Significant changes expected to employee benefit accounting under IASB proposals
Companies need to be vigilant over actuarial consequences
Proposals recently published by the International Accounting Standards Board (IASB) to revise the accounting for pensions and other long-term employee benefits under International Financial Reporting Standards (IFRS) have drawn widespread comment. The proposals will, if adopted as is, introduce significant changes for most entities with defined benefit obligations (such as pension, post-retirement medical benefits and other long-term benefits), and will impact in particular on those entities currently using the option to defer recognition of actuarial gains and losses.
Although defined benefit pension plans constitute a relatively small proportion of the total number of pension/provident funds in South Africa (and most have been closed to new entrants); there are a number of companies with fairly sizeable obligations. All of the big four banks have defined benefit pension plans. Many companies also have post-retirement medical benefit plans.
One of the IASB’s main proposals is to require immediate recognition of all gains and losses arising in defined benefit plans. At present IAS 19 Employee Benefits permits the use of the ‘corridor’ method, under which the actuarial gains and losses arising on post-employment benefits such as pensions can be deferred and recognised in net income in later periods. The new proposals advance that such gains and losses be recognised in full, but as part of other comprehensive income – i.e. outside net income. Actuarial gains and losses can vary significantly from period to period as they include not only changes in estimates regarding employee turnover and life expectancy, but also investment gains and losses and the impact of changes in discount rates.
“The corridor proposal will no doubt be a headline story,” said Kim Bromfield, Technical Partner from KPMG in South Africa and member of the IASB’s Working Group on Employee Benefits. “But an important detail that shouldn’t be overlooked is that net income will be affected by the Board’s proposal to redefine the calculation of pension cost. In many cases net income is likely to be reduced because a part of the return on plan assets will, under the proposals, be recognised outside net income in other comprehensive income. Entities will need to consider the impact of these proposals not just on their pension costs, but also on wider matters such as compliance with debt covenants.
“The corridor approach can produce some bizarre results,” she adds. “For example, one large financial institution, which applies this approach, reported a net pension liability of R133 million on its balance sheet in 2009; yet the real net deficit was actually R543 million. This was due to unrecognised actuarial losses of R410 million. Their post-retirement medical liability was reflected as R2 billion on the balance sheet, yet the liability was actually approximately R300 million less than this due to unrecognised actuarial gains. Under the corridor approach the balance sheet figure is meaningless.”
Lynn Pearcy, KPMG’s global IFRS employee benefits standards leader based in the United Kingdom, noted that “the global economic crisis has increased the focus on the off-balance sheet pension liabilities that can result from using the corridor approach. While the IASB’s proposal to eliminate this is likely to be controversial, it responds to criticism of current pension accounting, which permits deferred recognition of certain gains and losses. In proposing a presentation solution that keeps the resultant volatility out of net income the Board has tried to be responsive to concerns about this important performance measure otherwise being undermined.”
Another change proposed by the IASB that is likely to draw considerable comment is that the net interest component of pension expense would be calculated by applying a single interest rate – the rate used to discount the obligation – to the entity’s net balance sheet asset or liability. The expected long-term return on plan assets would no longer be part of the net pension cost reported in net income. Instead, any gains (or losses) for returns that are higher (or lower) than the interest rate used would be recognised only in other comprehensive income, outside net income.
Bromfield also notes that “accounting for other long-term employee benefits, such as deferred bonus schemes, long-term profit sharing plans and long-term leave would also change under the proposals. It would now be aligned with defined benefit pension accounting. This means that all changes in estimates, for example those relating to expected forfeiture or future salaries would be reflected in other comprehensive income and not the income statement. This may add complexity to the calculation of the components of the change in the liability.”
The proposals include some additional disclosure requirements, which focus on the risks arising from sponsoring employee benefit plans. The IASB retreated from earlier plans to have disclosures comparable in scope and detail to those for financial instruments.
