Facing up to pensions accounting

Pensions matter, and not just to a company’s balance sheet. Maintaining confidence in their financial well-being is important to all of us and therefore it is imperative that the way companies account for them, as with other post-employment benefits, is transparent and consistently applied.

In March the IASB published its ideas for reforming pensions accounting in a discussion paper Preliminary Views on Amendments to IAS 19 Employee Benefits. At one time the disclosure of the effects of pensions on a company was rudimentary and driven largely by a desire not to rock the boat. Then came FRS 17, the pensions standard in the UK, with its pioneering efforts in forcing uncomfortable disclosures about volatility and the fragile financial position that many companies found themselves in. Since then the pensions world has changed, both in terms of disclosures and also in how companies view post-employment benefits. It is no wonder that, a few more years down the line, there is a clamour to update and reform the existing rules. ‘The original standard was issued more than ten years ago and was much like the FASB standard at the time. It contained already some of the compromises that we are addressing today but at that time and under the circumstances they seemed acceptable’, says Stephen Cooper, part-time member of the IASB.

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A growing awareness of pension issues around the world, changing market conditions and an increasing complexity of post-employment benefit schemes are all factors that have made a substantial overhaul of pensions accounting necessary. A glance at the numbers shows just how important the issue is. In 2007 the estimated pension liability for 80 of the top companies around the world was almost £700 billion. There are some cases where the pension liability exceeds the market capitalisation of the company. Two aspects of the accounting for pension liabilities under IAS 19 are causing the biggest trouble.

One is the option for deferred recognition of gains and losses and the other is the accounting for promises linked to returns on assets or an index.

Addressing the main issues

Under IAS 19 companies can recognise a pension asset on the balance sheet even when the plan is running a funding defi cit and vice versa’, says Jenny Lee, project manager for post-employment benefits. When IAS 19 was created it was reckoned that, in the business climate at that time, companies just would not accept a tougher standard. As a result various options for recognising gains and losses were allowed, making comparisons almost impossible. But it is not only comparability that is at stake. Because of the option to defer recognition of changes in the liability under IAS 19, nobody can truly be assured that the figures shown reflect the pension liabilities of a company to its full extent.

The option to defer recognition allows companies to feed losses or gains into the income statement gradually. ‘This smoothing approach does not help to give a true picture of the pension liabilities’, says Cooper, adding ‘accounting standards must ensure that the balance sheet reflects an appropriate picture of how good or bad a company is doing in terms of its pensions assets and liabilities.’

Companies that do not currently use immediate recognition might not welcome the IASB’s proposal to remove deferred recognition, arguing that it would introduce volatility, whereas analysts are likely to welcome it because it would show them exactly what is going on. ‘The changes proposed would not increase the volatility of a pension fund.

Instead, what they will do is provide a more realistic picture of the current state of a company’s pension liabilities’, explains Lee. Where gains and losses are not recognised immediately, the balance sheet fi gures show amounts based on estimates of the future that are subjective and this can lead to misjudgements from both the company itself and users of financial statements. The ideas we are putting forward would help to avoid this in the future.’

The IASB wants to focus the discussion on where these gains and losses should be presented in the financial statements. ‘There are three options’, Lee explains. ‘First, everything could go into profit or loss. Second, the cost of service could go into profit or loss and everything else into other comprehensive income. Third, the cost of service, interest costs and imputed income on assets could go into profit or loss and all remeasurements could go into other comprehensive income.’

‘People now recognise the importance of the underlying realities and there is a growing awareness of the importance of getting the pensions accounting right’ says Cooper.

There will be plenty of time for the issues to be aired. There is a six-month comment period following which the comments will be considered by the IASB and an exposure draft produced. Timetables for the publication of an exposure draft will depend on the feedback and the IASB’s decisions.

However, the IASB hopes for a final standard in 2011. ‘What we need now is extensive discussions with input from all sides’, says Cooper. ‘We are actively encouraging a debate about these important issues.’

To come to these initial proposals the IASB has consulted external parties, including the project’s working group  which comprises industry experts, preparers, actuaries and analysts from around the world. Further discussions on the paper will follow later this year. And as pensions are an issue that interests many, the IASB is also trying to reach out by using new methods such as a live Webcast at the launch of the discussion paper and a voice-over presentation  both available on the project Web pages.

‘We want to make people understand that we are fixing a real problem’, says Cooper and adds: ‘It is important for all that we create a standard that ensures that companies make a good assessment of their obligations and whether they can meet them.’