SOAI Pensions Accounting Seminar 14 November 2007 Brian Mulcair FSAI
Agenda Background Key differences between the standards Recent developments - FRS17 amendments - FAS158 - IAS19 asset ceiling IASB / FASB / ASB convergence project Other hot topics! Results of SOAI pensions accounting survey Auditor and the Actuary
Importance of accounting for long term employee benefits Company should have accumulated adequate provisions at retirement, termination, paying benefits should not cause "strain" Cost of long term employee benefits for an individual should be charged to P&L in a sensible fashion cost spread over period of working lifetime As well as pension applies to lump sums on retirement, post retirement medical care etc Applies regardless of how the promise is funded Cost of promise Normal prudent principles Different funding approaches Entry Start benefit Service
History of various standards IAS 19 IAS 19 revised IAS 19 revised IAS 19 revised 1966 1980 1983 1987 1988 1995 1998 2001 2004 2006 APB Opinion FASB FAS 87 SSAP 24 FRS 17 FAS 158 Key Drivers of International Accounting Standards Fair value accounting of benefits Greater consistency in treatment of liabilities/expenses Enable better comparability of benefit costs Provide adequate disclosure Recognize surplus/deficiency on Company s balance sheet More prescriptive Less wriggle room
Background Movement to fair value / market assessment of pension liabilities Treat pension liabilities as a corporate debt Off-market Development over time On-market Book values/ Fixed discount rates Market values/ Occasionally changing discount rates FAS 87 (US) Market discount rates Much smoothing IAS 19? Market discount rates. Some Smoothing. No smoothing optional FRS 17 (UK) Market discount rates No Smoothing
Accounting results can add value and understanding Set negotiation stance on sales and purchases - potentially huge sums at stake Gives a sound platform to review financing options Assess the impact of possible plan changes Key benchmark measure in new UK SSF regime Understand the future progression of pension costs and company's control over them Measure the P&L and balance sheet impact of: restructurings/ redundancies salary increases market volatility in interest rates changing workforce composition An opportunity, not just a compliance exercise! Accounting disclosures increasingly driving behaviour
Key Differences in Standards
IAS 19 vs FRS 17 vs FAS 87 All three standards almost the same on: actuarial method assumption setting composition of the P&L charge But differ in: Timing and location of recognition of gains / losses FAS 87 allows asset smoothing fine details of past/future service attribution of benefits approach to benefit improvements, settlements, curtailments transition rules and lots more subtle but important points of detail IASB favours moving IAS19 towards immediate recognition
IAS 19 vs FAS 87 vs FRS 17 Main differences P&L Account FRS 17 IAS 19 FAS 87 Gains/losses: Immediate recognition through STRGL Spread recognition - 10% corridor allowed OR immediate through SORIE (or / P&L!) Spread recognition - 10% corridor allowed (or faster) Plan amendments: Immediate recognition (if vested) Immediate recognition (if vested) Amortisation over average future service Assets: Market value Market value Market or marketrelated value
IAS 19 vs FAS 87 vs FRS 17 Main differences - Balance Sheet FRS 17 IAS 19 FAS 87 Net pension asset/ liability on balance sheet: Limited to economically usable surplus Otherwise, equals plan surplus/deficit Limited to economically useable surplus Either smoothed version of plan surplus/deficit or equal to surplus/deficit (when SORIE is used) Unlimited Equals plan surplus/deficit (FAS158)
IAS 19 vs FAS 87 vs FRS 17 Main differences - Other FRS 17 IAS 19 FAS 87 (/ 88) *Curtailments/ settlements: Losses: when employer is demonstrably committed Gains: when all parties are irrevocably committed When event occurs When event occurs but when probable and estimable if curtailment loss Multi-employer plans: Defined benefit accounting if possible Defined benefit accounting if possible Group plans: always DB accounting Defined contribution accounting Interest Cost and Expected Return on Assets: Actual cash flows (benefit payments and contributions) Actual cash flows (benefit payments and contributions) Estimated cash flows (benefit payments and contributions)
Recent amendments to accounting standards
FRS 17 amendments Disclosures brought into line with IAS 19 including use of bid value of assets Further disclosures recommended in a best practice Reporting Statement Relationship between the company and the trustees Liabilities on a buy-out basis Mortality assumptions must be disclosed Analysis of sensitivity of liabilities to changes in the principle assumptions Agreed contributions Recovery plan contributions Funding objectives Duration of liabilities Risks and rewards arising from the assets
FAS158: SEC Report on Off-balance sheet liabilities, 15 June 2005 Triggered by Enron - B/S liabilities: $13B - Effective debt: $38B - Off B/S liabilities: $25B (SPVs) Retirement Arrangements empirical findings: Sample of 200 companies: Aggregate deficit: US$86B Aggregate net asset on BS: $91B Off balance sheet liabilities: $177B SEC: Good disclosure doesn t cure bad accounting
FAS 158 Balance Sheet Changes Effective for financial years ending after 15 December 2006 Net funded status is a balance sheet asset/(liability) Overfunded plans are aggregated as a balance sheet asset Underfunded plans are aggregated as a balance sheet liability Uses the PBO and APBO as the liability measures, and FVA as the asset measure The Accumulated Other Comprehensive Income (AOCI) item of the balance sheet will immediately reflect amounts for Net gains/losses Net prior service costs/credits Net transition obligations/assets prior service costs and experience items will continue to be amortised through the P&L as previously
FAS 158 Measurement Dates Effective for financial years ending after 15 December 2008 Use of early measurement dates will be eliminated Early adoption encouraged but may not be possible if there are FAS88 events between measurement date and end of financial year Two methods to transition to the new measurement date Remeasurement Method Alternative Method Multinational organizations with many plans may be most affected
IAS19: Asset Ceiling and recent IFRIC14 Unrecognised actuarial losses and past service cost plus Present value of economic benefits to employer of: refunds contribution reductions Adjustment flows through the income statement The idea is to limit such assets to the extent that an economic benefit is available to the reporting company
Defined Benefit Asset - Limitation Plan Assets DBO Unrecognised losses Unrecognised Past service cost? Defined Benefit Asset Refund or reduction of contributions? Recognised liability Recognised liability
IFRIC 14 IFRIC 14 addresses three issues: How to determine the economic benefit that might be available from refunds or reductions in future contributions. If the reduction in future contributions that might be available is affected by a minimum funding requirement, how this should be accounted for. If a minimum funding requirement might give rise to any further commitment that should be recognised as an additional balance sheet liability.
IFRIC 14 Decision Tree Right to immediate refund OR 1. Can the Scheme be run off over time until the last pensioner is paid, without any third party intervention and 2. Once the last pensioner is paid, can the employer take any surplus, without requiring consent of third party Yes No STOP Any surplus may be fully recognised and there is no impact of any minimum funding standards Is your scheme in surplus or deficit? Deficit Surplus Is there a minimum Funding requirement? Investigate Further No Yes STOP IFRIC 14 has no impact Investigate further
Clarifications following press reports! The Interpretation does not change the rules on funding The Interpretation does not affect an entity s ability to get a refund An additional liability is recognised only if two conditions exist at the same time - if entity has obligation to pay additional amounts to the plan and - if entity s ability to recover amounts in the future by refund or otherwise is restricted. The Interpretation clarifies when a surplus in a pension plan can be recognised The Interpretation ensures that the accounting for surpluses is consistent and transparent
Convergence of accounting standards
International Accounting Standards The future Convergence in medium term Short term projects to eliminate narrow differences between standards Joint long term projects to develop common standards (significant changes) Coordinating future technical agendas Purpose: Improve and harmonize external financial reporting for reasons of: transparency Comparability FAS 87 IAS 19 FRS17 Move to comparability and consistency
Key Issues P&L Recognition Liability Measurement Conceptual framework Cost Classification Consolidation
Liability Measurement Liability Measurement P&L Recognition Phase 2 Issues Cost Classification Consolidation
Liability Measurement Future salary increases Discount rate Termination or ongoing liability Non-service related benefits Intermediate risk plans (i.e. cash balance plans) Rescindable obligations
P&L Recognition Liability Measurement P&L Recognition Phase 2 Issues Cost Classification Consolidation
P&L Recognition Current FAS 87 requirements allow significant smoothing Both the amounts and mechanisms for smoothing will be debated The FASB will seek to balance competing viewpoints Too much smoothing results in costs not being recognized when they occur Too little smoothing results in volatility distorting plan costs and overall corporate financials
Gains and Losses FASB / IASB - Gains and losses outside the 10% corridor are amortized over the average future working lifetime Gains and losses on market values are real Should be recognized when they occur (theoretically) Too much volatility can distort accounting statements Is there a compromise between the immediate recognition camp and the smoothing camp? (Yes!)
Cost Classification Liability Measurement P&L Recognition Phase 2 Issues Cost Classification Classification Consolidation
Cost Classification/Bucketing Current income statement classification all components of expense are operating costs under FAS one P&L number Bucketing pension expense components paints a more transparent picture Divide expense into three buckets Operating Cost: Service Cost Financing Cost: Interest Cost Investing Cost: Everything Else I think that [concerns about income statement volatility] assumes a little bit the way the income statement is constructed today. [The FASB s project on financial statement presentation looks] at different ways of constructing the income statement different sections and it may change the way people look at things or think about things. It is very important. --FASB Chair Bob Herz discussing bucketing Only the operating cost is associated with the core business
Consolidation Liability Measurement P&L Recognition Phase 2 Issues Cost Classification Consolidation
Consolidation FAS 158 puts the net funded status on the balance sheet Phase 2 may put the pension assets on the asset side of the balance sheet and the liabilities on the liability side Impacts corporate finance measures such as the debt/market capitalization ratio
IAS24 and IFRS2 IAS24 Related third party disclosures Includes key management personnel Disclosure on an aggregate Silent on valuation of benefits IFRS2 Valuation of share based remuneration Key area for actuaries