UK - The Accounting Standards Board (ASB) has reiterated its view that pension fund accounting should use ‘risk free’ discount rates, as evidence suggests the UK AA corporate bond rate reduced the level of reported liabilities making schemes appear stronger than they were.

In a follow-up report - ‘The Financial Reporting of Pensions: Feedback and Re-deliberations” - the ASB reaffirmed most of the proposals it originally outlined in a discussion paper published in January 2008.

It admitted some of the recommendations “cover difficult issues and are controversial”, including the use of a risk free discount rate, but stated it had spent “considerable time” reviewing issues raised by respondents.

Many had criticised the idea of moving from an AA corporate bond rate to a ‘risk-free’ or government gilt rate on the basis it would increase liabilities. (See earlier IPE article: ASB changes will “fast-forward” demise of defined benefits)

But the ASB argued the UK AA corporate bond rate had been moving away from the underlying gilt rate reducing the level of reported liabilities and causing “the funding position of many pension plans to appear stronger than the underlying economic reality”.

The ASB also noted that because some countries do not have a “deep and liquid market” of high quality corporate bonds they use the market yields on government bonds. It said the “consequence of this was that UK entities that report in accordance with IAS 19 could potentially show a lower pension liability to a comparable entity - due in part to the spread on corporate bonds”.

It stated: “The ASB, in considering concerns arising from the use of the AA corporate bond rate in the UK at this time, affirmed its view that the discount rate should reflect the time value of money, and therefore should be a risk-free rate. In its view, the risk associated with the size and variability of the liability is more appropriately addressed through disclosure.”

The report, which aims to feed into work on the IAS19 standard by the IASB, also clarified how risk should be addressed in the use of cash flows to measure the liability to pay pensions.

However the ASB did backtrack on one proposal, namely that the actual return on the assets held to fund pension liabilities should be presented separately as financing income.

It noted that although “although this is a conceptually pure approach, it may not meet the needs of users. The ASB considers that further research is required in this area and alternative approaches should be evaluated before development of a new financial reporting standard”.

Ian Mackintosh, chairman of the ASB, said: “This report sets out the ASB’s views following re-deliberations and I believe provides the IASB with valuable material for consideration in its current short-term project and for the longer term fundamental review of the financial reporting of pensions.”

However the recommendations follow a decision by the IASB in October to scrap plans to widen the range of bonds that could be used for discount rate calculations. (See earlier IPE article: IASB cancels plan to alter IAS19 discount rate source)

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