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All change… again

Stephen Bouvier reviews changes to the IAS19 employee benefits standard

Mercer senior partner John Hall was clear about the task facing defined benefit (DB) plan sponsors as they implement the International Accounting Standards Board's (IASB) recent amendments to IAS19, employee benefits.

Companies who sponsor DB plans, he said "need to make sure that not only are the changes incorporated and understood, and communicated, but also have a compelling story to tell about how they are managing risk associated with these plans.

"These changes," he added, "will impact the profit and loss accounts, balance sheets, balance sheet recognition and disclosure required of DB sponsors. The changes have been designed to bring more transparency and consistency to the way that companies account for pension liabilities. However, they will also raise the question of pension risk under increased review by shareholders and analysts and auditors."

And to underline the point, Isabel Coles, a principal with Mercer, added: "Because the changes affect all areas of the accounts, the possible consequences could affect a wide range of company practices. They could affect how a company chooses to structure its finance, and it could affect the pay given to individual senior executives."

On the separate question of ‘will it affect me?', Mercer believes it all depends on what you are exposed to. But the rule of thumb appears to be that the greater a sponsor's past use of deferral mechanisms, the greater the hit on shareholder equity and profit or loss.

Indeed, Coles added that "those of you who are already on an immediate recognition approach will perhaps have the simplest position. Because you are already recognising actuarial gains and losses immediately, there is no big effect on your balance sheet.

"However, you could still see an effect on the profit or loss account by virtue of the change to the net interest cost," she continued. "If your expected return on asset assumption for one of your funded plans is greater than your discount rate, then your P&L position is likely to worsen. Conversely, if the expected return on assets is less than the discount rate, then you'd expect to have a better P&L position."

As for the downside for those who previously relied on delayed recognition and smoothing, Coles warned: "For those taking a deferred recognition approach, the position is perhaps less certain. Much of the impact will depend on whether an entity has unrecognised losses or unrecognised gains."

Regarding the balance sheet, Coles explained: "In either case the balance sheet is going to become more volatile with the removal of the unrecognised gains and losses and the P&L effect can be uncertain, depending on how the net interest cost is going to interact with the removal of the amortisation of your unrecognised gains and losses.

"So, really, what this means is that there is no one-size-fits-all that allows us to tell you how your group accounts will be affected, without actually going into a little bit of the detail to find out what DB plans you have and the situations of them." In short, it all depends how the three net-interest components combine in the profit and loss account.

And it is striking that although the changes to the balance sheet entries are less dramatic than those on the income statement, they could have a major impact on shareholders' equity. This is because, on the switch to the new accounting, once a line has been drawn under today's accounting for the net liability or asset, any difference that results from the ending of deferred recognition accounting is taken as an adjustment to shareholder equity.

The impact, Coles said, could extend beyond pensions accounting: "This is definitely something that you will want to take a look at in advance of adopting the revised IAS19 standard to make sure that you are aware of effects like this, that can move into other areas of your accounts, and [which] can also affect some of your other accounting ratios." The updates are aimed at teasing out the consequences of five key areas on a sponsoring company:
• Nature of the plan liabilities;
• Size of the plan liabilities;
• Extent of any funding of those liabilities;
• Investment of any plan assets;
• How the sponsoring entity controls those five factors.

Mercer partner Deborah Cooper explained: "IAS19 requires quite a lot of new disclosure, and it changes the existing requirements. But helpfully it clearly articulates the purpose of the disclosures." Indeed, amended IAS19 now features three principles to guide disclosures:
• Explain the characteristics of their plans and the risks they pose;
• Identify and explain how the amounts in the financial statements arising from the DB plans have emerged;
• Describe how each DB plan might affect the amount, timing, and uncertainty of the reporting entity's future cash flows.

One piece of advice from Mercer ought to arouse curiosity: revisit your key assumptions. And the most intriguing possibility here arises out of the interplay between the net interest approach and the IAS19 discount rate.

Aon Hewitt principal Simon Robinson says: "This is an interesting point because playing around with the discount rate would generally have little effect on your profit or loss charge. As plans are getting bigger and more mature the drivers of P&L charge have been interest cost and expected return on assets.

"Interest cost is quite insensitive to discount rate - compare, say, a 5% discount on a DBO of 1000 (producing an interest cost of 50) with a 5.5% discount rate. Using a 5.5% discount rate, your DBO would fall to something like 875, and 5.5% of 875 is about 48. The expected return on assets would be unchanged."

And so, he explains, if you set aside the sensitivity disclosures: "With the amendments to IAS19, the net finance item is more sensitive to discount rate. If the plan had assets of 800, using a 5% discount rate would give a net finance charge of 10; using a 5.5% discount rate would give a net finance charge of four - three times the impact compared with the current IAS19."

Robinson also agrees that, first, the discount rate might well fall "under even greater scrutiny from auditors", second, that "the range of discount rates that is available to an entity is much narrower than the acceptable range of expected assets returns ever was".

And that ought to be the end of it. But, largely as a result of the IASB's failure to measure intermediate-risk plans, at its May and July meetings the IFRS Interpretations Committee embarked on a journey that could end with it reissuing a draft interpretation IFRIC D9. Theoretically, the IASB could have to make further amendments to IAS19.
 

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