Accounting: OAP opera - the pensions problem that just won't go away

Pensions are a nightmare on so many levels – ­ accounting,
financing, investor relations, cash management, legal and human resources… have
we missed anything? Pensions are taking up an ever larger chunk of resources,
the time of senior directors and managers within the company and the chargeable
time of an increasing army of consultants, not to mention the actual cost of
funding the company pension schemes.

The concept of the pension is so embedded in our work culture that no one
really dares question why organisations should have a continuing financial
responsibility towards individuals who left their employ years ago.

Instead, we wrestle on with a series of problems. While the credit crunch hit
with the speed of a train at full pelt, the pensions problem has been moving at
a pace that would shame a glacier. And although many corporates were slow off
the mark, most are now taking action in an attempt to put a lid on their
upcoming exposure. But this is not an easy task.

In August, actuary firm Lane Clark & Peacock (LCP) published its 16th
annual Accounting For Pensions survey, which received a slew of coverage
reporting the ballooning deficit among the FTSE-100: UK pension schemes are
£96bn in the hole in 2009, compared with £41bn the previous year. Painful, but
the outlook is even gloomier. According to LCP, expected changes to IAS19, the
international accounting standard on employee benefits, will provide yet more
pension trauma for corporates.

It has taken reported profits for FTSE-100 companies with December year-ends
and worked out for year-end 2008 that the £45bn of profits under the present
pension rules would have collapsed to less than £15bn had they been worked out
and reported using the IASB proposals. LCP went further and illustrated how the
flattish, but respectable, profits of FirstGroup would rise more sharply, before
embarking on a precipitous decline into the red.

Under IASB proposals, the gains and losses on pension funds would be seen
directly on the face of the income statement rather than, as now, being taken
through the statement of gains and losses. Such volatility would clearly spook
any market, never mind one with any degree of fragility. The IASB says, though,
from the feedback it has received, that most support recognising all changes in
defined benefit obligations and in plan assets in the period they occur.

If the IASB’s ideas come into force, then clearly users of accounts would
need specific understanding of the meaning of the pension charge. They may well
decide that the earnings before interest, tax, deprecation and amortisation
(EBITDA) would need to become EBITDAP, with the pension charge added to the list
of figures stripped out by analysts trying to see what was really going on.

That might be one solution, but it can hardly be what the accounting standard
setters are out to achieve. What exactly should the accountancy profession be
trying to achieve?
While awareness of the problems of pensions has increased significantly, the
financial reporting of pensions has been understandably stuck in the logjam that
is the IASB’s to-do list. It has half promised a comprehensive review of pension
accounting ­ and that really needs to happen. It is trying to reach a partial
version of the right answer by 2011, which means accounts won’t reflect the
changes until 2012 at the earliest. But away from the international scene it
should be noted that some progress has been made. The Accounting Standards Board
(ASB) has led work on pension reporting, along with various European groups, and
has produced one discussion paper with questions seeking views and a further
response setting out more definitive thoughts is expected in the final quarter
of 2009.

From the work it has done so far, the ASB is saying that a fundamental review
of the approach of pension accounting standards is required. Accounting thinking
has moved on since the IASC developed IAS19 in the 1990s and again since the AS
B published FRS17 in late-2000. For instance, one fundamental shift has been the
need to identify principles for accounting for pensions which does not rely on
the distinction between defined contribution and defined benefit plans.
Accounting standard setters have been rethinking the major problems with the
financial reporting of pensions: the nature, ownership and the measurement of
the liability, longevity, future salary increases, consolidation, assets and
returns on assets, the use of the income statement and disclosures.

While there will always be disputes, the accountancy profession is making
progress and is creating the possibility of better answers to tough questions.
It should certainly be possible to come up with better accounting answers than
those currently in use which won’t solve the pension problem, but could more
accurately describe it in financial terms.

Over the past few years, the financial reporting of pensions has been
dominated by other professions, notably actuaries. And that is why many in the
accountancy profession have been so spooked by the problem. It is time FDs and
standard setters snatched back the initiative.