With the introduction of new UK Generally Accepted Accounting Practice (UK GAAP), and subsequently, the introduction of Financial Reporting Standard 102 (which replaces Financial Reporting Standard 17 as the financial reporting standard in the UK and Ireland) we ask employers to consider the impact this may have on their P&L and balance sheet, and note some actions employers can take to limit this impact.
The most significant change under new UK GAAP for defined benefit pension schemes is in relation to non-segregated multi-employer arrangements where employers are unable to identify their share of the assets and liabilities in the Scheme. Under old UK GAAP (and hence FRS 17) there was a exemption that allowed employers in this position to account for their pension costs on a defined contribution basis, by recording the contributions paid to the scheme in the profit and loss account. No account had to be taken of any pension deficit that may have existed at that date.
Under new UK GAAP this is no longer an option and employers that were previously ‘exempt’ under the old rules have two options:
- If it is possible to reasonably identify your share of the assets and liabilities in the scheme then you must produce a full FRS 102 disclosure.
- If it is not possible to identify your share of the assets and liabilities in the scheme then you must record the Net Present Value of your future deficit reduction contributions in your balance sheet. An allowance must also be made in the profit and loss account for the interest accruing on the deficit over the year.
So what does this mean? Employers participating in non-segregated multi-employer pension schemes that previously used the exemption under old UK GAAP will now have to disclose a potentially significant balance sheet item in their accounts. The effect of this will depend largely on the size of the pension scheme deficit in relation to the net current assets of the entity as a whole. In many cases however this is likely to be significant.
- Reduction in net assets – potentially moving to a ‘net current liability’ position;
- May impact on the ability to obtain new funds for charity and not-for profit organisations if the future of the organisation seems ‘unviable’;
- May be an impact on the PPF levy payable by employers if insolvency ratings rise;
- Could potentially lead to insolvency.
From an overall perspective, these changes will lead to clearer disclosure across organisations with those disclosing under the exemption in the old rules now being on a level playing field with all other organisations. It will also lead to greater consistency within organisational groups, where entities within the group were both exempt and non-exempt under the old rules. However there may still be some cases where groups have inconsistencies – for example where there are employers accounting under the full disclosure method and NPV method within the same Group.
What should you do if you are an employer? Understanding your position and understanding the potential impact is key. If you are a ‘small entity’ you have the option of deferring this change to 1 January 2017 as the accounting standard for small entities will still reference the old UK GAAP until this date when it is then expected to be revised. For employers affected, it is about limiting the impact as much as possible.
- Ensure the assumptions used to value your liabilities reflect your ‘best estimate’ of the future taking into account your own organisations future business plans. Consider especially the salary increase assumption, which can often be overstated in ‘standard’ assumptions. It is ultimately the responsibility of the directors of the organisation to set the assumptions – ensure they reflect your future plans.
- Develop a strategy for managing your liabilities going forward. Further accrual is likely to result in a larger, more volatile deficit over time and hence a more volatile balance sheet position. There are ways to reduce your deficit and the volatility of your deficit over time, such as:
- Liability management exercises
- Ceasing future accrual
- Limiting the membership
- Exiting the Scheme
The changes to UK GAAP are most likely to affect Charitable organisations participating in large non-segregated schemes such as the Pension Trust arrangements (SHPS, SHAPS, Growth Plan, SVSPS etc) and any employers participating in the Universities Superannuation Scheme, and any other non-segregated arrangements. The Charity Commission require that any charities showing a ‘net current liability’ position in the annual accounts explain the risks attached – this will include pension risks and it is important therefore that organisations have a strategy in place for managing these risks.
Employers should also understand the non-pension aspects of FRS 102 as there are many other changes coming into force that may improve, or worsen, your balance sheet position. For example we worked with an organisation recently that early adopted FRS 102 - despite it adding £20m to their balance sheet – as the revaluation of their fixed assets under FRS 102 more than offset this increase.
The Spence & Partners Online FRS 102 Liability Calculator
can assist employers in understanding the potential additional liability to be included in next year’s balance sheet prior to the end of this financial year. We would recommend that all employers engage with the necessary advisors to understand their obligations, the potential impact of these and any possible mitigation to ensure there are no surprises when the new rules come into force.