FRC's asset-ceiling proposals for DB sponsors draw mixed reactions

The UK Financial Reporting Council (FRC) has issued proposals for public comment it hopes will clarify how defined benefit (DB) plan sponsors will account under UK and Irish Generally Accepted Accounting Principles (GAAP).

In a statement, Roger Marshall, FRC board member and chairman of the FRC’s accounting council, said: “The proposed amendments are intended to resolve uncertainty over the application of FRS 102 in a proportionate and practical manner before FRS 102 becomes mandatory.”

But expert practitioners who spoke to IPE.com about the move gave the proposals, referred to as FRED 55, a mixed reaction.

In particular, KPMG director Narayan Peralta warned that the move risked accounting arbitrage between FRS102 and International Financial Reporting Standards (IFRS).

However, speaking in support of FRED 55, Aon Hewitt accounting specialist Martin Lowes said: “This strikes me as a very sensible departure from IFRIC 14, and they have clearly taken a pragmatic approach within the spirit of simplifying GAAP for smaller companies.”

FRS102 is a simplified and localised version of the IFRS for SMEs.

It takes effect for accounting periods beginning on or after 1 January 2015 and replaces the majority of today’s UK Financial Reporting Standards and UITF Abstracts.

In effect, this means the majority of UK and Irish large and medium-sized entities – among them public benefit entities, retirement benefit plans and financial institutions – will apply the new standard.

The source of the dispute between the experts are proposals in FRED 55 that the FRC hopes will address concerns over whether or not an entity that applies FRS102 should have regard to the principles in IFRIC 14.

IFRIC 14 is a guidance document issued by the IASB in 2007.

It deals with the interaction between a minimum funding requirement and the restriction in paragraph 58 of IAS19 on the measurement of the DB asset or liability.

FRED 55 would kick in where an entity reports under FRS102 and has already booked a DB asset or liability on its balance sheet.

As the proposals stand, an entity in that position would need to recognise no further liability in respect of an agreement to pay future deficit contributions (in excess of the accounting deficit) under a schedule of contributions.

In addition, on a separate issue, FRED 55 confirms that entities should recognise the effect of restricting the recognition of surplus in a DB plan, where surplus is not recoverable, in other comprehensive income and not in profit and loss.

The FRC has issued a number of editorial amendments and clarifications to FRS102 since it released the new standard on 14 March 2013.

Entities that are not required to apply EU-endorsed IFRS, the FRS101 Reduced Disclosure Framework or the FRSSE must apply FRS102.

Explaining the impact of the FRED 55 approach against full IFRS, Martin Lowes told IPE: “The FRC has proposed a few extra words to bring about some clarity.”

The UK regulator, he said, has “clarified that if you have promised to pay future deficit contributions, you don’t need to look at whether you will build up a surplus in the future and then look at whether you can get benefit from that future surplus.”

Instead, he said, DB sponsors “just need to look at whatever the pension surplus or deficit is at the balance sheet date”.

But this clarification, Narayan Peralta argued, runs the risk of creating accounting arbitrage between FRS102 and IAS19R/FRS101.

“This is unfortunate, as, faced with the option between FRS101 and FRS102, there is now a ‘pensions arbitrage’ if an entity faces no other material differences between the standards,” he said.

Choosing FRS102, he explained, “could leave them with a significantly better balance sheet position”.

For IFRS reporters who recognise an additional liability under IAS19, Peralta went on, “there will be a GAAP difference to their statutory accounts”.

The FRC has previously said one of FRS102’s objectives is to “have consistency with international accounting standards through the application of an IFRS-based solution unless an alternative clearly better meets the overriding objective”.

Practice around the asset ceiling in pensions accounting has gained added urgency since May this year, when the IFRS Interpretations Committee (IFRS IC) began looking at the issue.

Specifically, the committee is mulling changes to IFRIC14 that could restrict the size of the balance-sheet asset a DB sponsor is able to recognise on its balance sheet asset. 

A constituent has asked the committee to consider whether preparers should take account of events that might disrupt the plan unfolding in line with the IAS19 assumptions when they apply IFRIC 14.

An example would be the trustees of a DB scheme whose future actions could reduce the ability of a sponsor to recognise an asset, even though they might have taken no steps to do so at the entity’s balance sheet date.

Neil Crombie, a senior consultant with Towers Watson, said: “We are surprised by the FRC’s decision to adopt the approach it has with FRED55 in that we would probably have expected an approach more consistent with the direction of travel on IFRIC 14.”

As for concerns about accounting arbitrage, he said although he agreed there was now potential for inconsistency between IFRS and FRS102, “any decision to go for UK GAAP over IFRS will come down to a lot more than just pensions”.

Interested parties have until 21 November to comment on the proposals.

If adopted, the amendments will be effective for accounting periods beginning on or after 1 January 2015.