What trends in pensions accounting have recently come to light?

23 March 2016

This week’s guest blogger is Brian Peters, partner and lead of PwC's pension accounting business. Connect to him on LinkedIn

Following the 31 December 2015 year-end financial reporting process, it is time to reflect on some of the interesting trends and issues in pensions accounting that came to light, and what can be learned for the future.

Planned amendments to accounting rules could affect the balance sheet of companies with pension schemes in surplus or making deficit repair contributions

The IFRS Interpretations Committee has issued an exposure draft with amendments to IFRIC 14. IFRIC 14 clarifies when a company must restrict a pension scheme surplus and/or show the value of future deficit contributions as an additional liability on the balance sheet.

The proposed requirement applies if a third party (such as the scheme trustees) can prevent a company from receiving a refund of surplus. We have seen a number of situations where it’s possible that the wording of the scheme rules is such that pension surpluses would potentially need to be restricted or liabilities would need to be recognised under the new guidance.

Whilst many of the comment letters were broadly supportive, so we can expect to see an amendment consistent with the Exposure Draft, there were a lot of detailed comments made and so there could be changes to the wording which could have a significant impact on which plans, and therefore companies, are affected.

The new rules are unlikely to be in force for some time and, given that it is not yet clear whether the proposed amendments will be issued unchanged, for many it is very much a case of watch and wait. Nevertheless, many companies have been considering making amendments to the rules of their pension schemes in anticipation of the changes and, in the case of RBS, the Exposure Draft appears to have triggered a re-evaluation of their position in this area.

Have you considered the implications or are you holding off for now until more is known?

Many companies have seen pension deficits under IAS 19 reduce over the year to 31 December 2015

Many companies reported reduced pension deficits (or greater surpluses) at the end of 2015. This was due to a combination of favourable factors leading up to the end of 2015, despite a volatile year in the investment markets:

  • Over 2015, UK and Eurozone bond yields rose, leading to higher interest rates used to discount liability values and therefore a lower deficit, although this would have been to some extent offset by flat asset returns over the same period.
  • People are not expected to live as long as previously thought. Recent analysis shows that, although younger people are still expected to live longer than their parents, the rate of improvement in life expectancies has reduced over the last three years. Companies moving their assumptions to the latest mortality tables and models are likely to see a reduction in their pension accounting liabilities.
  • Companies have continued to fund pension deficits with cash generally reducing reported pension accounting deficits.

The net result of the above factors seems to have been an overall reduction in pension accounting deficits under IFRS over 2015.

Market volatility in 2016

In 2016, investment markets have picked up where 2015 left off with continued volatility. General market weakness have seen both government bond yields and equity prices fall, which is doubly bad news for pension schemes since it drives liabilities up and assets down. Consequently, the reduction in pension accounting deficits during 2015 might already have been reversed. Many companies are monitoring their pension schemes’ positions.

Changes to pension cost calculation methodology

Traditionally, a single average discount rate has been used for the purposes of calculating both defined benefit obligation (DBO) and related pension cost items (i.e. service cost and interest cost). However, there is a growing trend to use multiple discount rates to calculate pension cost (so far mostly in the US but we expect the UK and others to follow). Under this approach, expected future pension scheme cash flows are broken down by term. These cash flows are then discounted by a different interest rate for each term appropriate for the nature of the calculation (e.g. for interest cost purposes). This is seen by many as a refinement of the traditional approach but sound justification needs to be given for any such change.

The calculations are complicated but, with rates generally higher for longer terms, moving to this approach can result in both a lower service cost and a lower interest cost being recognised in a company's income statement, although there should be no change in the DBO as a result of the change in approach.

This has so far mainly been used by companies financially reporting in the US, where the technical change was approved last year via discussions with the Securities and Exchange Commission (SEC). Furthermore, under US reporting rules, the impact on the interest charge is much greater as it applies only to the liabilities (not the assets), whereas under IFRS the effect is smaller because it applies to the net deficit (or surplus). Companies should ensure that they are aware of the approaches being used in the market and what it might mean for them.

However, the question I would like to ask you is: do you think these changes are an improvement or simply an over-complication given the approximate nature of predicting cash flows many years into the future?

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