Introduction
Hong Kong’s employment and retirement schemes have been designed to balance the interests of employees and employers, ensuring adequate protection to employees and retirement benefits. Among these, the Mandatory Provident Fund (MPF) scheme plays a key role in providing retirement benefits for the workforce. Prior to 1 May 2025, Hong Kong employed an offsetting arrangement that allowed to use employers’ accrued MPF mandatory contributions to offset severance payments (SP) and long service payments (LSP) (“offsetting arrangement”). This offsetting arrangement was intended to reduce employers’ costs associated with employee’s termination benefits. Effective from 1 May 2025, this offsetting arrangement was abolished as stipulated in the Employment and Retirement Schemes Legislation (Offsetting Arrangement) (Amendment) Bill 2022. This article explores the changes that this legislative shift has brought to accounting practices, focusing on financial impact, calculation and recognition, and related considerations.
Impacts on Accounting
Before the abolition of the offsetting arrangement, employers could offset their MPF mandatory contributions against the liabilities for SP and LSP. This offsetting arrangement often led to a reduction in the reported liabilities on the balance sheet, as the employer’s mandatory contributions made to the MPF scheme were considered as partial offsets to termination or retirement benefits. Consequently, the liabilities recognized for employment-related obligations appeared lower.
After the enactment of the abolition of the offsetting arrangement, the increase in recognized liabilities related to SP and LSP directly impacts overall financial health and key financial ratios, such as the debt-to-equity ratio and current ratio. It is particularly important for companies operating in industries with regulatory requirements on liquid capital and/or net assets. It is recommended that these companies assess the impact on their financial position.
Calculation of Provision for LSP
The abolition of the offsetting arrangement is a legislative change in the Employment Ordinance, while the relevant accounting standard, Hong Kong Accounting Standards (“HKAS”) 19 Employee Benefits, remains unchanged. Under HKAS 19 Employee Benefits, the provision for LSP is classified as a defined benefit plan, which is calculated using the projected unit credit method. This method estimates future employer obligations (i.e., benefits to employees) based on expected salaries and years of service at retirement.
Several parameters should be considered in calculating the provision for LSP, including:
- Salary level of employees
- Age of employees
- Expected return on plan assets
- Inflation rate and discount rate
- Actuarial assumptions about retirement age, salary increment, employee turnover rate, mortality rate, etc.
These actuarial assumptions are critical for accurately estimating the present value of future LSP obligations. Regular reviews and adjustments are necessary to account for changes in demographic and economic factors. Furthermore, any changes in actuarial assumptions will affect the LSP liability and the reimbursement asset (under Approach 2), resulting in a remeasurement gain or loss recognised in Other Comprehensive Income.
Tax and Audit Considerations
The Hong Kong profits tax treatments
Deductibility of provision for LSP
The Hong Kong profits tax deduction for LSP is governed by sections 16(1) and 17 of the Inland Revenue Ordinance (IRO). Any provision for LSP made in accordance with the Employment Ordinance will be deductible under section 16(1) of the IRO, provided that the provision is reasonably accurate and incurred in production of assessable profits.
Two acceptable approaches to account for the provision for LSP
According to the guidance1 issued by the HKICPA, employers have the option to select one of two acceptable accounting methods for recognizing the provision for LSP (including the offset mechanism) and the effects of the abolition of the offsetting arrangement:
(a) Under Approach 1:
The accrued benefits from an employer’s mandatory MPF contributions that have vested with the employee and can be used to offset the employee’s LSP benefits (referred to as “offsetable accrued benefits”) are considered a deemed contribution by the employee toward the LSP, resulting in a reduction in service cost related to the LSP. The LSP obligation is measured on a “net” basis after deduction of the service cost related to the offsetable accrued benefits.
The abolition of the offsetting arrangement leads to a decrease in the expected offsetable accrued benefits. Consequently, a one-time catch-up adjustment is recognized as an additional past service cost in the profit or loss, along with a corresponding increase in the LSP obligation in the year the Employment and Retirement Schemes Legislation (Offsetting Arrangement) (Amendment) Ordinance 2022 is enacted (i.e. 16 June 2022).
(b) Under Approach 2:
The LSP obligation is measured on a “gross” basis, without any deductions for offsetable accrued benefits.
The employer’s MPF contribution is recognized as a separate asset (the Reimbursement Asset) on the balance sheet and is measured at fair value until the value reaches the amount of LSP related to the employment period before the Transition Date (i.e. 1 May 2025).
An one-off adjustment is made to the LSP obligation to account for the change in the reference date used to determine the last month’s salary for calculating the pre-transition portion of LSP.
Audit Considerations
Auditors play a critical role in verifying that employers have correctly recognized and disclosed these liabilities related to LSP. They will review the accuracy of the liability calculations, ensuring the provision for LSP reflect and comply with the new legislative requirements and are supported by appropriate actuarial assumptions.
Conclusion
The abolition of the MPF offsetting arrangement in Hong Kong marks a significant change in the accounting and operation for employers. The abolition of the offsetting arrangement may result in increased liabilities and adverse effects on financial ratios. Employers, auditors, and stakeholders are required to adapt to this legislative shift, ensuring compliance with legal and financial reporting requirements moving forward.
- Accounting implications of the abolition of the MPF-LSP offsetting mechanism in Hong Kong
https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-and-regulation/SSD/gMPFLSP.pdf ↩︎