At a glance:
- New accounting standard FRS 102 introduces a number of reporting changes affecting pension schemes, effective for accounting periods beginning on or after 1 January 2015.
- Pension schemes will have their own set of investment risk disclosures, less onerous than those applying to other financial institutions.
- Some issues, such as valuation and disclosure of risks surrounding pooled investment vehicles, and the valuation of annuities require further clarification.
In March 2013, the Financial Reporting Council (FRC) released Financial Reporting Standard (FRS) 102, which brings GAAP into line with a framework of accounting based on International Financial Reporting Standards (IFRS). This bulletin explains how the standard will affect pension schemes. The new requirements extend and enhance disclosure in some areas although the changes to accounting requirements are not as extensive as first envisaged.
Now that FRS 102 has been published, further guidance will be developed by industry bodies, including the production of a revised Statement of Recommended Practice (SORP) by the Pensions Reporting Accountants Group (PRAG), before implementation of the revised régime for accounting periods beginning on or after
1 January 2015. However, early adoption is permitted for accounting periods ending on or after 31 December 2012, providing this does not conflict with the existing SORP.
Key points from the new standard for pension scheme accounting are summarised here.
Pension schemes are included within the definition of financial institutions, along with entities such as banks and insurance companies. Financial institutions will be required to make extensive risk disclosures covering credit, liquidity and market risks arising from financial instruments. However, pension schemes are specifically exempted from the disclosures for financial institutions and have their own set of less onerous investment risk disclosures. These are, however, new requirements as compared to the current SORP.
- Actuarial liabilities will, as now, be disclosed in a separate report together with the date of the most recent valuation and the methods and assumptions used.
- Net assets available for benefits will continue to be reported at fair value. In addition, the application of fair value will be extended to cover additional asset types. Specifically, investments in entities which are deemed to be subsidiaries by virtue of the proportion of shares held, will be reported at fair value rather than consolidated. Also, in an updated provision within the finalised standard, investments held through special purpose vehicles will similarly not be consolidated in scheme financial statements. Scheme liabilities (other than actuarial liabilities) will have to be carried at fair value under FRS 102.
- FRS 102 will not require the significant additional non- financial disclosures which were originally proposed. These are, in any event, largely required by the SORP and local disclosure regulations.
Although the requirements for pension scheme accounts have been honed during consultation, FRS 102 requires some additional investment disclosures, such as:
- Disclosures around credit and market risks. Required disclosures will encompass exposures, objectives, policies and processes for managing that risk, and any changes in the period.
- Analysis of investments based on a valuation hierarchy. Strangely, this valuation hierarchy is not the same as the investment pricing hierarchy required under IFRS.
New requirements for credit risk disclosures comprise details of maximum exposures, collateral held as security, disclosure of the amounts by which credit derivatives mitigate credit risk and more detailed analysis of credit quality.
FRS 102 requires an analysis of financial instruments held at fair value and has formulated a valuation hierarchy, based on three ‘levels’:
As mentioned earlier, this hierarchy is not the same as that required under IFRS, which, whilst utilising three levels, categorises mainly by reference to observable and unobservable inputs for levels 2 and 3.
Level 1 – the best evidence of fair value is a quoted price of an identical asset.
Level 2 – If a quoted price of an identical asset is not available, then a recent transaction price of an identical asset will provide good evidence of fair value provided that the valuation is relatively recent and there has not been a significant change in economic circumstances since that transaction took place. If the last transaction is not a good estimate of fair value the price must be adjusted to reflect this.
Level 3 – Should either of the above options not be available, an estimate of fair value may be obtained by using a valuation technique.
Topics requiring clarification
Although the final standard streamlines the originally proposed pension scheme disclosures, a number of issues remain.
Three critical areas requiring clarification are:
- The valuation and disclosure of risks surrounding pooled investment vehicles and whether to ‘look under the bonnet’ at the underlying investments of such vehicles
- The valuation of annuities – the current option to value certain annuities at a nil valuation has been removed. Annuities must be reported at the value of the related obligation. This mirrors the treatment required for reporting scheme assets in employer financial statements. However, the value of the related obligation for employer accounting is determined using the discount rate based on bonds whilst the related obligation for pension schemes will be based on the discount rate used in the scheme funding valuation. This would appear to drive two different values for the same asset!
- It is not currently clear whether the SORP’s current way of dealing with transaction costs and bond coupons will fit with the new standard. This will need to be addressed by the new SORP working party.
Further guidance will be needed to clarify an appropriate approach to the valuation and reporting of more recently developed investment types, such as longevity swaps and buy-in / buy-out policies.
Where to from here?
Scheme years ending on 31 December 2015 will be the first to be directly affected by the new regime (requiring comparative disclosures for years ending on 31 December 2014). PRAG hope to have a revised SORP published in autumn 2014. While this may seem some while ahead, there is still a lot of work to be done to ensure that all requirements are met and
Actions: Trustees should discuss with their Scheme Administrator the potential need for any significant revisions to their accounting policies
Status: Financial standard – compulsory
Timing: Applies for accounting periods beginning on or after 1 January 2015; early adoption possible
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