THE EUROPEAN COMMISSION is set to endorse amendments to International Accounting Standard (IAS 19) in the coming months, yet no consensus has been reached over the interpretation of some of the revised requirements.
The revisions to IAS19 aim to make the treatment of pensions risk on a company’s balance sheet more transparent to investors, in the financial statements, by requiring immediate recognition of any under- or over-funded liabilities, and in the disclosures.
Companies with schemes that impose relatively large liabilities on their balance sheets, and that have relatively high exposure to risk seeking assets, might find the footnotes to their financial statements get greater scrutiny by stakeholders seeking to understand what steps are being taken to mitigate the volatile effect on the company’s balance sheet, according to consultants Mercer.
This may well prompt a wide-spread review of the risk management procedures applied to Defined Benefit (DB) pension schemes.
According to Deborah Cooper, partner at Mercer, the revised IAS19 requires companies to disclose more information about their pension plan risks and liabilities.
“This will give investors more insight into the pension risk that a company carries. All else being equal, where the risks are material, investors are likely to prefer those companies that can identify stronger governance and internal controls. While this attempt at transparency is a welcome move, the effects of some other aspects of the revisions have yet to be ironed out.”
For UK businesses the revised IAS19 is likely to reinforce company behaviour that is already apparent, since most employers already aim to de-risk their defined benefit plans
“Revised IAS19 makes companies’ profit & loss statements independent of the investment risks taken by their pension plans. This removes a perceived barrier to de-risking, since holding risky assets will no longer be rewarded in the P&L by supporting a higher expected return on assets.”
Mercer considers that removing the expected return on assets is likely to make companies focus more on their choice of discount rate. The discount rate prescribed by IAS19 is driven by yields on high-quality corporate bonds but in most European countries the market for these has come under considerable pressure recently due to the sovereign debt crises.
“We expect companies to be more careful about how they choose to value their pension liabilities, now that the effect of the discount rate will hit balance sheets immediately and also affect the bottom line. The market for ‘high quality’ bonds is not that deep, and a significant proportion are issued by companies operation in the financials sector, so is likely to be distorted by the euro crisis,” continued Cooper. “Simply selecting a yield from a bond index might result in a company disclosing a worse position than is intended under accounting standards.”