Benefit Costs for Multinationals
Significant changes in accounting requirements for
multinational companies in relation to employee benefits can be
expected in the near future. A new international standard is
being developed by the International Accounting Standards
Committee (IASC) which, if it follows the approach proposed in
exposure draft E54, will have wide implications for
multinationals everywhere. This development results from changes
being driven by the International Organisation of Securities
Commissions (IOSCO) prompted in part by European-based
multinationals looking for a satisfactory international standard
in a number of key areas, including employee benefit costs.
IAS19
The current Accounting Standard, IAS19, which relates to
accounting for retirement benefit costs in financial statements
of employers, came into effect on 1 January 1985. At that time it
provided a standard which could be adopted in countries where
there was no local standard and accordingly was applied in
various countries outside the UK and the US. However, as the
provisions of IAS19 were broad enough to accommodate both FAS87
and SSAP24, it had no real impact in the UK or the US.
This is about to change, as the new proposals set out in E54
involve significant differences from both FAS87 and SSAP24. Local
accounting standard setting bodies will have to decide whether to
follow the international standard or develop their own local
standards.
In its current form IAS19 covers only retirement benefits and
allows for a relatively free choice of actuarial method and
assumptions. It was revised in 1995 in order to establish the
Accrued Benefit Method as the benchmark approach, with the
Projected Benefit Method as an alternative. However, the key
shortcomings perceived by the IASC in relation to IAS19 are that
it gives little guidance on balance sheet treatment, inadequate
guidance on specific types of plan, allows too much diversity of
accounting methods, and restricts comparability of accounts
between different enterprises.
Proposed changes
These concerns resulted in the development of the current
exposure draft, E54, which includes the following proposed
changes:
- the company balance sheet is required to recognise a net
pension asset or liability;
- the Projected Unit Credit Method is prescribed;
- the discount rate is prescribed as the current yield on
corporate bonds of appropriate maturity (or government
bonds where there is no market in corporate bonds);
- there is to be a 10% corridor within which actuarial
gains and losses would be deferred, but with immediate
recognition of gains and losses outside this corridor;
- plan assets are to be taken at market value.
One key concern is that whereas the move to market value of
assets is acceptable, it is essential for the discount rate to be
based on the spread of investments, including equities for salary
related liabilities (at least in those countries in which the
normal practice for such liabilities would be to fund in this
fashion), and not simply on bond yields.
A second concern is that the amortisation of actuarial gains
and losses should be spread over the expected future working
lifetime of the employees. In responding to the exposure draft
the International Forum of Actuarial Associations (IFAA) has
argued that the corridor is an unnecessary complication and that
amortisation should be applied to all actuarial gains and losses,
except that actuarial gains and losses beyond a 25% threshold
should be acknowledged immediately, since they are unlikely to be
reversed in the foreseeable future.
The scope of the proposals
If adopted without any modifications, E54 would lead to more
volatile pension costs. Calculations we have made for a number of
companies demonstrate clearly that the volatility of pension
costs over recent years would have been much greater under the
current proposals than was the case under either FAS87 or SSAP24.
Significant fluctuations in asset values will lead to large
provisions or prepayments appearing on company balance sheets. As
the gain or loss recognised in this fashion is contingent upon
the future fortunes of the pension plan, it is hard to understand
the rationale for its immediate recognition. If analysts
eliminate this item in making inter-company comparisons, this
would negate the attempt to provide an accepted uniform benchmark
for comparative analysis.
In addition, the proposals could require specific calculations
to be made for arrangements which have not conventionally been
subject to calculation. Examples include Dutch industry-wide
arrangements and the Swedish ITP system (particularly if the
FPG/PRI book reserving approach favoured by larger enterprises
has been selected). Moreover, whereas IAS19 currently applies
only to pensions, all employee benefits are covered by E54. This
will include healthcare (both in- service and after retirement),
long service awards and deferred compensation arrangements such
as stock plans. The effects could be far reaching.
Consultation
The IASC visited interested parties to make submissions with
their observations on the draft. Through the IFAA we have been
pressing for certain changes to be made to the exposure draft.
The main areas on which the IFAA has focused have been :
- the preference that gains and losses should be amortised
over the expected future working lifetime of employees;
- the fact that for many defined benefit plans, equities
are the most appropriate match. The proposed use of bond
yields for discounting will overstate the liabilities and
give rise to unnecessary volatility in pension expense.
The IFAA's preferred approach is to adopt a framework, agreed
by the 40 actuarial bodies it represents, setting out the general
principles which any actuarial guidance note prepared by national
actuarial bodies would follow. Each national body would then
decide whether to develop its own guidance. At the least it might
be anticipated that specific guidance would be issued in
Australia, Canada, South Africa, the UK and the USA.
Timescale
The IASC is currently considering comments on E54, and the
result of their deliberations is to become known later this year.
Their aim is go publish the revised standard by March 1998. Once
the final form of revisions to IAS19 is settled, companies are
likely to have until the year 2001 before the revisions take
effect, but earlier compliance is encouraged. Thus companies are
likely to need to give serious consideration to these proposals
within the next 12 months.
At present, it is unclear whether the IFAA and others will be
successful in persuading the IASC to change its present course.
Also, the US has shown some inclination to disregard the
proposals, perhaps reflecting a belief that FAS87 remains an
appropriate standard given its widespread use. It is possible
that the current status quo will be preserved; but on balance,
this seems unlikely.
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