GLOBAL - Proposals for employers to account immediately for all estimated changes in the cost of providing defined benefit (DB) pension schemes have been cautiously welcomed by pension consultants.
The International Accounting Standards Board (IASB) last week sought to end the deferral of smoothing mechanisms found in IAS19 by publishing proposals to require employers to "recognise all changes in DB obligations and in the fair value of plan assets when those changes occur."
Under the proposed new accounting regime, the IASB would scrap not only the amortisation of DB actuarial gains and losses (the so-called IAS19 corridor method) but also the ‘other comprehensive income' (OCI) presentation option.
In place of the current accounting treatment, the IASB wants DB sponsors to divide changes in their DB obligations and the fair value of pension fund assets into: service cost; finance cost; re-measurement components. The sponsor would then present: service cost in profit or loss; finance cost (the net interest on the net DB liability or asset) as a component of finance costs in profit or loss; re-measurements in OCI.
The IASB are now consulting the industry on the proposals and a number of commentators have publicly criticised the proposals for their potential to increase the financial burden on DB sponsors. However, two leading pensions consultants who have reviewed the proposals have given them a qualified early welcome.
"As a headline reaction, I would see the move to a net interest income/expense approach as the dawn of a new era of conservatism in pensions accounting," said Tim Reay, principal at Hewitt Associates.
"However, I welcome the proposals because they remove some of the difficulty of accounting for intermediate risk plans, and they treat assets and liabilities consistently. And there is certainly little incentive now for DB plan sponsors to act irrationally when making investment decisions in a bid to bring down the pension expense."
Deborah Hewitt, partner and head of the retirement resource group at Mercer, said: "The approach is certainly, on the face of it, a lot purer, cleaner and more sensible in the sense that there is less of a connection between the trustees' investment decisions and the P&L [profit and loss] account.
"The level of risk chosen by the trustees doesn't now impact on the employers profit or loss under the proposals, which people might see as either a good or a bad thing. Currently, if trustees take more investment risk, the consequences of the risk don't emerge in terms of volatility on the P&L. On the other hand, if they choose to take less risk, the employer's costs will increase."
Cooper expects the proposals to "provide some clarity around DB risk", but she does warn there could be "unintended consequences."
Reay added: "Clearly, making the expected return on assets equal to the discount rate will have a major impact on a company's pension expense."
He also expects the exposure draft to go part of the way toward addressing the concerns of critics who claim IAS19's projected unit credit methodology fails to account satisfactorily for hybrid pension schemes, such as cash balance schemes.
"I think that underpinning this proposal, at least in part, has been their continued difficulty in working out what to do with cash balance plans," Reay told IPE.
Despite the changes affecting OCI, IASB has not yet published its "forthcoming exposure draft on the presentation of items of other comprehensive income".
In October 2009, IASB members cleared an amendment to paragraph 81 of IAS 1, Presentation of Financial Statements, which will remove the option for preparers to present a single statement of comprehensive income.
Ken Wild, a leading IFRS practitioner and current head of Deloitte's global IFRS practice, said: "This is the first of this year's exposure drafts to tie in with the board's plans for financial statement presentation, in particular the move to a single statement format. I expect this to be the start of what could prove to be an enormously political and emotional debate."
Constituents have until 6 September 2010 to send their views on the proposals to the board.