Accounting matters: Limiting the scope

The IASB is looking at IAS 19. Will the project run into the sand?

Staff at the International Accounting Standards Board (IASB) are developing a narrow-scope research project to consider a range of pension promises that depend wholly or partly on asset returns. In terms of where the project is heading, the most likely output is a body of evidence to help the board decide whether or not to undertake a full standard-setting project in the area with a view to making a series of targeted amendments to International Accounting Standard 19, Employee Benefits (IAS 19).

In other words, there are no current plans to amend IAS 19. Moreover, if the sceptics are right, the effort will run into so many obstacles that the IASB will eventually concede defeat and abandon the project.

And the omens do not bode well. Over the past decade, the IASB has made numerous attempts to mount limited-scope projects to address this or that shortcoming under IAS 19. Typically, these amendments flounder because they are limited in scope and collapse under the sheer weight of their own contradictions. Equally, the IASB’s US counterpart, the Financial Accounting Standards Board, has failed in both of its recent bids to tackle cash-balance plan accounting. 

If anything, a discussion in December between IASB representatives and members of the board’s Accounting Standards Advisory Forum, suggests history might be about to repeat itself. But to dig deeper into the detail of the IASB’s current plans, the first point to note, as staff explain in paragraphs 4 to 8 of their meeting paper for the December gathering, is that the project scope is defined in terms of types of benefit, not types of plan.

This might well be a crucial distinction to bear in mind as the research project evolves. It also means that the board is not going to investigate specific types of benefit or plan such as higher-of guarantees or the myriad other features of hybrid plans.

As for the problem the staff are trying to address, they explain at paragraphs 9 to 12 of the paper how IAS 19 is currently applied in practice to pension benefits that depend on asset returns. Put simply, the collision of these pension promises with IAS 19 produces a measurement inconsistency as a result of projecting forward with an asset return and discounting back at a more conservative corporate bond yield. 

So what is the potential solution? Essentially, the staff have put a single approach on the table: they want to cap the rate of return on assets at the level of the discount rate. If that sounds simple enough, so too was their warning: “If our research establishes that the approach being explored would not be feasible then we expect to recommend that the board perform no further work on pensions.”

What has been the reaction from Europe? Andrew Watchman, who is both CEO of the European Financial Reporting Advisory Group – the body that advises the European Union on accountancy matters – and the chairman if its technical expert group, was broadly supportive of the approach.

He said: “First of all, we think that there is an issue with the asset return-based promises with projecting the benefit on an expected asset return and discounting them back at a different discount rate.

“So we do see that as a mismatch, and this seems to address the mismatch. In that sense it seems to have the potential to improve the reporting of these types of scheme. Some people think this isn’t enough in isolation to make it work.”

It is worth pointing out at this stage that EFRAG is also running a research project and hopes to publish a discussion paper imminently. In addition to the capped asset-return approach, that paper will also likely contain two other approaches. These are tentatively labelled ‘fair value’ and ‘fulfilment value’. And there are also a number of potentially important differences to note between the EFRAG research approach and the IASB’s project. 

“We think that there is an issue with the asset return-based promises” - Andrew Watchman 

First, according to the project page on the EFRAG website, the scope of the European research is potentially much wider in that it refers to ‘hybrid pension plans’. 

Second, the EFRAG effort looks beyond so-called measurement mismatches and goes on to examine pension promises where sponsors provide minimum-return guarantees. 

Third, EFRAG refers to situations where “the promised benefit is linked to the return on specified assets held”. This serves to differentiate promises where the return is linked to the performance of specific assets from promises where the return is linked, say, to some other performance indicator. 

Furthermore, there is still some confusion about the types of pension promise that could eventually be affected by the project, such as employer schemes in Belgium, which are basically defined contribution promises except for the sponsor’s liability for a minimum-return guarantee. Also, contributions to these schemes are typically invested in what is an employees’ fund.

Because the December meeting heard that, at least for some, there is a distinction between pension promises linked to the performance of a specified pool of assets and those where it is not. ASAF member Patrick de Cambourg said: “[Your approach] makes economic sense and accounting sense if you own all the assets and if your assets have a return of 5%. You know you obviously have a mismatch. But if you don’t have assets, what is the mismatch?”

He added that although he was pleased that the board had decided to tackle this issue, they had to be aware that the problems they would encounter were not “really as simple as the one you put in the [staff] paper” – because pension promises feature not only simple mismatches but caps and floors and even interactions between those individual components.  

In essence, Patrick de Cambourg’s argument is that it is easier to achieve a quick fix for those who carry not only the obligation but also the corresponding assets. Moreover, his question about the nature of the mismatch raises the issue of the risk that the entity is running when it promises, say, outperformance on a typical equity return. De Cambourg even briefly compared it to a situation where a scheme is invested in its sponsor’s stock. 

And yet comments from one board member during the meeting suggest that the idea of different types of mismatch are perhaps an issue that the IASB has yet to consider. Indeed, it was IASB member Mary Tokar who questioned whether the difference matters and, significantly, whether it is enough of a reason not to try to fix at least some of the problems in the market. 

She said: “I think it’s an interesting observation and analysis about where the risks are buried in a business, and in this case what risks in effect the employees [and] the pensioners are being asked to take, but it doesn’t fit into the situation that I think the staff is trying to scope.”

She also raised a worthwhile question about limited-scope projects: “If you see these other inconsistencies, does that make you say unless you can answer all of these you shouldn’t do a limited scope project?”

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