I recently presented at a ‘Future Influencer’ breakfast seminar hosted by Spence & Partners, on Financial Reporting Standard 102 (FRS102) and its effect on accounting for pension costs.
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 both FRS17 and IAS19 which will have an effect on the profit disclosed in Company accounts, and the final balance sheet position.
The main changes are as follows:
Multi-employer Schemes with non-segregated assets
- There is no longer an exemption for Companies participating in multi-employer Schemes with non-segregated assets
- Companies can no longer take advanced recognition of asset returns in their pension cost
- When setting the discount rate, consideration must be given to the duration of the Schemes liabilities
There is currently an exemption under FRS17 and IAS19 that allows Companies to account for their pension costs on a Defined Contribution basis, if they participate in a multi-employer Scheme with non-segregated assets (i.e. they cannot determine their asset share). This means only the contributions payable to the Scheme are recorded in the profit and loss account (P&L). No other costs are accounted for and there is no liability in the balance sheet.
Under FRS102, this exemption has been removed and Companies will now have to disclose a liability on their balance sheet. An allowance for the interest accruing on the liabilities over the year must also be included in the P&L account.
FRS102 gives two methods under which to account for pension costs going forward:
- Perform a valuation under either FRS17 or IAS19
The liability disclosed will be the deficit on this basis and a pension cost will be carried through to the P&L account to allow for further accrual of benefits and any interest accruing on the liabilities
- Record the present value of future deficit contributions
The liability disclosed will be the present value of all future deficit contributions. This is likely to be higher than under the first method as the deficit is valued on a more prudent basis which places a higher value on the liabilities. Interest accruing on the deficit over the year must also be recorded in the P&L account. Again, this charge is likely to be higher than under the first method as the deficit is likely to be higher in this case.
The resulting effect is that Companies will have an increase in their P&L charge and a significant deterioration in their balance sheet position which may have an effect on:
Advanced recognition of asset returns
- Banking covenants
- The cost of obtaining finance
FRS102 has brought FRS17 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 was to reduce the pension cost recorded in the P&L account.
Under FRS102 the expected return on assets assumption must be equal to the discount rate. The effect of this is to increase the pension cost recorded in the P&L and as a result, reduce the corresponding profit shown in the accounts.
Consideration must be given to the duration of the Schemes liabilities when setting the discount rate
Under FRS17 and IAS19, the discount rate is set with reference to high quality corporate bond yields (rated AA or equivalent). Yields are normally set with reference to the iboxx corporate bond index which has a duration of around 13 years.
Under FRS102, the discount rate now has to be set with reference to the duration of the Schemes liabilities. As the yield curve is currently upward sloping, this means that yields are higher at longer durations. If the duration of a Scheme liabilities is longer than 13 years, an upward adjustment will have to be made to the yield to account for this difference, which would result in a lower figure being placed on the Scheme liabilities. Similarly, if the duration of the Scheme liabilities is lower than 13 years, a corresponding reduction should be made to the yield which will place a higher value on liabilities.
These changes come into effect from 1 January 2015 although earlier adoption is permitted. By far the most significant change will affect those Companies currently accounting for their pension costs under the multi-employer exemption and advice should be sought as soon as possible to determine the effect this may have on the overall balance sheet position of the Company.
Click here to download the presentation from the Future Influencer event