When a proposed amendment to an accounting standard collides with accepted practice, the standard-setting bodies can expect to get more than a few bricks thrown their way. When the collision adds volatility to the balance sheet and pushes up compliance costs significantly, you can bet there will be huge opposition. When the proposed changes do all of the above with respect to final salary pension schemes, the reaction is going to be particularly sharp.
But what is the International Accounting Standards Board (IASB) to do? It has set itself the task of modernising its standards and IAS 19, the international equivalent of the UK standard FRS 17 on accounting for pension costs, is now up for ‘renewal’. A revised standard is proposed for publication in 2011.
To many finance directors, busy trying to position their organisations to catch any upswing that might come along as the global economy struggles out of recession, changing standards without some deep and urgent need is just foolery. Changing them so that they mess up the balance sheet is madness.
While the new exposure draft on IAS 19 contains a number of changes, the common consensus is that controversy lies in three areas.
One, the rules would end the option to use the ‘corridor’ method, the accounting method of disclosing actuarial gains or losses on pensions if either exceed 10 percent of the fair value of the pension assets, requiring more disclosure; two, it is proposed that companies should capitalise the administration cost of running the scheme, for the life of the scheme; and three, it is suggested that companies move the calculation of the return on scheme assets to a discount basis, rather than estimated returns.
In particular, some observers think outlawing the corridor rule could cut the reported earnings of UK companies by as much as £10bn.
Tim Marklew, partner at Lane Clark & Peacock (LCP) specialising in pensions accounting, sees real and practical problems with the IASB’s p roposals, particularly with respect to reserving future expenses associated with the scheme. “One has to remember this is an international standard it is proposing,” says Marklew. “It will affect all multinational companies all over the world. In the UK, there is a consensus that UK Gaap has run its course and that we are going to move to international standards, but these proposals will be relevant to companies that still use UK Gaap.”
Marklew calls the expenses issue a “hidden surprise” in the exposure draft. “It is not obvious or well highlighted and no details have been given as to how one should go about calculating these numbers,” he says. So why has the IASB gone down this route? “If you look at the existing IAS 19’s rules on calculating the expected return on assets, these include rules on accounting for running costs,” he says. “So when the IASB decided to change the rules on calculating the expected return on a fund’s assets, it was forced to consider accounting for running costs at the same time.”
Mike Smedley, pensions partner at KPMG, agrees that this will be a big issue for his clients. “People hate the idea of treating the costs of running the pension scheme as a past cost, when you won’t be paying it for 20 years. Companies do not capitalise other future costs in this way, so why single this out for special treatment?” he asks.
Changes to the corridor rule will also be painful, but more for European and US companies, where it is more commonly used, than for UK companies. It allows companies to spread the volatility impact of a major hit to the pension scheme – from another stockmarket crash, for example, over future years.
There are currently two ways to recognise such a hit: take it on to the balance sheet immediately, or use the corridor method to damp down the impact of the loss. But the IASB dislikes the corridor method because it allows a company’s balance sheet and its ‘real’ position to get out of sync. The balance sheet might show a large asset as far as the fund is concerned, while, in reality, if the loss was recognised immediately, it would generate a significant liability instead of an asset.
As Marklew points out, companies in the European banking sector, where volatility on the balance sheet is proving difficult to manage, and where the corridor method is widely used, will not like this change at all.
Peter Black, partner with Punter Southall, points out that things could have been worse. “At one point there was a move to say that all the gains and losses in the fund had to go through the company’s P&L immediately. That would have had a hugely volatile impact on the P&L and since many of those gains and losses would be theoretical – because the company, or rather the scheme, was not about to crystalise the losses – the P&L would have been catapulted quite a long way from reality,” he explains. “Not exactly the outcome that a standard-setting body should be seeking.”
Black points out that the additional disclosure demanded in the draft will be particularly annoying to many companies. “There is already a huge amount of disclosure required with respect to company pension schemes, and most finance directors will feel that adding still more disclosure will further increase costs without necessarily increasing comprehension,” he says.
As LCP’s Marklew points out, the IASB wants companies to move from a rules-based approach on disclosure to principles-based disclosure, with the presumption being that companies should provide more rather than less information. “It remains to be seen how companies will react to this new approach and whether they use it to make more relevant information available to users of accounts, or simply fill the pages with irrelevant detail.”
Marklew argues that despite the controversial bits, the IASB is likely to press ahead and he expects most of the changes it is proposing to go through. “The new exposure draft taken as a whole has the merit of being simple and practical,” he concludes. “So companies should face up to the idea that the IASB will probably get the standard issued in the time scale it is proposing.”
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