Not quite a revolution
The introduction of a new accounting framework in the UK and Ireland could lead to much less upheaval in pensions accounting than some plan sponsors fear, discovers Stephen Bouvier
The move to a new financial reporting regime in the UK on 1 January 2015 will affect all areas of accounting by defined benefit plan sponsors. But challenging though the shift might be, the change is less one of revolution than evolution.
“Most of the evolution was from SSAP24 to FRS17,” argues Andrew Mandley, a consultant actuary with Towers Watson. “That was the key change. It became much more obvious whether there was a surplus or deficit. This latest move is not fundamentally changing the asset or liability that you show. Instead you are basically doing what IAS19 did. You are losing the ability to invest in equities and book that as a gain on your P&L.”
The new UK GAAP requirements start with FRS100, Application of Financial Reporting Requirements. This document details the accounting framework for entities in the UK and the Republic of Ireland. It serves as a pointer to relevant accounting literature: EU-endorsed International Financial Reporting Standards (IFRS), FRS101, FRS102, or the Financial Reporting Standard for Smaller Entities (FRSSE).
• Incorporates guidance on the application of statements of recommended practice, SORPs
• Makes consequential amendments to the FRSSE flowing from the introduction of FRSs100-103;
• Lists the accounting literature rendered redundant by the FRS100 regime;
• Addresses transition to the new accounting framework.
If you put both full IFRS and FRSSE to one side, you are left with an accounting landscape where a UK entity will apply either FRS101 or FRS102. The latter is essentially an abbreviated, localised version of the IFRS for small- and medium-sized enterprises (SME). This means that the change in the UK reporting landscape largely affects non-listed entities.
Evolution in UK GAAP
Before SSAP24, Accounting for Pension Costs, was introduced in 1988, pensions costs were accounted for in the UK on a cash basis. In other words, the SSAP24 required pension plan sponsors to recognise the underlying cost of accruing pension promises.
FRS17, Retirement Benefits, superseded SSAP24 in stages between June 2001 and June 2003. In the view of many, the leap from SSAP24 to FRS17, a localised UK version of IAS19, was far more significant than the move to the Employee Benefits section of FRS102.
But not everyone views this process of slow evolution as progress.
Tim Bush, head of governance and corporate analysis at Pensions & Investment Research Consultants, says: “SSAP24 correctly addressed the likely cash flow to the company due to the pension scheme. IFRS instead produces a point in time value that is neither here nor there in terms of cash flow, and in most cases demonstrably wrong.”
Historically, no UK entity has ever applied the IFRS for SMEs. But in common with the IASB’s thinking with its SME standard, the FRC hopes that FRS102 will reduce the accounting and compliance burden on entities with less complex accounting requirements.
The FRS102 pensions accounting regime is detailed in section 28 of the standard. An entity that opts to apply FRS102 will apply not only the pensions section in isolation but all of its accompanying sections. Regardless of the accounting framework that companies use, they will be faced with very similar types of accounting for pensions: calculate the defined benefit obligation (DBO) using actuarial assumptions and then deduct assets to provide a net asset or liability.
“In that regard there is not a huge amount to choose between the two, and the choice depends on factors outside of pensions,” says Mandley. “It might also turn on where their parent company is based. So if the parent reports under IFRS, it could make more sense to use IFRS; however, if they report under US GAAP, using FRS102 could turn out to be the more sensible choice.”
The main difference between IFRS and FRS102 is disclosures. Whereas the disclosure requirements that IASB added to IAS19 in 2011 are much more entity-specific around, say, risks and the disaggregation of plan assets, FRS102 simply lists disclosure items.
Mandley believes that the transition from FRS17 to FRS102, or even to IFRS, will be largely uneventful. “For most companies and schemes, the differences will be fairly minor in pension terms. The key thing is for preparers to understand that FRS17 is going and that they will be accounting under a different standard. The expected return will also be scrapped, and the net effect is a change to the numbers that will go through the P&L.
At a glance
• New UK accounting rules applicable from 2015 will be less burdensome than the move to FRS17 for DB pension sponsors.
• FRS102 is intended reduce the accounting and compliance burden on less complex entities.
• Problems could arise with the FRC’s FRED 55 amendments, which remove the requirement to show a liability for a minimum funding requirement.
“Preparers must restate accounts back to the start of the previous year. So, for an entity applying FRS102 from 1 January 2015, you have to go back to the beginning of 2014 and restate your balance sheet and P&L account using the new standard.” Equally, the move from FRS17 to FRS102 is less burdensome in terms of disclosures than the move from FRS17 to IAS19.
One issue that could cause at least a minority of preparers to scratch their heads is the so-called FRED 55 problem. In August, the FRC released FRED 55, Amendments to Financial Reporting Standard 102 – Pension Obligations. In short, the document removes the requirement to show a liability for a minimum funding requirement.
Clive Fortes, a consultant actuary with Hymans Robertson, says: “FRED 55 is essentially saying that if you are accounting for a DB obligation, you don’t need to recognise an additional liability if you have agreed a schedule of contributions that calls for higher contributions. The move is intended to allay the fear that IFRIC14 would introduce considerable additional liabilities into company accounts.
“Although this makes UK GAAP less onerous,” explains Mandley, “it has the consequence that a deficit might not be apparent in the accounts.” Of course, consolidated accounts prepared under IFRS will continue to show a liability for an onerous funding requirement where there is no prospect of getting those contributions back.
Mandley adds: “Before FRED 55 came out, you would have to be very brave to say you would get a more favourable balance sheet under FRS102. It was unclear whether the full weight of IFRIC14 would apply.” It appears unlikely, however, that UK GAAP will force entities to show a balance-sheet liability purely for agreeing to a schedule of contributions to eliminate a technical pensions deficit. That is unless, of course, there is a concern that the sponsor will have no unconditional right to a refund at some point in the future. Even so, not every adviser has welcomed the FRC’s clarification in FRED 55.
Robinson says: “The wording in FRED 55 is explicit that additional funding liabilities need not be recognised, so it is clear that the equivalent part of IFRIC14 is not to be applied. However, FRED 55 is silent on the treatment of a surplus.
“My concerns around FRED 55 are twofold. First, it creates a difference between UK GAAP and IFRS, and, secondly, it is all well and good to tell preparers, effectively, to ignore IFRIC 14 in relation to liability recognition, but it fails to deal clearly with surplus recognition.”