Introduction. International Financial Accounting The Swedish pension system and IAS 19

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1 Introduction Sweden, like many other countries, has a public pension system builds on a defined benefit system and in year 1999 and made some changes in the pension system (Miyazato 2004). The old pension system was based on a so called 15/30 rule. This rule signify, that a citizen has to have some sort of income during a 30 years period or more, to get full additional pension and it depends on the citizen s average income during 15 years (Hörngren 2001). A new pension system was implemented after 15 years of preparation from the parliament, which should lead to a more functional pension system for the Swedish citizens. Furthermore, the EU had decided that companies in all member state, including Sweden, have to convert their consolidated accounts to IAS/IFRS from 2005 for easier comparison between companies (Axelman et al. 2003). The pension system is a complicated system and it needs a lot of time to get involved in. How the companies can perform their calculation according to IAS 19 has not been presented in this paper because lack of time and also the complication of this standards. This is why the paper only contains basic definition from IAS 19. This study will also concern how the Swedish pension system is built and why Sweden made the changes to abolish the old system and implemented a new one. The study also will contain a short presentation of IAS 19/RR 29 works for Swedish companies. 1

2 The Swedish pension system As we all know, pensions is a risky investment (Dowd & Woods 2009) and the meaning of these various pension systems depends on the country (Alexander et al. 2009). The Swedish public pension system can be classified in three categories. Because of the change in 1999, categories number two and three has increased in value (Sundgren et al. 2007). 1. Guaranteed pension, 2. Income pension, and 3. Premium pension. These three categories together decide how much a citizen will get when he or she are retiring (Diamond 2009). In some countries, the public pension is the most important income source for senior citizens and in some countries is the income pension and the premium pension is the important because the public pension is low (Alexander et al. 2009). Citizens whom were born before year 1937, their pensions will be calculated according to the old system, which will be presented later on this paper. For citizens whom were born , will get their pension calculated partly their pension according to the old system and for citizens whom are born after 1954 and forward will calculate their pension system according to the new system (Försäkringskassan 2008). Guaranteed pension Guaranteed pension plan intends to give all citizens that are registered in authorities in Sweden (Sundgren et al. 2007). A citizen has to live here in Sweden for at least three years to have the right to get guaranteed pension. This is a basis for the Swedish citizens and the guaranteed pension is eligible at age 65. This pension plan is based on a citizen s residence in the country, it means a citizen needs to stay in the country for 40 years from the year you turn 16 for those citizens born 1938 or after. For citizens, who was born 1976 or after may not count the years before his or her 25 th birthday. For every year a citizen have miss out of the residence, it will decrease with 1/40 per year, e.g. a person who has lived in Sweden for only 27 years; will get 27/40 of the guaranteed pension (Försäkringskassan 2008). If a person stays in other EU countries the income also will be credited toward a guaranteed pension plan. The guaranteed pension can only be paid to persons who live in Sweden or other EU countries, and also countries which Sweden has an agreement providing for payment (Diamond 2009). According to Miyazato (2004), there are two main characteristics with the guaranteed pension; the pension is financed by taxes and the pension will decrease if an individual has an income pension. Furthermore, there are other factors that can influence the guaranteed pension, like premium pension, supplementary pension, window s pension or other foreign pension (Försäkringskassan 2008). 2

3 Income pension Income pension can sees as one of the supplements to the guaranteed pension. The income pension is based on a citizen s lifetime earnings by having a collective agreement or other agreement with his or her employer. It is the employer s responsibility for taking care of their employees income pension (Sundgren et al. 2007). The income pension is also called a Notional Defined Contribution (NDC) system and is referred to a pay-as-you go system and complete with a buffer fund (Diamond 2009). In comparison to the old system which was the 15/30 rule (Hörngren 2001). The buffer fund includes four AP funds which are running by the government agencies. Premium pension Another supplement for guaranteed pension is the premium pension. A premium pension is a citizen s own savings in form of investment (Sundgren et al. 2007). For every year, 2.5 percent of a citizen s pensionable salary will allocate to premium pension in form of funds, which the citizen can chose to invest their savings through Premium Pension Authority (Försäkringskassan 2008). This kind of pension is a small but important part of the whole pension system, because it is the citizen, himself or herself, who chose where and how to invest the money by choosing a fund that fits them. Premium pension is a long-term saving plan which influence by the stock markets. The size of premium pension depends on three things: 1. how much money a person have paid into the premium pension account 2. the changing value in those fund a person have invest their money 3. when a person choose to withdraw your premium pension, but earliest the day a person turn 61 (Premiepensionsmyndigheten [PPM] 2009). The old pension system Sweden introduced a public old age pension plan in Furthermore, the public pension plan was complemented by a compulsory income-related pension system in year This pension system was based on the pay-as-you-go system (Hörngren 2001). According to Miyazato (2004), this pension system consist financial problems and it was inequitable. As written before, this old pension system is built on a so called 15/30 rule and this rule only benefit those citizens with a higher lifetime income. The benefit formula for calculating the pension according to this old system was based on the citizen s highest income during 15 years. Furthermore, it also based on how much a citizen has been working during 30 years or more (Hörngren 2001). Due to these rule, two citizens with a same lifetime earnings may receive different pension after retiring. This pension system caused a weak link between the lifetime earnings of an individual and pension benefits. Due to solve the inequitableness and the sustainability, Sweden has to reform its old pension system (Miyazato 2004). 3

4 The new pension system Miyazato (2004) and Hörngren (2001) wrote in their study, that this new pension system has two parts; a pay-as-you-go pension system and a premium pension system. The new system consist a contribution rate of 18.5 percent of pensionable income. Furthermore, Miyazato (2004) also state that there are two interest rates in the new pension system, the average income index and the rate of return to assets in the funds. The notional defined contribution system consist either average income index or index growth rate, but in the premium pension system the interest rate is the rate of return to capital in the funds. According to Miyazato (2004), the new pension system has four perceptual points. The first point is this new pension system is an income related pension. The second point considered the rising longevity and the economic growth fluctuations. The third point is the guaranteed pension is financing with taxes. The last point is the flexible pensionable age. The new pension system is a defined contribution plan and therefore, as mentioned earlier, this system is called the Notional Defined Contribution (NDC) pension system. It has been taken more than 15 years for developing this new pension system, from the day the proposal was made to the final decisions in the parliament. The new pension system is a bit complicated, but it is not hard to understand the basic of it (Hörngren 2001). Long term employee benefit: Pension plan There are two types of pension plans, defined benefit and defined contribution plans (Alexander et al. 2009). According to IAS 19 every pension plan shall classifies either as defined contribution plan or defined benefit plan. The economic life of a pension plan decides how the plan is going to be classified. However, when the classification is done, it also needs to decide how the accounting of pension cost and pension provision shall be valued (Sundgren et al. 2007). The pension plan can be seen as an agreement between a company and their employees (Alexander et al. 2009). Defined Contribution plan A defined contribution plan means that a company pays a define fee to a separate juridical entity, e.g. an insurance company or a fund. The employee chose himself or herself how the pension shall invest and are responsible for the financial risks. It means the employee will know the sum of the pension before he or she retires (Alexander et al. 2009). A company account a defined contribution plan by accounting the due as a cost in the income statement and as a debt to the extent that no payment has been done (Axelman et al. 2003). 4

5 Defined benefit plan The other pension plan is called the defined benefit plan. There are three important types of pension payment plans. The first one is the final payment which the benefit calculates as a percentage of the final salary before the retirement. The second is the average payment plan, which the benefit calculates as a percentage of the average salary of the three to five latest years before retirement. The last one is a career average plan which the benefit are related to the average salary that person earn during his or her whole career (Alexander et al. 2009). Furthermore, the company has to make payments for present and former employees. Due to this, it is the company who bear the actuarial risk, which means payments are higher than expected and the investment risk (PWC 2003). Accounting of a defined benefit plan is complicated because of the actuarial assumptions which are needed for calculating the responsibility and the cost. Due to this, actuarial gains and loss can occur. How to compute according to actuarial method is defined in IAS In IAS 19.64, it states An entity shall use the Projected Unit Credit Method to determine the present value of its defined benefit obligations and the related current service cost and, where applicable, past service cost (FAR SRS 2009). In the balance sheet the defined benefit liability will declare as: the present value of the defined benefit obligation at the balance sheet day plus possible actuarial gains/minus possible actuarial loss minus possible cost consider income of earlier periods which have not been declared minus the actual value per balance sheet day of possible plan assets amounts recognized in financial statements (Axelman et al. 2003). IAS 19/RR 29 in Sweden The purpose with implementing the IAS 19 was it will increase the comparability between accounts in companies in different countries. Swedish companies should consequently adapt the international development of accounting (SOU 2003:71). According to IAS 19, the main purpose is to specify how the compensation to employees should be declared and how this kind of information should be submitted (FAR SRS 2009). The accounting recommendation, RR 29, published by the Swedish Financial Accounting Standards Council (Redovisningsrådet), is based on IAS 19 and came into effect 1th January RR 29 does not correspond with IAS 19 in two parts; RR 29 includes specific rules for accounting of defined benefit plan for a legal person and also includes the disclosure requirements from the Swedish Annual Accounts Act s. Therefore RR 29 shall be applied in consolidated accounts as a legal person, but specific rules for this kind of account of defined benefit plans for legal persons. Furthermore, RR 29 standard require companies to declare the amount as a cost for defined contribution plan (PWC 2003). 5

6 The adoption of IAS 19 the 1 January 2005 have results spectacular changes for rating and accounting of the pension commitment. Before the implementing of IAS 19 it was many uncertainty how huge the pension provision are in many Swedish corporate groups and the pension provision was declare according to the country s law the subsidiary company was settle. Due to this, the pension provision will be declaring according to IAS 19 for all groups (Sundgren et al. 2007). The public pensions do not usually give companies any accounting problems. IAS 19 involves how companies shall declare the employees income pension. Therefore, the individual pension savings are not being declared in this legal framework (Alexander et al. 2009). One positive effect of implementing RR 29/IAS 19 into Swedish legislation is the internal control has improved because this standard needs a declaration of a company s replacement benefits. Another positive effect will be the comparability considers the pension provision and the pension cost between companies annual report because all companies has to do calculation according to the standard (PWC 2003). 6

7 Discussion and analysis As written in the frame of reference, the Swedish pension system is based on three different categories; guaranteed pension, income pension and premium pension. However, this pension system is built so all Swedish citizens can have pension when they retire. The guaranteed pension is insurance for those citizens, e.g. immigrants or those who have not work during their lifetime. They will not get much from the government but this sum of money will give them a secure retirement, especially for those who do not have relatives. The other part of this guaranteed pension system, means that a citizen will get fully pension payment if they have not lived in Sweden for 40 years (Försäkringskassan 2008). However, I believe this is a fair system; because it depends on the citizen himself or herself how much they will get paid after retiring. It would be unfair for those citizens which have lived here longer than others if everyone will get the same payment. The income pension can also sees as another income source for future retirement payment. Furthermore, according to Sundgren et al. (2007), as the name states, the income pension is based on a citizen s life time earnings by working. If Swedish government still used the old pension system which was based on the so called 15/30 rule it will be inequitable for those citizens which does not have a high lifetime earnings. I believe this can be the main source of the unbalanced old system and this because of some citizens will have more money than other after retiring despite the income earning the citizens have work so hard for. However, the third income source is the premium pension which the citizen can choose how and where they want to invest their pension saving on funds. According to Dowd & Woods (2009) is pension investment risky, because the investment will be influence by the stock market, specific for the premium pension (PPM 2009). This kind of investment should give the future senior citizen a more comfortable and well paid retirement, but if there the stock market decreases it maybe will results less payment for them. The comparison between the old and the new pension system is the pay-as-you-go which has developed into the new pension system. The old pension system consisted lots of problems, which Miyazato (2004) stated in her study. In comparison to the old system, the new pension system is income related. What counts here is how much a citizen has work during his or her lifetime is the basis for calculating the pension. I does not consist of how long the citizen needs to work to get a fully pension payment after retiring. There is many positive points of the new pension system, one of them are the flexible pension age. A citizen do not need to retire at age 65, according to the new pension system, a citizen can already start to get his or her pension payment start at age 61 from the premium pension. There are two types of pension plan states in IAS 19; it can either be define as a defined contribution or a defined benefit plan. How the pension plan is defined, it will still concerns the 7

8 employees, depending on which plan the companies are going to choose (defined contribution or defined benefit) it will affects their pension payments in the future. According to Sundgren et al. (2007) this implementation of IAS 19 was a positive start for the Swedish corporate groups. This standard clears the insecurity of how to account pension provision in these companies. Due to this, the companies can now make easier assumptions on how the pension provision should be calculated by following the standard. Conclusions In comparison with the new pension system, the old pension system was unbalanced on the payment part. The new pension system on the other hand, gives a balanced and a fair view of each citizen s income pension. Due to this, this new pension system is a better way to get pension payments in the future based on the pay-as-you-go system, which a citizen can have an income part and also a premium pension part there they can invest the amount after their needs. Implementing of the IAS 19 was a positive thing, because this standard cleared all the insecurity of how to account the pension provision for companies in Sweden. On the other hand, Sweden is a member of the European Union, so sooner or later; Sweden has to implement the standard, because it will be easier to compete with other companies in other member states. However, the standard is still complicated. 8

9 References Alexander, D., Britton, A. & Jorissen, A International Financial Reporting and Analysis. London: Cengage Learning. Axelman, L. Philips, D. & Wahlqvist, O. (2003). IAS/IFRS 2005 En jämförelse mellan International Financial Reporting Standards och Redovisningrådets rekommendationer. Stockholm: Ernst & Young Diamond, P-A. (2009). Economic globalization and Swedish pensions. Stockholm: Globalisation Council: Ministry of Education and Research Sweden, Regeringskansliet. Dowd, K & Woods, Margaret. (2009). Pensions risk. Financial Management. [Online], February, Available: fe6a-42c1-b791-05f9062e46bd%40sessionmgr104 [ ] FAR SRS. (2009). Internationell redovisningsstandard i Sverige IFRS/IAS Stockholm: FAR SRS Förlag. Försäkringskassan 1. (2008). Indexering av pensionerna. [Online]. Available: ing%20av%20pensionerna.pdf [ ] Försäkringskassan 2. (2008). Garantipension för dig som är född 1938 eller senare. [Online]. Available: pension%20 %20för%20dig%20som%20är%20född%201938%20eller%20senare.pdf [ ] Försäkringskassan 3. (2008). Premiepension för dig som är född 1938 eller senare. [Online]. Available: pension%20 %20för%20dig%20som%20är%20född%201938%20eller%20senare.pdf [ ] Hörngren, L. (2001). Pension reform: the Swedish case. Journal of Pensions Management. [Online], 5 (2), Available: fe6a-42c1-b791-05f9062e46bd%40sessionmgr104 [ ] 9

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