IASB Amends IAS 19 The Next Phase in the Evolution of Accounting for Retirement Benefits

 
IASB Amends IAS 19
The Next Phase in the Evolution of
Accounting for Retirement Benefits
July 2011
Executive Overview                                         •• Clarification of guidance on measurement issues,
                                                              such as the treatment of plan administration costs,
                                                              taxes paid by the plan and the implications of risk-
In a further step in the evolution of the accounting
                                                              sharing features of the plan
for retirement benefits, the International Accounting
                                                           •• Expanded disclosures to provide more insight about
Standards Board (IASB) has issued its long-awaited
                                                              the company’s risks associated with the retirement
amendment to IAS 19, Employee Benefits (IAS 19, rev.
                                                              plans, including the timing, amount and uncertainty
2011). As amended, IAS 19 will require immediate
                                                              of future cash flows, and the implications of the
recognition of all changes in the funded position of
                                                              regulatory environment in which the plans operate
employers’ retirement plans. It also establishes a new
measure of net interest income or cost. The effect of      The changes to IAS 19 will affect entities differently,
the changes will vary depending on a company’s current     depending on the nature of their plans and current
accounting policy under IAS 19. The key changes for        accounting policies, but will often result in some or all
plan sponsors to consider are:                             of the following:

                                                           •• Lower net income
•• Immediate recognition of all noncash changes in
                                                           •• Less volatility in net income
   funded position — gains and losses arising from
                                                           •• Higher balance sheet liability or lower balance sheet
   experience differing from what was assumed,
                                                              asset for retirement benefits
   changes in assumptions, investment gains and
                                                           •• Greater volatility in the balance sheet asset or
   losses on plan assets, and the effect of plan
                                                              liability
   changes
                                                           • More onerous disclosure requirements
•• Replacement of interest cost and the expected
   return on plan assets with net interest income/cost     IAS 19, rev. 2011 is effective for fiscal years beginning
   on the asset or liability recognised on the balance     on or after 1 January 2013; retrospective application
   sheet; this net interest income or cost is measured     (restatement of prior periods’ financial statements and
   based on the plan’s discount rate                       financial information presented for comparative
•• Disaggregation of the components of retirement          purposes) is required. Early adoption is permitted.
   cost into service cost, net interest on the defined
   benefit asset or liability, and remeasurement effects
   (gains/losses, including asset returns differing from
   the discount rate and changes in the asset ceiling);
   the remeasurement component is reported in other
   comprehensive income (OCI), whereas the service
   cost and net interest income/cost are reported in
   profit and loss (P&L)

towerswatson.com                                                                 IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 2
Background                                                   undertake such a project depends on the outcome of
                                                             its public outreach on the future strategic direction and
                                                             balance of its overall work plan. As such, we believe
Users of financial statements have expressed concerns
                                                             more comprehensive changes to benefits accounting
about employers’ transparency in accounting for and
                                                             are unlikely in the next several years.                                   “The
                                                                                                                                        “   IASB believes greater
reporting on their benefit promises under current
accounting rules, the risks associated with their benefit                                                                                transparency is achieved
                                                                                                                                         by immediately recognis-
plans and the effect of the benefit plans on the entities’
financial position and income. In addition, the increased
                                                             What Has Changed?                                                           ing changes in the funded
prevalence of less traditional retirement plan designs
                                                             The IASB believes greater transparency is achieved by                       position of retirement plans
has led to questions about the measurement of
                                                             immediately recognising changes in the funded position                      on the plan sponsor’s balance
retirement obligations.
                                                             of retirement plans on the plan sponsor’s balance sheet
                                                                                                                                         sheet and comprehensive
In June 2011, the IASB issued an amendment to IAS            and comprehensive income statement, and enhancing
19 to address short-term targeted changes to the             financial statement presentation and disclosures. As                        income statement, and by
accounting for employee benefits. Those changes,             amended, IAS 19 more closely aligns the balance sheet                       enhancing the financial
which are responsive to the concerns raised by analysts      effects with the balance sheet effects reported under                       statement presentation and
and investors, are focused on recognition and presenta-      U.S. GAAP — but the income statement effects are
                                                                                                                                         disclosures.”
tion of changes in the defined benefit obligation (DBO)      vastly different.
and plan assets, expanded disclosures and clarification
                                                             IAS 19, rev. 2011 makes the following substantive
of miscellaneous measurement and definitional issues.
                                                             changes to plan sponsors’ accounting for retirement
The amendment sets the stage for a more comprehen-
                                                             benefits (referred to as “post-employment benefits”).
sive reexamination of the accounting for, and financial
reporting of, post-employment benefit promises.
However, whether and, if so, when the IASB will

towerswatson.com                                                                   IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 3
Immediate Recognition of Gains/Losses
and Plan Changes

   Currently                                                                          IAS 19, rev. 2011

   Gains and losses may be recognised either                                          All gains and losses are to
   immediately through P&L or OCI, or on a delayed                                    be recognised immediately
   basis. At a minimum, plan sponsors must                                            through OCI.
   amortise the net gain or loss outside a corridor
   (defined as 10% of the greater of the DBO or the
   fair value of plan assets) over participants’ future
   service periods.

   The change in the DBO due to plan changes                                          The entire change in the
   affecting vested benefits is recognised immedi-                                    DBO due to plan changes
   ately; the effect of plan changes affecting                                        is to be recognised
   nonvested benefits is amortised over future                                        immediately through P&L.
   periods to the date the amended benefits vest.

Figure 1 illustrates the resulting change in the amount
reported on the balance sheet for a company currently
deferring recognition of gains and losses.

Figure 1. Balance sheet implications of adopting IAS 19, rev 2011

                         Balance Sheet — After IAS 19, rev. 2011
       Assets                                          Liabilities and Equity
       Postretirement benefit asset       0            Postretirement benefit liability 60 + 40 = 100
       Deferred tax asset*     18 + 12 = 30            Other liabilities                          720
       Other                           961             Total liabilities                          820
       Total assets                    991
                                                       Total equity                   199 – 281 = 171

                                                       Total liabilities and equity               991

      Funded status reconciliation
      DBO                                      (900)
      Plan assets (fair value)                  800
      Funded status                            (100)

      Unrecognised PSC                10
      Unrecognised net loss           30
      Total deferred costs            40        40
      Accrued DB liability                     (60)

         Current               Amendment
     * Assumes 30% effective tax rate
     1
       Shareholders’ equity is reduced/increased by unrecognised costs/credits, net of tax effects, i.e.,
       previously deferred costs of 40 − (40 x 30%) = 28.

towerswatson.com                                                                                               IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 4
Towers Watson Observations

Immediate recognition of gains and losses is intended to                    income statement effects related to a plan change,
improve transparency in entities’ financial reporting.                      curtailment or settlement) may reflect the current
After considerable debate, the IASB decided to require                      discount rate and plan asset values, the current service
immediate recognition of retirement plan gains and                          cost and net interest on the defined benefit asset or
losses in OCI rather than in P&L.1 This will isolate the                    liability continue to be based on the financial assump-
effect of unexpected changes in the DBO and fair value                      tions determined at the beginning of the year.
of plan assets in OCI, which is useful to financial
                                                                            Immediate recognition of all plan changes reflects the
statement users. By eliminating the P&L volatility arising
                                                                            views expressed by most respondents to the changes
from those unpredictable changes, period-to-period
                                                                            proposed in the IASB’s April 2010 Exposure Draft.
comparisons of profitability are enhanced.
                                                                            However, particularly for changes in benefits that don’t
For entities that currently delay recognition of gains and                  vest until retirement eligibility, such as some retiree
losses (for example, by using the “10% corridor” option                     medical benefits, it will result in more P&L volatility.
under IAS 19), the move to immediate recognition of
gains and losses is a significant change that may                        “Immediate
                                                                          “           recognition of gains
dramatically increase their balance sheet liability or
reduce the asset recognised, and lead to substantially                    and losses also has implications
more balance sheet volatility.
                                                                          for interim reporting purposes.”
Immediate recognition of gains and losses also has
implications for interim reporting purposes. IAS 34,                        As a result of these changes, plan sponsors will report a
Interim Financial Reporting, requires the use of the same                   defined benefit asset for their plans that are overfunded
accounting policies in the interim financial statements                     and a defined benefit liability for plans that are under-
as those applied in the annual financial statements. It                     funded. The resulting balance sheet aligns with the
also requires an explanation of events and transactions                     reporting under U.S. GAAP, but is subject to an asset
that are significant to understanding the changes in                        ceiling based on the recoverable surplus and a potential
financial position and performance since the last fiscal                    liability for onerous funding obligations for past service.
year-end. Consequently, an interim remeasurement of
                                                                            In adopting these changes, any plan costs that have
the plan’s funded status (and effects of the asset
                                                                            been deferred (unamortised losses or gains and
ceiling) is required if there has been a significant change
                                                                            unamortised past service cost or credit) will be charged
in the economic environment or other events that
                                                                            or credited to equity. This enhanced balance sheet focus
materially affect the amount reported on the balance
                                                                            may lead some employers to reconsider how they
sheet. Note, however, that IAS 34 also states that the
                                                                            measure risk in their pension plans. Plan sponsors
frequency of an entity’s financial reporting (quarterly,
                                                                            should also consider the implications for debt
half-yearly or annually) should not affect the annual cost.
                                                                            covenants.
So, although the balance sheet asset or liability (and

1
    The IASB did not change the accounting for “other long-term benefits.” Gains and losses arising from unexpected changes in the funded status of
    other long-term benefits continue to be required to be recognised immediately in P&L.

towerswatson.com                                                                                        IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 5
Interest Cost and the Expected Return on Plan Assets Are
Replaced With a Measure of Net Interest on the Defined
Benefit Asset or Liability
    Currently                                                                 IAS 19, rev. 2011

    Interest cost reflects the expected increase in                           Net interest income or cost measures the expected
    the DBO due to the time value of money.                                   change in the balance sheet asset or liability
                                                                              (“defined benefit asset or liability”) due to the
    The expected return on plan assets reflects the
                                                                              time value of money; the discount rate2 is used to
    expected increase in the fair value of assets due
                                                                              measure the effect of the passage of time.
    to investment performance.

    Towers Watson Observations
The new measure of net interest income or cost reflects                        The new standard does not specifically address whether
the market’s view of unfunded benefit obligations as debt                      interest on current service cost is to be included in
or debt-like. As with debt, plan sponsors will accrue                          service cost or the net interest income/cost. The
interest cost on the unpaid principal, that is, the unfunded                   explanation of the calculation of net interest income or
DBO, or accrue interest income on the plans’ recoverable                       cost and an example in IAS 19 suggest it should be
surplus (Figure 2). It also reflects the IASB’s and analysts’                  included in service cost. However, it is not clear that is
concerns about the significant judgment required by                            the only reasonable interpretation, since the net interest
entities in selecting their assumption about the expected                      cost is to reflect the change in the DBO due to the
rate of return on plan assets and its relationship to the                      passage of time. Once accrued, current service cost is
discount rate.                                                                 included in the DBO, with future increases in that DBO
                                                                               seemingly reflecting the passage of time — consistent
The net interest approach effectively assumes an
                                                                               with the concept of interest cost (as opposed to an
expected rate of return on plan assets equal to the
                                                                               exchange for additional service). Similarly, past service
discount rate and ignores the plan’s asset allocation. The
                                                                               cost is measured as the change in the DBO due to a
difference between the actual return on plan assets and
                                                                               plan amendment or curtailment, and does not include
the discount-rate-based estimated return is included in
                                                                               the effects of interest for the remainder of the year.
the gains and losses recognised through OCI.
                                                                               Therefore, we believe interest on current service cost
In a change from the current treatment, no interest                            arguably may be either included entirely in current
income (expected return) is accrued on any irrecoverable                       service cost, or split between current service cost and
plan surplus3 (that is, the plan surplus in excess of the                      net interest cost based on the portion of the accounting
asset ceiling). However, like its predecessor, the new                         period before and after service is rendered (half a year on
standard is silent with respect to an additional liability                     average). The latter treatment would also be consistent
arising due to a minimum funding requirement4 and                              with the treatment of contributions and benefit payments.
whether interest on any such additional liability should                       The method selected should be followed consistently.
be accrued. We believe it is consistent with the underlying
notion of accruing interest on the defined benefit asset or
liability to include interest on any additional liability in
measuring the net interest income or cost.

2
 		Discount rates are based on market yields on high-quality corporate bonds; where there is no deep market in such bonds, government bond
   yields are used.
3
 		Under the current rules, the expected return on plan assets is based on the fair value of all plan assets, including any plan surplus in excess
   of the asset ceiling. Asset returns not recoverable due to the asset ceiling are recognised as a gain or loss arising from changes in the
   irrecoverable surplus due to the asset ceiling.
4
   IFRIC 14, The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction, requires recognition of an additional
   liability in cases where funding a minimum funding requirement for past service would lead to irrecoverable surplus under IAS 19.

towerswatson.com                                                                                          IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 6
Figure 2 compares the current approach of recognising                         and plans anywhere with heavily de-risked investment
         interest cost on the DBO and the expected return on                           strategies may have after-tax asset returns that are
         plan assets, with the net interest on the defined benefit                     actually lower than the discount rate; in those cases,
         asset (recoverable surplus) or liability (plan deficit). It is                the plan sponsor’s net income will actually increase.
         admittedly counterintuitive to recognise net interest
                                                                                       Implicitly assuming an expected rate of return on plan
         income on a plan deficit that the market views as debt
                                                                                       assets equal to the discount rate could encourage more
         or debt-like.
                                                                                       conservative investing and de-risking strategies. Over
         In most cases, the net interest approach will reduce net                      the long term, such a reaction will likely increase the
         income, since a plan sponsor’s P&L will not benefit from                      plan sponsor’s real cost of providing defined benefits,
         the expectation of higher returns on riskier investments.                     but should reduce balance sheet volatility. On the other
         In some countries, such as Hong Kong, where the                               hand, higher asset returns realised from riskier
         discount rate is based on government bond yields,5 the                        investment strategies improve a plan’s funded position,
         reduction in net income can be significant. On the other                      and reduce the future net interest charge and the
         hand, some plans in countries such as Indonesia,                              employer’s real cost of providing the benefits, but may
         Japan, Malaysia, the Philippines, Singapore and Taiwan,                       increase balance sheet volatility.

         Figure 2. Net interest on DB liability/asset replaces interest cost and EROA
         Assume 5% discount rate, 7.5% EROA and the following funded position:

                                      Today                                                                        Future

 DBO =                              IC: 10,000 x 5% =          500                                             Deficit = 2,000
10,000
                                                                                       DBO =
              DBO =                 EROA: 8,000 x 7.5% = (600)                        10,000                   Net interest cost =
             10,000                 Net cost (income)        (100)                                             2,000 x 5% = 100
                                                                                                                                       Surplus = 2,000
                         FVA =        FVA =                                                       FVA =                                Asset ceiling = 1,500
                         8,000       10,000                                                       8,000       FVA =
                                                                                                                                       Net interest income
                                                                                                             10,000
                                                                                                                                       on net recoverable
                                                                                                                                       surplus =
                                                 DBO =                                                                   DBO =
                                                 8,000                                                                   8,000         1,500 x 5% = 75

                                                             IC: 8,000 x 5% =              400
                                                             EROA: 10,000 x 7.5% = (750)
                                                             Net cost (income)     (350)

         5
             If there is no deep market in high-quality corporate bonds, the discount rate is to be based on market yields on government bonds.

         towerswatson.com                                                                                         IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 7
Post-employment benefit cost is                                             Towers Watson Observations

disaggregated into service cost,                                         Reporting service cost and net interest on the defined
                                                                         benefit asset or liability in P&L and remeasurement
net interest income or cost, and                                         effects in OCI should align with the needs of the users
remeasurement effects                                                    of the company’s financial statements. By reporting
                                                                         unexpected and uncontrollable changes in the plans’
                                                                         funded status in OCI, investors and analysts should be
Post-employment benefit cost is to be disaggregated                      able to better assess the company’s current operating
into three components:                                                   performance and forecast future earnings. Companies
•• A service cost (current and past service cost,6                       may also find the resulting measure of EBIT (or EBITDA)
   and nonroutine settlement effects), which will be                     to be more useful.
   reported in P&L
•• A financing cost (net interest on the defined benefit
   asset or liability), which will be reported in P&L
                                                                         Figure 3. Reporting the components of cost
• A remeasurement component (actuarial gains and
   losses, including the difference between the actual                      Statement of Income
   return on plan assets [net of taxes and investment
                                                                            Business:
   management costs] and the return implied by the
                                                                            Operating income and expenses
   discount rate, and changes in the asset ceiling),
   which will be reported in OCI                                                                                           Service cost (current service cost, past service
                                                                            Employment costs*                              cost including curtailment effects, gain/loss from
Currently, IAS 19 does not prescribe how the                                                                               [nonroutine] settlements)
components of benefit cost are to be presented in                           Finance costs:
the financial statements, that is, as a single amount                       Pension financing cost*                        Net interest on DB liability/asset
(e.g., in operating costs) or separate components                           Taxes
(e.g., reporting service cost in operating costs, and
                                                                            Net income
interest and the expected asset return in financing
costs). The IASB had considered specifying in
IAS 19, rev. 2011 where in P&L the service cost and                         Statement of Comprehensive Income
net interest income/cost are to be reported, but
decided to continue to leave this to the employer’s                         Net income
discretion, pending completion of the financial                             Other comprehensive income, net of tax effects:
statement presentation project. They recognise that                                                                        Remeasurement effects (gains/losses from
the consequence of this interim decision will lead to                                                                      assumption changes and experience different than
comparability issues, but are relying on plan sponsors                      Pension remeasurements                         assumed, including gain/loss from asset returns
                                                                                                                           different from the return implied by the discount
to present the service cost and net interest income or                                                                     rate, and changes in the asset ceiling)
cost where it would be most useful for investors’
                                                                            Other comprehensive income
analysis. Figure 3 provides an example of how the
                                                                            Total comprehensive income
components of cost could be reported.
                                                                         *The IASB has not specified where the service cost and net interest cost components are to be reported.
The remeasurement effect recognised in OCI does
                                                                         The approach illustrated above is expected to be the predominant approach.
not recycle through P&L. It may be accumulated as
a separate account within equity or closed out to
retained earnings.

6
    Past service cost has been defined to include curtailment effects.

towerswatson.com                                                                                   IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 8
Clarification of the Recognition                               Towers Watson Observations
of Taxes Payable by the Plan                                 Taxes are levied on employee benefit costs in a number
                                                             of jurisdictions. These can take a number of forms and
Currently, taxes payable by the plan may be reflected as     sometimes are referred to as social charges. For
a reduction in the return on plan assets or included in      example:
the actuarial assumptions used to measure the DBO.
                                                               Nature of tax                     Common in
As illustrated in Figure 4, under IAS 19, rev. 2011, taxes
payable by the plan on contributions from the plan            Tax on contributions
sponsor and on benefit payments are to be included in         to the plan:
the actuarial assumptions used to measure the DBO;               •• Paid by the plan            Australia, Belgium and
taxes payable by the plan on the plan’s investment                                              Denmark
returns are included in determining the actual return            •• Paid by employer            Belgium, France, Norway
on plan assets.                                                                                 and Sweden

Figure 4. Accounting for taxes paid by plan                   Tax paid by employer on           France, U.S.
                                                              benefits payments                 (nonqualified plans)
                        Accrued in          Reduces
                        measuring DBO       actual return     Tax on local GAAP                  Sweden
                        and current         on plan           liabilities arising from
                        service cost        assets            benefit promise
  Nature of tax                             Tax on
                        Tax on benefits                      As noted in Figure 4, the taxes paid by the plan on
                                            investment
                        payable                              contributions, benefits or the benefit promise will be
                                            return*
                        Contributions tax
                                                             accrued in measuring the DBO and current service cost.

* Effectively recognised through OCI                         Many countries, such as Australia, Denmark, New
                                                             Zealand and the U.S. (for retiree medical/welfare
                                                             plans), explicitly tax plans’ investment returns. As noted
                                                             in Figure 4, taxes paid by the plan on investment
                                                             returns reduce the actual return on plan assets. Since
                                                             asset returns different from the discount-rate-based
                                                             implied return are considered a remeasurement effect,
                                                             taxes paid by the plan on investment returns (and asset
                                                             management fees) are effectively charged to OCI rather
                                                             than P&L.

                                                             Canada has a unique form of “refundable tax” on
                                                             nonregistered pension plans (retirement compensation
                                                             arrangements or RCAs) whereby plan sponsors are
                                                             required to deposit half of the RCA trust assets with the
                                                             Canadian government. Those assets, which do not grow
                                                             with interest, are returned to the trust when benefits are
                                                             paid. The accounting for such arrangements is unclear,
                                                             and will require further analysis and discussions with
                                                             auditors.

                                                             IAS 19 addresses only taxes paid by the plan. If
                                                             material, taxes paid by the employer should be accrued
                                                             in accordance with IAS 12, Income Taxes, IAS 19, or IAS
                                                             37, Provisions, Contingent Liabilities and Contingent
                                                             Assets. The IASB chose not to provide guidance
                                                             between these treatments, but rather indicated that
                                                             judgment should be applied.

towerswatson.com                                                                     IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 9
Expanded Guidance on                                                             Towers Watson Observations

Recognition of Plan Expenses                                                  The IASB’s decision to require plan sponsors to
                                                                              expense plan administration costs as incurred is
                                                                              good news for many companies, but will be a step
Plan expenses can effectively be divided into two
                                                                              backward for plan sponsors that have been accruing                              “The
                                                                                                                                                               “   IASB has clarified that
categories — the cost of administering the plan and
                                                                              plan administration costs as future benefit costs are
the cost of managing the plan’s investments (for                                                                                                               plan administration costs
                                                                              accrued (current service cost) and in measuring the
funded plans).                                                                                                                                                 are not to be deducted
                                                                              DBO. Although the standard does not specify where
Currently, plan sponsors recognise plan administration                        the costs of administering the plan are to be reported,                          from plan asset returns.”
costs either as a reduction in the return on plan assets,                     we suspect most entities will include the cost in selling,
a direct charge to P&L, or an explicit assumption in                          general and administrative expenses (SG&A) or in the
measuring the DBO. The IASB had proposed explicitly                           same line item(s) as (but not a part of) service cost
requiring plan sponsors to include assumed administra-                        — whether or not the costs are paid from plan assets.
tive costs in measuring the DBO and service cost.                             Regardless of where the plan administration costs are
While such an approach more appropriately measures                            reported, we believe the use of surplus to pay those
the ultimate cost of providing the benefits, the cost of                      costs is permitted for purposes of determining the
developing the resulting measure could well exceed its                        economic value of the surplus pursuant to IFRIC 14.
value to investors.
                                                                              Because the difference between the actual return on
The IASB has clarified that plan administration costs                         plan assets and the return implied by the discount
are not to be deducted from plan asset returns.                               rate is recognised as a remeasurement effect in OCI,
Although the standard is silent on the treatment of                           reducing the actual return on plan assets by the
those costs, the basis for conclusions is fairly clear that                   investment management costs effectively results in
the costs of administering the plan should be expensed                        recognising those costs through OCI. The distinction
as those costs are incurred.7 The costs of managing the                       between the plan administration costs and asset
plan’s investments are also recognised as incurred, but                       management costs is therefore important. Conse-
are to be reported as a reduction in the actual return                        quently, in cases where a single fee is charged for
on plan assets. Reducing the asset return by only those                       asset management and plan administration, the
administrative costs that are related to managing                             standard requires that the plan sponsor determine
the plan assets better aligns the recognition and                             a best estimate of the allocation of the fee between
presentation of plan administration costs for funded                          the two services. For example, employers could
and unfunded plans.                                                           determine the cost of administering the plan if it were
                                                                              unfunded or determine the market price for asset
                                                                              management, with the residual fee allocated to the
                                                                              plan administration services.

7
    The standard continues to require an explicit assumption about the expected future cost of processing retiree medical claims in measuring the
    service cost and DBO.

towerswatson.com                                                                                        IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 10
Implications of Risk-Sharing                                      Towers Watson Observations

Features in a Plan                                             The clarification about attribution may affect plans with
                                                               employee contributions, but the actual implications are
                                                               unclear. Although the objective is apparent, the applica-
The standard clarifies that the objective in measuring the
                                                               tion of the rules may create challenges in determining
DBO is to determine the employer’s share of the ultimate
                                                               the split between employees’ past contributions and the
cost of providing the benefits. The employer’s cost can
                                                               employer’s share of cost. For example, there may be
be affected by certain risk-sharing features in a plan:
                                                               insufficient documentation of the amounts that have
•• Member contributions: The benefits of a plan surplus        been contributed by employees in prior years. And even
   or the cost of a plan deficit may be shared by the          when those records do exist, it is unclear how experi-
   employer and current and/or former employees,               ence gains and losses and assumption changes (e.g.,
   including retirees. IAS 19, rev. 2011 clarifies that        the discount rate) should be considered in determining
   the plan sponsor’s and employees’ shares of the             the portion of the DBO representing the employer’s
   expected cost of the defined benefits should be             versus employees’ share of the cost.
   separately attributed to years of service based on
                                                               The implications of the other clarifications around risk
   the benefit formula or, if the benefit is back-loaded,
                                                               sharing are too situation-specific to permit any general
   on a straight-line basis. This results in attributing the
                                                               commentary, as they depend on the particular features
   employer’s net benefit cost (i.e., expected benefit
                                                               of the plan and the extent to which the risk-sharing
   cost net of employee contributions for past and
                                                               aspects are already reflected in measurement of the
   future service) rather than the gross cost reduced by
                                                               DBO. As a general observation, though, we note that
   current period contributions. Employee contributions
                                                               plans with risk-sharing features are common in the
   increase the DBO when they are received.
                                                               Netherlands and Switzerland, and therefore recommend
•• Contribution limits: There may be limits on the plan        particular attention be paid to plans in those countries.
   sponsor’s obligation to make additional contributions
   for past service. The standard observes that the            Figure 5. Risk sharing may apply on three different levels:
   DBO should take into account any limit on the
   contributions a plan sponsor is required to make
   toward the cost of the benefits.                                                                                                             Third party
                                                                    Reporting entity                        Employer                          (e.g., fund or
•• Conditional indexation: Benefit increases may be                                                        contribution                    insurance company)
   conditioned on a plan’s funded status. For plans with                                                   (e.g., limit on
   conditional indexation — whether automatic or a                                                         contribution)
   past practice that creates a constructive obligation
   — plan sponsors are to project the expected benefit
                                                                                                Be

                                                                                                                                       fit

                                                                                                                                               (e.g., adjustments of
                                                                                                                                     ne
                                                                                                 ne

   based on the current funded status of the plan and                                                                                          benefits depending on
                                                                                                                                  Be
                                                                                                   fit
                                                                              Pa ont
                                                                                c
                                                                                r t rib

                                                                                                                                               performance target or
   assumptions about current market expectations
                                                                                   ic ut

                                                                                                                                               other criteria, e.g., funded
                                                                                     ip io

                                                               (e.g., participant
                                                                                       an n

   (e.g., expected long-term rate of return on plan            contributions are                                                               position)
                                                                                         t

   assets) for the future periods that could lead to           fixed percentage of
                                                               total cost or contribution,
   indexation of the benefit.                                  increase when plan becomes              Employee/Retiree
                                                               underfunded, or increase if
                                                               benefit cost exceeds limit on
                                                               employer’s share of that cost)

towerswatson.com                                                                         IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 11
Expanded Disclosures Focused                                  reporting the effect on the DBO of changes in the key
                                                              assumptions that are reasonably possible, the methods
on Assessing Risk                                             used in preparing that analysis and any limitations on
                                                              those methods and changes from prior years. (Disclo-
                                                              sure of the sensitivity information is required only for
IAS 19, rev. 2011 takes a principle-based approach to         fiscal years on and after the date IAS 19, rev. 2011 is
disclosures by providing a description of the underlying      adopted — 2013 and later for companies not adopting
objectives of an entity’s disclosures:                        the new rules early.)
•• Explain the characteristics of the defined benefit
   plans and the risks to the company as the plan             Disclosures were added to provide insight about the
                                                              uncertainty of the plans’ future cash flows. Those                          “The
                                                                                                                                           “   principle-based focus
   sponsor
•• Identify and explain the amounts recognised in the         disclosures focus on:                                                        of the disclosures should
   financial statements                                       •• A description of asset/liability matching strategies                      result in disclosures that are
• Describe the plans’ effect on the company’s future             including annuity purchases and other techniques                          less generic and more com-
   cash flows                                                    to mitigate risk                                                          pany-specific, and therefore
In order to meet those objectives, companies are              • Information about future cash flows including
                                                                                                                                           more useful to investors and
required to disaggregate plans with materially different         expected contributions for the next year and a
                                                                 maturity profile (weighted average duration) of the                       analysts.”
risk features (e.g., based on geography, regulatory
environment or funded versus unfunded plans) and                 DBO; a maturity analysis, identifying the distribution
describe characteristics of the plans and the risks they         of the timing of benefit payments, is encouraged but
pose to the entity. Although not specifically required, the      not required
standard seems to strongly encourage an analysis of the       Disclosure requirements for employers participating in
DBO that provides insight into the nature, characteristics    a multiemployer plan have also been expanded to
and risks of the obligation. For example, plan sponsors       include a description of how any surplus or deficit is
might disclose the DBO separately for active employees,       to be allocated upon windup of the plan or how the
deferred vested employees and retirees; identify the          amount to be paid on withdrawal from the plan is
portion of the DBO related to benefits that are vested        determined. Employers accounting for their participation
versus those that are accrued but not vested; and/or          in a multiemployer plan as though it were a defined
disclose the effects on the DBO of conditional benefits,      contribution plan are also required to disclose their
amounts attributable to future pay growth and other           expected contributions for the next year and provide
benefits.                                                     a measure of the level of the company’s participation
Disclosure of the reconciliation of changes in the DBO,       in the plan, such as the company’s share of the total
fair value of plan assets and reimbursement rights —          contribution to the multiemployer plan or the portion of
from the beginning to the end of the fiscal year —            the total members in the plan.
continues to be required, as is a description of the
relationship of reimbursement rights to the DBO.
                                                                Towers Watson Observations
Disclosure of the reconciliation of changes in the asset
ceiling has been added. Enhanced information about            The principle-based focus of the disclosures should
asset risk, including disaggregation of the plan assets       result in disclosures that are less generic and more
into asset classes based on the nature of the assets          company-specific, and therefore more useful to inves-
and risk profile, is required. Disclosure of the fair value   tors and analysts. Companies may wish to rethink the
of those asset classes is to be split between the assets      aggregation of plan disclosures in light of the emphasis
with a quoted market price and those without a quoted         on identifying risk.
market price.
                                                              Some existing disclosures related to the funded status
As in the past, significant actuarial assumptions are to      of the plans and amounts recognised on the balance
be disclosed, but the assumptions are not specified,          sheet have been eliminated because they are no longer
leaving it up to the company to determine the key             necessary or are apparent from the financial reporting.
assumptions needed to understand the amounts                  Others, such as the five-year history of the DBO, fair
reported in the financial statements. That disclosure is      value of plan assets, surplus or deficit, and experience
to be supplemented with a sensitivity analysis to aid the     gains/losses are no longer required as the information
financial statement user in understanding the uncer-          is redundant with disclosures provided in prior year
tainty of the reported amounts. This analysis requires        financial statements.

towerswatson.com                                                                    IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 12
Termination Benefits                                          •• Expected changes in mortality (e.g., allowance for
                                                                 future improvements) should be considered
                                                                 in developing the mortality assumption.
Termination benefits are accounted for separately from
                                                              Although not unique to IAS 19, it is also worth noting
other benefits and exclude benefits payable in exchange
                                                              that the newly issued IFRS 13, Fair Value Measurement,
for future service (such as involuntary termination
                                                              calls for measuring assets with a quoted market price
benefits that are, in substance, a stay bonus) and
                                                              using the price within the bid-ask spread that is most
benefits payable upon voluntary termination, unless the
                                                              representative of fair value. The use of a bid price is
termination was the result of a short-term offer by the
                                                              permitted, but not required. The use of mid-market
employer to encourage voluntary terminations (an
                                                              pricing or another pricing convention used by market
“open window”).
                                                              participants is also permitted.
The cost of termination benefits is to be recognised at
the earlier of the date the cost of any related restructur-
                                                                 Towers Watson Observations
ing is recognised or the date an employer can no longer
withdraw its offer. For an open window, that is the date      The clarification of the definition of a defined benefit
the employee accepts the offer and any restrictions on        plan may cause some plans, primarily certain Dutch
the employer’s ability to withdraw the offer take effect.     plans that have been accounted for as defined benefit,
                                                              to now be classified as defined contribution. Although
  Towers Watson Observations                                  those plans have a benefit formula, the employer
                                                              contributions are often limited to benefits earned for
The change in the timing of recognising the cost of an        current service; in those situations, funding shortfalls
open window — from the date the offer is made to the          for past service are borne by the plan members or
date the employees accept the offer — aligns with U.S.        through a reduction in benefits.
GAAP. However, unlike U.S. GAAP, an offer to provide
specified termination benefits if employees continue to       In assessing whether a plan is to be accounted for as
work until a specified date, for example, due to an           defined benefit or defined contribution, it will be
announced plant closing, is not considered to be a            necessary to consider not only the legal documentation
termination benefit under IAS 19, as it requires future       about contributions, but also whether there could be a
service by the affected employees.                            constructive obligation for the employer to make good
                                                              on any plan deficit. It is too early to say how practice in
The exclusion of benefits payable in exchange for future      interpreting the clarification may develop. However, plan
service could affect the accounting for “old age              documents and communications to members explicitly
part-time arrangements” such as Altersteilzeit or ATZ         excluding the possibility of additional contributions by
in Germany.                                                   the employer would seem to provide more evidence
                                                              that a plan is defined contribution than if the plan
                                                              documents and communications are silent on this
Miscellaneous Changes                                         issue.

                                                              The IASB opted not to address the issue of whether
The amendment to IAS 19 includes other clarifications         expected salary growth should be considered in
and amendments intended to address issues that have           determining whether a benefit formula attributes a
arisen in practice:                                           materially higher level of benefit to later years of service
•• The existence of a benefit formula does not, in            (i.e., formula is back-loaded). This issue is closely tied
   and of itself, cause a plan to be a defined benefit        to the consideration of contribution-based promises,
   plan; rather, it is a link between the benefit formula     which would likely be addressed in the IASB’s more
   and contributions creating a legal or constructive         comprehensive project on accounting for employee
   obligation to contribute amounts to fund the defined       benefits, if and when that project is undertaken. The
   benefits that creates a defined benefit plan.              IASB also decided not to incorporate IFRIC 14 into IAS
•• The distinction between short-term and long-term           19 due to concerns that drafting changes could have
   employee benefits depends on the timing of the             unintended consequences. Consistent interpretation of
   expected settlement (rather than when an employee          IFRIC 14 continues to be a challenge in some countries,
   would be entitled to the benefit).                         most notably Canada.

towerswatson.com                                                                    IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 13
Timing                                                          What You Should Do Now
IAS 19, rev. 2011 is effective for fiscal years beginning       You should analyse the effect of IAS 19, rev. 2011 on
on or after 1 January 2013, with earlier adoption               the level and volatility of your P&L — and balance
permitted. The new standard is to be applied retrospec-         sheet, if you are amortising gains and losses and/or
tively, which will require entities to restate prior periods’   have significant unamortised past service costs or
financial statements and financial information pre-             credits — and assess the need to communicate the
sented for comparative purposes.                                effect of the changes to your stakeholders. This
                                                                analysis should encompass the implications on key
Adoption of IAS 19, rev. 2011 may be subject to local
                                                                financial metrics and debt covenants.
endorsement. In particular, EU-listed companies will
need to await endorsement by the EU before adopting             Consideration should be given to whether the overall
the new rules.                                                  pension risk management and/or pension investment
                                                                strategy should be revised in light of the enhanced
Entities should keep in mind that for annual periods
                                                                balance sheet presentation, new measure of the net
prior to adopting the new standard, IAS 8, Accounting
                                                                interest on the defined benefit asset or liability, and the
Policies, Changes in Accounting Estimates and Errors,
                                                                effect on performance measures.
requires plan sponsors to disclose information relevant
to assessing the possible impact of IAS 19, rev. 2011           Similarly, the effect on performance-based compensa-
on the company’s financial statements.                          tion measures that are affected by retirement benefit
                                                                costs (such as unadjusted earnings per share) should
   Towers Watson Observations                                   be considered and adjusted as appropriate.

                                                                Consideration should be given to any additional
Companies adopting IFRS in 2011 or 2012 may choose
                                                                information and time needed to comply with the new
to adopt IAS 19, rev. 2011 in their initial IFRS financial
                                                                standard, for example:
statements to avoid having to restate the prior-year
information presented in their 2013 financial state-            •• Identifying taxes paid on benefits and/or
ments. Even if those companies opt to defer adopting               contributions (whether paid by the plan or the
the new rules until the 2013 effective date, they may              plan sponsor)
wish to consider the clarifications included in the new         •• Evaluating plans with risk-sharing features
standard.                                                       •• Developing a framework for meeting the new
                                                                   disclosure objectives and principles, and assigning
                                                                   responsibilities for preparing the new disclosures

Summary                                                         •• Adjusting internal reporting systems
                                                                • Gathering or developing comparative information
                                                                   needed for interim and annual financial reporting
The current amendment to IAS 19 represents an
                                                                Finally, you may wish to consider the timing of plan
evolution in the accounting for employee benefits that
                                                                changes, workforce reductions and/or settlements
should improve transparency and enhance comparability
                                                                based on the financial statement implications pre-
by eliminating accounting method choices and making
                                                                and post-adoption of IAS 19, rev. 2011.
short-term fixes. Although substantially more limited in
scope than initially contemplated in the 2008 Discus-
sion Paper, the changes may significantly affect plan
sponsors’ financial reporting and the information
disclosed about their benefit plans.

A more comprehensive reconsideration of the frame-
work for accounting for employee benefits, which could
be more dramatic, may be several years off.

towerswatson.com                                                                      IASB Amends IAS 19: The Next Phase in the Evolution of Accounting for Retirement Benefits 14
About Towers Watson
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