THE FRC’s formal approval of FRS 102, the new mandatory reporting standard for accounting periods beginning on or after 1 January 2015, is expected to bring the disclosure of retirement benefits more in line with the revised IAS19 standard.
While the revised standard does not propose radical changes in how defined benefit schemes are accounted for will impact in several areas.
Increased P&L charges
FRS102 follows the lead of the revised IAS19 standard in abolishing the expected return on assets in the profit and loss (P&L) account. Instead, the assumed discount rate will be used to calculate the ‘net interest on the net defined liability’.
As with IAS19, the move to using the discount rate instead of the expected return on assets is likely to increase the P&L charge where schemes have a growth-oriented asset strategy, as the discount rate will be comparatively lower in many such cases. To illustrate why this will worry many finance directos, similar revisions to the EU-wide IAS19 standard is estimated to have added an extra £5bn to the aggregate P&L charge of the FTSE350 companies.
For this reason, despite early implementation of FRS102 being permitted in most cases for accounting periods ending on or after 31 December 2012, it will be tempting for many companies to defer adoption of the standard until the latest possible date should there prove to be a negative impact on the P&L charge.
‘Appropriate term’ and duration of the liabilities
In deriving the discount rate, the specific reference to high quality corporate bonds as being rated as “AA or equivalent” has also been removed from the standard, in accordance with IAS19 (though this should not make a practical difference in most cases). However, the continued reference towards using bonds of ‘appropriate term’ to discount future cashflows should remind companies and their advisors of the need to be vigilant when deriving the discount rate. Those companies that continue to use an index yield without consideration of whether there is equivalence between the duration of the liabilities and the term of the chosen bond index may be in danger of overstating their accounting liabilities1.
This is particularly relevant in the current market environment where the steeply upward-sloping yield curve means that a small adjustment along the yield curve can have a significant impact on the discount rate being adopted and consequently on the balance sheet and P&L account.
For example, the duration of the iBoxx Sterling Corporates AA Over 15 years Index as at 31 March 2013 is approximately 13 years; this is generally shorter than the duration of most pension schemes’ liabilities.
The Bottom Line
The cost of a defined benefit scheme to a company will be portrayed much as before under FRS102. This will consist of four elements.
Within the P&L:
• the increase in liability due to employee pensionable service (if any) during the reporting period (the service cost);
• the net interest on the net liability (effectively the net balance sheet pension liability multiplied by the discount rate); and,
• plan introductions, benefit changes, settlements and curtailments
The fourth element is the re-measurement of the net defined benefit liability in the balance sheet (which is included within ‘Other Comprehensive Income’, formerly the ‘Statement of Total Recognised Gains and Losses’).
Multi-employer schemes
The approach to so-called ‘multi-employer’ defined benefit arrangements under FRS102 will mean that companies may be compelled to recognise a liability on the balance sheet for the first time. In particular, this may apply to plans with more than one participating employer where these are not under common control.
Under FRS17, a pension plan within this structure could have been treated as a defined contribution arrangement; under FRS102, companies will be obliged to disclose the present value of contributions payable under any deficit reduction schedule within the balance sheet (rather than just recognising actual contributions as an expense in the P&L).
Other highlights to note:
• Smaller entities still eligible for FRS for smaller entities (FRSSE) will not have to adopt FRS102 so long as they continue to qualify as such under the Companies Act (i.e. incorporating the majority of companies with a turnover of less than £6.5 million).
• The fair value of an asset no longer specifically refers to the bid price (though it is noted that it will ‘usually’ be so)
• There appear to be less restrictions on how surpluses may be recognised on the balance sheet
• The disclosure requirements relating to the funding of defined benefit schemes looks to be more onerous
As expected, companies reporting under the standard for the first time will need to disclose the impact of the changes during the transition.
Finance directors should now consider the implications of the new disclosure requirements and obtain projections of future year’s disclosures to better understand the impact of the revised standard.
Simon Taylor is an associate at Barnett Waddingham