The International Accounting Standards Board (IASB) has taken the first of its due-process steps toward the issue of a discussion paper on discounting practice, although it stressed the project was not about imposing a move to a fair-value or risk-free discounting approach under International Financial Reporting Standards (IFRS).
At a recent IASB meeting, project manager Aida Vatrenjak said: “The project is not about fair values – it is not really about historical cost, although it was hard not to mention because it was glaring at me.
“It really is about those measurements we use in IFRS described as ‘current value measurements’ but [which] are not a fair value.”
Among to the issues to emerge at the meeting, intended to take soundings from board members, were defining the discounting issue as opposed to a wider financial reporting issue; the challenge of applying an entity-specific measurement; the notion of a risk premium; and the relationship between taxation and discounting.
In relation to the first of the four issues, IASB member Patrick Finnegan said the confusion of consistency with uniformity was a key issue.
“Cashflow-based … and present-value measurement are similar, but they may not be identical,” he said. “That is different from the selection of a discount rate. There is always going to be differences in judgements … you’re never going to get uniformity.”
Of particular interest to defined benefit plan sponsors, IASB vice-chairman Ian Mackintosh pointed to the problems that can arise when the notion of an entity-specific measurement is applied in practice.
“I don’t assume the market value is a better indicator than the value in use,” he said.
Vatrenjak responded: “I am not arguing to say we should scrap entity-specific [discount rates] because I for one see value in using entity-specific values, [as] it allows companies the opportunity to actually show what is unique about them, what is specific.
“Let’s see if this really is a problem … [and] how that would be solved by simply tightening the description of this entity-specific measurement.”
Until now, the IASB’s research effort on discount rates has operated at a low level.
The board’s 2011 agenda consultation revealed moderate support among constituents for it to look into discounting under IFRS.
The project is limited in scope, and the board has allocated just one full-time staff member to it.
It is also possible that the board might issue its planned discussion paper on discounting and then make no changes.
The discounting project is not only looking at pensions accounting under IAS 19 but at all IFRSs that require discounting.
This includes IFRS 9, IAS 36 and IAS 37.
The research project remains, however, at an early stage.
Staff want to take soundings from the board on a draft discussion paper that looks at the measurement objective, components of present value measurement, measurement methodology, disclosures and terms and definitions.
According to the staff’s draft research paper, they have identified three main aspects of present value measurement methodology in IFRS: how risk adjustments are reflected, how tax is accounted for and how inflation is accounted for.
Developments on the research project will be of keen interest to DB plan sponsors looking increasingly at ever-more sophisticated approaches to discounting.
Whereas a decade ago a sponsor might have discounted an IAS 19 liability using a simple index rate, preparers are increasingly looking to blended discount rates to reflect the different nature and duration of the different components of their IAS 19 liability.
Under today’s accounting model, a DB sponsor must project its pension liability forward using the relevant plan assumptions and discount back using a AA-corporate bond discount rate to reach a net present value.
There will be a concern in some quarters that, balanced against the fact the IASB might do nothing on discount rates, it is also possible the board could propose a move to a risk-free rate.
This would bring with it the danger that sponsors would take a big hit to equity, which would, in turn, impact on lending if banks and rating agencies rely on the headline accounting numbers.