Who cares about pension scheme deficits?
FRS 17 & IAS 19
by Roderick Ramage, solicitor, www.law-office.co.uk
published (by distribution to professional contacts) on 30 December 2010
This article is not advice to any person and may not be taken as a definitive statement of the law in general or in any particular case. The author does not accept any responsibility for anything that any person does or does not do as a result of reading it.
Who cares? The answer, while the employer continues to pay contributions, is no one. That is to say, no one except accountants.
The directors of a company (or an LLP) must not approve its annual accounts unless they are satisfied that they give a true and fair view of the assets, liabilities, financial position and profit or loss of the company: Companies Act 2006, s 393. The Accounting Standards Board (ASB) has defined a true and fair view of an employer’s pension liability in Financial Reporting Standard 17 (FRS 17). If the pension scheme is a final salary or other defined benefits scheme, FRS 17 requires the deficit or, rare at present, the surplus and changes in them to be recognised in the accounts. Broadly similar principles apply under the International Accounting Standards (IAS 19).
“True and fair view” has a technical meaning in the context of a company’s audited accounts, which is very differ rent from that expression’s meaning in everyday usage, when the technically true and fair view may seem far from an everyday view of what is true or fair. Owners of companies carrying on business, people dealing with them and pension scheme members need the following information about a company and its pension scheme:
first whether the company, as long as it continues in business, can afford to fund the scheme sufficiently to enable it to meet its liabilities as and when they become payable and to continue to do so for the whole, or at least the foreseeable, life of the scheme; and
secondly whether, if a debt under s75 of the Pensions Act 1995, becomes payable, typically when the company becomes insolvent and the pension scheme must be wound up or one employer in a multi-employer scheme ceases to be an employer in relation to the scheme, when, in both cases, members’ benefits must be fully secured with an insurance company.
first – ongoing business
The information for this purpose is not and is not intended to be provided by FRS 17. The only information which FRS 17 gives is the market value of the scheme’s assets and the result of a mathematical calculation of its liabilities, both at the company’s ARD. These amounts must be reflected in the company’s accounts, have no direct relevance to its business, but have a major influence on how the company and its business are perceived.
All that one needs to know are the amount of the contributions and that the company has and is likely to continue to have the income to pay them. The capitalised values of the scheme’s liabilities and the calculated deficit or surplus figures in neither the actuarial valuation nor under FRS 17 have any bearing at all on the scheme’s current needs and the company’s resources while the scheme is on-going. A more useful tool for both company and trustees is a long term (at least 25 years) cash flow projection of the scheme’s annual liabilities and investment returns and hence its annual funding needs.
secondly – wind up and other s75 debts
Here too FRS 17 does not and is not intended to give the necessary information. In these circumstances the basis for calculating the liabilities is the cost of buying annuity and deferred annuity contracts for each member, which is higher, possibly by a factor of two or more, than their values calculated under FRS 17. Therefore the scheme’s deficit on a winding up is greater, often very much greater than is shown in the accounts.
It is possible but rare at the present for a pension scheme to be in surplus, in which case, although FRS 17 would show the surplus to be an asset of the company. However it could be paid to the company only if the trustees thought fit after securing members’ benefits in full, increasing them and complying with the statutory procedures for payments to employers; but it is quite possible for an FRS 17 surplus to be a deficit on a winding up basis.
the untrue and unfair view
Para 3.4.1 of “The Financial Reporting of Pensions – Feedback and Redeliberations” (November 2009) says is: “The ASB affirms its views that recognition should be based on the principles of reflecting only present obligations as liabilities.” If a liability is shown in the accounts, one can assume that it represents a present obligation that the company is or might be required to pay. There is no circumstance whatsoever in which a company can be required to pay the FRS 17 pension scheme deficit. All that the trustees can demand, unless a s75 debt becomes payable, are contributions in accordance with the schedule of contributions. No one is able to demand payment of an FRS 17 deficit, and therefore it is misleading and neither fair nor true to include it in the balance sheet as a liability.
It is undeniable that one needs a means of comparing and valuing future cash flows and discounting them to present values. This useful economic tool has however been turned into an accounting fetish to the detriment of businesses and pension schemes. The realistic, as opposed to the accounting, “true and fair” view of a pension scheme in a company’s accounts consists of the contributions payable under the scheme’s recovery plan and the deficit if any on the winding up basis if s75 were to become applicable. The inclusion in accordance with FRS 17 of the pension scheme’s assets and liabilities in the company’s balance sheet and P&L account shows neither of these, nor anything of any practical use; but it does enable the accountants to show consistency in their treatment of pensions in different companies’ accounts. It is a misfortune for accountants that their standards committees have given them this problem and forgetten what Emerson wrote about consistency.
copyright Roderick Ramage
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