(solution) Why accounting standards matter! In Britain, many companies are issuing alarming figures showing…

(solution) Why accounting standards matter! In Britain, many companies are issuing alarming figures showing…

Why accounting standards matter! In Britain, many companies are issuing alarming figures showing deficits in their pension funds. The sobering financial transparency provided to UK employees may soon spread to other countries. The International Accounting Standards Board is seeking a global convergence on an agreed standard for accounting for pensions – and is modeling its proposals largely on rules recently introduced in the UK. Sir David Tweedier, IASB chairman, wrote FRS 17, as the UK rule is known, when he was head of the UK Accounting Standards Board. In the 20 months since it came into force, some companies have blamed it for forcing the closure of their relatively generous defined benefit pension schemes. But Sir David has no regrets. ‘I think it is one of the best things we have done,’ he says. Like the IASB’s standard on financial instruments, the new rule on pensions is expected to put a heavy emphasis on ‘fair value’ accounting. As a result, it may run into opposition. Under FRS 17, the measurement of the assets in a defined benefit pension scheme should reflect their fair or market value. FRS 17 also tells accountants how to arrive at the present value for future liabilities; it tots them up and discounts back at an interest rate equal to that on AA-rated corporate bonds. According to WM Company, a performance measurement consultancy owned by State Street, the US bank, British pension funds lost about £100bn ($160bn) in 2002. Morgan Stanley says the gap between pension liabilities of companies in the FTSE 100 index and assets available to meet them widened to £85bn at the end of January 2003. Credit ratings agencies are responding to FRS 17 by downgrading the debt of companies such as BAE Systems, the defense group, where they have concerns about pension deficits. ‘They have got the same problems in America – funds in deficit,’ Sir David argues. ‘[But] it is not visible.’ Many UK employers, however, argue that FRS 17 is misleading: although a pension shortfall is presented as a liability, it is not one about to come due in full any time soon. Companies have used FRS 17 since mid-2001, after stock markets began falling. If stock markets start rising, the gaping holes in many pension funds will be reversed; indeed, a rise in interest rates may have a similar impact. Sir David refutes the idea that the deficit or surplus in a pension scheme has only limited utility because it is a snapshot at the end of a company’s fiscal year. He highlights how under FRS 17 companies are required to put figures in their annual reports that set out the scheme’s trend position over five years. He also challenges companies to assert that deficits are a temporary blip. ‘If it is not, you are going to have to take cash – which might have gone on dividends and investments – and put it into your pension fund. People should know that.’ Sir David’s successor at the UK Accounting Standards Board decided last year to delay bringing FRS 17 into full force pending the outcome of the IASB’s deliberations on a new global standard on pensions. The move followed an intensive campaign against the accounting rule by employer organizations and trade unions and pressure from the UK government. But the sting in the tail is that the international rule may turn out to be even tougher than FRS 17: the IASB voted in January to ban the practice of reflecting projected rates of returns on pension fund assets in income statements. At present, companies are allowed to reflect anticipated gains in the profit and loss statement. Some US companies in particular use estimates viewed as recklessly optimistic. FRS 17 does allow some leeway: the IASB may be stricter. Question 1 Outline the case for and against the FRS17 rule on pensions in the UK. 2 Why might a similar rule under consideration by the IASB create still more problems?