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Changes in accounting for defined benefit pension schemes Back  
The ABS has issued a new accounting standard covering retirement benefits. For companies operating defined benefit pension plans, FRS 17 is expected to make a material difference to reported profits as well as require much more onerous disclosures than its predecessor, SSAP 24.
FRS 17 covers all post retirement benefits but the requirements for defined benefit pension schemes are the most significant part of the standard. SSAP 24, which FRS 17 replaces, had fallen into disrepute as it was a P&L approach which produced meaningless balance sheet figures and also because it was too dependent on the assumptions of actuaries. The measurement provisions of the new standard are mandatory for years ending from June 2003 but extensive new disclosures are required for years ending from June 2001.

Impact on balance sheet
FRS 17, unlike SSAP 24, adopts a balance sheet approach. It requires that the assets held by the pension scheme are valued at market value. The scheme’s liabilities must be calculated using the projected unit method and discounted using a current AA corporate bond rate. The net of the pension scheme assets and liabilities is then shown, net of any deferred tax, as a separate balance sheet heading immediately after other net assets. A pension asset is however only recognised, to the extent the company can recover it through reduced contributions or refunds. A net pension liability is similarly only recognised to the extent the company has an obligation to fund it but, in practice, this will nearly always be the case.

Impact on profit and loss account
Operating profit will include:
• Current service costs - one year’s accrued pension benefit; as calculated by the actuary, irrespective of the funding position.
• Past service costs - the capital cost of any benefit improvements. This will mean an immediate hit to profits in respect of any benefit improvements.
• Settlement or curtailment gains and losses. These would occur, for example, when members take early retirement or when there is a bulk transfer out of the scheme.
The following items will be netted and shown in a separate category adjacent to interest:
• Interest costs - the unwinding of the discount on the pension scheme liabilities.
• Expected return on assets. This is based on the long-term expectations at the beginning of the period.

Impact on STRGL
The impact on the statement of total recognised gains and losses (STRGL) will show the differences between the actual and expected returns on pension assets and the actuarial gains and losses on the scheme’s liabilities. These actuarial gains and losses could have three components, all of which would require separate disclosure:

• Experience gains and losses - such as difference between actual deaths and mortality assumptions.
• The effect of changes in financial assumptions - for example, changes in rate of salary increases and inflation rates, and the effect of any change in the discount rate.
• The effect of changes in the demographic assumptions - such as changes in retirement ages and changes in mortality tables.

International harmonisation
FRS 17 is a step towards international harmonisation but there are still differences between FRS 17 and international practice. The main difference is that both IAS and US GAAP introduce an element of ‘smoothing’ through the so-called ‘corridor’. Under this approach the gains and losses that fall outside a plus or minus 19 per cent corridor may be deferred and recognised over the average remaining service period of the employees. The technical merit of this corridor is questionable. Its primary function seems to be to protect the income statement from too much volatility.

The EU is proposing that all EU listed companies should prepare their consolidated accounts under IAS by 2005. It may be that before June 2003, when FRS 17 becomes mandatory in all respects, IAS is amended to harmonise with FRS 17. If it is not, there may be another change in Irish and UK pension accounting to bring us in line with international practice. Companies which adopt FRS 17 early may then find that they have to change their accounting policy again in the next few years.

Transitional provisions
For years ending before June 2003, companies may choose to continue under SSAP 24. Companies which elect to do this must make disclosures (additional to those required by SSAP 24) as follows:

For years ending from June 2001:
• Scheme assets, liabilities, and resultant surplus/deficit (no comparatives)
• Reconciliation to ‘pension balance’
• Analysis of P&L reserve
• Financial assumptions (inflation rate, rate of salary increase, rate of pension increase, discount rate)

For years ending from June 2002:
• All of the above with comparatives
• Current P&L amounts (current service costs, past service costs, settlements/curtailments, interest cost, expected return on assets)
• Current STRGL amounts as expressed as a percentage of scheme assets or liabilities, as appropriate

These last two points will form part of a 5 year record of the STRGL to be built up as time elapses.

Although FRS 17 will mean more volatility in both the P&L and the STRGL, most of the volatility will be caused by changes in market values and assumptions, and will be included in the STRGL. We can also expect there to be large variations in the balance sheet figures.

Companies need to consider whether any banking covenants need to be renegotiated. The decision on whether to adopt early may well depend on such consideration as well as companies’ views on the fairness of the presentation of their pension figures under the existing standard.

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