Discussion Paper: the financial reporting of pensions

In January 2008, the European Financial Reporting Advisory Group (EFRAG) published a discussion paper 'The Financial Reporting of Pensions' on behalf of Pro-active Accounting Activities in Europe (PAAinE). The paper was developed by the UK standard-setter, the Accounting Standards Board (ASB). Comments from members are welcome; see below for details of how to contribute.

A company's financial statement should provide full and transparent information on the extent of the company's exposure to pensions, including any deficit. But existing standards do not always achieve this as well as they might. Whilst standard-setters are addressing some of the issues that have arisen, the ASB believes that a fundamental review needs to be undertaken, and the paper aims to both stimulate the debate and influence the International Accounting Standards Board (IASB) as it reviews the current standard (IAS 19 Employee Benefits) governing pensions.

The Discussion Paper seeks to contribute to such a review by considering the accounting issues in the light of current and emerging accounting thinking. It seeks to develop principles that may be applied to pension plans of all kinds – without relying on the distinction between defined contribution (DC) plans and defined benefit (DB) plans which is a feature of existing standards and is troublesome to apply to hybrid plans.

The UK context: non-quoted companies

The ASB's standard on accounting for pensions, FRS 17 Retirement Benefits, was published in November 2000, although its requirements only become mandatory in full for accounting periods beginning on or after 1 January 2005. The implementation of FRS 17 gave rise to a number of comments about the accounting for pensions, particularly in respect of defined benefit pension arrangements, which have attracted a good deal of media attention.

The legal and regulatory environment for company pension schemes has also changed significantly since the publication of FRS 17, notably as a result of the Pensions Act 2004. Regulatory changes include a new statutory obligation on solvent companies to meet their pension obligations; the establishment of the Pension Protection Fund (PPF) to provide a partial safety net for employees whose employers are unable to meet their pension obligations; and the establishment of The Pensions Regulator (TPR), a regulator with significant powers. These changes could not have been anticipated when FRS 17 was developed and have an effect on the relevant financial reporting.


Rather than seeking to improve existing accounting standards, the paper proposes a fundamental reconsideration of pension accounting. Consequently, some of the views in the paper differ markedly from existing standards on pensions. Some of the significant recommendations are outlined below.

One principle

A common set of principles for accounting for pensions should then be applied to all pension arrangements, whether defined contribution (DC), defined benefit (DB) or the increasingly common 'hybrid' plans. The paper highlights the deficiencies in accounting for DC and DB plans on distinct principles, and especially the problems in applying these differing principles to hybrid plans.

Pension liability

Only benefits that the entity is presently committed (by legal or constructive obligation) to pay should be reflected in the liability. Where the entity has genuine discretion to vary the amount of future benefit, this is not reflected in the liability.

The focus should shift from mechanisms that spread pension costs over employees' service lives to the principle of reflecting only present obligations as liabilities. Therefore, if benefits are linked to employees' salaries at or near retirement or leaving service, expected future salary increases would only be reflected in the liability when increases are required by law or contract or are seen as non-discretionary. Under this approach, the pension expense and the pension liability is increased only when pensionable salaries actually increase. (The report notes differing views on this issue.)

Measuring the liability

Pension liabilities should be measured at a current value, defined as the settlement amount that reflects the cash outflows needed now or in the future to discharge the liability.

The liabilities should be measured by discounting future cash flows using a current market discount rate that reflects the time value of money only, that is, a risk-free rate. Risks, such as mortality risk, would be reported via disclosure.


Assets held to pay benefits should be reported at current values, as is consistent with current standards. However, current standards require the reporting of expected return of assets rather than the actual return. The paper proposes the expected return on assets should be provided by disclosure only, and that the actual return be reported as part of the profit or loss for the year.

Changes in measurement

Changes in the measurement of assets and liabilities relating to pension plans should not be deferred, such as by spreading them over the average remaining service lives of employees or by a 'corridor' approach (IAS 19) under which changes are not recognised at all unless they exceed a certain threshold. The paper therefore proposes all changes in the amounts of the pension deficits and surpluses should be reported in the period in which they arise.

Consolidation of pension plans

Current accounting standards require an employer to record a pension liability (the amount by which the liability to pay benefits exceeds the plan's assets) in respect of any guarantee it has given. This assumes that the plan is genuinely independent of the employer, for example where it is governed by Trustees who are bound to act in the interests of the members rather than the employer.

The paper argues that if the control rests with the employer, it should be consolidated in the employer's financial statements. This differs from current accounting standards which provide an exemption from the usual principles of consolidation for pension plans.

The discussion paper can be downloaded, free of charge, from the FRC website (via the related links section of this page).