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The consultation document issued by the Accounting Standards Board

Comments from
The Association of Chartered Certified Accountants

Executive Summary

The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to comment on the above Exposure Draft (ED) of a proposed Financial Reporting Standard published by the Accounting Standards Board (ASB).

ACCA agrees that a new standard is required, in particular to cover the accounting for the cost of defined benefit pension arrangements. While we support many of FRED20’s proposals, there are substantial areas in the measurement and presentation of pension obligations which we think ASB should reconsider before a standard is issued.

ACCA supports FRED20’s use of fair values for scheme assets. These are more objective than actuarial values, and given the way financial markets are developing are probably the only realistic basis for the future. Fair values will, however, potentially create volatile movements in the scheme surplus/deficit. FRED20 proposes that these movements should be recognised immediately as gains and losses, mostly through the statement of total recognised gains and losses (STRGL) without affecting the profit and loss account (P&L).

ACCA considers that a spreading forward of gains/losses over average service lives would be a better solution than immediate recognition because

• this will produce reported results more helpful to users in estimating future performance

  and

• this is the prevalent international solution.

We accept FRED20’s prescribed AA corporate bond rate for discounting the liabilities because this will harmonise UK and international accounting standards

FRED20 proposes a separate pension balance (credit or debit) shown after other net assets, and a matching separate reserve (debit or credit). This unusual presentation is not fully justified or explained in FRED20. It does not seem appropriate because

• no other assets/liabilities are stated in balance sheets net of the related deferred tax

• this would over-complicate balance sheets

  and

• it is arguable whether the presentation complies with the formats in the Companies Act.

 

1. General Comments

1.1 ACCA agrees with the need for a replacement for the existing standard on accounting for the cost of defined benefit pension schemes (SSAP 24). A new standard along the lines set out in FRED20 would

• be based on market values for scheme assets which seem more objective and realistic
  

• provide better disclosures

  and

• harmonise on a single actuarial method.

1.2 We have included our main comments on the ED in our responses to the specific questions raised by ASB (see below).

1.3 There are, however, some matters not raised by the questions, to which we wished to draw attention, as follows.

1.4 We are not happy with the proposed presentation of reserves. We have included this in our response to Q6 below.

1.5 The unusual presentation set out on pages 50 to 52 of FRED20 to deal with a distributable profits problem would seem to raise similar problems to those dealt with under Q6 below.

1.6 The comparison in Appendix IV with IAS19 seems rather broad brush. It would assist if a more detailed comparison was set out including disclosure items, as has been done in other FRSs.

 

2. Answers to ASB’s Specific Questions

Q1. The proposals are based on two key principles: (i) measurement of scheme assets and liabilities at fair value and (ii) immediate recognition of gains and losses (but in the STRGL, not in the P&L). Do you support these principles?

2.1 We support the use of fair values for the measurement of scheme assets. The principle of fair values for scheme liabilities is easier to support in theory than to translate into practice. The concept of fair values for these pension liabilities seems largely meaningless given that there is no market in such liabilities. FRED20 itself admits that choosing an appropriate discount rate is difficult.

2.2 We do not support the principle of immediate recognition of all gains and losses. We appreciate that the approach proposed has considerable advantages in terms of transparency and disclosure of risks. We consider, however, that appropriate disclosures in the notes to the financial statements will be an adequate alternative way to deal with those. We continue to have a strong preference for the spreading of costs over expected service lives given

• the long term nature of the cost,

• uncertainty of the estimates involved

  and

• conformity with the prevalent existing international consensus (for example in IAS19).

2.3 We think that the large gains/losses which would be shown in the STRGL under the ED’s proposals will not be helpful to the interpretation by users of an enterprise’s likely future performance. This would be even more the case were the ASB’s proposals for a single performance statement to be put into practice. We noted with interest the views of the ASB expressed in FRED20 that one year’s total performance figures will not be very significant. This view was not expressed in the recent discussion paper of proposals for reporting financial performance. Nor did that discussion paper include a requirement for a five year summary of performance that would logically follow from that view.

2.4 We also note that the approach of FRED20 places great importance on distinguishing current service cost and expected return on assets from other components of pension costs. These seem subjective and difficult to distinguish consistently, the main check on the estimates involved being the five year history. This approach appears simply to shift the onus from the actuaries and management onto the users to “smoth” the actuarial gains and losses and so obtain a meaningful picture. Users may be less well placed to do this smoothing than the preparers.

2.5 In opposing immediate recognition, international harmonisation has been an important factor in our thinking. This does not mean, however, that we would support the introduction of the “corridor” approach of IAS19 in determining the cost variations to be spread.

Q2. Do you agree that defined benefit scheme assets should be measured at fair value?

2.6 Yes. Fair values are more objective than the alternative actuarial models. Market changes in terms of valuation models and other means of rewarding shareholders than dividends, have undermined these alternatives and fair value seems the only realistic option in the longer run. We also think that changes in market value of the scheme assets produce changes in expectations of pension costs.

Q3. Do you agree that defined benefit scheme liabilities should be measured using the projected unit credit method?

2.7 Yes. We think it a weakness of the existing standard SSAP24 that there is a choice of actuarial method which is left up to the employer and its actuary. Such a requirement will aid international harmonisation as both IAS19 and the US standard also specify this method as the only one to use.

Q4. Do you agree that the discount rate applied to the scheme liabilities should be the current rate of return on an AA corporate bond of equivalent term and currency to the liability?

2.8 We note that this is the rate specified in the international standard on the subject (IAS19). This proposal will assist, therefore, the harmonisation of UK accounting standards and we accept the rate on this basis.

2.9 We note, however, that this is a key change from the ASB’s 1998 proposals, when a matching asset portfolio rate was proposed.

2.10 We also observe that this leaves four recent accounting standards or exposure drafts from ASB putting forward three different rates for discounting:

• risk free

• risk adjusted

  and

• AA corporate bond.

2.11 We continue to believe that the ASB should have a project on discounting in financial reporting to ensure coherence of its application. This will enable ASB to contribute properly to the international debate on this subject. Projects on discounting are on the agendas of both the FASB and IASC, for example.

Q5. Do you agree that the surplus recognised by the employer should be limited to the amount that the employer could recover through reduced contributions and agreed refunds?

2.12 We think that this is a reasonable restriction. It seems difficult to see how otherwise the surplus would meet the definition of an asset.

Q6. Do you support the proposed separate presentation of the pension asset/liability in the balance sheet?

2.13 We do not agree with this. The presentation proposed is of a pension item (debit or credit) net of any deferred tax to be shown after other net assets. This seems an unusual presentation in two respects:

• separate net assets figures are not shown for any other assets or liabilities

  and

• no other assets or liabilities are presented net of tax in the balance sheet.

2.14 The corresponding separate reserve (debit or credit) also seems very unusual. Neither of these presentations is explained or justified by FRED20, either in the main text or in Appendix V. It is not clear whether the presentations are on the basis that pension items are especially uncertain and not rated by ASB as proper assets or liabilities, or because a large portion of such a balance might have come through the STRGL, or whether this is linked in some way to the problems of distributions dealt with in Appendix III.

2.15 If this presentation were to set precedents for other items (goodwill, intangible assets or deferred tax for example), some very odd balance sheets might result, with reported net assets before and after a number of items, and special reserves for all sorts of different items. Inevitably this presentation undermines the basic approach of FRED, by giving the impression that the ASB do not fully believe in these assets and liabilities.

2.16 At the bottom of page 48 it is stated that FRED20’s presentation is in accordance with the Companies Act. This seems to us at least arguable. The requirements to follow the balance sheet formats (paragraphs 3(2) and 5 of Schedule 4 in particular) could apparently have been contravened as set out below.

• For pension liabilities it would not be a question of being allowed to create a new balance sheet heading, but of the grounds for not using the prescribed heading under provisions for liabilities and charges.

• Pension assets would not have been included under either fixed or current assets.

• Assets and liabilities relating to different schemes might be netted off, and deferred tax would have been netted against the pension balance.

Q7. Do you agree that the expected return on assets and the interest cost should both be shown within the interest item in the profit and loss account?

2.17 We do not agree with this treatment. In fact the actual wording in FRED20 is “as a financial item adjacent to interest”, and not within it. We consider that the proposed treatment is making the accounting more complex, and the interest cost in the P&L less understandable than it should be.

2.18 We agree that, for the sake of clarity and of international harmonisation, the various components should be shown in the notes to the accounts. However the charge for pensions should be a single operating item.

Q8. The FRED proposes that the service cost and interest cost should be based on the discount rate at the beginning of the period. An alternative approach would be to base them on the average discount rate over the period. Do you prefer the use of the discount rate at the beginning of the period or an average rate for the period?

2.19 The average rate for the year seems conceptually preferable. We also consider the precision of budgeting argument to be irrelevant to financial reporting. For the sake of harmonisation with IAS19, however, it may be better to adopt the discount rate at the beginning of the period.

Q9. Do you agree with the method of calculating the expected return on equities or would you support the alternative approach of using a risk-free return?

2.20 We support the use of the expected rate, on the grounds principally that it is consistent with IAS19.

Q10. Do you agree that actuarial gains and losses should be recognised immediately in the STRGL?

2.21 No. See our responses to Q1 and Q7 above. We would support actuarial gains and losses being spread forward over service lives and not recognised immediately. Though the various components might be separately disclosed we would see the pension cost being charged as a single item in operating profit.

Q11. Do you agree that the actuarial gains and losses, once recognised in the STRGL, should not be recognised again in the P&L in subsequent periods (“recycled”)?

2.22 As noted above, we would not support a pension item in the STRGL. In general we agree that recycling should not be allowed. We recognise, however, that the difficulties of distinguishing elements referred to in our response to Q1 above will mean that

• it may be difficult to identify recycling in practice where it is happening

  and

• material elements of pension costs might never be charged as an operating cost, on the basis of some rather arbitrary distinctions.

Q12. Do you agree that past service costs should be recognised in the P&L over the period in which the increases vest?

2.23 Yes. Certainly if the immediate recognition approach is accepted, this seems the right answer.

Q13. Do you agree with the following proposed disclosures:

(a) disclosure of the contribution for the accounting period and any agreed contributions for future years?

(b) separate disclosure of each of the main financial assumptions?

(c) comparison of the expected rate of return on assets with the AA corporate bond rate?

(d) an analysis of the movements in the surplus/deficit during the period and disclosure of any surplus that is unrecognised because of its irrecoverability?

(e) the five year history of amounts recognised in the STRGL?

2.24 We agree with these in general.

2.25 The disclosure in (c) might perhaps be better stated as simply the disclosure of the expected rates of return on different asset groups and of the discount rate used for valuing the liabilities. We are not clear whether it is helpful to ask preparers apparently to explain the various rates of return currently prevailing in the market-place.

2.26 If the proposed recognition model were proceeded with, we would agree that the disclosure (e) is needed to help monitor the division between the costs in the P&L and the other gains/losses going to the STRGL. This is an area where there could be scope for manipulation.

Q14. Do you agree that the following funding disclosures currently required by SSAP24 should be discontinued:

(a) the funding policy?

(b) the level of funding expressed in percentage terms?

2.27 In the light of the other disclosures under FRED20, these others do not seem necessary.

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