Thursday, July 1, 2010

Comparative Study of Accounting Standards for Reporting of Pension Plans

By Gurtej Singh Sadiora

The main objective of pension plan reporting in financial statements is to make sure a true picture of pension scheme is provided in the plan sponsor’s financial statements. The accounting standard boards issue accounting standards to guide and regulate reporting of pension plans. Accounting standard statements have their own objectives but the main idea is to make financial statements more transparent, consistent, easily understandable to user of accounts and represent them in a more faithful manner.

A comparative study of accounting standards issued by Financial Accounting Standards Board (FASB) in USA, UK Accounting Standard Board (ASB), International Accounting Standards and by The Council of the Institute of Chartered Accountants of India is presented in this paper.


The Companies, filing accounts in USA, use accounting standards issued by Financial Accounting Standard Board (FASB). In December 1985, FASB issued SFAS No. 87 to regulate pension plan reporting in financial statements of employers, this is later amended by SFAS No. 132 in February 1998. SFAS 132 also amend SFAS No. 88 and SFAS No. 106. In September 2006 SFAS No.158 was introduced as “Employer’s Accounting for Defined Benefit Pension and other Post Retirement Plans” – an amendment to FAS 87, 88, 106 and 132(R). SFAS No. 158 is now requirement of companies to report pension plan in their financial statements.

In November 2000, the UK Accounting Standard Board (ASB) introduced FRS 17 to regulate retirement benefit plan’s reporting in financial statements of employers. It became mandatory for accounting period beginning on or after January 2005 and replaced Statement of Standard Accounting Practice (SSAP24). In December 2006, ASB issued an amendment to FRS 17 and in January 2007 (ASB) issued a reporting statement entitled “Retirement Benefits – Disclosures” and sets out additional disclosures that complement the disclosure requirement of FRS 17. This reporting Statement is a best practice guide and is not mandatory. We will discuss below the main objective of this reporting statement and the principles set out.

The companies governed by law of and EU member state, trading on a regulated market in any EU member state are required to prepare their consolidated accounts in compliance with international accounting standard for accounting period starting on or after 1 January 2005. For listed companies in UK, IAS 19 is a requirement but for unlisted companies the IAS19 is optional.

The benefit cost requirements in IAS19 and FRS17 are consistent in most respect; the only major difference is the recognition of actuarial gain and losses. We will discuses this later.

The Council of the Institute of Chartered Accountants of India issued Accounting Standard (AS) 15 in 1995 and revised it in 2005 to guide companies filing their accounts in India.

For a comparative study of the main three accounting standards please refer to the following summary of these accounting standards.



SFAS 158
FRS 17(amended in 2006)
AS 15(Revised 2005)
Other related Accounting Standards
·    FAS 87 (Employer’s Accounting for Pensions)
·    FAS 88 (Employer’s Accounting for Settlements and Curtailment of Defined Benefit plan and for Termination Benefits)
·   FAS 132(Employer’s Disclosures about     Pensions and Other Post Retirement Benefits.- an  amendment to SFAS No. 87, 88,
106)
·    FRS 17 issued in November 2000
·    Statement of Standard Account
     Practice 24(SSAP24)

·  Originally issued in 1995 Titled “Accounting for Retirement Benefits in the Financial statements of Employers”

Objectives
·    Full Recognition of funded status of a defined benefit post-retirement plan as an asset or liability in its statement of financial position
·    Recognition of changes in funded status in comprehensive income

·  Company pension assets and liabilities are measured at “fair value”
·  Operating and financing costs are recognized in the appropriate period
·  Proper disclosures are provided
·    To prescribe the accounting and disclosures for employee benefits.
·    Recognize a liability when an employee has provided service in exchange for employee benefits to be paid in the future and recognize an expense when enterprise consume the economic benefit arising from service provided by an employee in exchange of employee benefits
Effective Dates
For employers with publicly traded equities, fiscal year ending after December 15, 2006.
For employers without publicly traded equities, fiscal year ending after June 15, 2007.
Accounting period beginning on or after 1 January 2005
Accounting period commencing on or after December 2006
Measurement Date of Plan Assets and Benefit Obligation
Fiscal year end
Balance sheet date
Balance sheet date
Valuation Method
Projected Unit Credit Method for benefit obligations. Assets should be measured at their fair value as of the measurement date.
Projected unit method for benefit obligations. Assets should be measured at their fair value as of the balance sheet date
Projected unit method for benefit obligations.  Assets should be measured at their fair value as of the balance sheet date
Principal Actuarial Assumptions
·    Discount Rate:
It should be determined by reference to return on a high quality fixed income investments of equivalent term and currency to the liability.
·   Expected return on Plan assets
It shall be determined based on the expected long-term rate of return on market-related value of plan assets
·    Salary scale
·    Mortality
·    Rate of employee turnover
·    Other assumptions as per particular plan’s requirement.
·    Discount Rate should be determined by reference to return on a high quality corporate bond of equivalent term and currency to the liability. A high quality corporate bond means a bond that has been rated at the level of AA or equivalent status.
·      Expected return on Plan assets
·      Salary scale
·      Mortality
·      Rate of employee turnover
·      Other assumptions as per particular plan’s requirement
·      Discount Rate should be determined by reference to market yields at balance sheet date on government bonds of term equivalent to the term on liabilities.
·      Expected return on Plan assets.
·      Salary scale
·      Mortality
·      Rate of employee turnover
·      Other assumptions as per particular plan’s requirement
Amounts to be recognized in Balance Sheet
Funded Status measured as difference between fair value of assets and the benefit obligations should be recognized in Balance sheet as an Asset or Liability in appropriate section

Recognize components of Accumulated Other Comprehensive Income (AOCI) in Capital section of balance sheet.
The accumulated other comprehensive income includes the gain or losses, prior service cost or credit and transition assets or obligation that arise but are not recognized as components of net periodic benefit cost
The surplus/deficit in a defined benefit scheme is the excess/shortfall of the value of the assets in the scheme over/below the present value of the scheme liabilities.

Actuarial gain and losses are recognized “below the line” in the Statement of recognized gain and loss (STRGL)
The STRGL is an account used to reconcile balance sheet changes which do not form part of a company’s normal trading.

The amount recognized in balance sheet should be net total of
(a)   PBO at balance sheet date.
(b)  Less any past service cost not yet recognized
(c)   Less fair value of plan assets at balance sheet date
If the amount determined as above is negative that can be considered as an asset but capped by present value of any economic benefit available in form of refund from the plan or reduction in future contributions.
Amounts to be recognized in Income Statement
The following components shall be included in Net Periodic Pension Cost
(a) Service cost.
(b)    Interest Cost.
(c) Actual return on plan assets.
(d)    Amortization of any prior service cost.
(e) Amortization of gain or loss.
(f)     Amortization of any net transition asset/obligation.

The amount recognized in profit and loss account under FRS17 include items
(a)   The Service cost.
(b)   Interest cost.
(c)   Expected return on assets
(d)   Past service cost (if any).
(e)   Settlement and curtailment (if any).

The amount recognized in Profit & Loss should be net total of

(a)   Service Cost.
(b)  Interest cost.
(c)   Less Expected return on assets.
(d)  Actuarial gains and losses (fully recognized with no option of amortization)
(e)   Past service cost.
(f)   The effect of any curtailment and settlement.
Summary of Disclosure Requirements
·  Reconciliation of Benefit Obligation.
·  Reconciliation of fair value of plan assets.
·  Funded Status.
·  The amount of Net Periodic Pension Cost (NPPC).
·  Asset allocation.
·  The amount included in Other Comprehensive Income.
·  Principal Actuarial Assumptions
·  Employer’s Best estimate of contribution expected for next fiscal year
·  If applicable, cost of providing special or contractual termination benefits recognized during the period and description.
·  Accumulated Benefit Obligation
·  Expected Benefit Payments
·  If any alternative method of amortization used.
·  The expected Net Periodic Benefit Cost for next fiscal year, showing separately the amount in accumulated other comprehensive income that is expected to be recognized as net gain loss, net prior service cost or credit and net    transition assets or obligation in next fiscal year

·  Reconciliation of Benefit Obligation.
·  Reconciliation of fair value of plan assets.
·  The total expense recognized in P&L.
·  Asset allocation.
·  Amounts recognized in Statement of Total Recognized Gains and Losses (STRGL)

·  Principal Actuarial Assumptions
·  Employer’s best estimate of contribution expected for next fiscal year
·  Narrative description of the basis used to determine expected rate of return on assets.

·  Current and previous four year’s history of
o scheme liabilities , fair value of  assets and surplus/deficit in scheme
o Experience adjustments arising on scheme liability and assets in terms of either amount or percentage of scheme liability and assets respectively at balance sheet date
·  General Description of the type of scheme

·  Reconciliation of Benefit Obligation.
·  Reconciliation of fair value of plan assets.
·  A reconciliation of PBO and assets to the assets and liability recognized in the balance sheet.
·  The total expense recognized in P&L.
·  Asset allocation.
·  Analysis of PBO in amounts arising from plans that are wholly unfunded and that are fully or partly funded.
·  Principal Actuarial Assumptions.
·  Employer’s best estimate of contribution expected for next fiscal year.
·  Narrative description of the basis used to determine expected rate of return on assets.

·  Current and previous four year’s history of
o scheme liabilities , fair value of  assets and surplus/deficit in scheme
o Experience adjustments arising on scheme liability and assets in terms of either amount or percentage of scheme liability and assets respectively at balance sheet date
·  General Description of the type of scheme
·  The enterprise’s accounting policy for recognition of actuarial gain and losses.
·  Amount included of plan assets in enterprise’s own financial instruments.
 Recognition of Actuarial Gain/Loss
Recognition of Actuarial gain or loss is based on 10% corridor approach. If cumulative unrecognized gain or loss exceeds 10% of the greater of PBO or market value of assets at the beginning of the year, amortization is required. The amount to be amortized is the excess divided by average remaining service period of active employees expected to receive benefits under the Plan.
The unrecognized part of actuarial gain loss is set up in Accumulated Other Comprehensive Income and will be recognized in later years.
Actuarial Gain and losses are immediately recognized in Statement of Total Recognized Gain and Losses (STRGL). Gains and losses on settlement and curtailment are immediately recognized in profit and loss account.
AS 15 requires actuarial gain or losses should be recognized immediately in the statement of profit and loss as an income or expense.

IAS 19 Vs FRS 17

The pension cost requirement in FRS17 is consistent with IAS 19, the only major difference is recognition of actuarial gain or losses. 

The FRS requires actuarial gain and losses to be recognized immediately in the statement of total recognized gains and losses.


IAS 19(revised) requires an entity to either
  1. Recognize the specified portion of net cumulative actuarial gain or losses in the profit and loss account to the extent they exceed the greater of 10% of the fair value of plan assets and 10% of defined benefit obligation. The amount to be recognized is the excess that falls outside the 10% corridor spread forward over the remaining working lives of employee participating in the scheme; or
  2. Recognize immediately all actuarial gain or losses in the period in which they occur outside the profit and loss account in a Statement of Recognized Income and Expense; or
  3. Use any systematic method of faster recognition provided the same basis is applied to both gains and losses as the basis is applied consistently from period to period.
As we have discussed earlier ASB has issued a reporting statement on retirement benefit disclosures; the main objective of this reporting statement is to set out notes on best practice when providing disclosures for pension schemes. This statement sets out six principles to be considered when providing disclosure as following:
  1. The relationship between the company and trustee.
  2. The principal assumptions used to measure the scheme liability.
  3. The sensitivity of the principal assumptions used to measure the scheme liabilities. 
  4. How the liabilities arising from the defined benefit plan are measured.
  5. The future funding obligation in relation to the defined benefit scheme.
  6. The nature and extent of the risk arising from financial instruments held by the defined benefit scheme.
These principles are aimed to assist the user of financial statement in understanding the risk and rewards and funding obligations arising from defined benefit scheme.

Finally we can conclude the followings:
  1. All three standards are similar in:
    • Actuarial valuation method.
    • Composition of pension cost.
    • Amount to be recognized in balance sheet.
  2. AS15 (revised 2005) and FRS17 are similar on disclosure requirements.
  3. If an asset is to be recognized in the balance sheet, then this is limited to economically usable surplus in both AS15 and FRS17.
  4. The 10% corridor approach is a common method for recognition of gain/loss in IAS19 and FAS 158
References
  1. SFAS 87,132,106 and158 issued by FASB. 
  2. FRS 17 and Reporting Statement – Retirement benefit Disclosures, issued by ASB UK. 
  3. AS15 (revised 2005) issued by council of ICAI. 
  4. “Defined Benefit Answer Book”, Fourth Edition by G.Neff McGhie III. 
  5. ActEd Study Material: 2009, Subject SA-4. 

About the Author
Mr. Gurtej Singh Sadiora is an Actuarial Analyst working with Ranadey Professional Services. He is a Graduate from Punjab University and Student Member of Institute of Actuaries, UK and Institute of Actuaries of India.


Disclaimer: Information contained in and presented through this material is intended to provide a general understanding of the topics included, based on the author's understanding of applicable accounting standards. It should not be used for any other purpose.





No comments:

Post a Comment