FRS 102 – a quick recap
You may think I am a bit late to the party to be releasing a guide for Financial Reporting Standard 102 (FRS102) and its effect on accounting for pension costs, given that the first edition of the new standard was released in March 2013, and subsequently updated in August 2014.
However, as FRS102 only came into play from 1 January 2015 and we are now approaching the end of the transition year in which companies are required to restate the prior year’s disclosure under this new standard, many companies will only now be thinking about this in earnest for the first time, and so I believe there is no better time to consider the similarities and differences with the previous standard, FRS17.
Under the current regime, listed companies have to account for their pension liabilities under International Accounting Standard 19 (IAS19). Unlisted companies can choose to account for their pension costs under either Financial Reporting Standard 17 (FRS17) or IAS19.
FRS102 introduces amendments to FRS17 which will have an effect on the profit disclosed in company accounts, and the final balance sheet position.
Let’s start with the similarities
FRS102 shares many similarities with IAS19, and as such, the basic accounting framework of FRS17 is broadly retained:
- FRS17 and FRS102 require a market-related approach, with assets being taken at their fair value.
- Liabilities (i.e. the ‘defined benefit obligation’) are valued using the discount rate equivalent to that available on high quality corporate bonds. The rate should be adjusted to make it appropriate for the currency and maturity of the scheme’s liabilities (this will depend on the proportion of pensioner and non-pensioner members in the scheme).
- Other assumptions (e.g. pension increases, mortality) are on a best estimate basis.
- Any deficit / surplus in the scheme (net of deferred tax where appropriate) is recorded on the balance sheet as the ‘net defined benefit liability / asset’ respectively.
- The service cost, and any settlements and curtailments will be charged to the profit and loss (P&L) account.
- Any gains or losses on the scheme’s assets and liabilities will be recognised in ‘Other Comprehensive Income’ (previously known as the ‘Statement of Total Recognised Gains and Losses’ under FRS17) as a ‘remeasurement’ of the ‘net defined benefit liability / asset’.
So what is changing?
The headline changes between FRS17 and FRS102 are:
- The pension cost charged to the P&L will tend to increase for most employers because interest is charged on the net defined benefit obligation (the difference between the fair value of the scheme’s assets and the defined benefit obligation), but the expected return on assets is removed.
- There is no longer an exemption for companies participating in multi-employer schemes with non-segregated assets.
- Where a surplus exists, there is more scope for the sponsor to recognise this as a balance sheet asset.
I explore these key areas below.
Advanced recognition of asset returns
FRS102 is more in line with IAS19 in that companies can no longer take advanced recognition of asset returns that may be accumulated over the period. This was previously the case when companies could adopt a different assumption for the expected return on assets over the period, in comparison to the discount rate adopted. The net effect for most companies with a reasonable level of growth assets in their schemes was to reduce the pension cost recorded in the P&L account.
However, under FRS102, there is no longer an assumption for the expected return on assets as this is now set equal to the discount rate. The effect of this for most companies is to increase the pension cost recorded in the P&L and as a result, reduce the corresponding profit shown in the accounts. A small minority with de-risked schemes will actually see an improvement in their P&L, as the discount rate will be larger than the expected return on assets for those plans.
Multi-employer Schemes with non-segregated assets
As my colleague Angela Burns explained in a previous blog, under FRS17, organisations that participate in multi-employer schemes with non-segregated assets (i.e. they cannot determine their asset share) could benefit from an exemption, whereby under FRS17 and IAS19 that the pension cost was set equal to the amount of employer contributions and there was no balance sheet impact. However, under FRS102, if the organisation has a funding agreement in place to eliminate a deficit in the pension scheme, the organisation must recognise:
- a liability in their balance sheet equal to the net present value of the future deficit reduction payments. These payments are discounted to the present value using the market yield on high quality corporate bonds; and
- a finance cost in their profit and loss account equal to the unwinding of the discount rate. This will be broadly equivalent to the annual deficit payment.
For those organisations which are able to identify their share of the assets and liabilities in the scheme, a full FRS102 disclosure must be produced.
With many multi-employer pension schemes previously benefitting from the exemption under FRS17, there will be numerous employers who will now have to fully recognise defined benefit pension scheme liabilities for the first time and the implications of this are likely to be significant.
Where a surplus exists in a scheme, FRS17 limits the amount that can be recognised on the balance sheet. Surplus can only be recognised to the extent that an employer can expect to secure economic benefit from it, either by paying a reduced rate of contributions or taking a refund. With many schemes closed to future benefit accrual, FRS17 therefore imposes a strict limit for well-funded schemes, given the tight restrictions on refunding scheme assets to an employer.
Under FRS102, potential future refunds can be included in assessing whether surplus can be utilised in this way. To determine if this is possible, assets and liabilities can be projected into the future until the point at which all benefit payments have been made in full, and if a surplus remains at this point in time, a refund is possible and so can be recognised. This is dependent on whether the scheme rules permit the employer to take a refund. If this is not currently permitted, companies must act quickly as activating this provision will require trustee consent and there is a deadline of April 2016 to introduce this.
With the above changes under FRS102, employers should ensure they understand their position and the potential impact of these changes.