I suppose I should have guessed that storm clouds lay ahead when I first learned of its actual issue via a news item on Radio 4’s ‘Today’ programme. In recent weeks it has been mentioned regularly on television and radio news and in the national press, not always on the business pages. Indeed the debate has widened with a recent quote from a trade union leader imploring the government to ban FRS 17!
Why the notoriety?
A large number of major employers are replacing ‘final salary’ pension schemes with money purchase schemes offering less certain and widely believed poorer pensions. The blame for this move is being place at the door of the Accounting Standards Board. Indeed a piece in Accountancy Age on the 21st. February included the line ‘the new pensions standard is forcing them to close final salary pension schemes’.
Is this true?
FRS 17 makes two major changes in accounting for final salary (or defined benefit) schemes. It approached the problem by concentrating on the measurement of the assets and liabilities of the scheme and how the costs are reflected in the revenue statements.
The assets of the scheme should be valued at fair values. These will normally be market values with mid-market for quoted securities, open market for property and best estimates for unquoted securities. This is the major change from the old rules under SSAP 24 that employed an actuarial valuation approach for scheme assets.
The liabilities should be measured on an actuarial basis. These liabilities should include both the contracted obligations promised by the scheme and any constructive obligations where statements or past practice have lead to reasonable expectations by employees. Full valuations of liabilities must take place at least every three years. As the assets are to be valued annually at market value it seems probable that schemes will wish to value liabilities annually to avoid wild fluctuations.
The valuation of assets and liabilities will give rise to either a surplus or a deficit. This will be the difference between the market value of the scheme’s assets and the net present value of its liabilities. This must be recognised in the balance sheet of the employer to the extent that a surplus may be recovered by reduced contributions or a liability reflects its legal or constructive obligations.
The profit and loss account will recognise the annual cost estimated by an actuary to provide the promised benefits within the operating costs. Actuarial gains and losses arising from new valuations is to be recognised in the Statement of Total Recognised Gains and Losses.
What is so draconian?
The change from actuarial to market value of underlying investments will subject the asset values to the vagaries of market forces and give rise to more fluctuations. The old rules permitted deficits and surpluses to be spread over the future lives of the scheme members. The new rules will require recognition much earlier, albeit in the Statement of Total Recognised Gains and Losses rather than the Profit and Loss Account.
Is this the reason to the flight from defined benefit to defined contribution scheme?
A few short years ago many companies operating defined benefit schemes were showing an actuarial surplus and basking in the sunshine of a contribution holiday so that the only increases in the fund came from employees. What has happened since is that the values of the funds have fallen with the fall in stock markets across the world. Income has fallen from two main causes. The change in tax law that removes the right to reclaim imputed tax on dividend income (a strange move from a government advocating the importance of pension provision) coupled with a decline in interest rates and dividend yields.
At the same time the liabilities have been creeping upwards over a long period. This is caused to some degree by market forces with falling annuity rates with, at the same time, increases in life expectancy. Demographic changes in the workforce have also had an impact with increases in the number of women (with their longer life expectancy) in pension schemes. Pensioners are expecting their income to increase in line with inflation giving another open-ended liability.
The changes in expectation demanding (quite rightly) widowers as well as widows pensions and expansion of expectation to provide benefits to ‘partners’ other than spouses. Indeed, one national newspaper is running a campaign to extend widow(er)s benefits to post retirement marriages.
All of these forces are pushing up the liabilities of pension schemes at a time when the asset values are falling.
Who can blame finance directors from considering the transfer from open-ended final salary schemes to the simpler defined contribution scheme where the employers liabilities are fixed and the type of benefits are left to the individuals who will use their pot of money to purchase a pension to suit their circumstances?
It is these increases in liabilities and uncertainties that are driving companies away from final salary schemes.
FRS 17 requires companies to reflect their liabilities in their accounts. This, to an accountant who grew up under the prudence concept, does not seem unreasonable.
FRS 17 is being used as a scapegoat for companies anxious to reduce their costs.
- John Morley is a aenior lecturer in financial reporting at the University of Brighton where he lectures on financial accounting and reporting on undergraduate, post graduate and professional courses. He is a regular contributor to students’ magazines and lectures on accounting standards to local accountants’ societies.
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