24 August 2011

IASB Patricia McConnell: “Benefits of the IASB's recent revisions to pension accounting”

IASB member, Patricia McConnell, responds to the revisions of IAS 19 'Employee benefits' (effective from 1 January 2013), which changed the presentation and disclosure of net pension liabilities or assets and net pension cost, but did not change their measurement.

This article discusses two of the changes that should be of particular benefit to investors:

• immediate balance sheet recognition of all changes in pension liabilities and plan assets; and
• changes in the presentation of the components of pension cost.

Patricia McConnell believes that as a result of the changes that were made to IAS 19, the net pension liability or asset recognised in the balance sheet will actually be a relevant measure. It will be the difference between a current measure of what the company owes its employees for services provided (pension liability), and the fair value of the assets set aside to satisfy that liability (plan assets). Under the previous version of IAS 19, the amount recorded in the balance sheet could be misleading. For example, the balance sheet may have included a net pension asset, implying that the plan is overfunded when in fact it was in deficit, because IAS 19 previously permitted delayed recognition of many of the changes in plan assets and liabilities. As a result, profit or loss may have included gains and losses from events that happened in past periods. That will not happen under our revised standard. Now there is no corridor, no deferred recognition and no expected return on plan assets.

Some may be concerned that without these familiar smoothing techniques the volatility of changes in the pension assets and liabilities will obscure the profitability of the company’s core business. The IASB was concerned about that as well. To address that concern, and because the IASB believes that it is more useful to present separately items that have different predictive implications, the revised standard requires that the changes must be disaggregated into three components: service cost, net interest income and expense, and remeasurements. Service cost and net interest income and expense will be presented in profit or loss, and remeasurements will be presented separately in other comprehensive income (OCI). This will enable investors to isolate the different causes of the changes in the plan’s assets and liabilities.

Like the previous version, the revised IAS 19 does not specify where the individual components of net pension cost should be displayed, beyond specifying that service cost and net interest income or expense should go to profit or loss, while re-measurements go to OCI unless another IFRS permits or requires their inclusion in the cost of an asset. For example, service cost, or some portion of it, may qualify for capitalisation as a cost of inventory under IAS 2 'Inventories'. Consequently, a portion may remain in inventory at period end, while a portion may be in cost of sales. The portion, if any, that did not qualify for capitalisation will be included in profit or loss as well. It will be included in the same line item in which the company’s related compensation expenses are presented (e.g. within selling expenses, administrative expenses, research and development expenses etc.).

Response

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