IAS19 Presentation to IAP2

8/7/2019 IAS19 Presentation to IAP2

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W W W . W A T S O N W Y A T T . C O M

IAS19PresentationIAP

10 January 2006

Bernie Thomas


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Copyright W atson Wyatt Worldwide. All rights reserved.

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Contents

Structure of the IASB

Scope of IAS19

Fundamental principles

IFRS1 and transition issues

Curtailments and settlements

The December 2004 amendments

Other accounting standards

Convergence


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A non-profit independent organisation

Oversight: IAS Committee Foundation trustees

Advice: Standards Advisory Council Executive: IAS Board

Interpretation: IFRIC

Research: Staff

Structure of IASB

www.iasb.org
http://www.iasb.org/


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Over 90 countries follow IFRS and IASs, includingthe EU, South Africa, Australia, Japan, etc

India and China recently appointed as trustees in

preparation for these countries to adhere

USA and Canada still outside IASB but in regulardiscussions for convergence

Structure of IASB


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IAS19 covers almost all employeebenefits

Short-term employee benefits (salaries, bonuses, cashbenefits, vacation pay) - immediate recognition of costs

Post employment benefits (pension, retirement benefits, postemployment life insurance, medical)

Other long-term employee benefits (long service leave, longservice benefits) - must hold provisions

Termination benefits - immediate recognition of costs (but thismay change)

NOTE: Equity compensation benefits are covered under IFRS2

Todays discussion is on post employment benefits


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Accounting valuations require that both liabilities and assetsare measured at market value at the date coinciding with theentitys financial year

Funding valuations are carried out to assess the level ofcontributions required over time to ensure that the plan

assets are sufficient to meet the demands of benefitpayments

As these 2 valuations have different purposes they may end

up having different assumptions and calculation methodology

Todays discussion focuses on valuations for accounting

Overview of Accounting StandardsAccounting vs. Funding valuations


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Importance of accounting for longterm employee benefits

Company should have accumulated adequate provisions atretirement, termination,

paying benefits should not cause a "strain"

Cost of long term employee benefits for an individual shouldbe charged to P&L in a sensible fashion

cost spread over period of working lifetime

As well as pensions, this approach applies to lump sums onretirement, post retirement medical care etc

Applies regardless of how the

promise is funded

Start benefit ServiceEntry

Cost of promise

IAS 19Different

funding

approaches


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Why do we have accountingstandards for long term employeebenefits?

The difficulty is that the true cost of a long term employeebenefit is not known until the final benefit payment is made

Essentially, standards set out:

the assumptions used to value benefits

how to attribute benefits between past and future service

how to recognise deviations between actual and expectedexperience

Same company could report hugely different costs under

different standards

There is a problem to compare results across the globe


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What does IAS19 require (in brief!)

Requires a best estimate of likely future benefit payments

Future payments to be discounted back based on high qualitycorporate bond yields with matching duration

Value of future payments attributed to service over working

lifetime, or until vested

Gains/losses - deviations of actual experience from thatassumed, can be recognised immediately (through P&L orSoRIE) or can be amortised through the P&L


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Acceptance of IAS

IAS19 is obligatory for the consolidated accounts of allcompanies listed in the European Union with effect from 1January 2005

In addition, each EU country needs to decide whether to requireor permit non-listed entities to adopt the IAS 19 Standard

The changes introduced in December 2004(already endorsed by the EU) are only

obligatory from 1 January 2006 onwards, butmay be adopted earlier.

Prior to 2007, in certain EU countries theserules will not be obligatory to companies thatonly have debt listed in the EU or who arealready using a generally accepted accounting

standard.


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Implications of IAS 19 for P&L andbalance sheet

Depends on each company's approach!

IAS 19 liability assessment higher than manyapproaches

Companies with high equity investment could have:

volatility in disclosed funding position

BUT: at least for now, P&L impact can be mitigateddue to spreading rules


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To sum up, we can expect .

Increasing awareness of pension issues

Volatility of pension expense, leading to:

More consideration and analysis of investment strategies

Better understanding of assumptions by all parties involved:

more rigorous assumption setting Shareholder value still impacted by inefficient analysis of

pension expense, leading to:

Need for better communication of pension expense tofinancial press and investors

Accelerated trend to DC plans?

Far reaching consequences


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MethodologyRecognition and Measurement

Balance Sheet and P&L


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IAS 19 Key Points

One method to value and apportion liabilities ("Projected Unit Credit")

Value both formal and "constructive" obligations

Discount rate follows AA corporate bonds (government bonds if no deepmarket in corporate bonds exists)

P&L charges can smooth out fluctuations in assets and liabilities("gains/losses")

Disclose surplus/deficit and provision/pre-payment

Balance sheet provision/pre-payment is a smoothed version ofsurplus/deficit

Similar to the US standards: FAS87, 88, 106, 112, 132


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Methodology

Projected Unit Credit Method:

attribution of benefits to service according to theplans benefit formula

if formula is back-loaded then use straight lineattribution

Value legal obligation plus constructive obligation:

no realistic alternative but to pay the benefit

e.g. unacceptable damage to employee relations

One prescribed method


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Balance Sheet (actuarial view)

Defined Benefit Obligation (DBO)

Fair Value of Plan Assets

(Deficit) / Surplus

Unrecognised actuarial loss / (gain)

Unrecognised past service cost

Defined benefit (liability) / asset

(Disallowed Assets - Par 58)

Balance sheet (liability) / asset

The defined benefit (liability) / asset appears in the BalanceSheet and is a smoothed version of the Plan (deficit) / surplus


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Balance Sheet (accounting view)

Defined Benefit Obligation = (DBO)

+ (Plan assets)

= Deficit / (Surplus)

+ Unrecognised actuarial (loss) / gain

+ Unrecognised past service (cost)

= Defined benefit liability / (asset)

+ Disallowed Assets - Par 58

= Balance sheet liability / (asset)

The defined benefit liability / (asset) appears in the BalanceSheet and is a smoothed version of the Plan deficit / (surplus)


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Spread recognition / smoothing

Actuarial gains and losses:

minimum recognition is to amortise over expected working lifeto the extent that they fall outside 10% of the greater of theobligation or the value of the plan assets (the 10% corridor)

quicker recognition is allowed (but applied consistency)

immediate recognition could go through P&L

immediate recognition could go outside P&L (through SORIE)

Past service cost (benefit improvements):

immediate (if vested)

over period to vesting (if not vested)


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SORIEStatement of RecognisedIncome and Expenses

According to IAS 19 (amended December 2004), actuarialgains and losses can be recognised immediately (in theperiod in which they occur) outside P&L provided:

it is applied consistently:

for all defined benefit plans

for all actuarial gains and losses

for gains and losses arising from the asset ceiling

it is presented in a statement of changes in equity called

SORIE Requirement to disclose accumulated values


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Asset Ceiling

IAS19 permits a company to hold an asset in its BalanceSheet even though there exists an unrecognised deficit inan employee benefit plan. There is however a limit on thesize.

IAS19 also permits a company to show a liability in itsBalance Sheet even though there is an unrecognisedsurplus in its employee benefit plan.

Plan Liability

Asset ValueDeficit

Unrecognised Loss

Balance Sheet Asset

(100)

90(10)

20

10


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Paragraph 58A

Paragraph 58 should not result in a gain/loss recognised solely as a result of an

actuarial loss and past service cost/actuarial gain resulting in the current period.

3020Balance Sheet Asset / (Liability)

(30)(40)Disallowed Asset3020Asset Ceiling

1010EVA

6060Plan Asset / (Liability)

2010Unrecognised (Gain) / Loss

4050Plan Surplus / (Deficit)

140150Plan Assets

(100)(100)DBO

EoYBoY

Funded Status

Hence recognise a loss of 10


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Insurance contracts andreimbursement assets

Special care needed when insurance contracts areestablished to settle plan liability

Consider whether the asset is a plan asset or a

reimbursement asset If it is a group insurance company issuing the

contract then special care is needed

If nothing else, issuing a group policy goes against

prudent man investment philosophy


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IAS19 - Defined Benefit Plans -

Disclosures

Accounting policy for recognizing actuarial gains & losses

General description of the type of plan

Reconciliation of the assets and liabilities (balance sheet)

The amounts included in the fair value of assets of own

financial instruments and property or other assets used bythe employer

Reconciliation with movements during the period of theliability in the balance sheet

Details of total P&L expense (income statement)

Actual return on plan assets

Principal actuarial assumptions


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IAS19 - Defined Benefit Plans -

Disclosures 2

Current year plus 4 historic years of plan obligation, planassets and experience analysis (differs from gains / lossesby changes in assumptions), if available

Sensitivity analysis for medical trend costs

Description of how asset return assumption is derived Assets broken down into major classes (equity, debt,

property, other)

Consolidate without loss of key information


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IAS19 - Assumptions

Assumptions are owned by the reporting entity but

should take into consideration the opinion of anactuary

Auditors are looking at assumptions in greaterdetail, especially the discount rate and mortality

Portugal needs a rigorous study into mortality trendsand whether generational mortality tables should be

considered


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Transition requirements: IFRS1

First reporting period for EU HQ companiescommences on or after 1 January 2005

In first reporting period, show at least last years

accounts on same basis First time application of IFRS1

Many companies have tended to immediatelyrecognise all gains/losses at Transition Date via

Retained Earnings

Transition Date = Start of period for IFRSaccounts


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IAS19 vs FAS87

Both standards almost the same on:

actuarial method

assumption setting

composition of the P&L charge

But differ in:

Timing and location of recognition of gains / losses

FAS 87 allows asset smoothing

fine details of past/future service attribution of benefits

approach to benefit improvements, settlements, curtailments

transition rules

and lots more subtle but important points of detail

IASB favours moving IAS19 towards immediate recognition


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The future

International AccountingStandards

Globally

Convergence of FAS 87 and IAS 19, in medium term

Why?

Improve and harmonize external financial reporting for reasons of:

transparency

comparability

Move to comparability and consistency

FAS 87 IAS 19


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ConvergencePossible future changes

CurrentCurrent IASIAS 1919

Deferred recognition in incomestatement (10% corridor) and optionto recognise immediately throughSORIE (outside P&L).

If vested: Immediate recognitionIf non-vested: recognition on astraight-line basis over vestingperiod

An asset can be recognisedprovided

(I) the entity can benefit from refunds orreduction in future contributions

Possible futurePossible future IASIAS 1919

Immediate recognition only?

Immediate recognition?

Idem but also when thesurplus can be used to

(ii) fund increased benefits for

current and future employees (iii) fund future losses in the plan

IssuesIssues

Recognition ofgains/losses

Plan amendments

Asset ceiling


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ConvergencePossible future changes

CurrentCurrent IASIAS 1919

Expected return on assets

Difference between actualand expected return onassets is treated as again/loss

Possible futurePossible future IASIAS 1919

Actual return on assets

Use of two column

format for incomestatement as part of a

general review of

presentation (similar tocombined UK P&L andSTRGL)

income before

remeasurement (noasset return)

and income after

remeasurement (actualreturn)

IssuesIssues

Return on assets as acomponent of costs in theincome statement


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ConvergencePossible future changes - Other

Other changes likely to be linked to comprehensive review withFASB, but may include:

Definition of defined contribution, defined benefit plan, planassets

Presentation of components of the cost in the income statement

Consolidation and balance sheet presentation

Position of defined benefit asset/liability in the balance sheet

The basis for setting the discount rate

Whether it is appropriate to include the effects of future salary

growth in the liability assessment The expected return on plan assets

The possibilities for deferred recognition of gains and assets


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W W W . W A T S O N W Y A T T . C O M

Thank you

IAS19 Presentation to IAP2

Documents

Transcript of IAS19 Presentation to IAP2