19 June 2017
The key assumption for pensions accounting is the future investment return on the scheme’s assets – this is termed the discount rate. The higher the discount rate, the lower the pension liabilities on a company’s balance sheet and vice versa.
Discount rates for pensions accounting are set using corporate bond yields. In the UK, these yields hit a record low falling below 2% last summer, and have fluctuated between 2% and 3% since then. This has pushed pension accounting liabilities to all-time high levels, causing companies pain on both their P&L and balance sheets. This often leads to detrimental implications for dividends, credit ratings, and the ability to raise capital.
As a result of the increased materiality of pension scheme figures within a company’s accounts, it is perhaps no surprise that a number of companies are now reviewing their approach to the pensions accounting figures in greater detail. Due to its importance, the discount rate is getting the most attention.
There is some flexibility within the accounting standards as to how to set the discount rate. We have developed the LCP Treasury Model which produces discount rates that are typically 0.2% to 0.3% above usual audit benchmarks. Whilst this may not seem like a big change, small increases in discount rates can significantly improve pension accounting figures.
We have already helped many companies adopt the LCP Treasury Model for setting their accounting discount rate. Typical impacts relative to their original position include:
- 5% reductions in pension liabilities.
- 25% improvement in balance sheet position.
- 10% reduction in P&L costs.
You can find out more on how to significantly improve your financial results in our 4 minute video – watch it now.