LONDON - A proposed rewrite of U.K. accounting rules for pension plans will make pension costs more volatile and will demand sweeping new disclosures by companies.
The upshot is that U.K. corporations that enjoy pension surpluses will be able to reduce their pension cost substantially in early years and thus improve the bottom line. Alternatively, companies with weaker funding might take hefty hits on their profits.
Mandatory use of a straight-line method of amortization "will have a significant effect on company profits in some cases," said Andrew Wise, a consultant with Watson Wyatt Worldwide, London.
Among the other major implications and changes stemming from the U.K.'s Accounting Standard Board discussion document:
Employers may become far more reluctant to grant discretionary benefit increases for retirees and other former employees. The revision would require immediate recognition of benefit improvements for retirees and other former employees; current rules allow for amortization.
This provision "could increase pension cost by 3% to 4% of payroll" for some companies, said Martin Lowes, an associate at Bacon & Woodrow, Epsom.
Companies will be permitted to record negative pension costs, which may happen more readily from more rapid recognition of surpluses. A lower limit on negative pension costs will be implied through separate limits on recognizing pre-payments of pension debts but that test is believed to be fairly lenient.
Far-reaching disclosure requirements will require companies to publish in their annual reports various key assumptions, provide explanations of any changes in assumptions, and breakdowns of pension costs.
In effect, pension disclosure may become the largest single item in the corporate annual report. But experts don't believe most financial analysts will understand the level of detail provided, although they say reporting will be far more accurate.
Companies will be required to use a single actuarial method in calculating pension cost, the projected unit-credit method. This will not cause great change; more than 80% of employers already use that approach, according to a William M. Mercer survey.
Pension accounting for sales or closing of subsidiaries would be greatly affected by new rules involving settlement and curtailment of pension liabilities. Such liabilities would have to be recognized immediately.
Other post-employment benefits, such as retiree health, would have be recognized under the new standard. But these benefits already are covered by an existing rule.
The rewrite of Statement of Standard Accounting Practice 24, if adopted, will not make much difference for U.S. multinationals with British subsidiaries because U.S.-based companies are required to meet more stringent U.S. accounting rules anyway.
But the anticipated rewrite is expected to have a significant impact on British corporate financial statements, benefits policies and possibly investment policies. The proposed revisions are designed to bring British accounting standards closer in line with international standards. SSAP 24, which was issued in 1988, has been criticized for giving companies too much discretion, making comparisons between different companies' accounts meaningless.
A minority of the ASB's 10-member board favored an alternative approach based on measuring pension surpluses and deficits based on market values. But the majority favored retaining an actuarially based approach that smooths out fluctuations.
The alternative would keep volatility off of the profit and loss statement but would force changes to be recorded in the statement of recognized gains and losses, affecting the corporate balance sheet.
While the board asked for comments on the market-based approach, which is closer to U.S. standards, there is little outside support for the alternative approach because it would make pension costs far more volatile and could even upset some companies' debt-equity ratios and bank covenants.
Neverthless, the proposed revisions would greatly reduce employers' flexibility, but are designed to provide much more detailed and meaningful disclosure to shareholders.
The ASB's discussion paper, which was issued June 22, is the first step in rewriting the U.K. accounting rules. An exposure draft probably will be issued in the spring or summer of 1996, with final standards not expected to take effect until 1997 or 1998. Comments on the discussion paper are due by Oct. 27.
Treatment of surpluses changed
The biggest change affecting employers involves treatment of surpluses and deficits. Most British employers amortize pension surpluses or deficits through a level percentage of pay method, although some use the straight-line method, which is closer to the United States' FAS 87 methodology.
The ASB would require all employers to use the latter method, which has the effect of recognizing surpluses or deficits sooner. This will directly affect companies' profit and loss statements.
The straight-line method "is much more front-end loaded" than the proportion of pay method, Mr. Lowes explained.
Most affected will be large companies whose pension plan assets are larger than corporate assets, noted Tim Keogh, a research actuary with William M. Mercer Ltd., Chichester.
Experts said the proposed method could have a dramatic effect on pension costs. For example, a company with a normal pension cost of 10 million could see the amount recognized in the first year of the amortization period rise to 10 million from 3 million, according to Bacon & Woodrow. Overall, total pension cost - the combination of normal pension cost, amortization of deficit and interest - could rise to 28 million from 21 million, Mr. Lowes said.
Still, permitting companies to record negative pension costs creates another conundrum: it basically suggests the company owns the pension assets, an issue that has been fiercely debated by employers and unions.
By allowing negative pension costs, the ASB "opens up the argument over whose surplus is it anyway?" Mr. Wise said. The board is "saying plainly it's the company's money."
In another issue affecting surplus pension assets, the board no longer would allow refunds of surplus assets to be recognized as an immediate gain in the profit and loss account. Instead, such gains would affect the pension contribution and would thus show up only on the balance sheet.
With most pension surpluses having been eroded by contribution holidays, this is not a big issue now, experts said.
The most controversial change involves immediate recognition of benefit improvements for former employees.
While most companies automatically provide for benefit increases, a good number do not. Under the proposed changes, companies would be able to spread out the costs of benefit increases for employees over their working lifetime. But benefit improvements for ex-employees - including retirees and former vested employees - would have to be recognized immediately, causing a hit to corporate profits. That could discourage companies from granting benefit increases.
In the current low-inflation environment, that's not a problem, experts said. But if the double-digit inflation of the 1970s and 1980s is revived, that could put a lot of pressure on retirees - especially while state pensions are being trimmed. "You get losers all round for the sake of accounting tidiness," said Mercer's Mr. Keogh.
While employers who have contracted out of the State Earnings Related Pension Scheme will have to provide limited price indexation up to 5% a year after April 1997, that requirement will affect future accruals only and will not cover high inflation periods.
However, Jonathan Fisher, audit manager at Binder Hamlyn, London-based chartered accounts, and who helped the ASB draft the new standard, said the new rules would require immediate recognition when there was a real increase in benefits, such as adding a new benefit.
Inflation adjustments would not require immediate recognition because they should have been included in actuarial assumptions, he said. Any increase in benefits beyond those anticipated would affect the size of the pension surplus.
Pension experts also are astonished at the level of disclosure that would be required under the new standard. Still, many believe shareholders are entitled to fuller and more accurate disclosure of pension costs.
Companies will have to disclose a variety of assumptions, including rates of salary increases, rate of return on investments, increase in the rate of pensions paid out, and the discount rate for valuing liabilities.
In addition, companies will have to explain any changes in assumptions and the method used in valuing plan assets. Detailed breakdowns of pension cost, amortization calculation and changes in surpluses or deficits also will have to be explained.
Actuaries said the ASB might be thinking that annual "back of envelope" calculations of pension costs and surplus will be adequate. But Mr. Wise suggested that actuaries might feel legally exposed if such data were included in the annual report. Great Britain requires triennial actuarial valuations.
In addition, the U.K.'s new pension law's minimum funding rules will place added pressure for more thorough valuations on an annual basis.
Still, companies might not want a complete actuarial valuation calculated annually because of added costs, experts said. Plus, it's unlikely valuations could be completed in time for publication of annual reports.
Sales and layoffs affected
Accounting for pension liabilities for employees affected by sales and plant closures also could change dramatically.
The proposal says that settlement, involving bulk lump-sum payments or annuities, and curtailment, affecting stopping of future benefit accruals, would have to be recognized immediately.
The change also could affect enhanced early retirement schemes, which are used to shrink work forces and avoid mass layoffs.
Less clear, however, is whether British companies might want to settle liabilities for retired lives by purchasing annuities or creating dedicated or immunized bond portfolios, as many U.S. companies - particularly banks - did under Financial Accounting Standard 88 in the mid-1980s. Experts expressed hope that investment decisions would not be made on the basis of accounting rules.
Despite the added burdens, pension experts do not believe the accounting changes would drive companies away from defined benefit plans, at least not by themselves.
The accounting standard would be "one more burden," Mr. Wise said. It may not drive away employers, but perhaps the "knock-on effects of providing more actuarial valuations might be an extra straw on the camel's back," he said.