This page is quite old hence its rather spartan appearance.
Why not check out our Latest Stories page for our newest articles or search our site for anything.
QUALIPORT
By
Carburton Street, London -- Financial Reporting Standard 17 is the new accounting standard covering retirement benefits. All listed companies have to adopt it over the next year or two. Whereas its forerunner, SSAP24, allowed companies to present their pension liabilities in a somewhat covert and haphazard way, FRS17 brings the subject of pensions to the forefront of a company's accounts. Importantly, FRS17 does not affect a company's cash flow, nor should it alter a company's pension scheme strategy. FRS17 simply changes and improves the reporting of certain accounting items. FRS17 applies to all retirement benefits that an employer is committed to providing. As such, it primarily involves defined benefit, rather than defined contribution, pension schemes. In practice, the new reporting mechanism may not be ideal. But it does give investors far more help in spotting companies with onerous pension responsibilities.
One of the first companies to implement the new standard is Qualiport watch list constituent Renishaw (LSE: RSW). Using Renishaw's 2001 annual report as an example, here's how FRS17 will affect a set of accounts and what investors should look out for. Assumptions FRS17 requires companies to present in an accounting note: * An estimate of all future pension liabilities, alongside the actuarial assumptions used in their calculation; The first table shows the assumptions used by Renishaw. The figures are used to calculate the 'actuarial value of liabilities' in the second table.
* The market value of their pension investments, and;
* The overall net pension surplus or deficit position.Year to 30th June 2001 2000
(%) (%)
Rate of increase in pensionable salaries 4.5 4.5
Rate of increase in pension payments 2.5 3.0
Discount rate 6.0 6.5
Inflation 2.5 3.0
Expected return on equities 8.0 8.5
Expected return on bonds 6.2 6.5
Year to 30th June 2001 2000
(£000) (£000)
Market value of assets:
Equities 27,900 28,400
Bonds and cash 720 700
Actuarial value of liabilities (29,170) (28,600)
(Deficit)/surplus in scheme (550) 500
Deferred tax 230 (90)
Net pension (liability)/asset (320) 410
The net pension surplus or deficit is also shown on the group balance sheet. For Renishaw, the current deficit is relatively small:
Year to 30th June 2001 2000
(£000) (£000)
Net assets excluding pension
(liability)/asset 109,642 96,688
Net pension (liability)/asset (320) 410
Net assets 109,332 97,098
The points to consider here are:
* A large pension liability: If a company has an underfunded pension scheme, additional funding could hamper future profits, and;
* Unrealistic assumptions: Are those actuarial estimates prudent? Estimated pension liabilities can be reduced by optimistic projections of asset growth and pessimistic projections of salary expenditure.
Profit and loss
FRS17 also requires companies to recognise in their profit and loss account:
* The expected investment return from the company's pension assets for the year (i.e. the return based upon the asset values and assumptions at the start of the accounting period), and;
* The expected change in the company's pension liabilities for the year (i.e. as measured by the actuarial assumptions given at the start of the accounting period).
The following table highlights Renishaw's figures:
Year to 30th June 2001 2000
(£000) (£000)
Operating profit 27,943 25,677
Net interest receivable 2,252 2,384
Other finance income:
Expected return on pension fund assets 2,400 1,800
Interest on pension fund liabilities (1,800) (1,600)
Profit before tax 30,795 28,261
The points to consider here are:
* Enhanced profits: Reported profits can be enhanced by the new standard. But investors would do well to strip out any FRS17 credits from their earnings figures. Pension fund gains are ultimately distributable to the scheme's members, not company shareholders, and;
* Reduced profits: Reported profits can also be hampered by the new standard. However, unless the standard causes a significant or continual decline in profits, investors shouldn't be too alarmed. Although some companies may report expected pension liabilities growing quicker than expected pension asset growth, such funding shortfalls should be viewed over many years, not just one.
Recognised gains and losses
While the profit and loss account highlights the changes expected from a company's pension fund, how do investors find out what actually happened to the fund?
FRS17 requires companies to include the actual gains from their pension fund in the statement of total recognised gains and losses. This accounting note usually accompanies the consolidated balance sheet. It encompasses the gains a company made during the year that did not go through the profit and loss account. Of all the statements changed by FRS17, it's probably the most important one to study.
The statement of total recognised gains and losses statement contains:
* The difference between the actual and the expected return on the pension scheme's assets for the year;
* The difference between the experienced and the expected change in the pension scheme's liabilities during the year, and;
* The effect of any year-end assumption changes in the present value of the pension scheme's liabilities.
Renishaw's figures again:
Year to 30th June 2001 2000
(£000) (£000)
Profit for financial year 27,943 25,677
Currency translation (319) 171
Actual return less expected return
on pension scheme assets (4,100) 2,800
Experience gains and losses arising
on the scheme liabilities (200) (1,100)
Changes in assumptions underlying
the present value of liabilities 2,650 2,900
Total gains and losses 23,244 24,567
The points to consider here are:
* Underperforming assets: If the actual return from the pension scheme's assets undershoots prudent actuarial assumptions, inadequate investment managers could be at work.
* Expanding liabilities: Significant and unfavourable differences between the pension liability increases experienced during the year, and those that were originally expected, suggests very poor actuarial assumptions by the company.
* Changing assumptions: Revised actuarial assumptions can do wonders for reducing estimated pension liabilities. In each of the past two years, Renishaw has made favourable changes in this respect.
Thankfully, FRS17 requires companies to present a 5-year table to highlight past figures from this important statement. Although the 5-year table is not retrospective (i.e. it starts from the first year of FRS17 reporting), persistent offenders of the three key points above will gradually come to light.
Summary
FRS17 may not be ideal, but the information it reveals should highlight companies saddled with burdensome pension schemes. Of course, few firm conclusions can be made from the first year of data. Building a clear funding picture for any particular pension scheme could take at least three years of corporate FRS17 reporting.
That said, as companies begin to adopt the new standard, large pension deficits on the balance sheet could be an early sign of trouble. Furthermore, investors should be vigilant with companies whose pension liabilities continue to grow much larger than the actuaries expect.
And of course, it will be interesting to see the range of actuarial assumptions that companies use for FRS17. Certainly those businesses that apply relatively aggressive estimates of equity and bond returns to lessen any pension deficit should be treated with caution.
More: Boots Pension Fund Sells All Its Shares | Are Pensions Properly Funded? | William Mercer: FRS17 Explained | The Staple Inn Actuarial Society: FRS17 Explained (PDF)