ACCOUNTING STANDARDS BOARD NOVEMBER FRS 17 · ©The Accounting Standards Board Limited 2000 ISBN 1...

ACCOUNTING STANDARDS BOARD NOVEMBER 2000 FRS 17F

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RETIREMENT BENEF ITS

ACCOUNTINGSTANDARDSBOARD

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Financial Reporting Standard 17‘Retirement Benefits’ is issued by the Accounting Standards Board in respect of its application in the United Kingdomand by the Institute of CharteredAccountants in Ireland in respect of itsapplication in the Republic of Ireland.

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RETIREMENT BENEF ITS

ACCOUNTINGSTANDARDSBOARD

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©The Accounting Standards Board Limited 2000ISBN 1 85712 099 X

Financial Reporting Standard 17 is set out in paragraphs 1-105.

The Statement of Standard Accounting Practice, whichcomprises the paragraphs set in bold type, should beread in the context of the Objective as stated in paragraph 1 and the definitions set out in paragraph 2and also of the Foreword to Accounting Standards andthe Statement of Principles for Financial Reportingcurrently in issue.

The explanatory paragraphs contained in the FRSshall be regarded as part of the Statement of StandardAccounting Practice insofar as they assist in interpreting that statement.

Appendix IV ‘The development of the FRS’ reviewsconsiderations and arguments that were thought significant by members of the Board in reaching theconclusions on the FRS.

C O N T E N T S

Paragraphs

SUMMARY

FINANCIAL REPORTING STANDARD 17

Objective 1Definitions 2Scope 3-6Defined contribution schemes 7Multi-employer schemes 8-12Measurement of defined benefit schemes 13-36

Scheme assets 14-19Scheme liabilities 20-34

Actuarial method and assumptions 20-31The discount rate 32-34

Frequency of valuations 35-36Recognition of defined benefit schemes 37-74

Recognition in the balance sheet 37-49Recognition in the performance statements 50-74

Current service cost, interest cost and expected return on assets 51-56

Actuarial gains and losses 57-59Past service costs 60-63Settlements and curtailments 64-66Impact of limit on balance sheet asset 67-70Tax 71-72Death-in-service and incapacity benefits 73-74

Disclosures 75-93Defined contribution schemes 75Defined benefit schemes 76-93

Date from which effective and transitional arrangements 94-97

Withdrawal of SSAP 24 and UITF Abstracts 6 and 18 and amendment of other accounting standards 98-105

ACCOUNTING STANDARDS BOARD NOVEMBER FRS

ADOPTION OF FRS 17 BY THE BOARD

APPENDICES

I DISCLOSURE EXAMPLE

II NOTE ON LEGAL REQUIREMENTS

III COMPLIANCE WITH INTERNATIONAL ACCOUNTING STANDARDS

IV THE DEVELOPMENT OF THE FRS


S U M M A R Y

Financial Reporting Standard sets out therequirements for accounting for retirement benefits.

Defined contribution schemes

The cost of a defined contribution scheme is equal tothe contr ibutions payable to the scheme for theperiod.

Measurement of defined benefit scheme assets and liabilities

Defined benefit scheme assets are measured at fairvalue.

Defined benefit scheme liabilities are measured usingthe projected unit method.

Defined benefit scheme liabilities are discounted at thecurrent rate of return on a high quality corporatebond of equivalent term and currency to the liability.

Full actuarial valuations should be obtained at intervalsnot exceeding three years and should be updated ateach balance sheet date.

Recognition of defined benefit schemes

An asset is recognised to the extent that an employercan recover a surplus in a defined benefit schemethrough reduced contributions and refunds. A liabilityis recognised to the extent that the deficit reflects theemployer’s legal or constructive obligation.

The resulting defined benefit asset or liability ispresented separately on the face of the balance sheetafter other net assets.

SUMMARY

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The change in the defined benefit asset or liability(other than that arising from contributions to thescheme) is analysed into the following components:

(i) the current service cost

(ii) the interest cost

(iii) the expected return on assets

(iv) actuarial gains and losses

(v) past service costs (if any)

(vi) settlements and curtailments (if any).

The current service cost and interest cost are based onthe discount rate at the beginning of the period. Theexpected return on assets is based on the expected rateof return at the beginning of the period. The currentservice cost is shown within the appropriate statutoryheading for pension costs in the profit and lossaccount. The interest cost and expected return onassets are shown as a net amount of other finance costs(or income) adjacent to interest.

The expected return is calculated by applying theexpected rate of return over the long term to themarket value of scheme assets at the beginning of theyear, adjusted for any contributions received andbenefits paid during the year. Although the expectedrate of return will vary according to market conditionsit is expected that the amount of the return willnormally be relatively stable.

Actuarial gains and losses are recognised immediatelyin the statement of total recognised gains and losses.They are not recycled into the profit and loss accountin subsequent periods.


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Past service costs are recognised in the profit and lossaccount over the period until the benefits vest. If thebenefits vest immediately, the past service cost isrecognised immediately.

Gains and losses ar ising on settlements andcurtailments are recognised immediately in the profitand loss account.

Disclosures for defined benefit schemes

The following disclosures are required:

(i) the main assumptions underlying the scheme

(ii) an analysis of the assets in the scheme into broadclasses and the expected rate of return on eachclass

(iii) an analysis of the amounts included (a) withinoperating profit, (b) within other finance costsand (c) within the statement of total recognisedgains and losses

(iv) a five-year history of (a) the difference betweenthe expected and actual return on assets, (b)experience gains and losses arising on the schemeliabilities and (c) the total actuarial gain or loss

(v) an analysis of the movement in the surplus ordeficit in the scheme over the per iod and areconciliation of the surplus/deficit to the balancesheet asset/liability.

SUMMARY

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OBJECTIVE

The objective of this is to ensure that:

(a) financial statements reflect at fair value the assetsand liabilities ar ising from an employer’sretirement benefit obligations and any relatedfunding;

(b) the operating costs of providing retirementbenefits to employees are recognised in theaccounting period(s) in which the benefits areearned by the employees, and the related financecosts and any other changes in value of the assetsand liabilities are recognised in the accountingperiods in which they arise; and

(c) the financial statements contain adequatedisclosure of the cost of providing retirementbenefits and the related gains, losses, assets andliabilities.

DEFINITIONS

The following definitions shall apply in the and inparticular in the Statement of Standard AccountingPractice set out in bold type.

Actuarial gains and losses:-

Changes in actuarial deficits or surpluses that arisebecause:

(a) events have not coincided with the actuarialassumptions made for the last valuation(experience gains and losses) or


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(b) the actuarial assumptions have changed.

Current service cost:-

The increase in the present value of the schemeliabilities expected to arise from employee service inthe current period.

Curtailment:-

An event that reduces the expected years of futureservice of present employees or reduces for a numberof employees the accrual of defined benefits for someor all of their future service. Curtailments include:

(a) termination of employees’ services earlier thanexpected, for example as a result of closing afactory or discontinuing a segment of a business,and

(b) termination of, or amendment to the terms of, adefined benefit scheme so that some or all futureservice by current employees will no longerqualify for benefits or will qualify only for reducedbenefits.

Defined benefit scheme:-

A pension or other retirement benefit scheme otherthan a defined contribution scheme.

Usually, the scheme rules define the benefitsindependently of the contributions payable, and thebenefits are not directly related to the investments ofthe scheme. The scheme may be funded or unfunded.


Defined contribution scheme:-

A pension or other retirement benefit scheme intowhich an employer pays regular contributions fixed asan amount or as a percentage of pay and will have nolegal or constructive obligation to pay furthercontributions if the scheme does not have sufficientassets to pay all employee benefits relating to employeeservice in the current and prior periods.

An individual member’s benefits are determined byreference to contributions paid into the scheme inrespect of that member, usually increased by an amountbased on the investment return on those contributions.

Defined contribution schemes may also provide death-in-service benefits. For the purposes of this definition,death-in-service benefits are not deemed to relate toemployee service in the current and prior periods.

Expected rate of return on assets:-

The average rate of return, including both income andchanges in fair value but net of scheme expenses,expected over the remaining life of the relatedobligation on the actual assets held by the scheme.

Interest cost:-

The expected increase during the per iod in thepresent value of the scheme liabilities because thebenefits are one period closer to settlement.

Past service cost:-

The increase in the present value of the schemeliabilities related to employee service in prior periodsar ising in the current per iod as a result of theintroduction of, or improvement to, retirementbenefits.


Projected unit method:-

An accrued benefits valuation method in which thescheme liabilities make allowance for projectedearnings. An accrued benefits valuation method is avaluation method in which the scheme liabilities at thevaluation date relate to:

(a) the benefits for pensioners and defer redpensioners (ie individuals who have ceased to beactive members but are entitled to benefits payableat a later date) and their dependants, allowingwhere appropriate for future increases, and

(b) the accrued benefits for members in service onthe valuation date.

The accrued benefits are the benefits for service up toa given point in time, whether vested rights or not.

Guidance on the projected unit method is given in theGuidance Note GN issued by the Faculty andInstitute of Actuaries.

Retirement benefits:-

All forms of consideration given by an employer inexchange for services rendered by employees that arepayable after the completion of employment.

Retirement benefits do not include terminationbenefits payable as a result of either (i) an employer’sdecision to terminate an employee’s employmentbefore the normal retirement date or (ii) an employee’sdecision to accept voluntary redundancy in exchangefor those benefits, because these are not given inexchange for services rendered by employees.


Scheme liabilities:-

The liabilities of a defined benefit scheme foroutgoings due after the valuation date.

Scheme liabilities measured using the projected unitmethod reflect the benefits that the employer iscommitted to provide for service up to the valuationdate.

Settlement:-

An irrevocable action that relieves the employer (orthe defined benefit scheme) of the pr imaryresponsibility for a pension obligation and eliminatessignificant risks relating to the obligation and the assetsused to effect the settlement. Settlements include:

(a) a lump-sum cash payment to scheme members inexchange for their rights to receive specifiedpension benefits;

(b) the purchase of an irrevocable annuity contractsufficient to cover vested benefits; and

(c) the transfer of scheme assets and liabilities relatingto a group of employees leaving the scheme.

Vested rights:-

These are:

(a) for active members, benefits to which they wouldunconditionally be entitled on leaving thescheme;

(b) for deferred pensioners, their preserved benefits;

(c) for pensioners, pensions to which they areentitled.


Vested rights include where appropriate the relatedbenefits for spouses or other dependants.

SCOPE

The FRS applies to all financial statements thatare intended to give a true and fair view of areporting employer’s financial position andprofit or loss (or income and expenditure) for aperiod.

The covers all retirement benefits that an employeris committed to providing, whether the commitmentis statutory, contractual or implicit in the employer’sactions. It applies to retirement benefits ar isingoverseas, as well as those arising in the UK and theRepublic of Ireland. Retirement benefits include, forexample, pensions and medical care during retirement.

The covers funded and unfunded retirementbenefits, including schemes that are operated on a pay-as-you-go basis, whereby benefits are paid by theemployer in the period they fall due and no paymentsare made to fund benefits earned in the period. The requires a liability to be recognised as the benefitsare earned, not when they are due to be paid. Thefact that the employer is funded by centralgovernment (or any other body) is not a reason for theemployer not to recognise its own liabilities arisingunder the .

Reporting entities applying the FinancialReporting Standard for Smaller Entitiescurrently applicable are exempt from the FRS.


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DEFINED CONTRIBUTION SCHEMES

The cost of a defined contribution scheme isequal to the contr ibutions payable to thescheme for the accounting period. The costshould be recognised within operating profit inthe profit and loss account.

MULTI-EMPLOYER SCHEMES

Where more than one employer participates in adefined contribution scheme, no special problemsar ise, since the employer’s cost is limited to thecontributions payable.

Where more than one employer participates ina defined benefit scheme the employer shouldaccount for the scheme as a defined benefitscheme unless:

(a) the employer’s contributions are set inrelation to the current service period only(ie are not affected by any surplus or deficitin the scheme relating to past service of itsown employees or any other members ofthe scheme). If this is the case, theemployer should account for thecontributions to the scheme as if it were adefined contribution scheme.

(b) the employer’s contributions are affected bya surplus or deficit in the scheme but theemployer is unable to identify its share ofthe underlying assets and liabilities in thescheme on a consistent and reasonablebasis. If this is the case, the employershould account for the contributions to thescheme as if it were a defined contributionscheme but, in addition, disclose:


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(i) the fact that the scheme is a definedbenefit scheme but that the employer isunable to identify its share of theunderlying assets and liabilities; and

(ii) any available information about theexistence of the surplus or deficit in thescheme and the implications of thatsurplus or deficit for the employer.

Most multi-employer schemes will set contributionsfrom employers so as to make good any deficit in thescheme and may reduce contr ibutions to enableemployers to benefit from a surplus. However, insome multi-employer schemes, an employer may haveno obligation other than to pay a contribution thatreflects only the benefits earned in the current period.In this case, from the point of view of the employer,the scheme is a defined contribution scheme and isaccounted for as such. For this to be the case, theremust be clear evidence that the employer cannot berequired to pay additional contributions to the schemerelating to past service, including the existence of athird party that accepts that it has an obligation tofund the pension payments should the scheme haveinsufficient assets.

An employer may be required to make contributionsset at a level to make good any deficit but may beunable to identify its share of the underlying assets andliabilities in the scheme on a consistent and reasonablebasis. This may be the case if the scheme exposes theparticipating employers to actuarial risks associatedwith the current and former employees of otherentities, for example when the contributions fromemployers are set at a common level rather thanreflecting the characteristics of the workforces ofindividual employers.


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Subsidiaries are not exempt from the and, wherepossible, will account for defined benefit schemes inaccordance with its requirements. However, manygroup schemes are run on a basis that does not enableindividual companies within the group to identifytheir share of the underlying assets and liabilities. Inthese circumstances, the individual companies(including the parent company) within the group willaccount for the scheme as a defined contributionscheme and will give the additional disclosuresrequired above. From the point of view of the groupentity, a group defined benefit scheme is not a multi-employer scheme and is treated as any other definedbenefit scheme.

MEASUREMENT OF DEFINED BENEFITSCHEMES

Paragraphs - of the set out the requirementsfor measuring the assets and liabilities within a definedbenefit scheme (the scheme assets and the schemeliabilities). The recognition of an asset or liability andthe movements therein in the financial statements ofthe employer arising from the defined benefit schememeasured on this basis is covered in paragraphs -.

Scheme assets

Assets in a defined benefit scheme should bemeasured at their fair value at the balance sheetdate.

Scheme assets include cur rent assets as well asinvestments. Any liabilities such as accrued expensesshould be deducted.


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For quoted securities, the mid-market value is taken asthe fair value. For unquoted securities, an estimate offair value is used. The fair value of unitised securitiesis taken to be the average of the bid and offer prices.

Property should be valued at open market value or onanother appropriate basis of valuation determined inaccordance with the Appraisal and Valuation Manualpublished by the Royal Institution of CharteredSurveyors and the Practice Statements containedtherein.

Insurance policies that exactly match the amount andtiming of some or all of the benefits payable under thescheme should be measured at the same amount as therelated obligations. For other insurance policies thereare a number of possible valuation methods. A methodshould be chosen which gives the best approximationto fair value given the circumstances of the scheme.

Notional funding of a pension scheme does not giverise to assets in a scheme for the purposes of the .

Scheme liabilities

Actuarial method and assumptions

Defined benefit scheme liabilities should bemeasured on an actuar ial basis using theprojected unit method. The scheme liabilitiescomprise:

(a) any benefits promised under the formalterms of the scheme; and

(b) any constructive obligations for furtherbenefits where a public statement or pastpractice by the employer has created a validexpectation in the employees that suchbenefits will be granted.


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Where the scheme rules require a surplus arising inthe scheme to be shared between the employer andmembers (perhaps in conjunction with a similarshar ing of deficits), or where past practice hasestablished a valid expectation that this will be done,the amount that will be passed to members should betreated as increasing the scheme liabilities.

The benefits should be attributed to periods ofservice according to the scheme’s benefitformula, except where the benefit formulaattributes a disproportionate share of the totalbenefits to later years of service. In such cases,the benefit should be attributed on a straight-line basis over the period during which it isearned.

The assumptions underlying the valuationshould be mutually compatible and lead to thebest estimate of the future cash flows that willar ise under the scheme liabilities. Theassumptions are ultimately the responsibility ofthe directors (or equivalent) but should be setupon advice given by an actuary. Anyassumptions that are affected by economicconditions (financial assumptions) should reflectmarket expectations at the balance sheet date.

Because of the long-term nature of most definedbenefit schemes and the inherent uncertaintiesaffecting them, the liabilities of the scheme aremeasured on an actuar ial basis. This involvesestimating the future cash flows arising under thescheme liabilities based on a number of actuarialassumptions such as mortality rates, employee turnoverrates and salary growth, then discounting the cashflows at an appropriate rate.


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Some of these assumptions are affected by the sameeconomic factors. Actuarial assumptions are mutuallycompatible if they reflect the underlying economicfactors consistently. To be consistent with themeasurement of the assets of the scheme at fair value,they must also reflect market expectations at thebalance sheet date.

For example, the rate of increase in salaries and thediscount rate must reflect the same rate of generalinflation. In jurisdictions where there is a liquidmarket in long-dated inflation-linked bonds, the yieldson such bonds relative to those on fixed interest bondsof similar credit standing will give an indication of theexpected rate of general inflation.

The actuar ial assumptions should reflectexpected future events that will affect the cost ofthe benefits to which the employer is committed(either legally or through a constructiveobligation) at the balance sheet date.

Expected future events that will affect the cost of thebenefits include:

(a) any expected cost of living increases either providedfor in the scheme rules, publicly announced orawarded under an established practice that createsamong the employees a valid expectation ofreceiving them;

(b) in the case of pensions based on final salary, anyexpected salary increases; and

(c) expected early retirement where the employee hasthat right under the scheme rules.

These events affect the measurement of benefits towhich the employer is committed at the balance sheetdate.


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Expected future redundancies are not reflected in theactuarial assumptions because the employer is notcommitted (either legally or constructively) to makingsuch redundancies in advance. When the employerdoes become committed to making the redundancies,any impact on the defined benefit scheme is treated asa settlement and/or curtailment (see paragraph ).

Expected future changes in the cost of retirementhealthcare are particularly difficult to estimate—thecost often increases at a faster rate than either the retailpr ice index or national earnings rate. Relevantconsiderations in determining the assumptions used toarrive at the retirement healthcare obligation include:

(a) advances in medical skills and technologies, ofteninvolving more expensive treatment;

(b) the rise in the expectations of prospective patients;and

(c) the effect of the above on companies, governmentsand insurance schemes in cutting back benefits, ormaking the patient pay a proportion.

It is not appropriate to assume a reduction in benefitsbelow those currently promised on the grounds thatthe employer will curtail the scheme at some time inthe future.

The discount rate

Defined benefit scheme liabilities should bediscounted at a rate that reflects the time valueof money and the characteristics of the liability.Such a rate should be assumed to be thecurrent rate of return on a high qualitycorporate bond of equivalent currency andterm to the scheme liabilities.


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For this purpose, a high quality corporate bond meansa bond that has been rated at the level of AA orequivalent status. The rate of return for such a bondreflects the time value of money and a small premiumfor risk. That premium is taken to reflect the optionsthat the employer has to reduce the assumed schemeliabilities, including in extremis the option of closingdown the scheme. If there is no liquid market inbonds of this type or duration, then a reasonable proxyshould be used. This may be government bonds plusa margin for assumed credit risk spreads derived fromglobal bond markets.

Many pension schemes provide benefits at least partlylinked to inflation. One way to reflect thatcharacteristic would be to consider the return on anindex-linked corporate bond. However, given thatthere are few such bonds in existence, a more reliablealternative is to consider fixed interest corporate bondsand increase the cash flows to be discounted in linewith inflation (ie project the liability to be discountedin nominal terms). Guidance on the inflationassumption is given in paragraph .

Frequency of valuations

Full actuarial valuations by a professionallyqualified actuary should be obtained for adefined benefit scheme at intervals notexceeding three years. The actuary shouldreview the most recent actuarial valuation atthe balance sheet date and update it to reflectcurrent conditions.


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The actuarial valuations required for the may usedifferent assumptions and measurement methods fromthose used for a scheme’s funding valuation. Fullactuarial valuations under the are not needed atevery balance sheet date. Some aspects of thevaluation will need to be updated at each balancesheet date, for example the fair value of the assets andfinancial assumptions such as the discount rate. Otherassumptions, such as the expected leaving rate andmortality rate, may not need to be updated annually.

RECOGNITION OF DEFINED BENEFITSCHEMES

Recognition in the balance sheet

The surplus/deficit in a defined benefit schemeis the excess/shortfall of the value of the assetsin the scheme over/below the present value ofthe scheme liabilities. The employer shouldrecognise an asset to the extent that it is able torecover a surplus either through reducedcontributions in the future or through refundsfrom the scheme. The employer shouldrecognise a liability to the extent that it reflectsits legal or constructive obligation.

A surplus in the scheme gives rise to an asset of theemployer to the extent that:

(a) the employer controls its use, ie has the ability touse the surplus to generate future economicbenefits for itself , either in the form of areduction in future contributions or a refund fromthe scheme; and

(b) that control is a result of past events (contributionspaid by the employer and investment growth inexcess of rights earned by the employees).


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Usually the employer’s obligation under the trust deedis to pay such contributions as the actuary believes tobe necessary to keep the scheme fully funded butwithout building up a surplus. When a surplus arises,it is unlikely that the employer can be required tomake contr ibutions to maintain the surplus. Inaddition, the award of benefit improvements is alsousually in the hands of the employer. Thus, in general,the employer controls the use of a surplus in thescheme.

Conversely, the employer has a liability if it has a legalor constructive obligation to make good a deficit inthe defined benefit scheme. In general, the employerwill either have a legal obligation under the terms ofthe scheme trust deed or will have by its past actionsand statements created a constructive obligation asdefined in ‘Provisions, Contingent Liabilitiesand Contingent Assets’. The legal or constructiveobligation to fund the deficit should be assumed toapply to the deficit based on assumptions used underthe .

In a scheme where employees as well as the employermake contributions, any deficit should be assumed tobe borne by the employer unless the scheme rulesrequire members’ contributions to be increased tohelp fund a deficit. In this case, the present value ofthe required additional contributions should be treatedas reducing the deficit to be recognised by theemployer.


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In determining the asset to be recognised inaccordance with paragraph 37, the amount thatcan be recovered through reduced contributionsin the future is the present value of the liabilityexpected to arise from future service by currentand future scheme members less the presentvalue of future employee contributions. Nogrowth in the number of active schememembers should be assumed but a decliningmembership should be reflected if appropriate.The amount that can be recovered should bebased on the assumptions used under the FRS,not the funding assumptions. The present valueof the reduction in future contributions isdetermined using the discount rate applied tomeasure the defined benefit liability.

The amount to be recovered from refunds fromthe scheme should reflect only refunds that havebeen agreed by the pension scheme trustees atthe balance sheet date.

The employer may not control or be able to benefitfrom the whole of a surplus—it may be so large thatthe employer cannot absorb it all through reducedcontributions, and refunds from the scheme may bedifficult to obtain.

The amount recoverable through reducedcontributions reflects the maximum possible to berecovered without assuming an increase in the numberof employees covered by the scheme. There is norestriction on the period over which the reduction incontr ibutions can be obtained, but the effect ofdiscounting will increasingly reduce the impact of thereductions the further into the future they are, leadingto an absolute limit on the amount that can berecognised.


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In practice, a surplus that potentially could berecovered will instead often be used in part to providebenefit improvements to members, thereby reducingthe amount that the employer recovers throughreduced contributions. The use of a potentiallyrecoverable surplus in this way should be treated as apast service cost when it occurs (see paragraph ) andnot anticipated by reducing the amount recognised asan asset.

Paragraphs - specify how the limit on the amountthat can be recognised as an asset should be recognisedin the performance statements.

Any unpaid contributions to the scheme shouldbe presented in the balance sheet as a creditordue within one year. The defined benefit assetor liability should be presented separately onthe face of the balance sheet:

(a) in balance sheets of the type prescribed forcompanies in Great Br itain* by theCompanies Act 1985, Schedule 4, format 1:after item J Accruals and deferred income butbefore item K Capital and reserves; and

(b) in balance sheets of the type prescribed forcompanies in Great Br itain* by theCompanies Act 1985, Schedule 4, format 2:any asset after ASSETS item D Prepaymentsand accrued income and any liability afterLIABILITIES item D Accruals and deferredincome.


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* The equivalent statutory provisions for Northern Ireland are in the Companies(Northern Ireland) Order 1986, Schedule 4; and for the Republic of Ireland are in theCompanies (Amendment) Act 1986, the Schedule.

Where an employer has more than one scheme,the total of any defined benefit assets and thetotal of any defined benefit liabilities should beshown separately on the face of the balancesheet.

An example of the required presentation for thedefined benefit asset or liability other than any unpaidcontributions is shown in Appendix I.

The deferred tax relating to the defined benefitasset or liability should be offset against thedefined benefit asset or liability and notincluded with other deferred tax assets orliabilities.

Recognition in the performance statements

The change in the defined benefit asset orliability (other than that ar ising fromcontr ibutions to the scheme) should beanalysed into the following components:

PERIODIC COSTS

(a) the current service cost;

(b) the interest cost;

(c) the expected return on assets;

(d) actuarial gains and losses;

NON-PERIODIC COSTS

(e) past service costs; and

(f) gains and losses on settlements andcurtailments.


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Current service cost, interest cost and expected return on assets

The current service cost should be based on themost recent actuarial valuation at the beginningof the period, with the financial assumptionsupdated to reflect conditions at that date. Itshould be included within operating profit inthe profit and loss account (except insofar asthe related employee remuneration is capitalisedin accordance with another accountingstandard). Any contributions from employeesshould be set off against the current servicecost.

The current service cost will be based on the discountrate at the beginning of the period and will thereforereflect current long-term market interest rates at thattime.

The interest cost should be based on thediscount rate and the present value of thescheme liabilities at the beginning of theperiod. The interest cost should, in addition,reflect changes in the scheme liabilities duringthe period.

The expected return on assets is based on long-term expectations at the beginning of theperiod and is expected to be reasonably stable.For quoted corporate or government bonds,the expected return should be calculated byapplying the current redemption yield at thebeginning of the period to the market value ofthe bonds held by the scheme at the beginningof the period. For other assets (for example,equities), the expected return should becalculated by applying the rate of returnexpected over the long term at the beginning of


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the period (given the value of the assets at thatdate) to the fair value of the assets held by thescheme at the beginning of the period. Theexpected return on assets should, in addition,reflect changes in the assets in the schemeduring the period as a result of contributionspaid into and benefits paid out of the scheme.The expected rate of return should be set bythe directors (or equivalent) having taken advicefrom an actuary.

For quoted fixed and index-linked securities, theexpected return can be observed from the market.For other assets, the expected return has to be basedon assumptions about the expected long-term rate ofreturn. The rate of return expected over the longterm will vary according to market conditions, but itis expected that the amount of the return will bereasonably stable.

The net of the interest cost and the expectedreturn on assets should be included as otherfinance costs (or income) adjacent to interest.

Actuarial gains and losses

Actuarial gains and losses arising from any newvaluation and from updating the latest actuarialvaluation to reflect conditions at the balancesheet date should be recognised in thestatement of total recognised gains and lossesfor the period.

Actuarial gains and losses may arise on both thedefined benefit scheme liabilities and any schemeassets. They comprise:


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(a) on the scheme assets, differences between theexpected return and the actual return (forexample, a sudden change in the value of thescheme assets);

(b) on the scheme liabilities, (i) differences betweenthe actuarial assumptions underlying the schemeliabilities and actual experience during the periodand (ii) the effect of changes in actuar ialassumptions; and

(c) any adjustment necessary in accordance withparagraph resulting from the limit on theamount that can be recognised as an asset in thebalance sheet.

Once an actuarial gain or loss has been recognised inthe statement of total recognised gains and losses it isnot recognised again in the profit and loss account insubsequent periods.

Past service costs

Past service costs should be recognised in theprofit and loss account on a straight-line basisover the period in which the increases in benefitvest. To the extent that the benefits vestimmediately, the past service cost should berecognised immediately. Any unrecognised pastservice costs should be deducted from thescheme liabilities and the balance sheet asset orliability adjusted accordingly.

Past service costs arise when the employer makes acommitment to provide a higher level of benefit thanpreviously promised, for example the creation of apension benefit for a spouse where such a benefit didnot previously exist or a grant of early retirement withadded-on years of service.


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Past service costs do not include increases in theexpected cost of benefits that the employer is alreadystatutorily, contractually or implicitly committed to,for example cost of living increases to pensions inpayment and deferred pensions. Such increases arecovered by the actuar ial assumptions and anydifference between actual exper ience and theassumptions or the effects of any changes in theassumptions are actuarial gains and losses.

Past service costs include benefit improvementsawarded as a result of a surplus arising in the scheme.The fact that they are funded out of a surplus does notresult in there being no cost to the employer if thesurplus was potentially recoverable by the employer—the use of the surplus for benefit improvements meansthat the employer cannot then benefit from it in otherways.

Settlements and curtailments

Losses arising on a settlement or curtailmentnot allowed for in the actuarial assumptionsshould be measured at the date on which theemployer becomes demonstrably committed tothe transaction and recognised in the profit andloss account covering that date. Gains arisingon a settlement or curtailment not allowed for in the actuarial assumptions should bemeasured at the date on which all parties whoseconsent is required are irrevocably committedto the transaction and recognised in the profitand loss account covering that date.


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Where under the scheme rules the employees have theoption to retire early or transfer out of the scheme, theresulting settlements and curtailments are allowed forin the normal demographic assumptions made by theactuary and any gains and losses arising are actuarialgains and losses.

In contrast, some settlements and curtailments arisefrom specific decisions made by an employer that arenot covered by actuarial assumptions, for examplemajor changes in the circumstances of the schemeinstigated by the employer, such as the transfer ofaccrued benefits of some or all the members into adefined contr ibution scheme or a reduction inemployees because of the sale or termination of anoperation. Gains and losses arising from such eventsare part of the employer’s operating results for theperiod (unless they attach to one of the items shownimmediately after operating profit).

Impact of limit on balance sheet asset

The limit set out in paragraph 41 on theamount that can be recognised as an asset mayresult in there being some part of a definedbenefit scheme surplus that is not recognised.Where this is the case, the amounts recognisedin the performance statements should beadjusted as follows.

(a) First, if any refund is agreed and is coveredby the unrecognised surplus, it should berecognised as other finance income adjacentto interest, with separate disclosure in thenotes.


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Refunds from schemes where the whole surplus isregarded as recoverable do not give rise to gains.The cash received simply reduces the balancesheet asset (along with any related tax effect).

(b) Next, the unrecognised surplus should beapplied to extinguish past service costs orlosses on settlements or curtailments thatwould otherwise be charged in the profitand loss account for the per iod, withdisclosure in the notes of the items andamounts so extinguished.

(c) Next, the expected return on assets shouldbe restricted so that it does not exceed thetotal of the current service cost, interestcost (and any past service costs and losseson settlements and curtailments not coveredby the unrecognised surplus) and anyincrease in the recoverable surplus.

(d) Finally, any further adjustment necessaryshould be treated as an actuarial gain orloss.

An increase in the recoverable amount of asurplus arising from an increase in the activemembership of the scheme should berecognised as an operating gain.

An increase in the active membership can arise eitherfrom an increase in general recruitment or from thetransfer of employees following an acquisition. Thegain arising in the latter case is a post-acquisitionoperating gain, not an adjustment to the purchaseprice and goodwill.


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A decrease in the recoverable amount of asurplus ar ising from a fall in the activemembership should be treated as an actuarialloss unless it arises from an event not coveredby the assumptions underlying the amountoriginally regarded as recoverable, for examplea settlement or curtailment. If it does arisefrom such an event, it should be treated as partof the loss arising on that event.

Tax

When current tax relief arises on contributionsmade to a defined benefit scheme, it should beallocated to the profit and loss account orstatement of total recognised gains and losseson the basis that the contribution covers firstthe items reported in the profit and lossaccount and then any actuarial losses reportedin the statement of total recognised gains andlosses, unless it is clear that some otherallocation is more appropriate. To the extentthat the contribution exceeds these items, thecurrent tax relief attributable to the excessshould be allocated to the profit and lossaccount, again unless it is clearly moreappropriate to allocate it to the statement oftotal recognised gains and losses.

Current tax relief is usually available on contributionspaid to the scheme and deferred tax usually arises onthe balance of the charges/credits. The tax followsthe relevant item, ie tax on the service cost, interestcost and expected return on assets will be recognisedin the profit and loss account and tax on the actuarialgains and losses will be recognised in the statement oftotal recognised gains and losses. ‘Current Tax’requires disclosure of the current tax recognised in theprofit and loss account and statement of totalrecognised gains and losses. The question arises of


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where the current tax relief arising on contributionsshould be deemed to belong. Sometimes it will beclear what the contribution relates to, for examplewhen a special contribution is made to fund a deficitarising from an identifiable cause, say an actuarial loss,in which case the current tax relief should be allocatedto the statement of total recognised gains and losses.In the absence of a clear link between thecontr ibution and the items recognised in theperformance statements, the allocation in paragraph should be followed.

Death-in-service and incapacity benefits

A charge should be made to operating profit toreflect the expected cost of providing anydeath-in-service or incapacity benefits for theperiod. Any difference between that expectedcost and amounts actually incurred should betreated as an actuarial gain or loss.

Where a scheme insures the death-in-service costs, theexpected cost for the accounting period is simply thepremium payable for the period. Where the costs arenot insured, the expected cost reflects the probabilityof any employees dying in the period and the benefitthat would then be paid out.

DISCLOSURES

Defined contribution schemes

The following disclosures should be made inrespect of a defined contribution scheme:

(a) the nature of the scheme (ie definedcontribution);

(b) the cost for the period; and


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(c) any outstanding or prepaid contributions atthe balance sheet date.

Defined benefit schemes

The following disclosures should be made inrespect of a defined benefit scheme:

(a) the nature of the scheme (ie definedbenefit);

(b) the date of the most recent full actuarialvaluation on which the amounts in thefinancial statements are based. If theactuary is an employee or officer of thereporting entity, or of the group of which itis a member, this fact should be disclosed;

(c) the contribution made in respect of theaccounting per iod and any agreedcontribution rates for future years; and

(d) for closed schemes and those in which theage profile of the active membership isrising significantly, the fact that under theprojected unit method the current servicecost will increase as the members of thescheme approach retirement.

Paragraph requires additional disclosures about somemulti-employer defined benefit schemes that areaccounted for as if they were defined contributionschemes.


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Assumptions

Each of the main financial assumptions used atthe beginning of the period and at the balancesheet date should be disclosed. They should bedisclosed as separate individual figures, notcombined or netted. The main financialassumptions include:

(a) the inflation assumption;

(b) the rate of increase in salaries;

(c) the rate of increase for pensions in paymentand deferred pensions; and

(d) the rate used to discount scheme liabilities.

The most important assumptions underlying the presentvalue of the scheme liabilities are the rates of increase insalaries and pensions in payment and the rate of interestapplied to discount the estimated cash flows arisingunder the liabilities. The valuation of assets in thescheme is not affected by the actuarial assumptionsbecause the assets are measured at fair value.

Fair value and expected return on assets

The fair value of the assets held by the pensionscheme at the beginning and end of the periodshould be analysed into the following classesand disclosed together with the expected rate ofreturn assumed for each class for the periodand the subsequent period:

(a) equities;

(b) bonds; and

(c) other (subanalysed if material).


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The assumption made for the expected return onassets does not affect the valuation of the scheme assetsbecause they are measured at fair value. It does,however, determine the amount to be recognised inthe profit and loss account.

Components of the defined benefit cost

The following amounts included withinoperating profit (or capitalised with the relevantemployee remuneration) should be disclosed inthe notes to the financial statements:

(a) the current service cost;

(b) any past service costs;

(c) any previously unrecognised surplusdeducted from the past service costs;

(d) gains and losses on any settlements orcurtailments; and

(e) any previously unrecognised surplusdeducted from the settlement orcurtailment losses.

Any gains and losses on settlements orcurtailments (and any previously unrecognisedsurplus deducted from the losses) includedwithin a separate item after operating profitshould be disclosed in the notes to the financialstatements.

The following amounts included as otherfinance costs (or income) should be disclosedseparately in the notes to the financialstatements:

(a) the interest cost; and


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(b) the expected return on assets in the scheme.

The following amounts included within thestatement of total recognised gains and lossesshould be disclosed in the notes to the financialstatements:

(a) the difference between the expected andactual return on assets;

(b) experience gains and losses arising on thescheme liabilities; and

(c) the effects of changes in the demographicand financial assumptions underlying thepresent value of the scheme liabilities.

History of amounts recognised in the statement of totalrecognised gains and losses

The notes to the financial statements shoulddisclose, for the accounting period and previousfour periods:

(a) the difference between the expected andactual return on assets expressed as (i) anamount and (ii) a percentage of the schemeassets at the balance sheet date;

(b) the experience gains and losses arising onthe scheme liabilities expressed as (i) anamount and (ii) a percentage of the presentvalue of the scheme liabilities at the balancesheet date; and

(c) the total actuarial gain or loss expressed as(i) an amount and (ii) a percentage of thepresent value of the scheme liabilities at thebalance sheet date.


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A consistent trend of experience losses/gains in thestatement of total recognised gains and losses mayindicate that the assumptions used have been over-optimistic/over-pessimistic and may cast doubt uponthe reliability of the amounts reported in the profitand loss account. Where such a trend has emerged itis important that careful consideration is given to thechoice of assumptions in the future.

Reconciliation to the balance sheet

The fair value of the scheme assets, the presentvalue of the scheme liabilities based on theaccounting assumptions and the resultingsurplus or deficit should be disclosed in a noteto the financial statements. Where the asset orliability in the balance sheet differs from thesurplus or deficit in the scheme, an explanationof the difference should be given. An analysisof the movements during the period in thesurplus or deficit in the scheme should begiven.

Differences between the asset or liability in the balancesheet and the surplus or deficit in the scheme willarise because of the related deferred tax balance andalso when part of a surplus or deficit has not beenrecognised in the balance sheet, for example whenpart of the surplus in the scheme is not recoverable bythe employer or when past service awards have not yetvested.

Analysis of reserves

The analysis of reserves in the notes to thefinancial statements should distinguish theamount relating to the defined benefit asset orliability net of the related deferred tax.


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Comparative amounts

There is a general requirement in companieslegislation and accounting standards for comparativefigures to be given. It should be noted that thisrequirement applies to the disclosures specified inparagraphs and relating to the position at thebeginning of the period.

Entities with more than one scheme

Where an employer has more than one definedbenefit scheme, disclosures may be made intotal, separately for each scheme, or in suchgroupings as are considered to be the mostuseful. When an employer provides disclosuresin total for a number of schemes, theassumptions should be given in the form ofweighted averages or of relatively narrow rangeswith any outside the range disclosed separately.

Useful groupings of schemes for disclosure purposesmay be based on:

(a) the geographical location of the schemes, forexample by distinguishing UK schemes fromoverseas schemes; or

(b) whether the schemes are subject to significantlydifferent risks, for example pension schemes andretirement medical care schemes.


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DATE FROM WHICH EFFECTIVE ANDTRANSITIONAL ARRANGEMENTS

The following amounts, measured in accordancewith the requirements of the FRS, should bedisclosed in the notes to the financialstatements:

(a) for financial statements relating toaccounting per iods ending on or after 22 June 2001: the disclosures required byparagraphs 76-81 and 88-93 of the FRSrelating to the closing balance sheet(without comparatives for the previousperiod);

(b) in addition, for financial statements relatingto accounting periods ending on or after 22 June 2002:

(i) the disclosures required by paragraphs76-81 and 88-93 of the FRS relating to theopening balance sheet (withoutcomparatives for the previous period);

(ii) the disclosures required by paragraphs82-85 of the FRS relating to theperformance statements (withoutcomparatives for the previous period);and

(iii) the disclosures required by paragraph 86for the current period only.

None of these amounts need be recognised inthe pr imary statements in these financialstatements.


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All the requirements of the FRS should beregarded as standard for accounting periodsending on or after 22 June 2003. Earlieradoption is encouraged.

Gains and losses ar ising on the initialrecognition of items in the primary statementsunder the FRS should be dealt with as priorperiod adjustments in accordance with FRS 3.It is not required to create retrospectively thefive-year history of amounts recognised in thestatement of total recognised gains and lossesbeyond those figures already disclosed infinancial statements under paragraph 94 above.

requires the fair value of the deficit or surplus tobe recognised as part of a business acquisition. This applies the same policy in requiring the fair valueof the defined benefit asset/liability to be recognised.The method of arriving at fair value under this may be different from that previously used onacquisition, but any such difference should be treatedas a change in assumptions (ie an actuarial gain or loss)arising since acquisition. Goodwill arising on theacquisition should not, therefore, be restated.

WITHDRAWAL OF SSAP 24 AND UITFABSTRACTS 6 AND 18 AND AMENDMENTOF OTHER ACCOUNTING STANDARDS

When applied in full, the FRS supersedes SSAP 24 ‘Accounting for pension costs’, UITFAbstract 6 ‘Accounting for post-retirementbenefits other than pensions’ and UITF Abstract18 ‘Pension costs following the 1997 tax changesin respect of dividend income’.


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SSAP 15 ‘Accounting for deferred tax’ isamended as follows:

(a) the following sentence should be added tothe end of paragraph 16 “An exception to thisrule is required by ‘Retirement Benefits’.”

(b) in paragraph 32A the words “ ‘Accounting for pension costs’ and UITF ‘Accounting for post-retirement benefits otherthan pensions’” are replaced by “ ‘Retirement Benefits’”.

In FRS 5 ‘Reporting the Substance ofTransactions’, paragraph 44 is amended asfollows:

(a) in the first sentence the words, “ ‘Accounting for pension costs’” are replaced by“ ‘Retirement Benefits’”.

(b) in the second sentence the words “ ”are replaced by “ ”.

FRS 7 ‘Fair Values in Acquisition Accounting’ isamended as follows:

(a) in paragraph 19 the words “to the extent thatit is reasonably expected to be realised” arereplaced by “to the extent that it can berecovered through reduced contr ibutions orthrough refunds from the scheme”.

(b) the final sentence of paragraph 70 is deleted.


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(c) the text of paragraph 71 is replaced by:

“The fair value of the deficiency or surplusshould be measured in accordance with therequirements of ‘Retirement Benefits’.The extent to which a surplus can be recoveredshould also be determined in accordance with therequirements of .”

(d) paragraph 72 is deleted.

(e) in the final sentence of paragraph 73 thewords “ ” are replaced by “ ”.

(f) the following footnote is added to the lastsentence of paragraph 42 of Appendix III:

“This requirement was amended by so thata surplus is recognised to the extent that it can berecovered through reduced contr ibutions orthrough refunds from the scheme.”

(g) the following footnote is added to the lastsentence of paragraph 43 of Appendix III:

“ was superseded by .”

FRS 12 ‘Provisions, Contingent Liabilities andContingent Assets’ is amended as follows:

(a) in paragraph 8 the words “ ‘Accounting for pension costs’” are replaced by“ ‘Retirement Benefits’”.

(b) in paragraph 48 the words “a financial itemadjacent to interest but should be shownseparately from other interest either on theface of the profit and loss account or in anote” are replaced by “other finance costsadjacent to interest”.


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In FRS 13 paragraph 5 the words “SSAP 24‘Accounting for pension costs’ and UITFAbstract 6 ‘Accounting for post-retirementbenefits other than pensions’” are replaced by“FRS 17 ‘Retirement Benefits’”.

In UITF Abstract 4 ‘Presentation of long-termdebtors in current assets’ the following footnoteis added to the end of the second sentence inparagraph 2:

“Under ‘Retirement Benefits’, the pensionasset or liability will be shown separately ratherthan under these format headings.”

In UITF Abstract 13 ‘Accounting for ESOPtrusts’, Appendix I, third paragraph, the words“ ” are replaced by “ ‘RetirementBenefits’”.


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A D O P T I O N O F F R S 1 7 B Y T H E B O A R D

Financial Reporting Standard 17 ‘Retirement Benefits’was approved for issue by the ten members of theAccounting Standards Board.

Sir David Tweedie (Chairman)

Allan Cook CBE (Technical Director)

David Allvey

Ian Brindle

Dr John Buchanan

John Coombe

Huw Jones

Isobel Sharp

Professor Geoffrey Whittington

Ken Wild


A P P E N D I X I

D I S C L O S U R E E X A M P L E

Balance sheet presentation

20X2 20X1£ million £ million

Net assets excluding pension asset 700 650Pension asset 335 143Net assets including pension asset 1035 793

Reserves note


Profit and loss reserve excluding pension asset 400 350

Pension reserve 335 143Profit and loss reserve 735 493

Pension cost note

Composition of the schemes

The group operates a defined benefit scheme in theUK. A full actuarial valuation was carried out at December X and updated to DecemberX by a qualified independent actuary. The majorassumptions used by the actuary were:

APPENDIX I - DISCLOSURE EXAMPLE

At At At31/12/X2 31/12/X1 31/12/X0

Rate of increase in salaries 4.0 % 5.5 % 6.5 %Rate of increase in pensions in payment 2.0 % 3.0 % 3.5 %

Discount rate 4.5 % 7.0 % 8.5 %Inflation assumption 2.5 % 4.0 % 5.0 %

The assets in the scheme and the expected rate of return were:

Long-term Value at Long-term Value at Long-term Value at rate of 31/12/X2 rate of 31/12/X1 rate of 31/12/X0return return return

expected £ million expected £ million expected £ millionat at at

31/12/X2 31/12/X1 31/12/X0

Equities 7.3% 1116 8.0% 721 9.3% 570Bonds 5.5% 298 6.0% 192 8.0% 152Property 6.0% 74 6.1% 49 7.9% 38

Total market value of assets 1488 962 760

Present value of scheme liabilities (1009) (758) (668)

Surplus in the scheme 479 204 92

Related deferred tax liability (144) (61) (28)

Net pension asset 335 143 64

[Note: shaded figures not mandatory under the ]


Analysis of the amount charged to operatingprofit


Current service cost 34 25Past service cost 12 —

Total operating charge 46 25

Analysis of the amount credited to otherfinance income


Expected return on pension scheme assets 73 68

Interest on pension scheme liabilities (53) (57)

Net return 20 11

Analysis of amount recognised in statement oftotal recognised gains and losses (STRGL)


Actual return less expected return on pension scheme assets 480 138

Experience gains and losses arising on the scheme liabilities (58) (6)

Changes in assumptions underlying the present value of the scheme liabilities (146) (41)

Actuarial gain recognised in STRGL 276 91


Movement in surplus during the year


Surplus in scheme at beginning of the year 204 92

Movement in year:Current service cost (34) (25)Contributions 25 35Past service costs (12) -Other finance income 20 11Actuarial gain 276 91

Surplus in scheme at end of the year 479 204

The full actuarial valuation at December Xshowed an increase in the surplus from £ million to£ million. Improvements in benefits costing£ million were made in X and contributionsreduced to £ million ( per cent of pensionablepay). It has been agreed with the trustees thatcontributions for the next three years will remain atthat level.


History of experience gains and losses

20X2 20X1 20X0 20W9 20W8Difference between the expected and actual return on scheme assets:

amount (£ million) 480 138 (6) 94 (73)

percentage of scheme assets 32% 14% (1%) 16% (26%)

Experience gains and losses on scheme liabilities:

amount (£ million) (58) (6) 34 25 (23)

percentage of the present value of the scheme liabilities (6%) (1%) 5% 2% (2%)

Total amount recognised in statement of total recognised gains and losses:

amount (£ million) 276 91 1 66 (158)

percentage of the present value of the scheme liabilities 27% 12% 0% 5% (14%)


A P P E N D I X I I

N O T E O N L E G A L R E Q U I R E M E N T S

Great Britain

The statutory requirements relating to the presentationof pension costs in company accounts are set out inthe Companies Act . The relevant requirementsare contained in Schedule and are summarisedbelow. Schedule to the Act does not apply tobanking and insurance companies and groups, nor tosmall companies to the extent that they choose insteadto comply with the reduced requirements set out inSchedule . Requirements corresponding to those ofSchedule are set out for banking companies andgroups in Schedule and for insurance companies andgroups in Schedule A.

The specific references in Schedule include thefollowing:

(a) the balance sheet formats include a heading:

“Provisions for liabilities and charges:

1 Pensions and similar obligations”.

(b) the profit and loss formats and include aheading:

“Staff costs:

(a) wages and salaries

(b) social security costs

(c) other pension costs”.

(c) When profit and loss formats and are used,paragraph () requires the information in (b) tobe disclosed.


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Pension costs are defined in paragraph of Schedule as follows:

‘‘‘Pension costs’’ includes any costs incurred by thecompany in respect of any pension scheme establishedfor the purpose of providing pensions for personscurrently or formerly employed by the company, anysums set aside for the future payment of pensionsdirectly by the company to cur rent or formeremployees and any pensions paid directly to suchpersons without having first been set aside.’

Paragraph () requires disclosure of particulars ofany pension commitments under any provision shownin the company’s balance sheet and any suchcommitments for which no provision has been made.

The requirements in the regarding the recognitionof the amounts arising from a defined benefit schemeare that:

(a) the service cost should be presented withinoperating profit in the profit and loss account;

(b) the interest cost and expected return on assetsshould be presented as a net financial item in theprofit and loss account;

(c) actuarial gains and losses should be recognised in thestatement of total recognised gains and losses; and

(d) the net pension asset or liability should be presentedseparately on the face of the balance sheet followingother net assets and before capital and reserves.

The Board has received legal advice that theserequirements do not contravene the Companies Act but that the interest cost and expected returnshould be presented in a new format heading separatefrom “interest and similar charges”. Accordingly the

APPENDIX II - NOTE ON LEGAL REQUIREMENTS

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requires these items to be included as other financecosts (or income) adjacent to interest.

Northern Ireland and the Republic of Ireland

The relevant references to companies legislation inNorthern Ireland and the Republic of Ireland are asfollows:

* Note The definition of pension costs in the Republicof Ireland legislation is slightly different from that inUK legislation (see paragraph ) and is as follows:

‘…“pension costs” include any other contributions bya company for the purposes of any pension schemeestablished for the purpose of providing pensions forpersons employed by the company, any sum set asidefor that purpose and any amounts paid by the companyin respect of pensions without first being so set aside’


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Great BritainCompanies Act 1985:Schedule 4:

paragraph 8

paragraph 50(4)

paragraph 56(4)

paragraph 94

Schedule 8

Schedule 9

Schedule 9A

Northern IrelandCompanies (NorthernIreland) Order 1986:Schedule 4:

paragraph 8

paragraph 50(4)

paragraph 56(4)

paragraph 92

Schedule 8

Schedule 9

Schedule 9A

Republic of IrelandThe Schedule to theCompanies (Amendment)Act 1986:

paragraph 3

paragraph 36(4)

paragraph 42(2)

paragraph 74*

no equivalent

European Communities(Credit Institutions:Accounts) Regulations 1992

European Communities(Insurance Undertakings:Accounts) Regulations 1996

A P P E N D I X I I I

C O M P L I A N C E W I T H I N T E R N A T I O N A LA C C O U N T I N G S T A N D A R D S

The requirements for retirement benefit costs areincluded in International Accounting Standard (IAS) (revised ) ‘Employee Benefits’. Therequirements of the are consistent with IAS (revised) in most respects. The only major differenceis the recognition of actuarial gains and losses.

The requires actuarial gains and losses to berecognised, immediately they occur, in the statementof total recognised gains and losses. IAS (revised)requires actuarial gains and losses to be recognised inthe profit and loss account to the extent that theyexceed per cent of the greater of the gross assets orgross liabilities in the scheme.* Recognition ofactuarial gains and losses exceeding the per centcorridor may be spread forward over the expectedaverage remaining working lives of the employeesparticipating in the scheme.

APPENDIX III - COMPLIANCE WITH INTERNATIONAL ACCOUNTING STANDARDS

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* Recognition of actuarial gains and losses within the 10 per cent corridor is allowedbut not required.

The structure for reporting financial performance ismore developed in the UK and the Republic ofIreland than under IASs: a second performancestatement—the statement of total recognised gains andlosses—was introduced by ‘Reporting FinancialPerformance’ in , whereas no such statement isused in practice under IASs. For the reasons set out inAppendix IV paragraphs -, the Board believesthat immediate recognition in the statement of totalrecognised gains and losses is a major improvementfrom the traditional treatment of spreading actuarialgains and losses forward in the profit and loss account.

There is some indication that the InternationalAccounting Standards Committee (IASC) may alsowish to follow this route once it has moved forwardwith its work on reporting financial performance.* InIAS (revised), Appendix ‘Basis for Conclusions’discusses the option of immediate recognition ofactuarial gains and losses in a second performancestatement. It states that:

“the [IASC] Board found the immediate recognitionapproach attractive. However, the [IASC] Boardbelieves that it is not feasible to use this approach foractuarial gains and losses until the [IASC] Boardresolves substantial issues about performance reporting.When the [IASC] Board makes further progress withthose issues, it may decide to revisit the treatment ofactuarial gains and losses.”


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* IASC is currently (November 2000) working on a project on reporting financialperformance.

A P P E N D I X I V

T H E D E V E L O P M E N T O F T H E F R S

BACKGROUND TO THE FRS

The has been developed from the proposals set outin ‘Retirement Benefits’, which was publishedin November . was itself the result ofmany years’ deliberations by the Board in which anumber of factors were influential, in particular:

(a) concerns in the UK about the existing standard, ‘Accounting for pension costs’;

(b) the trend internationally towards the use of fairvalues for pension cost accounting; and

(c) the move within the UK actuarial profession awayfrom traditional actuarial valuation methodologiesto a greater use of market values.

The main concerns about were:

(a) there were too many options available to thepreparers of accounts, leading to inconsistency inaccounting practice and allowing a great deal offlexibility to adjust results on a short-term basis;and

(b) the disclosure requirements did not necessarilyensure that the pension cost and related amountsin the balance sheet were adequately explained.

APPENDIX IV - THE DEVELOPMENT OF THE FRS

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In response to these concerns, in June the Boardpublished a Discussion Paper ‘Pension Costs in theEmployer’s Financial Statements’ which set out twocontrasting approaches to accounting for pensioncosts:

(a) an actuarial approach, which relied on actuarialmeasurement of pension scheme assets butremoved many of the options in andenhanced the disclosure requirements; and

(b) a market value approach, which was based onmeasuring the pension scheme assets at marketvalue.

The Discussion Paper noted that the Board’s initialview was that the actuarial approach was preferable.The market value approach was included because theBoard was aware that the International AccountingStandards Committee (IASC) was likely to proposesuch an approach and the Board wished to gauge UKreaction to it.

IASC published an exposure draft, E, in October and a revised standard was issued in February. As expected, IAS (revised ) ‘EmployeeBenefits’ adopts a market value approach that is verysimilar to the US standard, FAS .

The Board set out its views on IAS (revised) in aDiscussion Paper ‘Aspects of Accounting for PensionCosts’, published in July . It explained that theBoard did not believe that there were sufficient reasonsto stand out against the global trend to a market valueapproach as long as such an approach could bedeveloped in a way that did not introduce undue


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volatility into the profit and loss account. It was clearthat a pensions standard based on actuarial values forassets would be regarded internationally as weak andwould not be an approach that other standard-setterswould follow. Given this, and the increasing use ofmarket values by the actuarial profession, it concludedthat the UK and the Republic of Ireland should moveinto line with international practice and use marketvalues rather than actuarial values for scheme assets.This view was accepted by a major ity of therespondents to the Discussion Paper.

The Discussion Paper then set out some options forhow the Board might proceed in developing astandard based on market values. tookforward some of those options, and they are nowembodied in the , as explained below. Theresulting main changes from are:

(a) measuring pension scheme assets: a move fromusing an actuarial basis to using market values (thisis consistent with IAS (revised) and FAS *).

(b) the discount rate for scheme liabilities: a movefrom using the expected rate of return on thescheme assets to a rate that reflects thecharacteristics of the liabilities (resulting in the useof a high quality corporate bond rate, againconsistently with IAS (revised) and FAS ).


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* However, FAS 87 allows the market values to be averaged over a period up to fiveyears, which the FRS and IAS 19 (revised) do not.

(c) recognition of actuarial gains and losses: a movefrom gradual recognition of such gains and lossesin the profit and loss account to immediaterecognition in the statement of total recognisedgains and losses (an approach that IAS (revised)indicated a willingness to revisit once furtherdevelopments have taken place in the IASCproject on reporting financial performance (seeAppendix III) and which the G4+1 has alsosupported in general terms*).

(d) as a consequence of (c), the balance sheet shows apension liability or asset equal to the deficit orrecoverable surplus in the scheme.

The Board believes that these changes, as well asmoving practice in the UK and the Republic ofIreland more into line with international practice,reflect the underlying economics of providing definedbenefit promises. The detailed reasoning behind thechanges is set out below.

In practical terms, the Board believes that the will,when implemented, make the reported amounts forretirement benefits more transparent and easier tounderstand. The pension scheme assets and liabilitieswill be measured at fair value. The balance sheet willshow the surplus/deficit in the scheme to the extentthat the employer expects to benefit/suffer from it.The profit and loss account will show the ongoingservice cost, interest cost and expected return on assetswhile the market fluctuations will be recorded in thestatement of total recognised gains and losses.


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* The G4+1 is a group of representatives of the national standard-setters of Australia,Canada, New Zealand, the UK and the USA, and of IASC. In the communiquéissued by the G4+1 after its meeting in April 2000, the Group expressed support forthe direction of the conclusions in FRED 20.

MEASUREMENT OF SCHEME ASSETS AND SCHEME LIABILITIES

Scheme assets

As noted above, the Board did not believe that therewere sufficient reasons for the UK to differ from therest of the world by measuring scheme assets at anactuarial value that did not equal fair value. Inaddition, and perhaps more importantly, it was clearthat substantial changes were taking place within theactuarial profession relating to the traditional actuarialmethodologies for measuring assets in a pensionscheme. Of the actuaries responding to the Discussion Paper, all but one supported the use ofactuarial valuations. Of the actuaries responding tothe Discussion Paper, all but one supported theuse of market values. Given this, and the advantagesof market values in terms of objectivity andunderstandability, the Board believes there is nocredible alternative to their use.

Scheme liabilities

Ideally, under a market value approach, the schemeliabilities would, like the scheme assets, be measured atmarket value. However, there is no active market formost defined benefit scheme liabilities. Their fairvalue has therefore to be estimated using actuarialtechniques. There are two families of actuar ialmethods for valuing defined benefit liabilities: accruedbenefits methods and prospective benefits methods.The difference between them lies in their treatment ofthe time value of money. Under an accrued benefitsmethod each per iod is allocated its share of theeventual undiscounted cost, the liability arising fromthe costs to date is discounted and the discount


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unwinds in the normal manner over the employee’sservice life. This results in a higher cost at the end ofan employee’s service life than at the beginningbecause the effect of discounting the cost lessens as theemployee approaches retirement. Under a prospectivebenefits method, the total cost including all theinterest that will accrue is spread evenly over theemployee’s service life. This does not represent theeconomic reality that, because of the time value ofmoney, the cost of providing a defined benefitincreases nearer retirement and such valuationmethods do not, therefore, approximate the fair valueof the liability. For this reason, the requires the useof an accrued benefits method.

The requires the defined benefit liability to be thebest estimate of the present value of the amount thatwill actually be paid out. For this to be the case, allexpected changes in factors affecting the paymentsshould be taken into account. For final salaryliabilities, the liability will therefore be based on theexpected final salary, not the current salary. Someargue that this is not consistent with ‘Provisions, Contingent Liabilities and ContingentAssets’ because the employer has some control overthe future increases in salary and hence does not havea present obligation relating to those increases.However, there is a difference between a presentcommitment to pay a pension based on present salaryand a present commitment to pay a pension based onfinal salary, which the Board believes should bereflected in the measurement of the liabilities. Theuse of expected final salaries is also consistent with IAS (revised) and FAS . For retirementhealthcare liabilities, calculating the best estimate of thepayments to be made in the future means taking intoaccount expected changes in the cost of medical care.


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The discount rate

In the UK, actuaries have traditionally discounted theliabilities in a defined benefit scheme at the expectedrate of return on the assets in the scheme (prudentlyestimated). IAS (revised) and FAS require theuse of a high quality corporate bond rate.

The Board believes that the discount rate shouldreflect the time value of money and the risk associatedwith the liability. The view put forward in theDiscussion Paper published in was that such arate could be determined by looking at the rate ofreturn on matching assets. (If the assets exactlymatched the liability they must have the same fairvalue and hence the discount rate appropriate for theliability must be the same as the rate of return on theasset.) Matching assets were expected to be:

(a) for pensions fixed in monetary terms, fixed rategovernment bonds;

(b) for index-linked pensions in payment anddeferred pensions, index-linked governmentbonds;

(c) for final salary liabilities, a portfolio containingsome element of equity investments.

However, later research conducted by the Faculty andInstitute of Actuaries demonstrated from past data thatthe correlation between equities and salaries had notbeen close and that the best match for final salaryliabilities was probably index-linked bonds.


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Some argue that even if there is no close correlationbetween equity and salary growth, it is appropriate touse the expected return on equities as the discountrate if the scheme is invested therein because, over thelong term, that return is relatively secure. However,the higher return expected on equities is a reward forthe risk involved in equity investment. Unless the riskmatches that associated with the liabilities, discountingthe liabilities at the higher return anticipates theexpected benefit of equity investment withoutrecognising the risks involved. The higher returnshould instead be recognised as it is earned over theperiod the equities are held.

On the other hand, although index-linked bonds seemto have been a better match for final salary liabilities,they are not a perfect match and an index-linked bonddiscount rate would ignore some important aspects ofa final salary pension liability, for example theuncertainty of the amounts ultimately to be paid out.The Board has therefore decided not to try to findmatching assets but to build up the discount rate fromits components. As noted above, it believes that, ifpossible, the discount rate should reflect:

(a) the time value of money (given by the rate ofreturn on an investment regarded as being risk-free); and

(b) the risks associated with the liability because ofthe uncertainty surrounding the ultimate cashpayments due.


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The requires the assumptions to reflect the bestestimate of the ultimate cash flows. The resultingliability is clearly subject to uncertainty—the ultimatecash flows are not contractually fixed and will dependon final salar ies, length of retirement etc. Theuncertainty of the future cash outflows might beexpected to make the liability more onerous—mostentities are risk-averse and would prefer to avoid thepossibility that the cash flows might be more thanexpected.

However, in many defined benefit schemes, theemployer has the option of preventing the cash flowsbeing greater than expected and even of reducing thecash flows if necessary (eg if investment performancehas been consistently poor for a long period). Theseoptions exist because the best estimate of the cashflows will include expected benefit increases likely tobe granted by the employer such as (i) increases inpensions in payment and deferred pensions at abovethe minimum required by statute or the scheme rulesand (ii) increases in benefits ar ising from salaryincreases for active members over and above the rateapplicable if they left service (it is assumed that anemployer would, over any substantial period, have toincrease salaries by at least the indexing rate applied todeferred pensions). Although the employer expects togive these increases, they are not guaranteed. Ifnecessary the employer could, in many cases, givelower than expected increases in benefits and givelower than expected salary increases. In extremis, theemployer could even close the scheme down.


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These options are a crucial factor in the operation ofUK defined benefit schemes and the level of benefitsthat is given. Employers’ willingness to provide theexpected benefits is often based, at least partly, on theassumption that the liability can be funded in equities.The expectation is that a higher return on equitiescompared with that on less risky investments willmake such promises affordable. The employer canbear the r isk associated with the higher returnbecause, if equities were to underperform for a longper iod, the options descr ibed above allow theemployer to take action to mitigate the financialimpact.

These options make the liability less onerous and canbe reflected by using a discount rate higher than arisk-free rate. In principle, the premium over therisk-free rate should vary from scheme to scheme (andwithin schemes), reflecting the differing levels ofdiscretion that exist for different scheme liabilities.However, assessing the appropr iate premium isdifficult and subjective. In the interests of objectivityand international harmonisation, the Board hastherefore decided to adopt a standard discount rate:the rate of return on a high quality corporate bond, ieone rated at the level of AA or equivalent status. Thisincludes a small premium above the risk-free rate,which can be regarded as reflecting the options opento the employer to limit the pension scheme liabilities.

Reflecting these options in the discount rate is notinconsistent with the proposal in paragraph of the that it is not appropriate to assume a reduction inbenefits below those currently promised. It is notappropriate to assume that a curtailment of the schemewill take place in the future but it is appropriate toreflect the value of the option to make that curtailment.


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Frequency of valuations

The requires the actuarial valuation to be updatedat each balance sheet date to reflect cur rentconditions. The Board does not believe that thisimposes an excessively onerous or impracticableburden on preparers of accounts for two reasons.

(a) The figures in the profit and loss account arebased on assumptions at the beginning of theperiod, and will therefore be known before thebalance sheet date. It is only the figures in thestatement of total recognised gains and losses andthe balance sheet that depend on the valuationupdated at the balance sheet date.

(b) Unless there have been major changes to thescheme, only the financial assumptions and thefair value of the assets need to be updated at thebalance sheet date. The actuarial profession ispreparing guidance on what the annual updateshould involve.

Recognition in the balance sheet

Pension schemes will not usually be subsidiary (orquasi-subsidiary) undertakings of the employerbecause defined benefit schemes are controlled by thetrustees, not the employer. It is not, therefore,appropr iate to consolidate the scheme into theemployer’s financial statements. A pension scheme cangive rise to assets and liabilities of the employer butthese are not the gross amounts of the pension schemeassets and liabilities—the employer does not controlthe assets nor is it directly liable for the pensionpayments. Instead, the employer has a pension asset orliability to the extent that it is entitled to benefit fromany surplus or has a legal or constructive obligation tomake good any deficit.


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Pension schemes differ in this respect from employeeshare ownership plans (ESOPs). The key differencelies in the control that the employer has over the trust.ESOP trusts are such that the actions that the trusteescan take are very limited—the ESOP exists only tohold the sponsoring company’s own shares for futuredistribution to employees. ESOP trusts are designedto ensure that there is minimal risk in practice that thetrustees would act other than in accordance with thesponsor ing company’s wishes. The sponsor ingcompany has, in effect, de facto control. In contrast,for a pension scheme, the trustees’ rights and dutiesare much wider. The employer cannot in practiceensure that the trustees will act as it would wish inmany significant areas and, hence, does not control theassets and liabilities in the scheme.

Many respondents to questioned whether asurplus in the pension scheme should give rise to anyasset in the balance sheet of the employer. Their viewwas that the employer did not own or control thesurplus in the scheme and, hence, it was notappropriate to recognise an asset. The Board’s view isthat the employer has an asset if it has the right toreduce its contributions in the future. It is unlikelythat an employer could be required to makecontributions to a scheme in order to maintain asurplus. Accordingly, in general, a surplus will giverise to an asset for the employer.


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The amount recognised as an asset cannot, of course,exceed the amount that the employer can recover andsuch a limit is included in the . The limit reflectsthe maximum that can be recovered through reducedcontributions together with any refunds that havebeen agreed at the balance sheet date. Some arguethat the reductions in contributions must be assessedin relation to the funding assumptions rather than theaccounting assumptions because it is in relation tofunding assumptions alone that the trustees of thescheme will agree to any such reductions. It is truethat the trustees will set the contributions based on thefunding assumptions, but over the life of the schemethe accounting and funding assumptions must cometogether. The delay in accessing the surplus does notaffect its measurement because, in the period wherethe company is still making contributions based onfunding assumptions, the accounting surplus will begrowing because of the return earned by the excessassets in the scheme with the result that the surplusthat the employer will eventually recover throughreduced contributions in future will be larger. Inpresent value terms (which is how the surplus ismeasured), the amount by which the employer canbenefit is the same.

Furthermore, the assumptions required by the area best estimate. Funding assumptions may well buildin an element of prudence. It is not appropriate toreflect an arbitrary element of prudence in themeasurement of the pension asset for financialreporting purposes.


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RECOGNITION IN THE PERFORMANCESTATEMENTS

Analysis of pension cost

The requires the ongoing defined benefit cost tobe analysed into (i) the service cost (ii) the interestcost and (iii) the expected return on assets, with (ii)and (iii) presented as finance costs (or income). TheBoard believes that including the interest cost and theexpected return on assets with the service cost withinoperating activities distorts the operating cost that isshown. For example, the pension cost recorded for anunfunded scheme would be higher than that recordedfor a funded scheme with exactly the same pensionobligations. This does not properly reflect the factthat the pension in both cases costs the same, it is onlythe funding policy that is different. The interest costand expected return are matters relating to thefinancing of the pension promise. The Board believesthat the three components of the pension cost andtheir underlying economic nature are well acceptedand understood and, hence, should be reflected intheir presentation in the profit and loss account.

Expected return on assets

Although the Board wishes to move to market valuesfor retirement benefit accounting, it does not believethat it would be appropr iate for the short-termvolatility associated with equity returns to be reflectedin the profit and loss account. Rather, the profit andloss account should reflect the long-term return thatequities are expected to produce with any fluctuationsaround that return shown in the statement of totalrecognised gains and losses. The rationale for thisview is explained further below (see paragraph ).


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In practice, it is difficult to judge the long-term rate ofreturn on equities at any particular date, given that itneeds to reflect the current state of the market. The, therefore, requires the disclosure of an analysis ofthe assets in the scheme and the expected rates ofreturn assumed so that users may assess theassumptions and calculate the effects of makingdifferent assumptions. It is to be expected that thoseusing rates at the extremes of the range at anyparticular date will come under close scrutiny andpossible challenge.

The higher long-term return expected on equitiescompensates for the uncertainty over the return. noted that some believe, therefore, that it isnot appropriate to recognise the expected higherlong-term return in the profit and loss account everyyear with the fluctuations around the return going tothe statement of total recognised gains and losses.Doing so separates the reward for risk (the expectedhigher return) from the results of taking the risk (thevariability in the actual return). It was suggested thatan alternative approach would be to record in theprofit and loss account a risk-free return on assets(removing the effects of risk to the statement of totalrecognised gains and losses completely).

There was almost no support for this alternativeapproach in the responses to and it hastherefore not been taken forward in the .


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Recognition of actuarial gains and losses

required actuarial gains and losses (variationsfrom regular cost) to be recognised gradually over theservice lives of the employees. In the DiscussionPaper, under the alternative market value approach, adifferent treatment was proposed. The profit and lossaccount would be charged with the cost of pensionsearned in the period. Actuarial gains and losses wouldbe recorded in the statement of total recognised gainsand losses.

This approach was explored in more detail in the Discussion Paper and in . It is based on theview that items of financial performance should begrouped together according to their characteristics.The Board’s approach was set out in detail in itsDiscussion Paper ‘Reporting Financial Performance:proposals for change’ (June ). That Paperexplained that, where gains and losses ar isepredominantly from price changes and relate to assetsand liabilities that are held not with a view tobenefiting directly from changes in their value butbecause they are needed for the employer’s operatingactivities (eg a head office), it would be misleading toinclude those gains and losses within operating profit.Instead, they should be reported as ‘other’ gains andlosses, ie at present within the statement of totalrecognised gains and losses rather than the profit andloss account.

The Board expects to publish shortly a onreporting financial performance. The proposals in the on the reporting of holding gains and losses willbe consistent with those in the Discussion Paper notedabove.


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The Board regards actuarial gains and losses as similarin nature to revaluation gains and losses on fixed assets.In relation to the assets in the pension scheme, theyare held with a view to producing a relatively securelong-term return that will assist in financing thepension cost. The length of the term, coupled withthe options available to the employer to restrict theliability in extreme circumstances, mean that much ofthe fluctuations in market values does not affect therelatively stable cash flows between the employer andits pension scheme. Market fluctuations are incidentalto the main purpose of the pension scheme just as therevaluation gains and losses on a fixed asset areincidental to its main operating role. They aretherefore best reported within the statement of totalrecognised gains and losses.

On the scheme liabilities side, the effect of bothexperience gains and losses and changes in actuarialassumptions is to update the liabilities to reflectcurrent conditions consistent with the current marketvalue used to measure the assets. As with fixed assets,where the profit and loss account reflects the currentdepreciation charge, so for scheme liabilities the profitand loss account reflects the service cost and interestcost of providing the pension promise. Subsequentchanges in the value of the liabilities are generallyrelated to financial assumptions and are caused bygeneral changes in economic conditions. Thesefluctuations of the liabilities to reflect current marketconditions are, like the market value fluctuations ofthe assets, incidental to the main operating business ofthe employer.


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In the periods after their recognition in the statementof total recognised gains and losses, actuarial gains andlosses do not change in nature to become operatingcosts. They should not, therefore, be ‘recycled’ byrecognition in the profit and loss account in lateryears. (An additional, pragmatic, reason for notrecycling the gains and losses is that doing so wouldintroduce volatility into the profit and loss account.Actuarial gains and losses arising under a market valueapproach are such that, even when spread over theremaining service lives of the employees, they wouldcause significant fluctuations in the total amountcharged to the profit and loss account. Further, therewould be problems in knowing how to allocate therecycled amount between operating and financialcosts.)

In addition to the fact that this approach is consistentwith its views on reporting financial performance, theBoard prefers immediate recognition in the statementof total recognised gains and losses to the spreadingapproach required under for the followingreasons.

(a) The balance sheet reflects the surplus (to theextent that the employer can benefit from it) ordeficit (to the extent that the employer is obligedto fund it) in the scheme based on the latestactuarial valuation. These amounts meet theBoard’s definitions of assets and liabilities of theemployer. In contrast, under , someactuarial gains and losses were not recognised atthe balance sheet date. In a market value model,there is no conceptual reason to defer therecognition of these gains and losses. Deferralmeans that the asset/liability in the balance sheetdoes not equal the recoverable surplus or thedeficit in the scheme. In fact, it was notuncommon under for a deficit in the


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scheme to give rise to a supposed asset in thebalance sheet which built up as the deficit wasfunded faster than it was recognised. Such figuresdo not meet the Board’s definition of assets.

(b) The figures in the balance sheet and performancestatements are transparent and easy to understand.

(c) The complex and arbitrary rules needed togovern spreading gains and losses forward are notrequired.

The main concerns expressed about this approach inthe responses to the were the following.

(a) The figures in the statement of total recognisedgains and losses and balance sheet can be large andvolatile. They will distort the financial statementsof the employer and will not be understood byusers of the accounts.

(b) Some gains and losses are never recorded in theprofit and loss account. This concern had twoaspects:

(i) Some believed that all gains and losses (inparticular, all losses) should be recorded in theprofit and loss account at some point. Doingso is necessary for the profit and loss accountto show the true margins achieved by theemployer.

(ii) Others accepted the distinction in principlebetween actuar ial gains and losses andoperating costs but were concerned at thepossibility of understating the costs thatshould be reflected in the profit and loss account. Over-optimistic actuar ialassumptions could lead to lower service and


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interest costs in the profit and loss account,while the difference between the assumptionsand actual experience would be reflected as aloss in the statement of total recognised gainsand losses.

In relation to the point (a), the Board believes thatusers of accounts are sufficiently sophisticated to viewthe figures in their proper context. It is important toremember that the amounts reported in the statementof total recognised gains and losses in any one periodhave relatively little significance and should notnecessarily cause concern. What matters is the patternthat emerges over a number of years. For example, if asubstantial actuarial loss arises in one year, but thenreverses over the next few years, there may well be noimpact on future cash flows. If, on the other hand,the loss does not reverse and perhaps even is repeated,then it is more likely that additional contributions tothe pension scheme will be required. Repeated gainsor losses may also imply that pension costs in thefuture will be lower or higher as experience causes theactuary to change his assumptions. These trends willbe highlighted by the disclosure of a five-year historyof actuarial gains and losses.

The different context in which the figures in thestatement of total recognised gains and losses andbalance sheet need to be viewed is also highlighted bytheir position in the accounts: the actuarial gains andlosses are reported in the statement of total recognisedgains and losses, not the profit and loss account (orearnings per share), and the pension asset/liability ispresented at the foot of the balance sheet separatelyfrom and after all other net assets.

It is of note that all the users responding to supported the approach in the .


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The Board’s view on the fact that the approach in the does not report actuarial gains and losses in theprofit and loss account at any time (paragraph (b)(i))is that this is entirely in line with the approach toreporting financial performance set out in the Board’sDiscussion Paper on the subject—some gains andlosses have different characteristics from those thatar ise from the employer’s mainstream operatingactivities and it is therefore appropriate for them to bereported separately. This does not imply that they areunimportant or can be disregarded in assessing theemployer’s performance. It is simply a reflection ofthe fact that they are different in nature fromoperating gains and losses.

The Board accepts that the concern aboutunderstating the costs in the profit and loss account isvalid (paragraph (b)(ii)), although as, withexperience, more attention than hitherto is paid togains and losses reported in the statement of totalrecognised gains and losses, such manipulation willbecome less effective. In the meantime, the five-yearhistory of actuarial gains and losses will separatelyhighlight experience gains and losses so that users ofthe accounts are aware when actuarial assumptions areconsistently not being met. It would be expectedthat, although the assumptions would probably not bemet in each and every year, the experience gains andlosses would over time compensate for each other. Aconsistent trend of experience losses (or gains) shouldcause the preparers of accounts and the auditors to re-examine the assumptions.


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It is worth noting that an approach that spreads theactuarial gains and losses forward in the profit and lossaccount is equally open to abuse. Although the lossesar ising from over-optimistic assumptions arerecognised in the profit and loss account, only a smallproportion is recognised in any one year. Thebeneficial effects of the over-optimistic assumptionsoutweigh that small proportion until the effect hasbuilt up over many (typically twelve to fifteen) years.Such a delay in the bad news hitting the accounts islikely to be more of an incentive to manipulate theassumptions than immediate recognition of the lossesin the statement of total recognised gains and losses.

Recognition of past service costs

Under past service costs for current employeeswere spread forward in the profit and loss account andpast service costs for former employees wererecognised immediately in the profit and loss accountto the extent that they were not covered by a surplusin the scheme.

The decision to improve benefits or award newbenefits in relation to past service increases the schemeliabilities immediately. If an employee left the dayafter the increased benefits vested (usually at the timeof the award), the transfer value would reflect thoseincreased benefits—no further service from theemployee would be required to earn them. TheBoard does not, therefore, believe that there is anyreason to defer recognition of the increased liabilitybeyond the date the benefits vest.


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This leaves the question of how the cost should berecognised in the performance statements. Many ofthe respondents to the believed that the cost ofthe improved benefits should be offset against anysurplus in the scheme, with only the excess cost beingrecognised in the profit and loss account. Theyargued that this properly reflects the fact that suchbenefit improvements may have been awarded onlybecause there was a surplus in the scheme andtherefore no cash cost to the employer.

The Board’s view is that although there may be nodirect cash cost, by using a surplus in this way theemployer loses some of the advantages that it couldotherwise obtain, for example reduced contributions.Further, by awarding such benefit improvements, itmay be able to reduce other aspects of its staff costs.From this perspective, it seems appropriate that thecost of the benefit improvements should be recognisedas an employment cost. The manner in which thecost is funded, whether through cash or the use of asurplus that could otherwise have been used to reducecontr ibutions, does not affect that classification.However, sometimes the benefit improvements arefunded out of a surplus that the employer could nototherwise benefit from, ie a surplus so large that theemployer could not absorb it fully through reducedcontributions (or agreed refunds). In these cases, thesurplus will not have been recognised in fullpreviously and to the extent that it has been used tofund the past service costs the unrecognised amountshould now be offset against the past service cost inthe profit and loss account.

This treatment of past service costs (including the useof any irrecoverable surplus) is consistent with IAS (revised).


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Impact of limit on balance sheet asset

The limit on the amount that can be recognised as anasset in the balance sheet may mean that some part ofa surplus is not recognised. The effect of the balancesheet limit might be allocated to the various pensioncomponents in the performance statements in anumber of ways. The allocation required by the isone that preserves the structure of the ongoing items(ie the current service cost, interest cost and expectedreturn on assets) as far as possible but allows one-offcosts (eg past service costs) to be offset against theunrecognised surplus.

DISCLOSURES

proposed sufficient disclosures for a reader tounderstand the various elements that constitute thepension cost and the relationship between the actuarialvaluation and the amounts recorded in the balancesheet. These disclosures were largely supported by therespondents to the , with the exception of:

(a) a comment on the difference between theexpected rate of return on equities and the AAcorporate bond rate; and

(b) the five-year history of amounts recognised in thestatement of total recognised gains and losses.

The first of these disclosures has been dropped,because the two rates are required to be disclosedanyway and any comment was likely to be couched interms that added little extra information.

The second disclosure has been retained because theBoard believes that it helps place in context theactuarial gains or losses in any one year and henceplays an important role in the .


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TRANSITIONAL ARRANGEMENTS

The allows for a long implementation period, withdisclosures building up in the notes to the accounts.The reasons for this are:

(a) to avoid companies having to revisit previousactuarial valuations;

(b) to give the Board a chance to persuade IASC tofollow the UK approach on the immediaterecognition of actuarial gains and losses; and

(c) to give preparers and users of accounts theopportunity to become accustomed to the figuresarising under the before they are recognised inthe primary statements.

IMPACT ON DISTRIBUTABLE PROFITS

Appendix III to set out a possible approach tomitigate the impact on distr ibutable profits of apension deficit measured and recognised in accordancewith the . Some respondents to thoughtthis approach was unsatisfactory in a number ofrespects. In the light of these responses and because adistribution problem is unlikely to arise often,* theBoard has decided not to proceed with this approach.It believes that it is better for those few companies thatare affected to find appropriate solutions with the helpof their legal advisers.


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* A distribution problem will arise only when individual company accounts show adefined benefit liability so large that it reduces distributable reserves to below thatneeded to cover any intended distribution. In this context, it should be noted that theFRS allows an exemption in some circumstances from the recognition of a definedbenefit liability in the accounts of individual companies that are members of a groupdefined benefit scheme.

ALTERNATIVE CASH-BASED APPROACHTO PENSION COST ACCOUNTING

Throughout the development of the , a number ofrespondents to the various consultation documentsraised the possibility of a return to a cash-basedmethod of accounting for pension costs. It wassuggested that in the UK the Pensions Act ,together with the existing tax regime, would imposesuch constraints on the contributions that an employermade to an approved UK pension scheme that, forsuch schemes, the contributions made in each periodcould be regarded as an appropriate measure for thepension cost for that period. The argument was that,because the scheme could be neither substantiallyoverfunded (the tax limit) nor underfunded (theminimum funding requirement (MFR) of thePensions Act), the contributions each year must beequivalent to the increase in the pension obligationthat had arisen that year, ie the pension cost. The costof implementing an accruals-based system, therefore,exceeded the benefits.

This argument does not apply to unfunded or overseasschemes, for which an accruals-based method wouldstill need to be prescribed. Also, pension regulationstill allows substantial scope for employers and trusteesto agree on different and varying contr ibutionschedules.


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For example, for a typical UK pension scheme, itwould not be unusual for a scheme to be regarded as per cent funded when measured using the test forthe upper tax limit on funding, but per centfunded using the MFR test. The profile of someschemes may lead to even larger discrepancies thanthis. A pension scheme funded between the percent level on the MFR basis and per cent level onthe maximum funding basis may be able to justifypaying contributions at any level between zero (ie atemporary contribution holiday) and the full regularcost calculated on a conservative basis. With typicalregular cost levels being between per cent and per cent of pensionable salar ies, the differencebetween full regular cost and no contr ibutionswhatsoever is likely to be material.

The Board does not, therefore, believe that a return toa cash-based method would ensure that the propercost of a pension is measured and recognised as itarises over the service lives of the employees.

ALTERNATIVE ACCOUNTINGSTANDARDS

Some respondents to the consultation papers havesuggested that if overseas pension schemes have beenaccounted for under a ‘recognised’ standard (forexample, FAS ), those figures could be included inUK financial statements without restatement. Thesame suggestion was made for retirement benefitsother than pensions that have been accounted forunder FAS . The Board does not accept thissuggestion. While it may sometimes be possible, usingoptions in standards, to achieve a high degree ofconvergence between the effect of each, where thereare differences the Board’s standards must be followed.


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ACCOUNTING STANDARDS BOARD NOVEMBER FRS 17 · ©The Accounting Standards Board Limited 2000 ISBN 1...

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Transcript of ACCOUNTING STANDARDS BOARD NOVEMBER FRS 17 · ©The Accounting Standards Board Limited 2000 ISBN 1...