The International Accounting Standards Board (“IASB”) has made a number of changes to IAS19: Employee Benefits. The new version will be effective for accounting periods beginning on or after 1 January 2013 and the key changes are:
- all companies will be required to immediately recognise all gains and losses on the balance sheet (now referred to as the Statement of Financial Position) in the year they arise. The option that currently exists to spread gains and losses – the “corridor approach” – will be removed;
- a new presentation approach, with the benefit cost being split between service cost, finance cost and remeasurement components;
- more guidance on the treatment of expenses; and
- a large number of additional disclosure items will be required. Additional information will also be required about multi-employer plans.
The IASB is carrying out a fundamental review of its accounting standards. They are making a number of “improvements” that will affect the accounting treatment of defined benefit pension plans, as set out in IAS19.
The proposals affect the consolidated accounts of companies listed anywhere in the EU. They do not affect those companies who only report under the UK accounting standard, FRS17.
The new standard will be effective for accounting periods beginning on or after 1 January 2013, but earlier adoption is permitted.
For a company with a 31 December year end:
- the new standard will first apply for the 2013 accounts; and
- the 2012 profits and balance sheet shown in the 2013 accounts will need to be restated as prior year comparators.
A key feature of the current IAS19 is that it provides companies with a choice as to when they recognise, on the balance sheet, actuarial gains/losses arising on the assets and liabilities (known as defined benefit obligations).
In the UK, most companies choose to recognise all gains/losses in full in the year they arise. The amounts are recognised in ‘other comprehensive income’ (“OCI”). However, some companies currently choose to adopt the corridor approach. Under the corridor approach, the impact on the balance sheet of actuarial gains/losses is smoothed because actuarial gains/losses above the corridor (defined as 10% of the greater of the defined benefit obligation or the fair value of the assets) are recognised in the profit and loss account.
Under the new standard, actuarial gains/losses are renamed ‘remeasurements’ and must be recognised in full in the balance sheet, through OCI, at the time they arise.
Comment – For the minority of companies that currently use the corridor approach, the move to immediate recognition may lead to a significant change to their balance sheet and substantially more balance sheet volatility.
The new IAS19 includes a new presentation approach, which is designed to provide greater consistency between different organisations. The benefit cost is to be split between the service cost, finance cost and remeasurement components.
The service cost combines the current service cost (the cost of benefits accrued in the current period) and benefit changes (past service costs, including curtailment effects and gains/losses from non-routine settlements).
The service cost will be shown as an employment cost in the profit and loss account.
The most significant of the presentation changes relates to the way the finance cost component of the profit and loss is to be calculated.
The key difference relates to the treatment of assets. Currently, the expected return on the actual assets held by the plan is used. Under the new IAS19, the actual asset allocation will have no influence on the amount credited to the profit and loss. Instead, the discount rate, used to value the defined benefit obligation, will be used to determine both the expected increase in the value of the assets and the interest on the defined benefit obligation. This approach – a net interest approach – effectively assumes an expected rate of return on assets equal to the discount rate.
Comment – This change will raise the reported pension costs for most companies. As most pension plans invest in assets that are expected to yield a higher return than the return on high quality corporate bonds (the latter being used to determine the discount rate), this proposal will result in a higher financing cost in profit and loss. It may also lead to some companies reviewing their investment strategy because it could reduce the incentive to hold riskier growth assets such as equities.
The remeasurement of the assets and the defined benefit obligation will be reported under OCI. It will consist of a combination of:
- gains and losses arising from experience adjustments and changes to the actuarial assumptions, with those arising from changes in the demographic assumptions being shown separately from those arising from changes in the financial assumptions;
- the difference between the actual return achieved on the assets (net of investment management expenses) and the return implied by the net interest income; and
- the effect of any changes to asset ceilings that apply when a company has a surplus that cannot be fully recovered.
The new IAS19 also clarifies the treatment of expenses. Investment management expenses should be recognised as part of the return on the plan assets. Other administration costs of running a pension plan should be recognised when the administration service is provided.
A number of additional disclosures will be required to help readers of the accounts understand the characteristics of the defined benefit plans and the associated risks (including the amount, timing and uncertainty of future cashflows). For a summary of the main additional disclosures required, please see our full briefing.
Comment – Preparation of these new disclosures is likely to increase the time required to prepare the accounts, together with the associated costs. The costs of complying with the new IAS19 could prove particularly onerous for smaller pension plans.
For companies that participate in a multi-employer plan for non-associated employers, a number of additional disclosures will be required to ensure that any extra risk the company may face as a result of actions taken by other employers participating in the plan are made clear.
Where a company participates in a defined benefit multi-employer plan, it should usually account for its share of the plan in the same way as for any other defined benefit plan. However, companies may not always be able to identify their share of plans with sufficient reliability for accounting purposes. In these cases, companies should continue to account for their plans as if they were defined contribution plans.
There are also new disclosures required where the plan is being accounted for as if it were a defined contribution plan.
A summary of the additional disclosures relating to multi-employer plans can be found on our full briefing.
Companies should review how profits and balance sheets will be affected by the new rules and consider whether to adopt the new standard early.
Companies may also need to understand any impact on other areas, such as the investment strategy of their plans and any de-risking measures currently being considered.
For more detail please see our full First Briefing on the “New IAS19, January 2012” . This can be found along with past briefings on our website. Alternatively for further information please contact us.