GLOBAL - Proposed changes to the international pension accounting standard could unwittingly lead to a divergence between European and US accounting practices, according to Lane Clark & Peacock (LCP).
Colin Haines, partner at LCP, said the changes proposed by the International Accounting Standards Board (IASB), which would effectively replace expected returns on assets with a net interest/income figure (See earlier IPE article: IASB amendments sensible, say pension consultants), would not only need to be carefully communicated to investors but might also widen the gap between IAS 19 and pension accounting under US GAAP rules.
Haines explained: "US GAAP has an expected return on assets component, and a lot of criticism about this accounting entry was directed at US companies whose expected return assumptions have often been higher than what we see in other countries. So we will have a situation where the IASB is proposing to move in one direction, while the US accounting setters [are] staying somewhere else."
The development would be completely counter to the ongoing drive for global accounting harmonisation. Haines added: "Both the IASB and the FASB want to converge standards, but if they are now moving apart where are you going to converge to?"
Haines pointed to two possible future scenarios: either Europe converges with the US, in which case the IASB proposals would have to be reversed and European employers would face further a second round of rules changes; the US would have to adopt changes similar to those proposed by IASB.
He said: "If we look at the 100 largest companies in the world, around 50% are in the US and 50% in the euro-zone or other countries that have adopted IFRS. If these changes are implemented, major multinationals will be calculating profit and loss in different ways so international comparability will be very difficult. This may cause a bit more confusion than might have been expected," said Haines.
James Atherton, partner at LCP, also highlighted the practical implications of moving to an accounting treatment that basically allows for expected return on assets at the same rate as the discount rate, which is a high quality corporate bond yield.
"What that does is remove one of the incentives for pension plans to invest in riskier assets like equities which are expected to give a higher return. Previously if you invested in something expected to give a higher return you could take credit for it in your profit and loss. From 2013 you may not be able to."
"So if we're in that environment where everyone is risk averse, and trying to manage pension risk down, you might as well invest your plan in bonds, which will give you a return pretty much in line with what you get in your accounts. That should take volatility out, so the changes to the accounting standard might be a driver for further de-risking by pension schemes," he added.
Atherton acknowledged the proposed move allow for clearer comparisons between pension funds but said, "whether it's a more accurate view of what's happening in each particular plan is perhaps open to debate".
Haines also noted the difference in accounting standards could affect merger and acquisitions, as it will be difficult to compare companies. This could lead to an increased focus on earnings measures and pension costs so that instead of EBITDA, it would become EBITDAP - earnings before interest, taxes, depreciation, and amortisation and pensions - to strip out the pension financing issue.
He said: "The bigger picture is you have different accounting standards around the world. International financial standards are now being used in many countries, with Brazil, Japan, Canada and India all in the process of adopting it. So it is becoming almost the US against the rest of world, so while the setters are really trying to work hard on convergence, there will be lots of differences until there is convergence, if there is."
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