FRS 17
& IAS 19 – Who cares about pension scheme deficits
by
Roderick Ramage, solicitor, www.law-office.co.uk
not
previously published – first posted on this website 26 September 2010
DISCLAIMER
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 about
pension scheme deficits?
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 171); and auditors
will not state in their reports that annual accounts give a true and fair view
of the state of the employer’s business and its profits or losses, unless the
pension scheme is accounted for in accordance with FRS 17. The objective of FRS 17 is copied in the box
below. If the pension scheme is a final
salary 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 192), which companies may
use as an alternative to FRS 17.
“True and fair view” has a technical meaning in the context
of a company’s audited accounts, which is very different 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 at
the company’s accounting reference date and the result of a mathematical
calculation of its liabilities at the same date, showing capital values for
both, and therefore the scheme’s surplus or deficit, as at that date: there is
a touch of apples and pears in the comparison of a market value for assets and
a calculated value of liabilities. 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.
The contributions which an employer pays to the scheme are
in accordance with the contribution schedule produced as a result of its
so-called “recovery plan”, on the basis of its triennial actuarial
valuation. The basis of the recovery
plan is that the deficit (as calculated by the actuary) at the valuation date
will be reduced to zero at the end of an agreed period, commonly up to ten
years from the valuation date, but increasingly for longer periods. This is a prudent approach given that the
life of the scheme can be longer than half a century. Normally the contribution rate is more than
adequate to enable the scheme to meet it liabilities to members as and when
they fall due.
Therefore all that a company, people dealing with it and the
members of the pension scheme need 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
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 assumed annual liabilities and investment returns and hence its annual
funding needs to be met by the employer and, if still open, members.
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, ie a market value, 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 would be 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 when it is wound up, in which case, although FRS 17 would show
the surplus to be an asset of the company, 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: and it is quite possible for an FRS 17 surplus to be a deficit on a
winding up basis.
the untrue and unfair view
Not only does FRS 17 not tell anyone what they actually need
to know about the impact of a pension scheme on a company, but it misleads them
by what on one interpretation, is a wholly false statement in the accounts
A difference between a lawyer’s and an accountant’s view of
the world is illustrated in para 3.4.1 of “The Financial Reporting of Pensions
– Feedback and Redeliberations” published in November
2009 by Pro-Active Accounting Activities in Europe (PAAinE)3
(evidently no pun or irony intended).
What para 3.4.1 says is: “The ASB affirms its views that recognition
should be based on the principles of reflecting only present obligations as
liabilities.”
The lawyer’s view of this statement is that, if a liability
is shown in the accounts, one can assume that it represents a liability 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 shown in its accounts. Only the trustees of the scheme can demand
payments, and all that they can demand, unless and until a s75 debt become
payment, 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.
Similar, although some accountants appear to argue to the
contrary (on the basis of IFRIC 144,
which, to be fair, would have only limited application), it should be inconceivable that
a company could argue that a reported pension scheme surplus could be treated as
a basis to justify the payment of a dividend or a larger divided than would
otherwise be justifiable.
Whilst is useful as a conceptual tool to convert income
streams into present values. and to show
and explain them in notes to accounts, it is misleading to incorporate them in
balance sheets and P & L accounts.
As a final (and not wholly frivolous) suggestion, ought not
the accountants, if they are to be consistent, tell us not just the date but
also the time of the day at which the pension scheme is to be valued, so that
we know whether their snapshot of the pension scheme was taken before or after,
say, the close of the Hang Seng market or the announcement of the collapse of
Lehmann Brother?
conclusion
It is undeniable that one needs a means of comparing and
valuing future cash flows and discounting them to present values. My complaint in this article is that such a
useful economic tool as discounted cash flow has 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
(first) the contributions payable under the scheme’s recovery plan and
(secondly), to show what would happened if a s75 were to become payable, the
deficit if any on the winding up basis.
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. Everyone else
remembers, as Emerson said, but in rather more words, that a foolish
consistency is the hobgoblin of little minds5.
END
|
Financial
Reporting Standard 17 published November 2000 OBJECTIVE The objective of this FRS is to
ensure that: (a) financial
statements reflect at fair value the assets and liabilities arising from an
employer's retirement benefit obligations and any related funding; (b) the operating costs of providing retirement benefits to
employees are recognised in the accounting periods in which the benefits are
earned by the employees, and the related finance costs and any other changes
in value of the assets and liabilities are recognised in the accounting
periods in which they arise; and (c) the financial statements contain adequate disclosure of the cost
of providing retirement benefits and the related gains, losses, assets and
liabilities. |
footnotes
1 www.frc.org.uk/asb/technical/standards/pub0206.html
(accessed 26/09/10).
2 www.iasplus.com/standard/ias19.htm
(accessed 26/09/10).
3 www.frc.org.uk/inages/uploaded/documents/Pensions Redeliberations Report.pdf (accessed 26/09/10).
5 Ralph Waldo Emerson, Essays First Series (1841), Essay II Self-Reliance.
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