A look over the horizon
One IAS19 issue that blew up at the end of last year was the potential scope within the standard to discount a defined benefit obligation using a one-year forward rate rather than the AA corporate-bond rate. The expectation of Towers Watson’s Eric Steedman and Aon Hewitt’s Simon Robinson is that either the International Accounting Standards Board (IASB) or its interpretations committee will, at the very least, deliberate this issue.
“This strikes me as the sort of issue that the board could fully address only as part of a full-blown project. It throws up a lot of issues about what is in the discount rate – time-value of money, illiquidity premium, credit risk – and so my gut feeling is that looking at this would inevitably lead to bigger questions,” says Steedman
And Simon Robinson adds: “I think the issue will be raised with the IASB by someone. If the IASB does discuss it, either they will say it is obvious or they might approve the treatment. This would open up a can of worms, including divergence from current US practice.”
But talking of the US, what might be on the cards stateside in 2014? According to one of the country’s leading pensions consultants, Diana Scott, there is “a high probability that the Financial Accounting Standards Board (FASB) will add a project on pensions; the key question is just how far reaching it will be.”
Those in the know will recognise the Towers Watson expert as a former member of the IASB’s pensions working group. Speaking with IPE, Scott singled out the delayed recognition of actuarial gains and losses, discount rate assumptions, and cash-balance plans, as possible targets for action by the FASB, the US standard-setter.
She explains: “A number of issues have been raised in the US. So far the FASB has explored these issues in education sessions in an effort to assess how critical the issues are. I think the biggest area of concern for users is delayed recognition of gains and losses in P&L. This covers a number of concerns – perhaps the greatest is the relevance of recognising gains and losses in the current year’s operating income, even though they may have arisen years ago.
“There is also the question of the relevance of the expected return on plan assets, which harkens back to the worries that the IASB had in this area. Is this wishful thinking, and why is it more relevant than reporting what has actually happened?
“Additionally, US GAAP currently allows entities to use a smoothed asset value to come up with the market-related value of assets. This can be either fair value or a value that is smoothed over a period of more than five years. That market-related value is used for two things, one of which is to determine the expected return on plan assets component of costs, and the other is to determine the corridor for gain or loss recognition. “
Broadly endorsing this take on the US outlook, Eric Keener, a partner and chief actuary with Aon Hewitt in the US, explains: “Some of the key issues under a potential project are focused on the timing of the recognition of certain elements of pension cost. Irrespective of whether asset returns are more favourable or less favourable than expected, the current model allows a company to recognise those asset gains or losses on a delayed basis.
“Furthermore, in recent times, a number of companies have moved to mark-to-market accounting and this can produce quite violent swings in earnings. Recently these have been quite favourable, but in prior years they were moving in the opposite direction. This in turn brings about a lack of comparability among company financial statements, which has become a concern for analysts.”
Scott expects the FASB to take action. “I would be shocked if the board does not address that issue,” she says. “The question is, do they go for immediate recognition in P&L or opt for OCI with no recycling through profit or loss in the future, consistent with IAS19. I think some of the board members have some conceptual concerns about the IASB approach because they believe all gains and losses should go through profit or loss.”
Another concern singled out by Scott is the presentation of a net pension cost. Unlike IAS19, where each item of cost can be a separate line item, under US GAAP it is simply reported as net periodic cost. “I think we may see the FASB considering something similar – allowing the disaggregation of the cost components and reporting them where they are most relevant. In my view, these are pretty easy fixes for the FASB to make,” she says.
Back on the theme of IFRS-US GAAP convergence, Eric Keener notes that any action by the FASB on pensions accounting will be a litmus test on the willingness of standard-setters to match each other’s actions. “In its recent work on IAS19, the IASB addressed the point that companies were permitted to use an expected return on plan assets.
“This meant that a company with aggressive investment assumptions could benefit from that expected equity outperformance in its profit or loss account, while a more conservative competitor with a less aggressive assumption would report a higher expense for a comparable plan.
“One option open to the FASB is to follow the IASB and scrap the use of an expected return on plan assets. This raises the question of convergence between IFRS and US GAAP. In recent years the two boards have leapfrogged each other – the FASB brought in its changes to the balance sheet with FAS158, and the IASB followed suit with its 2011 revisions to IAS19, leaving the two boards largely converged on the balance sheet.
“But in recent years we have seen a slow-down in the convergence effort, after a number of years during which pensions accounting has been one of the areas of focus for the two boards. So for that reason alone it will be interesting to see just how much importance the FASB attaches to convergence as it plots its next steps on pensions accounting.”
And a further area for action is the discount rate. “The big difference between US GAAP and IFRS is that there is no notion of using a government bond rate in the absence of a deep market,” explains Scott. “There has been pressure on the FASB to ease up on the discount rate. I think the message has been that they have no intention of doing that. I hope that will be more clear once they have agreed where they go with the project.”
And as the IASB learned to its cost with the 2008 discussion paper on contribution-based promises, Diana Scott believes that any action by the FASB on cash balance plans could prove challenging. “Some board members have some concerns about accounting for cash-balance plans and believe the balance sheet represents the walk-away value. It is not quite that simple, however, and so it will be interesting to see where they go,” Scott says.