Spain has introduced new accounting rules. Guillermo Ezcurra explains how the new regulation is organised and identifies which parts are relevant to pensions accounting
At the beginning of 2008, Spain adopted new GAAP accounting rules for unlisted companies and consolidated groups. The changes made to the Plan General de Contabilidad (PGC) were part of a reform of corporate and accounting law.
With Spain being part of the European and global market, any domestic accounting idiosyncrasies hamper the development of corporate pension plans. The new regulation was inspired by, but has significant differences from, the IFRS, notably with regard to pensions accounting. However, local market actors were initially puzzled by the new PGC’s pensions accounting frame of reference.
To understand the situation one should bear in mind that previously the government had declared that book reserves were an unsuitable way of financing corporate pension commitments. Consequently, actuarial consultants spent considerable time and effort attempting to marry the proper application of IFRS/IAS 19 with the local prohibition of book reserves.
Generally speaking there were two views. Some accountancy consultants, auditors and pension consultants held that the book reserve prohibition implied that they could not be used in Spain under any set of accounting standards, not even IFRS/IAS 19. However, others understood that, while book reserves were forbidden under the compulsory minimum funding level, they were allowed in addition to the minimum funding level.
In the event, the no-book-reserves-under-any-circumstances approach was applied more frequently in local cases while the minimum funding with additional book reserves option was applied in purely international cases.
Listed groups are unaffected by the new regulations and should follow the IFRS, as adopted by the EU. But amazingly some corporate groups listed on the Spanish stock exchange did not apply IAS 19 properly, arguing that book reserves were forbidden in Spain.
The PGC clarified that book reserves should live together with the compulsory minimum funding level, also known as compulsory externalisation, and established a method of valuing and accounting pension commitments that is similar to IAS 19 but maintains differences that have a remarkable impact in the company accounts.
However, while several European countries have precise and comprehensive standards for pension accounting, the PGC sets regulations for all corporate accounting and the information on pensions is scattered throughout the document. So Article 16 of the second section of the PGC, on procedure of accounting and valuation of liabilities for long-term compensation and benefits, prescribes the accounting method to be used by employers for employee benefits. In its third section, on annual accounts, it sets out the disclosure requirements. Other sections establish additional accounting and disclosing guidelines.
Employee benefits include post-employment benefits such as pensions, post-employment medical care and additional retirement benefits and other long-term employee benefits if they are payable for longer than a year after retirement.
The standard distinguishes between DB and DC plans. For the PGC, DC plans are those under which an enterprise pays fixed contributions into a separate entity (a fund) and has no legal or constructive obligation to pay further contributions.
DB plans are defined as plans other than DC plans. They may be unfunded, wholly or partly funded by a company qualified pension plan (PPE), and/or by a group insurance policy (SC/Ext) that is legally separated from the reporting enterprise and from which the employee benefits are paid. The PGC explicitly establishes that with regard to DB plans the enterprise is, in substance, underwriting most of the risk associated with the plan. Consequently, the expense recognised for a DB plan is not necessarily the amount of the contribution due for the period.
The prescribed method for accounting DB plans implies the following steps:
Using actuarial techniques to make a reliable estimate of present value of obligations; Determining the fair value of any plan assets (materialised in a PPE and/or a SC/Ext); Determining the total actuarial gains and losses; and Determining the resulting past service cost where a plan has been introduced or changed.
When applying these steps the following should be taken into consideration:
The PGC does not specify which actuarial method should be applied to determine whether the past service cost corresponds to the current and prior periods, leaving it instead to the actuarial criteria. Nevertheless, there is a general consensus on the use of the projected unit credit method, which most professionals consider generates an accrual path that is pro rated on service that meets the generally accepted accrual principle; The assumptions used should be unbiased and mutually compatible but the new PGC does not make explicit the actuarial method to be applied for setting the assumptions, leaving the responsibility to the actuary. There is no general consensus on this.
This lack of a legal definition and a professional consensus on assumption-setting methods may result in a range of assumptions far wider than for other accounting standards. However, consensus exists in some areas, as with the expected return on plan assets, while professionals differ in others, as on the discount rate.
Some assert that a market-related discount rate should be used to actualise the expected future payments and the DB obligation. This supports the IAS 19 approach where the discount rate is determine by reference to market yields at the balance sheet date on high-quality corporate bonds. Others believe that the market-related approach should be corrected given the financial instrumentation of the plan via the PPE and/or the SC/Ext.
The PGC says fair value should be used to calculate asset values. No methods are specified for PPEs and SC/Exts but despite the complexity and variety of SC/Ext contracts in the Spanish market, there is a general consensus that valuing PPE
and SC/Ext assets should be linked to market value. In some contracts the market value is corrected if the insured amounts exactly match the amount and timing of some or all of the benefits payable under the plan; the fair value of these insurance policies is deemed to be the present value of the related insured amounts calculated using same methods and assumptions as for the defined benefit obligation.
The PGC defines actuarial gains and losses as the result of fluctuations with reference to the corresponding anticipated values, in either the present value of a DB obligation or the fair value of any related plan assets. In contrast to IAS 19, gains and losses corresponding with post-retirement DB plans should immediately be recognised on the balance sheet in full during the year in which they arise under the PGC, but outside the profit and loss account through a performance statement called a statement of changes in equity.
The new PGC approach matches IAS 19 with regard to past service cost, and defines past service cost as the change in the DB obligation resulting from a plan amendment or introduction that considers prior employee service. The past service should be recognised over the period until the benefits concerned are vested.
Given these points, the net liability or assets to be recognised in the company balance sheet should be determined as plus present value of the obligation minus fair value of plan assets plus or minus past service to be recognised in later periods equals net liability/(asset) recognised in the company balance sheet.
On first adopting the PGC, a company should determine its net liability for DB plans and if the net liability is different from the existing liability on the company balance sheet the company should recognise the difference immediately through equity/hedge reserves.
The net periodic pension cost to be recognised in the profit and loss account will be calculated as plus service cost component plus interest cost component minus return on plan assets plus or minus past service cost component equals net periodic pension cost to be recognised in the P&L account.
When calculating the P&L charge for other long-term DB plans, the eventual actuarial gains and losses charge should be added to the net periodic pension cost. Each component of the net periodic pension cost should be shown in the company accounts. In addition, a reconciliation of assets and liabilities as well as detailed information about assets and its market value, commitments, assumptions and actuarial approach should be included.
Guillermo Ezcurra is a partner at the independent consultancy Aserplan and is responsible for the employee benefits business at the March UNIPSA subsidiary of Banca March group