Valuation of Long Service Payment and Severance Payment under Hong Kong Financial Reporting Standards

The Abolition of the Mandatory Provident Fund – Long Service Payment Offsetting

The abolition of the use of accrued benefits derived from employers’ mandatory contributions to the Mandatory Provident Fund (MPF) to offset Long Service Payment (LSP) and Severance Payment (SP) became effective on 1 May 2025.

To ensure compliance with Hong Kong Accounting Standard (HKAS) 19, a detailed assessment of the LSP provision is required. This involves developing actuarial and financial assumptions and applying advanced programming techniques to process large volumes of data.

A Guidance issued by the Hong Kong Institute of Certified Public Accountants (HKICPA) on 4 July 2023 discussed two acceptable approaches to accounting for LSP liabilities.

Approach 1: 
Net basis LSP liability – The employer’s contribution is used to offset the LSP liability through negative service costs.

Approach 2:
Gross basis LSP liability – The employer’s contribution is recognised as a separate reimbursement asset measured at fair value, offsetting the gross LSP liability.

*Remarks: While the net LSP liability under both approaches will converge to the same amount as the expected date of retirement approaches, the profit and loss (P/L) impact across the reporting periods typically differs.

The Projected Unit Credit Method is typically applied to measure the present value of LSP liability attributable to employees’ past service. Such LSP liability, along with current service cost and interest cost, are sensitive to the selection of appropriate discount rates in accordance with HKAS 19.

Key Data Inputs in LSP Liability Assessment

Actuarial assumptions generally take into account the following data or statistics:

• Salary growth – historical payroll records, internal policies, macroeconomic parameters
• Employee turnover rate – historical data (including voluntary and involuntary terminations)
• Mortality rate – statistics published by government authorities
• Discount rate – high-quality corporate bond yield (or an appropriate risk-free rate if not available)
• Fund asset return –historical performance of relevant MPF benchmark funds

*Remarks: Changes in actuarial assumptions will impact the measurement of LSP liability under both aforesaid approaches, and in the case of Approach 2, it also affects the valuation of the reimbursement asset. Such remeasurements are recognised in other comprehensive income as actuarial gains or losses.

Practical Considerations 

In addition to general actuarial inputs, LSP liability assessments often involve the following practical considerations:

• Salary structure complexity – Companies with multiple salary payout structures, such as fixed pay, commission-based compensation and tiered distribution face increased modelling complexity in projecting future salaries.
• Voluntary employer contribution – Additional benefits such as gratuity payments or entitlements under Occupational Retirement Schemes Ordinance (ORSO) plans may be considered LSP-offsetable under the amended legislation.
• Clarity of LSP entitlement – Short-term renewable contracts may create ambiguity regarding eligibility for statutory benefits, often requiring legal interpretation.
• Going concern uncertainty – If the entity’s going concern status is uncertain, separate modelling for SP may be required.

Due to the complexity and sensitivity of these factors, external consultants are often engaged to ensure compliance with HKAS 19, maintain confidentiality of employee data and ensure the accuracy of the LSP provision estimation.