The recent publication of FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland sets out a major change in accounting standards for the UK and Ireland. All of the existing Financial Reporting Standards (FRSs) are effectively being replaced by a single standard, FRS 102.

FRS 102 is based heavily on IFRS for SMEs, a simplified version of the full International Financial Reporting Standards (IFRS) designed for small and medium-sized enterprises (SMEs). It will apply to all non-listed companies other than those electing to use full IFRS and the very smallest entities, where an even more simplified set of accounting standards applies (see the box overleaf for more details).

FRS 102 applies to accounting periods commencing on, or after, 1 January 2015. Earlier adoption is allowed.

This briefing is focused on the changes that FRS 102 will make to the accounting treatment of defined benefit pension costs and obligations, which are currently dealt with by FRS 17 Retirement Benefits.

Comparison with FRS 17

Being based on a cut-down version of IFRS, it is no surprise that the pensions aspects of FRS 102 share many similarities with IAS 19 Employee Benefits. As such the basic accounting framework of FRS 17 is broadly retained:

The plans accrued liabilities the defined benefit obligation are to be measured on an actuarial basis, using unbiased actuarial assumptions and a discount rate based on high quality corporate bond yields.

Corporate briefing Number 61 | June 2013

Accounting for defined benefit pension obligations under FRS 102

Summary UK accounting standards are undergoing

significant change in 2015. This briefing explains the impact on the accounting treatment of defined benefit pension plans.

The Employee Benefits section of FRS 102 supersedes the current UK standard FRS 17.

Under FRS 102 the pension cost charged to profit and loss will tend to increase:

Interest, at a corporate bond-based discount rate, is charged on the difference between the value of the plans assets and liabilities instead of the full value of the plans liabilities;

but the expected return on assets is removed.

Entities that participate in plans serving more than one employer could see a fundamental change in accounting treatment some employers may have to show a liability on their balance sheet for the first time.

For plans in surplus there is more scope for the sponsor to recognise that surplus as a balance sheet asset.

Disclosure requirements are generally lighter than under FRS 17, with some additional disclosures for entities that participate in plans with more than one employer.

Prior year comparative figures will need to be restated under the new standard in the year of adoption.

There are no pension disclosure savings for subsidiaries that account under IFRS.

The main difference [between FRS 17 and FRS 102] for many entities is the removal of the expected return on assets assumption which will affect reported profits.

Any surplus or deficit in the plan is calculated as the difference between the fair value of the plans assets and the defined benefit obligation. It is recorded on the balance sheet as a net defined benefit liability or asset.

Pension costs continue to be recognised as employees provide service and will be charged to profit and loss the service cost.

The effect of any benefit changes, new plans, plan curtailments and settlements will also be charged to profit and loss.

Any gains or losses on the plans assets and liabilities will be recognised in Other Comprehensive Income as a remeasurement of the net defined benefit asset or liability. Remeasurement effects therefore include any asset returns which are more or less than the discount rate and the effect on the plans defined benefit obligation of changes in actuarial assumptions, or due to actual experience differing from those assumptions. As with IAS 19, there is no recycling of these gains and losses back into profit and loss in future years (unlike US GAAP).

Some of the key differences between FRS 17 and FRS 102 are covered below.

Expected return on assets

The main difference for many entities is the removal of the expected return on assets assumption which will affect reported profits. Interest, at the discount rate, on the net defined benefit asset or liability will be charged to profit and loss the net interest cost. This mirrors the recent change to IAS 19. Entities sponsoring a plan that invests a significant proportion of its funds in return-seeking assets may see their profit and loss costs rise; while those with plans heavily invested in government bonds may experience the opposite effect.

Plans with more than one employer

Entities that participate in a plan with multiple employers may need to change how they account for, and disclose, their pension liabilities. At present, there is a commonly used provision in FRS 17 that allows entities in a multiple-employer defined benefit plan where experience is aggregated and not allocated to each participating entity to treat the plan as a defined contribution plan. As a result, they book actual contributions as an expense in profit and loss and record neither an asset nor a liability for the plan on the balance sheet.

FRS 102 makes a distinction between different types of multiple-employer plans in a similar way to IAS 19. Multi-employer plans is the designated term for plans used by entities not under common control, such as industry-wide schemes. The term group plans applies to plans where all of the employers are under common control.

For entities that participate in multi-employer defined benefit plans universities for example going forward there will be two approaches to accounting for these plans:

If the entity can recognise its own assets and liabilities in the plan, then it should account for them in the same way as for a standalone plan.

Where this is not possible, the alternative is to treat the plan as a defined contribution plan; but there is an important difference from the FRS 17 approach. It will be necessary under FRS 102 to recognise a liability on the balance sheet equal to the present value of contributions payable under any agreement to fund a deficit.

Whichever approach is adopted, entities that participate in a multi-employer plan may need to recognise, perhaps for the first time, a liability on their balance sheet which reflects their share of any underfunding in that plan, either on an accounting or funding basis.

The hierarchy of standards

Entities required to file UK accounts will have the option to choose between up to three sets of accounting standards:

Full EU-adopted IFRS

FRS 102

The Financial Reporting Standard for Smaller Entities (FRSSE)

Listed companies are required to use full EU-adopted IFRS which means following the accounting standard IAS 19. Most other pension plan sponsors will have the choice between FRS 102 and full EU-adopted IFRS. In some cases a reduced disclosure regime can apply. FRSSE is an additional option for entities that are small for the purpose of companies legislation.

The choice affects all aspects of the accounts that are filed; it is not a case of being able to choose, for example, IAS 19 for pensions and FRS 102 for everything else. Accounting for pension obligations may be one factor in making the decision between the available options, but we do not expect it to be the main determinant for many.

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In contrast, the treatment of group plans depends on the nature of the obligation that the entity has in respect of the plan:

If there is a contractual agreement or stated policy for charging the pension cost between the participating employers then the pension cost should be allocated in that way.

Where there is no such agreement or policy, the group entity that is legally responsible for the group plan should recognise the cost for the whole plan in its own accounts. The other group entities can then simply account for the contributions they have paid. This mirrors a similar requirement in IAS 19, but does create an issue in a UK context as all employers that participate in a defined benefit plan have some legal responsibility. This was highlighted by the Pension Regulators recent campaign for pension scheme trustees to identify their statutory employers. A common approach under IAS 19 is for the Principal Employer to take the role of being legally responsible for this purpose, especially if it is the parent company, although this can be complicated if the Principal Employer is not a UK company.

Recognising a pension asset

FRS 102 potentially allows a surplus to be recognised as a balance sheet asset in more circumstances than FRS 17. Currently, FRS 17 only permits a surplus to be recognised to the extent that it can offset contributions for future service, or where it forms part of an agreed refund. For plans that are closed to future accrual, FRS 17 therefore generally prohibits an asset from being recognised given the tight restrictions under UK pensions law on refunding plan assets to an employer. Under FRS 102, potential future refunds can be included.

This is very similar to IAS 19. There it is possible to project the assets and liabilities of the plan far into the future, to the point where a refund is possible after all benefits have been paid out in full. It is therefore important to check whether plans include a provision to allow the employer eventually to take a refund. Many such refund provisions lapsed in April 2006 with the advent of the current UK pensions tax regime. These provisions can be reactivated by pension scheme trustees, but there is a deadline of April 2016 to do this for plans that have not already acted.

The similarity of the wording in FRS 102 and IAS 19 on this subject raises the possibility of having to follow the interpretation IFRIC 14 The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction. In addition to setting out further details on when a surplus can be recognised as an asset, IFRIC 14 also imposes an

additional balance sheet liability where there is a statutory requirement to fund the plan to a level in excess of the defined benefit obligation where this cannot be recovered through future refunds. This might be the case in the UK where, for example, the employer agrees to a schedule of contributions for funding purposes that has a present value of deficit contributions in excess of the FRS 102 net defined benefit liability.

In turn, this raises the wider question of how much to fall back on full EU-adopted IFRS in cases where FRS 102 does not provide enough detail. By way of comparison, Section 28 of FRS 102 (which deals with employee benefits) runs to 11 pages, compared with over 60 pages in the 2011 version of IAS 19. So there will be many issues not limited to pensions accounting where it will be tempting to seek additional detail from IFRS. FRS 102 does provide some guidance on this, allowing the management of the entity to make a judgement on a suitable accounting policy. Reference can be made to full EU-adopted IFRS in forming this judgement but it is not mandatory to follow the IFRS approach.

Discount rates

In countries where there is no deep market in high quality corporate bonds, FRS 102 requires government bond yields to be used. This differs from FRS 17 which allowed a reasonable proxy for corporate bond yields to be used, for example government bond yields plus a margin for assumed credit spreads. Potentially this could mean lower discount rates being used for some overseas plans.

The wording of FRS 102 and FRS 17 both implicitly assume that government bonds will be high quality which is not universally the case in practice. The International Accounting Standards Board and its Interpretations Committee are currently considering whether adjustments for credit risk should be made in territories where government bonds are not high quality.

Plan changes

All plan changes are recognised immediately in profit and loss under FRS 102, as opposed to being spread over the vesting period under FRS 17. This will have little practical effect for UK plans due to vesting periods of, at most, two years and many being closed to new entrants.

the disclosure requirements of FRS 102 in relation to defined benefit pension plans will largely be a subset of the current disclosure requirements under FRS 17

Towers Watson is represented in the UK by Towers Watson Limited and Towers Watson Capital Markets Limited.

The information in this publication is of general interest and guidance. Action should not be taken on the basis of any article without seeking specific advice.

Copyright 2013 Towers Watson. All rights reserved. WT-2013-BEN-EUMKT0091. June 2013.

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Transition

On first time adoption of FRS 102 it is necessary to restate the comparative financial statements shown in the accounts to be in line with FRS 102, rather than show them on the previous accounting framework.

Take for example an entity adopting FRS 102 with effect from 1 January 2015 and showing one year of comparative information in its 31 December 2015 accounts. Its date of transition to FRS 102 will be the start of the comparative period, that is 1 January 2014. As a consequence it needs to:

Restate the balance sheet as at 1 January 2014 in accordance with FRS 102, although this does not need to be shown in the accounts

Recalculate the profit and loss, cash flow and changes in equity statements, and any accompanying notes for the year ending 31 December 2014, and recalculate the balance sheet as at 31 December 2014 all in line with FRS 102. These will be disclosed as comparative figures in the accounts for the year ending 31 December 2015.

Disclosure requirements

FRS 17 was amended in 2006 to more closely reflect the disclosure requirements of IAS 19 at that time. Consequently the disclosure requirements of FRS 102 in relation to defined benefit pension plans will largely be a subset of the current disclosure requirements under FRS 17. Although FRS 102 has followed the approach in IAS 19 as revised in 2011 to determine pension cost, it has not adopted the revised disclosure requirements.

Some additional disclosures will be needed, notably in respect of multi-employer and group plans. Sponsors of multi-employer plans are required to describe the extent to which they can be liable for the liabilities of the plans other employers. Employers in group plans must disclose any agreement or policy for charging the costs of the plan and the policy for determining employer contributions.

Reduced disclosures for qualifying entities using full EU-adopted IFRS

For entities that elect to produce accounts in accordance with full EU-adopted IFRS there is a reduced disclosure framework contained in FRS 101 (see box above). However, this does not remove any of the disclosure requirements of IAS 19.

Further information

For further information, please contact your Towers Watson consultant, or:

Charles Rodgers +44 20 7227 2173

charles.rodgers@towerswatson.com Andrew Mandley +44 113 261 7759

andrew.mandley@towerswatson.com

Towers Watson is a leading global professional services company that helps organisations improve performance through effective people, risk and financial management. With 14,000 associates around the world, we offer solutions in the areas of benefits, talent management, rewards, and risk and capital management.

FRS 100 and FRS 101 FRS 102 is one of three standards that will govern accounts of UK entities from 2015. The other two standards set out more details of the accounting framework.

FRS 100 Application of Financial Reporting Requirements sets out the availability of the choice between the three sets of accounting standards: full EU-adopted IFRS, FRS 102 and FRSSE.

FRS 101 Reduced Disclosure Framework removes some of the disclosure requirements for entities accounting under full EU-adopted IFRS where:

They are a member of a group.

The parent of that group prepares publicly available consolidated financial statements which are intended to give a true and fair view.

That entity is included in the consolidation.

None of the disclosure exemptions covered by FRS 101 affect the disclosures required under IAS 19.