ias19 presentation to iap2
TRANSCRIPT
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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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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