Recent revisions to IAS 19 may have a significant effect on the financial statements of IFRS preparers with defined benefit (DB) pension schemes.
While the changes to the standard include a number of clarifications and updated disclosure requirements, here we concentrate on the changes most likely to affect how schemes are accounted for in the employer's financial statements. The revised standard applies for periods beginning on or after 1 January 2013.
Recognising movements in DB related assets and liabilities
IAS 19 (2011) has a simplified approach to recognising movements in pension assets and liabilities. The only items to be recorded in profit or loss for the year will be service cost and 'net interest'. Including net interest is a change from the existing treatment whereby both the discount rate on fund liabilities and the expected return on plan assets are recognised in profit or loss for the year. Net interest is calculated by applying the discount rate specified by the standard to the net pension asset or liability. The return on plan assets is often higher than the discount rate (for example when the scheme assets include equities or property). Consequently, the previous version of IAS 19 would have resulted in a lower total profit and loss charge (or higher total profit and loss credit) than would be the case under IAS 19 (2011).
All other remeasurements of the DB pension asset or liability will be included in other comprehensive income (OCI).
Smith & Williamson commentary
A majority of DB pension schemes will be at least in part invested in equities and property. Therefore many entities may find that adopting IAS 19 (2011) results in decreased profits and earnings per share, a situation that could also have an effect on loan covenants.
The elimination of reporting options, including the corridor method
Prior to the 2011 revisions, IAS 19 allowed a choice of methods for recognising actuarial gains and losses, including:
- immediate recognition via other comprehensive income
- immediate recognition via profit or loss for the year
- the corridor method (an approach which essentially allowed for the deferred recognition of a portion of actuarial gains and losses via profit or loss).
The existence of choice means there can be significant variation in the amounts reported by different preparers having similar economic circumstances. In particular, preparers applying the corridor method could potentially recognise a different pension scheme asset or liability to that recognised if either of the immediate recognition options were taken. The IASB consider that the lack of comparability arising from such a range of options is undesirable and, as a result, IAS 19 (2011) only allows one option – the immediate recognition of actuarial gains and losses via OCI. Amounts recognised in OCI under the revised standard will not be subsequently reclassified into profit or loss for the year.
Smith & Williamson commentary
Under the previous version of IAS 19, the majority of UK preparers utilised the approach of immediately recognising actuarial gains and losses in OCI. Many UK preparers will, therefore, find that their existing accounting policy with regard to actuarial gains and losses is consistent with the revised standard. However, any entities that previously applied the corridor method will be significantly affected by the revisions as they will be subject to increased balance sheet volatility and may be faced with the immediate recognition of previously deferred amounts. Entities that currently recognise all actuarial gains and losses in profit and loss will not be as severely affected, but will still face a change in accounting. For the affected entities, the switch to recognising all actuarial gains and losses in OCI will mean that profit or loss for the year, and any associated earnings per share figures, will no longer include volatile actuarial profits and losses.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.