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Pensions reporting - moving towards full recognition Back  
With standard-setters moving towards converging on a full recognition basis there are still multiple underlying issues with regard to measurement and disclosure of pension obligations. Brendan Sheridan weighs up the debate which standard setters globally are heavily engaged in.
After a five-year period from when the pensions financial reporting standard, FRS 17, was first issued in November 2000 - the longest fruition period of any standard in history – we have at last seen companies implement the full accounting recognition requirements of the standard with companies which defined benefit pension schemes recognising the full amount of the net pension scheme asset or liability on balance sheet with actuarial gains and losses also being fully recognised.

Many will therefore wonder why the debate is still open on accounting and disclosure requirements for pensions and other retirement benefits. Open it is, with major standard-setters throughout the world actively looking at various issues.

Many will recall the debate that took place at the time of issue of FRS 17 some years ago. Much of this was perhaps a reaction to having to recognise for the first time a liability, or in a few cases, an asset on the balance sheet. In many cases companies were recognising a liability which was very significant relative to their overall financial position and which was increasing alarmingly due to certain factors including adverse movements in investment markets and reducing interest rates which impacted on discounting pension obligations to their present value. There were other genuinely held concerns regarding whether sufficient information was disclosed to allow users of financial statements to obtain a clear view of the risks and rewards arising from defined benefit pension schemes.

In addition, there was disparity between accounting standards in different regions and globally. Most notably, the standard in UK and Ireland required full recognition of actuarial gains and losses. This differed from the U.S. standard and the international standard which permit partial recognition. Interestingly, the international standard was changed a couple of years ago to provide an option of either partial recognition or full recognition while the U.S. has recently issued a draft standard proposing to eliminate partial recognition, the so-called ‘corridor approach’, and require full recognition for all companies.

The general trend would seem to be that standard-setters are moving towards converging on a full recognition basis. However, there are multiple underlying issues with regard to measurement and disclosure.

Globally, standard setters consider that there are broad issues which need to be addressed. Some of these
issues include:-
• How is the relationship between the employer and a pension scheme best reflected in the financial statements?
• How should the employer’s liability in respect of pensions be quantified?
• What is the expected return on assets, and how (if at all) it should be reflected in the financial statements?
• Are the disclosures required by current standards appropriate?
• Whether more or different guidance should be provided regarding measurement assumptions?

The debate is likely to continue for some time particularly given the overall objective to global convergence of standards and the consequent need to reconcile different approaches currently being adopted by different standard-setters.

The disclosure question is the issue of most immediate consequence to the majority of our companies who are still applying the financial reporting standards issued by the Accounting Standards Board (ASB). The ASB recently issued an exposure draft proposing amendment of the current standard, FRS 17: ‘Retirement Benefits’. At the same time, the ASB issued a draft reporting statement ‘Retirement Benefits – Disclosures’.

The ASB proposes that the amendments to FRS 17 will become effective for financial reporting periods ending on or after 31 December 2006.

The proposed amendment of FRS 17 has the objective of converging its disclosure requirements with those of IAS 19 ‘employee benefits’. This will lead to certain additional disclosures but will also mean that certain disclosures will no longer be required. Additional disclosures would include, inter alia, the following:-
• Broader information to enable evaluation of the nature of the entity’s participation in defined benefit schemes and the financial effects of changes in those schemes;
• Additional disclosures regarding underlying assumptions; and
• An analysis of the opening and closing scheme liabilities and scheme assets showing separately the movements on scheme assets and scheme liabilities.
Disclosures that would no longer be required include:
• The date of the most recent full actuarial valuation and if the actuary is an officer or employee of the company;
• The financial assumptions at the beginning of the period;
• An analysis of reserves showing the impact of the defined benefit asset or liability.

Changes are also proposed with regard to the information to be disclosed in the historical five-year summary.

The need for improved information
The reporting statement is drafted on the basis of it being a formulation of best practice and is intended to have persuasive rather than mandatory force. The additional information which it recommends entities with defined benefit schemes should provide aims to address the need for a more comprehensive understanding of the financial position and underlying risks of the scheme.

The proposals set out in the draft reporting statement recommend complementary disclosures in the following areas:

• The relationship between the entity and the trustees of the scheme, including any constraints placed on the entity through powers delegated to trustees.

Powers held by the trustees to make calls for additional contributions to the scheme may be of particular significance in a takeover situation.

• Information about the principal assumptions to assist an understanding of the inherent uncertainties affecting the measurement of scheme liabilities.
With average life expectancy growing, the mortality rates being applied are of increasing significance.

• Sensitivity analysis for each of the principal assumptions used to measure scheme liabilities.

The obligations of the scheme are sensitive to changes in the assumptions used which may lead to significant increases or decreases in liability positions. An example of this may be the decline in yields on bonds which would reduce the discount factors used to calculate the present value of obligations. As a consequence the amount of scheme obligations would increase. This was a real issue for companies with their most recent financial statements.

• Information to enable understanding of the method used to measure liabilities.
The projected unit method is currently the required methodology. Some consideration is being given to whether the estimated buy-out cost of scheme liabilities should be disclosed. There is some resistance to this on the basis that the buy-out cost is a measurement of the amount required to settle scheme liabilities rather than to continue to operate the defined benefit scheme.
• An evaluation of funding obligations to the extent they have been agreed with the trustees.
The extent to which future contributions have been agreed with the trustees is relevant information, particularly if it has been agreed for more than one year ahead.
• An evaluation of the nature and extent of risks and rewards arising from the assets held by the scheme.

The nature of any particular risks attaching to the assets of the scheme is of significance to our understanding of the scheme. This may include financial instruments and any valuation issues.

While disclosure issues are currently being addressed by the ASB, it is clear that there are many issues in relation to recognition and measurement which we are some distance away from achieving a consensus on.
Companies may expect to have to meet the additional challenge of new disclosures in their financial statements from 2006 onwards. These should be considered now to understand their full implications and ensure that the underlying information required for any additional disclosures can be readily made available.

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