Accounting for Pensions Survey 2001
Appendix 3  -  Summary of Financial Reporting Standard 17: Retirement Benefits

The new UK pension accounting standard "FRS17" has at its heart the same financial economic theory as that underlying the US pension accounting standard, FAS132. However, whereas pragmatists tempered this theory to implement a smoothed and profit-focused standard in the US, the UK's Accounting Standards Board ("ASB") has been much bolder in its implementation.

Below we have set out an introduction to FRS17, highlighting the treatment of benefit improvements, along with a brief comparison of the new UK standard with the US standard. With many commentators fully expecting the international pension accounting standard (called IAS19) to come into line with the UK's new rules, the FRS17/FAS132 comparison will no doubt become critical to any companies with a listing on both sides of the Atlantic.

1. Introduction to FRS17

The main intention of the new standard is that pension surpluses or deficits for defined benefit schemes should be directly reflected in the company balance sheet at market value. The pension cost element of a company's operating profit is the regular cost ignoring any surplus or deficit. Liabilities will be valued on a nearly "risk-free" discount rate, being that on AA-rated corporate bonds. This is currently a lower rate than many actuaries use and will increase cost. In the financing lines of the Profit and Loss account an offsetting allowance can be made for the expected return on assets, including an expected return on equities.

The new standard will be implemented over a period of three years. It will commence with only balance sheet disclosure being required as at 31st December 2001, add Profit and Loss disclosure for 2002 and require full adoption subsequently. (For companies with a financial year end other than 31st December, the 3-year period starts with the first financial year ending after 22nd June 2001.)

Other very important features of FRS17 include:

actuarial gains and losses on the market value basis will go through the

  • actuarial gains and losses on the market value basis will go through the Statement of Total Recognised Gains and Losses ("STRGL") and so will not affect reported profits;

  • the value of one-off improvements to past service benefits will be charged to the Profit and Loss account in the year they are granted, even if financed by surplus; and

  • greatly increased disclosure requirements relative to the existing standard SSAP24.

During the implementation period the level of disclosure required will be further augmented as, essentially, both a SSAP24 and an FRS17 disclosure will be required.

2. Treatment of benefit improvements

Employers and pension scheme trustees occasionally make benefit improvements by allocating part of the surplus to the members.

Under SSAP24, the cost of a benefit improvement is allowed as a first charge on surplus and so is, effectively, spread over the remaining service of the current employees. However, under FRS17, such a cost will have to be recognised immediately in the Profit and Loss account.

Despite the fact that benefit improvements may only be provided because a surplus exists, surplus (unless non-recoverable) cannot be offset from the cost of the improvement - the entire cost is recognised immediately in the Profit and Loss account.

When the full cost is a direct hit to company profit, employers are bound to be deterred from making improvements. The ASB explain that if the employer uses surplus for members' benefits when he could alternatively use it to reduce contributions, the full cost of that decision should be reflected in that year's profits. We believe this is an unfair approach because the ASB are at the same time not allowing surpluses to affect profits.

In our view the changes will certainly reduce the likelihood of future benefit improvements.

3. Comparison of FRS17 and FAS132

Whilst there are many differences between FAS132 and FRS17, the basic building blocks are similar in many ways. For example, the assets and liabilities can be similar under the two sets of rules, although there is more scope to be prudent under FAS132. Similarly, the key components of the FRS17 Profit and Loss charge (Service Cost, Interest Cost and Expected Return on Assets) are taken, broadly, from FAS132.

The treatment of benefit improvements under FAS132 will vary from case to case. Taking the example mentioned above, the FAS132 impact would be to charge the cost of the improvement against profits over, say, 15 years. This is consistent with the treatment of surpluses and deficits in FAS132, discussed below, but in stark contrast to the immediate hit to profit generally required under FRS17.

Each of the above figures is brought into the accounts in a very different way under FRS17, compared to FAS132. Essentially this is because FRS17 is a move towards focusing on balance sheet values, whereas FAS132 was driven by the Profit and Loss account.

As an example, consider a decrease in the pension scheme surplus. This hit would be recognised immediately under FRS17 (although it would never impact on company profit). In contrast, none of the poor experience would be recognised in the year it occurred under FAS132, but in due course all of the impact would be expected to flow through against profit.

Under both FAS132 and FRS17, all of the components and underlying assumptions must be disclosed. As such, it is possible to approximate the accounting impact of FRS17 on a company, based on their FAS132 disclosure. The numbers provided for the assets and liabilities under FAS132 are not identical to those which would be produced under FRS17, for example the FAS132 asset figure is based on bid-values, not mid-market values and may be smoothed or offset by up to three months. However, the figures are generally sufficiently close to be applied as a reasonable proxy.