Accounting for pension costs
| by John Davies 03 Jan 2000 Diploma in Financial Management Relevant to All Papers |
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One of the most contentious technical issues facing the accountancy profession has resurfaced in the form of a new exposure draft from the Accounting Standards Board (ASB). The draft in question is FRED 20: Accounting for Retirement Benefits. It deals with how companies that sponsor occupational pension schemes for their employees should account for the costs of doing so in their annual accounts.
The draft new standard would replace the current standard on this matter, SSAP 24, which has been standard practice since 1988. The proposed revision of the SSAP is the result of developing international practice that calls for a radically different approach to the accounting treatment of companies’ pension scheme assets and liabilities.
Under SSAP 24, a company’s pension obligations are expressly described as a long-term commitment, rather than a liability that needs to be separately valued on a regular, current basis. The objective of accounting for this long-term commitment is to recognise the cost of providing pensions on a systematic and rational basis over the period during which the employer benefits from the employee’s services. In the case of defined benefit schemes (where the member’s pension entitlement is a function of his wage or salary at the time of retirement from the scheme) this systematic and rational basis involves using actuarial assumptions of future rates of inflation and pay increases, increases to pensions in payment, earnings on investments, the number of employees joining the scheme, the age profile of employees and the probability that employees will die or leave the company before they reach retirement age. Thus, in accounting for pension costs, the employer is required to report an annual cost which is calculated on the assumptions that the scheme’s liabilities, and the assets that will fund them, are elements whose value can only be calculated in the context of the essentially long-term nature of a pension scheme.
As a matter of general policy, ASB is keen to ensure that standard practice in the UK and Ireland does not conflict with international practice. Aware that the rationale behind SSAP 24 was being contested by the US profession, it commissioned research into the continuing suitability of existing practice in the early 1990s, and followed this up with a formal discussion paper in 1995. Following the publication by the International Accounting Standards Committee of IAS 19, which adopted an explicit market value approach to pension scheme accounting, ASB issued a further discussion paper which suggested at least a partial revision of SSAP 24 so as to accommodate the new international standard. While a significant majority opposed any change, a majority of respondents to the discussion paper agreed that the UK and Ireland should adopt international practice and value scheme assets by reference to market values rather than actuarial values.
The reason why the proposed reform has proved so controversial is that the market value basis has the potential to produce annual reported costs that are extremely volatile. Since, as we all know, the values of securities can and do go up as well as down, the obligation for companies to post pension scheme assets at their market value carries with it the risk that the year-on-year cost of their scheme will fluctuate significantly. This is what worries many finance directors, who are concerned above all to ensure stability in their reported pension costs. Surveys have suggested that, rather than have their p&l accounts subjected to extreme volatility, many companies would re-consider their commitment to defined benefit schemes.
Apart from the move to measuring assets at market value, the main changes that FRED 20 would make to SSAP 24 are as follows:
i) in calculating the present value of the scheme’s liabilities, companies would use a discount rate corresponding to that which applies to high-quality corporate bonds (as opposed to the current approach which uses the expected rate of return on scheme assets);
ii) actuarial gains and losses would be recognised immediately in the company’s statement of total recognised gains and losses (as opposed to the current basis whereby such gains and losses are subject to gradual recognition).
The deadline for comments on FRED 20 is 5 February 2000. It is probable that, as on the previous occasions that this issue has been discussed, the FRED will arouse strong feelings. What adds to the equation this time is that the Government is engaged in a separate exercise of review and reform of pensions law. Among its initiatives is the introduction of the new stakeholder pension, which will be a defined contribution-type scheme characterised by ease of administration on the part of employers. While the consequences of new accounting practice in terms of employers’ future choice of pension schemes is not an issue which concerns ASB, the impact of the proposed change on employers’ attitudes to pension provision is a matter of wider importance which affects millions of employees.
Insolvency
Among the new Bills announced in the Queen’s speech
on 17 November 1999, which set out the Government’s legislative programme
for the new session of Parliament, is a Bill which would make significant
changes to the law on insolvency, the first major changes proposed for over a
decade. These measures have already provoked controversy.
The Government’s intention in the Insolvency Bill is to add to the range of measures in the Insolvency Act to help insolvent companies re-structure themselves and avoid winding up. In the case of individual voluntary arrangements (IVAs) under the Act, an insolvent individual can apply for and receive court protection against his debtors, so that none can make him bankrupt or take enforcement action against him while he and his advisers put together a proposal for the re-structuring of his debts which is subsequently put to creditors for their approval. Currently, companies that wish to enter into a company voluntary arrangement (CVA) under the Act do not benefit from the same breathing space. The Government feels that the absence of a moratorium for companies hinders efforts to save companies and the jobs that they provide.
Therefore, the new Bill is proposing to allow companies as well as individuals to apply for a moratorium while a voluntary arrangement is put together. It will also provide for banks and other secured creditors to give a company formal notice of its intention to appoint a receiver to recover money owed to it.
Unfortunately for the Government, the Society of Practitioners in Insolvency, the representative body for insolvency specialists, has expressed the firm opinion that these measures will not have the desired effect of helping companies in trouble to avoid liquidation. On the contrary, it argues that they would have the opposite effect of making lenders more suspicious of struggling companies and more likely to seek their winding up at the first sign of trouble. There is thus a major disagreement over the feasibility of the Government’s plans, and this will no doubt be debated with some force as the Bill is considered in Parliament.
Accountancy and new technology
The internet is becoming used more and
more for the publication of business information, and its potential for the
dissemination of accounting and financial information is being explored.
The International Accounting Standards Committee is shortly to publish a proposal for a code of practice for companies publishing financial and business information on the web. This will address the steps businesses should take when publishing information in this way and consider the potential of new digital languages that allows financial information to be prepared and exchanged between computer applications.