IAS19 under scrutiny
Since its implementation in January 2005, international accounting standards rule IAS19 - which was developed to disclose actuarial gains and losses in the main income statement of pension funds and increase comparability between pension funds of different countries - has constantly been evolving and faced plenty of criticism.
Now IAS19 is undergoing a comprehensive review, which the International Accounting Standards Board (IASB) decided upon in July of this year after a number of constituents brought issues to the board for consideration. The review is looking at the fundamental principles and is divided into two phases. Phase one is expected to be completed in 2010, while phase two is set to end in 2014.
The review focuses on immediate recognition, the definition of defined contribution (DC) and defined benefit (DB) schemes, disclosure as well as settlements and curtailments.
Immediate recognition will look at how experience of a pension scheme, such as asset performance, the changes of life expectancy and discount rates, is recognised in the company's accounts.
In IAS19's original approach, it allowed a delay in the company account's recognition and could be spread effectively over a number of years. But now there is a steady move towards immediate recognition following the implementation of immediate recognition in the US OACI (other accumulated comprehensive income) framework and the UK's equivalent law, Financial Reporting Standard 17 (FRS17), while IAS19 allows it as an option.
The definition of DB and DC schemes will come under scrutiny as IAS19 struggles to cope with schemes that are a mixture of both.
IAS19's review will also look at disclosure and what is presented in reports and accounts, and at settlements and curtailments, in other words, the treatment if a large number leave a plan, or it closes.
The discount rate is another widely debated topic. Some people are for risk-free discount rates instead of AA corporate bonds, and some are in favour of an asset-reflecting discount rate, while others prefer a discount rate which reflects the credit worthiness of the company concerned. Another issue is the right obligation to measure and whether to base pension accounting on a projected future salary or the benefit of today.
WatsonWyatt's senior international consultant Eric Steedman thinks all these issues are tied together and sees the review as the result of ongoing debates on both sides of the Atlantic striving to align IAS19 with US standards.
He says: "Fundamentally what it comes down to is whether you are trying to smooth the cost of pensions out over the whole career or whether you are looking at the hypothetical market value of the break-up liabilities," he says.
"The move to today's pension accounting standards has significantly increased awareness of the pension obligations, their disclosure etc. IAS19 has been one of the contributory factors that causes companies in all countries to look closely at a pension scheme and review their provision and risk, but it also makes them think about the recruitment and retaining of people."
"The review would only indirectly impact on pension funds because it primarily affects their sponsoring companies and the company's accounts. The refinements of IAS19 will have a much smaller impact than the original introduction of FRS17 and IAS19."
But Steedman adds: "One disincentive, probably a fairly small disincentive, to developing a cash-balance design in Europe at the moment is that it's not really clear how to account for it under IAS19."
Pension funds in all countries have been affected by IAS19, but some were more affected than others.
In Belgium, the definition of DB and DC is an issue as Belgian pension funds with DC have a guaranteed rate of return, which makes them a DB scheme under IAS19. The widely welcomed review could clarify this and harmonise various international pension systems with IAS19.
In the Netherlands, around 80% of employees are part of industry-wide pension funds, compared to only 20% who are part of company pension funds and insurance companies, which means that DC-classified schemes prevail. Companies, mainly smaller ones, that are not listed on the stock exchange, but are part of industry-wide pensions funds, are accounted for as DC. For non-listed companies the Dutch regulation RJ271 applies, while listed companies have to use IAS19.
But problems arise when listed companies are part of an industry-wide pension fund. Accountants and employers are currently discussing whether these should be accounted for as DB or DC, while in the meantime they continue to be classified as DC. Since the implementation of IAS19 in 2005, the country has seen a shift from DB to collective DC (CDC), a system in which assets and liabilities are not activated on the company's balance sheet.
CDC makes it possible to provide employees with a conditional DB scheme, as a rule for a five-year period, while premiums are fixed for the employer.
Gerhard Heeres, chairman for pension and accounting at Dutch employers' federation VNO-NCW, says that once the principle that allows companies to spread profit and loss over a number of years is no longer applicable, companies will have to show the pension fund's full volatility in their balance sheet.
He thinks that this enhanced volatility may put off companies from having a DB-classified pension scheme due to the high risk, in particular those with an ageing pension fund where the fund's participants outweigh the number of the company's employees. He blames IAS19 and probably this volatility for the move from DB to a - from an employer's point of view - less risky CDC.
Heeres says: "A CDC scheme is the best alternative for the unwanted, individual DC schemes. I am glad that IAS19 is now being reviewed to make it more practical, back to basics. Unfortunately, a lot of harm has already been done to the Dutch pension system."
The Dutch association of industry-wide pension funds VB agreed the review was urgently required because IAS19 does not fit the Dutch pension scheme in which employers, employees and pensioners share the future risks together, and the pension funds board decides about the financial management of the scheme, while the economic benefit was not exclusively owned by the employer as assumed by IAS19.
The UK Investment Management Association (IMA) would like the IAS19 review to be brought forward. IMA's head of communications Mona Patel said: "Currently ISA19 has a mismatch between what funds are invested in and how their liabilities are measured, for example, if funds are invested in equities, or liabilities are measured depending on bonds. We believe there are issues in relation to recognising and measuring pension schemes' assets and liabilities. And we would like the review to take place sooner rather than later." She added: "But we are pro-transparency and happy that FRS17 is being expanded so that disclosures will be made in relation to DB schemes."
The UK's Accounting Standards Board (ASB) is to amend the FRS17 retirement benefits accounting standard to align it with the international IAS19 standard. The amendment will be published this month and will be effective for accounting periods ending on or after 6 April 2007, although the ASB encourages early adoption.
The actual disclosure requirements for pensions in FRS17 will be replaced with those in IAS19. On top of that there will be some additional, non-mandatory best practice disclosures, which would complement the original disclosures and give fuller information such as mortality assumptions, a better sensitivity analysis and disclosures about the relationship between trustees and the company of the DB scheme.
According to the Society of Actuaries in Ireland, the FRS17 disclosure requirement of showing the buy-out cost for pension liabilities is difficult to apply in Ireland, as the country, unlike the UK, has neither developed a buy-out market nor a debt-on-employer requirement.
In general the Irish approach to adopting IAS19 is similar to the application of FRS17 because the majority of listed Irish companies - most of their non-listed counterparts continue to account for under FRS17 but have the option to apply IAS19 - apply the SoRIE (Statement of Recognised Income and Expense outside the profit and loss account) approach to recognise gains and losses under IAS19, which is similar to the accounting treatment for pension schemes under FRS17.
The final statement on the ASB proposals is expected at the end of 2006.