Recent revisions to the International Accounting Standard 19 (IAS 19) will have significant implications for corporate defined benefit (DB) accounting. In this article, we discuss the pertinent amendments to the standard, as well as some finer points that companies should be aware of, outlining key actions to implement in preparation for 2013, when the changes become effective.

Amendments to IAS 19: Challenges and opportunities for multinational employers

From January 2013, revisions to IAS 19 will fundamentally alter the way in which companies present the risks and costs of running DB plans, presenting both challenges and opportunities for multinational employers reporting under International Financial Reporting Standards (IFRS). This will be of interest to employers that use other reporting standards as well, given the potential for movement toward IFRS as a global reporting standard in the future.

The rationale behind the IAS 19 revisions is to improve the transparency and comparability of pension plans around the world, making it easier to assess a company’s risk and financial position.

For employers, particularly those with operations stretching across borders, now is the time to understand what the new IAS 19 means and to formulate a coherent strategy that will take advantage of potential benefits while avoiding costly pitfalls.

Reporting changes

The way in which companies report pension expense in their P&L statements will be considerably different under the new IAS 19. The use of expected return on assets will be abolished in favor of using a net interest cost based on the discount rate, commonly AA corporate bond yields. This means that companies will no longer be automatically rewarded in their statements for holding growth assets. For companies with high equity allocations, there will be a negative P&L impact. Conversely, where businesses have employed a matching strategy and have a high allocation to government bonds, the reported P&L costs may decrease.

Companies need to review their investment strategies and asset allocations to assess the possible accounting benefits of de-risking their DB plans by moving out of equities and into bonds. Companies will no longer be able to defer the recognition of gains and losses in their pension plans (commonly known as the corridor method) and must instead report the full deficit or surplus (subject to any asset limitation) immediately. This introduces greater balance sheet volatility, particularly for those plans with heavy equity investment, and may present another reason to consider a move from growth to matching assets. Conversely, if the balance sheet volatility is not a concern, companies that change from the corridor method may continue to support growth assets because the risk of asset losses will no longer be presented in the P&L.

Although there are almost 18 months to go until the new rules come into effect, subject to any local endorsement (for example, by the EU), some companies might want to adopt the changes early in order to benefit from the cost savings. Honeywell International, for example, was one of the first US companies to move in the direction of immediate recognition when it switched to mark-to-market last year, creating a potential cost saving of millions of dollars.

The immediate recognition of gains and losses may also make certain de-risking strategies, such as risk transfers, easier because companies will not be required to manage unrecognized losses through the P&L when there is a settlement or curtailment.

Changes to IAS 19 also mean an expansion of the employee benefit disclosure requirements. Companies will be expected to give more detail in financial statements regarding the risk and characteristics of their DB plans. For example, information will be required on the sensitivity of liabilities to changes in significant assumptions, the potential volatility of future pension contributions and how the pension risks are being managed.

This represents an opportunity for organizations with a robust risk management strategy in place to communicate their good practices to investors and analysts. However, for businesses without high levels of governance, now is the time to review risk management techniques and to formulate a coherent strategy across each jurisdiction.

IAS 19 will require companies to split the presentation of the pension costs between P&L and Other Comprehensive Income (OCI). Management decisions can influence this split, and the effect on key performance indicators needs to be considered carefully as part of a long-term strategy for employee benefits plans.

The revised IAS 19 contains further clarifications and subtle amendments that companies need to consider, as they will be important in some jurisdictions. These include the treatment of administration costs, termination benefits, risk-sharing plans and tax. Businesses need to ensure that they have a comprehensive understanding of all the IAS 19 details and must adapt and update their employee benefit strategies accordingly.

Key actions

• Understand the changes in each jurisdiction. The new rules will impose different outcomes depending on a company’s location. Multinational employers should understand how IAS 19 changes will affect their employee benefit plans in each country in which they operate, and need to ensure that their pension risk management strategies are still relevant and cost effective.

• Consider early adoption. Businesses have to decide whether moving to the new IAS 19 regime earlier than 2013 makes sense for their organization, and if so, whether this is appropriate for every location in which they operate.

• Formulate a coherent companywide strategy. Employers need to think about how their accounting strategies under IAS 19 link to other policies across the rest of the business. Following the changes, organizations need to ensure that their accounting policies are still in line with the overall company strategy.

• Communicate with investors and analysts. The new rules will mean a reduction in reported profit for many companies, even though there is no change to the underlying pension plan assets and liabilities. Companies will want to ensure that investors and analysts understand their employee benefits strategy and appreciate this long-term nature and overall risk management approach.

Early planning

Undoubtedly, the changes to IAS 19 need to be managed carefully; however, for companies that can demonstrate a robust risk management strategy there is the potential for reward. Multinationals should act now to be ahead of the game in 2013.