (DSA) Scheme. The DSA Scheme mandates employers to save up for their future SP/LSP liabilities. The monthly contribution to the DSA should equal to 1% of employees’ monthly relevant income. Employers may stop the contribution when the savings in the DSA reached 15% of total employee’s annual relevant income.

Valtech’s valuation team includes Master of Finance, Master of Statistics and valuation experts with background in quantitative finance and financial engineering. In the context of LSP valuatoin, Valtech also works with qualified fellow actuary to improve model accuracy and prevent errors. In addition, Valtech’s valuation services are ISO 9001 certified. If companies’ auditors do not require an actuary to be responsible for the calculations, our valuation team are capable of providing opinion on DBO for financial reporting purposes. Our qualified actuary can provide advice in truly complicated project upon request.

The details of the abolition of MPF offsetting arrangement could be referred below:

Abolition of Offsetting Arrangement (to be implemented in 2025)

The Legislative Council passed the Employment and Retirement Schemes Legislation (Offsetting Arrangement) (Amendment) Bill 2022 on 9 June 2022 to abolish the use of the accrued benefits of employers’ mandatory contributions under the Mandatory Provident Fund (MPF) System to offset severance payment (SP) and long service payment (LSP) (the offsetting arrangement). The Government will implement the abolition of the offsetting arrangement in tandem with the full implementation of the eMPF Platform of the Mandatory Provident Fund Schemes Authority, which is expected to be in 2025.

Key points of the abolition of offsetting arrangement:

  • After the abolition of the offsetting arrangement takes effect (the transition date), employers can no longer use the accrued benefits derived from their mandatory MPF contributions to offset employee’s SP/LSP;
  • Accrued benefits derived from employers’ voluntary contributions as well as gratuities based on length of service can continue to be used to offset SP/LSP.
  • To reduce the risk of large-scale dismissals before the transition date, the “grandfathering” arrangement will be put in place for the pre-transition portion of SP/LSP of employees who are already in employment before the transition date.

Key points of the “grandfathering” arrangement (only applicable to employees who are already in employment before the transition date):

  • For employees already in employment before the transition date, their SP/LSP will be divided into pre-transition portion (i.e. for the employment period before the transition date) and post-transition portion (i.e. for the employment period starting from the transition date).
  • The pre-transition portion will be calculated on the basis of the monthly wages immediately preceding the transition date and the years of service before the transition date, whereas the post-transition portion will be calculated on the basis of the last monthly wages before termination of employment and the years of service after the transition date.
  • The maximum amount of SP/LSP (i.e. the sum of pre-transition and post-transition portions of SP/LSP) is still capped at $390,000. If an employee’s total SP/LSP exceeds $390,000, the amount in excess of the cap will be deducted from the post-transition portion.
  • Employers can continue to use the accrued benefits derived from their MPF contributions (irrespective of whether the contributions are made before, on or after the transition date, and irrespective of whether the contributions are mandatory or voluntary) to offset the pre-transition portion (but not the post-transition portion) of SP/LSP.

After the abolition of the offsetting arrangement, calculation of SP/LSP payable to a monthly-rated employee is as follows:

(1) Employment period before transition date

  • Employee’s last full month’s wages immediately preceding the transition date× 2/3 × years of service before transition date

(2) Employment period after transition date

  • Employee’s last full month’s wages before termination of employment× 2/3 × years of service after transition date

(3) The ceiling on the monthly wages for calculating SP/LSP is $22,500 and the maximum SP/LSP amount is $390,000. These ceilings remain unchanged.

Further reference:

Concise guide of Severance Payment and Long Service Payment from Labour Department

https://www.labour.gov.hk/eng/public/wcp/ConciseGuide/11.pdf

Comprehensive and interactive information of Severance Payment and Long Service Payment from Labour Department with Calculator

https://www.op.labour.gov.hk/en/main.html

About Valtech Valuation

Valtech provides all-round valuation services including business valuation advisory, expected credit loss valuation, property valuation, mining valuation and valuation for other assets with ISO 9001 certified quality management system. Our team is experienced in serving listed companies, private equity and companies working for IPO. We were formed by a team of professionals with diversity of expertise and experience.  Besides, Valtech team has hand-on experience in valuing specialized assets such as biological assets and mineral assets.

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