This note highlights some of the recent developments relating to occupational (see OECD pensions taxonomy: EDG Contribution by J.M. Salou posted on February 20, 2003) pension accounting, and in particular that, under International Accounting Standard (IAS) 19 recommendations, unfunded pension benefits are to be recorded, as a general rule, as liabilities in the balance sheet of the sponsoring employer.
The International Accounting Standards Board (IASB) clearly distinguishes two categories: defined contribution plans and defined benefits plans. In this paper, the author focuses only on plans that are not defined contribution (from the plan sponsor?s, i.e. the employer?s, perspective). In defined contribution plans, the sponsor?s obligation is clearly defined under the terms of the plan. In these plans, employers face no liabilities under the existing arrangement. The IASB, through the rule IAS 19, has determined that in these cases the employer?s annual contribution under the terms of the occupational plan should be recognized as an expense.
The IASB Board approved IAS 19 in May 1999 and has since revised it in two occasions, in 2000 and in 2002. IAS 19 prescribes the accounting and disclosure rules with respect to employers? benefits, in particular "post-employment benefits such as pensions, other retirement benefits, post-employment life insurance and post-employment medical care". Post employment benefits plans are classified as either defined contribution plans or defined benefit plans. (See the EDG contribution by Ahmad Hamidi-Ravari posted on August 1, 2003)
Of course, the terms of the plan may be revised, and employers may be required to, for example, increase their contribution to the plan. If after any modifications the new plan is still a defined contribution one, the same IAS 19 rule applies for the recognition of employer?s expenses.
While defined contribution plans carry no liability for employers, they do not necessarily lay investment and biometric risks on the plan members. Occupational plans are sometimes administered by a third company, a life insurance company or a dedicated pension entity (who is often regulated as an insurance company), that may offer guarantees over returns or/and underwrite annuities. Such schemes are prevalent in some Nordic countries, such as Denmark and Iceland. The accounting treatment of the employer, however, is that of a defined contribution plan under the OECD/IASB definition.
IAS 19 foresees that unfunded pension benefits (using the projected unit credit method and a discount rate based on high quality corporate bond rate) in defined benefits plans should be recorded as a pension liability in the employer?s balance sheet. However, ?actuarial gains and losses? within a range of 10% of plan assets or obligations may not be reflected at all on the balance sheet. "Actuarial gains and losses" above/below this level can be amortized over the working life of employees.
Some European countries have already begun to adapt their accounting rules to comply with IAS 19. The United Kingdom recently introduced FRS17 which is largely consistent with IAS 19. The main difference is that FRS 17 requires that any actuarial and investment gains and losses are fully and immediately recognized on the company?s balance sheet statement. IAS 19 may actually be reformed to follow FRS 17 practice. Indeed, in June 2002, the IASB tentatively agreed that actuarial gains and losses should be recognized immediately. i.e. that the 10 percent corridor and spreading options within IAS 19 should be removed (see the EDG contribution by Anne McGeachin posted on June 24, 2003). This decision, if implemented, would also prohibit the smoothing of actual returns. The effect of return smoothing is similar to that of the spreading option within IAS 19. Instead, IASB seems to be veering towards fair value without any smoothing or spreading options.
Juan Yermo works at the OECD (Directorate for Financial, Fiscal and Enterprise Affairs). He is involved with the work of the OECD Working Party on Private Pensions.
The paper reflects personal views and does not engage the responsibility of the OECD.
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