PD-25:
IFRIC 14
TR-25 :
IDRIC 14
moDeraTor / moDÉraTeUr: Jason vary SPeaKerS / CoNFÉreNCIerS: lorraine Gignac
alan van weeldern ?? = Inaudible/Indecipherable
ph = phonetic
U-M = Unidentified Male U- F = Unidentified Female
moderator Jason vary: This is the session on IFRIC 14, dealing with international accounting for pension plans. My name is Jason Vary and I’ll be the moderator for the session. The session is being recorded so if you do have a question, please hold those until the end and use the microphones provided. The presenters will be talking entirely in English today.
Our first speaker, and in fact they will be switching back and forth throughout the presentation, is Lorraine Gignac. Lorraine is a consulting actuary and a principal in the Toronto office of Mercer. She has over 20 years of consulting experience with Mercer including consulting to a number of companies and subsidiaries of U.S. and European companies in the telecommunications, consumer products, manufacturing and financial services sectors. Lorraine consults to clients in all areas of actuarial and pension consulting. Her expertise include design, funding and expensing of defined benefit and defined contribution pension plans. Lorraine participates on Mercer’s Accounting Specialist Group, and is an expert on Canadian-U.S. international employee benefit accounting standards.
Alan Van Weeldern is our other speaker, he’s a guest speaker of ours. He’s a chartered accountant and an associate partner at KPMG in the department of national insurance and professional practice. He’s the leader of the firm’s technical topic team for pension accounting. He’s also the team leader in the area of the firm’s associa-tion as auditors with various offering documents as prospectuses, offering memoranda and informaassocia-tion circulars. Alan participated on the CIA Ad Hoc committee that monitored the implementation of CICA Handbook section 3460 in 1987. He’s also member of the CICA working group that developed the Employee Future Benefits imple-mentation guide in 1999 for the new CICA Handbook section 3461. Alan is currently a member of the CICA Employee Benefits Advisory Group which provides support to Canadian representatives of the Employee Benefits Working Group of the International Accounting Standards Board. So with that I’ll turn it over to our speakers. Speaker lorraine Gignac: Good morning. IFRIC 14—just to start off, IFRIC stands for International Financial Reporting Interpretation Committee and they are a group that are charged with issuing clarification concerning international financial reporting standards. IFRIC 14 is intended to clarify the International Accounting Standards Board’s interpretation of Paragraph 58 of IAS 19, which places a limit on the defined benefit asset that can be shown on a company’s balance sheet. IFRIC 14 has been in place since January 1, 2008.
So let’s start by talking about Paragraph 58(b) of IAS19, IAS19 being the International Financial Reporting Standard dealing with the accounting for employee benefits such as pension and non-pension post-retirement post-employment benefits.
Paragraph 58(b) of IAS19 has a similar requirement to Paragraph 101(b)(i) of 3461 in that it requires that the defined benefit asset shown on a company’s balance sheet be limited to the total of any unrecognized losses and unrecognized past service cost plus the present value of any economic benefit available in the form of either a refund of surplus or reductions in future contributions. Under Paragraph 58(b), any adjustment arising from the limit imposed under IAS19 is to be recognized in OCI or other comprehensive income, if the company is using the OCI approach for recognizing experience gains and losses. On the other hand, if the company is using the ten percent corridor approach for recognizing experience gains and losses, the limit or any change in the limit of the balance sheet asset is recorded directly in P&L expense.
Speaker alan van weeldern: Good morning. So you might ask why do we need a limit on a pension asset? Well, the statement is made, a company should not report an asset on its balance sheet in excess of its economic benefit, so we can say, we need a limit because IFRIC 14 says so but really it goes back to the framework that the IASB has for the preparation and presentation of financial statements in general. So any time they’re introducing a new standard or amending an existing standard, they go back to this framework just to make sure that the principles in this amended standard or new standard are consistent with their framework. And in the case of an asset, the framework defines it as “a resource controlled by the entity as a result of past events from which future economic benefits are expected to flow to the entity”.
Now if I read you the comparable definition in the CICA Handbook, which some of you may be more familiar with, the corresponding definition in the CICA Handbook is “assets are economic resources controlled by an entity as a result of past transactions or events and from which future economic benefits may be obtained”. So in concept the definitions are virtually identical, I’m not sure who copied who, maybe they both copied some U.S. concept statements, I didn’t go back to find out who said it first.
But in the case of a defined benefit registered pension plan then the economic benefit can be in the form of a refund of the surplus or a reduction in future contributions. Actually, I’m sorry Lorraine, I wanted to go a little bit back further and explain. Back in 1989, the CICA formed the Emerging Issues Committee. The Emerging Issues Committee is to Canadian GAAP what IFRIC is to IFRS. The Emerging Issues Committee provides inter-pretations on areas where there were maybe differences in or difficulties in understanding what was intended in a standard and their purpose was to clarify it. The very first abstract issued by the Emerging Issues Committee was on the topic of pension surpluses, it was a timely topic because at the time a number of regulators had declared a moratorium on surplus withdrawals, there were beginning to appear some court challenges to surplus and that brought into question whether a pension asset had economic value if you were unable to withdraw the surplus. Now even back then, 20 years ago, the EIC concept of an asset was consistent with the Handbook, they were looking for an expected future benefit. And in this case, they identified or concluded that expected future cash flows from a surplus if that would lead to a reduction in the future normal cost contributions then that surplus has economic benefit.
Speaker Gignac: So to give you a conceptual framework, the asset that shows up on a company’s balance sheet at the end of the year is equal to the asset at the beginning of the year plus funding contributions made during the year less expense recorded during the year. So if a company can take a contribution holiday, funding contributions will be set to zero and the DB asset will be drawn down over time because you’re subtracting more than you’re adding, so you will naturally use up that balance sheet asset over time.
If on the other hand, the present value of the funding contributions exceeds the present value of the pension expense, you’re adding more than you’re subtracting, the asset’s going to grow and grow and grow over time. If at the end of the day, at the end of the life of the plan, if the company cannot withdraw that surplus, upon wind-up of the plan you are going to have to recognize a settlement loss to write that asset down to the actual cash position. So the concept here is from an accounting perspective, you shouldn’t let an asset grow and grow and grow for
which you’re never going to have economic benefit from. You should deal with impairing that asset over the life of the plan and not wait until the end of the day to write it off with a settlement loss.
So IFRIC 14 states that “in order for a surplus refund to be considered an economic benefit, the company must have an unconditional right to a refund under one of three scenarios”. Either during the life of the plan or assuming gradual settlement of the obligations over time until all members, beneficiaries have been paid out; I refer to this as the last person standing. If after every member, every beneficiary, every surviving spouse has been paid out and there’s still money left over, could the company withdraw it? Or the third scenario is upon full wind-up in a single event.
Now it varies by jurisdiction but I would maintain that it would be rare for a company to have an uncon-ditional right to withdraw surplus either during the life of the plan or plan upon full wind-up in a single event. Because in many jurisdictions, you need to have a certain level of member consent to withdraw surplus from an on-going plan or on plan wind-up and in all jurisdictions you would have to demonstrate that the plan both today and historically has always allowed you to withdraw surplus or you reserved the right to amend the surplus withdrawal provision. With a plan with any history, especially the plans funded through a trust, that could be a very difficult exercise to undertake to prove that you do have surplus ownership.
The first and the third scenarios are the scenarios that we’ve seen under 3461 all these years, either can you withdraw surplus on plan wind-up or while the plan is on-going. What IFRIC 14 does is it introduces this middle scenario assuming gradual settlement. While that may appeared to have open the door to make a claim that you would have an unconditional right to withdraw surplus, I think practically speaking, plans would never get to that position because I believe regulators would step in long before the last beneficiary has been paid out and declare a wind-up, again it depends upon the jurisdiction but many would declare a plan wind-up when there are no active members.
So, you know, one might ask the question, does the fact that a regulator would likely declare a wind-up before all members have left the plan, does that remove the possibility that a company has an unconditional right to withdraw surplus? Or if surplus would be shared with members, can the company claim that it has an uncon-ditional right to the remainder of the surplus after it’s shared with the members? Well in answer to those types of questions, IFRIC 14 states that “a company’s right to a refund of surplus, if it depends on the occurrence or non-occurrence of one or more uncertain events not wholly within its control, then the company does not have any unconditional right and is not to recognize the surplus as an asset”. Alan?
Speaker van weeldern: So if we can’t get the economic benefit in the form of a refund of surplus, then we’re going to have to look for it in terms of a reduction in our future contributions for future service which typically we call future normal cost. So in a situation where we have no minimum funding requirements and at this point we haven’t explained or discussed what minimum funding requirements are but let’s just assume for the moment that there is no such thing, no minimum funding requirements for future service, what would be the maximum asset that you could sustain on your balance sheet? Well not surprisingly IFRIC 14 uses accounting measurements to determine this maximum ceiling amount. So first of all, there’s the IAS 19 surplus that you currently have, so you take the lower of your IAS 19 surplus or the present value of the future IAS 19 service cost over the shorter of the life of the plan or the entity.
Now in many circumstances and I’ll say closed plans aside, in many circumstances neither the entity nor the plan will have a foreseeable finite life. I really can’t think of a Canadian public company that has a finite life i.e. it’s known that it’s going to shut down operations at the end of 30 years or 40 years or some finite period. And while the absence of a foreseeable finite life doesn’t necessarily mean you have infinite life, accounting wise we’ve already dealt with that in the dealing with the lives of useful lives of intangible assets and that’s another area where you have intangible assets that are considered to have indefinite life.
But nevertheless, when you have an indefinite life, your first instinct or first cut is often to do with perpetuity calculation. So if we were to take the IAS or estimated future IAS service cost and divide it by a discount rate, we would get a first cut of a ceiling. Now that type of calculation has some history in Canada, it’s been referred
to as either a surrogate calculation way back in EIC 1 or as perpetuity formula in the CICA’s Employee Future Benefits implementation guide, so there is some history for that. IFRIC 14 itself does not raise the prospect of a surrogate calculation but it wouldn’t surprise me as we get more and more experienced in applying IFRIC 14 in the Canadian environment that some of these shortcut approaches may evolve over time.
Now the next step is where you do have some future minimum funding requirements for future service, so you’re obligated to make some contributions for normal cost in future years. So the formula I discussed on the previous slide, which gives you the maximum amount with no minimum funding requirement, is necessarily going to be eroded to the extent that you do have funding commitments for future service cost. And that will then tend to erode your maximum asset and potentially lead to situations where you need a valuation allowance if your current IAS 19 surplus exceeds that ceiling amount. Now again this present value calculation uses the accounting estimate of the discount rate so it’s your IAS 19 discount rate as at the reporting date i.e. it’s the rate you use to determine your obligation at the end of the year.
Speaker Gignac: That’s different from 3461 where we would have used the expected rate of return on assets to calculate these present values, and again the calculations are done over the life of the plan or the life of the entity, so most likely in perpetuity.
Speaker van weeldern: So we’ve talked about minimum funding requirements several times but well, what is it? Well the basis for conclusions for IFRIC 14 provides some clarification, it’s says it’s “any statutory or contractual requirement to make contributions to fund a post-employment benefit plan or other long-term defined benefit plan”. I looked up “any” in the dictionary; my dictionary said it meant “whatever number or quantity”. So person-ally I didn’t find a lot of clarification in the word “any”. Now when we first looked at this, we were looking more at IFRIC 14 Paragraph 2 where it states “minimum funding requirements normally stipulate a minimum amount or level of contributions that must be made to a plan over a given period”. Well I looked at words like “stipulate” and “minimum amount” and “given period” and quite frankly my first impression was, oh that means the contribu-tions spelled out in the actuarial report, because that’s exactly what’s in an actuarial report, it specifies your normal cost contributions and the given period is generally the next three years. In other countries, I understand in the U.K. there they have a practice of negotiating schedules of contributions with the trustees of the pension plan. So periodically the employers and the trustees sit down and hammer out a schedule of contributions which may cover five years. So I believe a number of U.K. accountants read that and read it and said, oh they must mean the schedule of contributions that we’ve agreed to. And I think this illustrates the type of problems that are inherent in international accounting standards that are going to be applied in hundreds of countries to start with and that’s generally going to mean hundreds of different contractual and legal circumstances.
Now I’m not ready to throw any bricks at IFRIC because the best our working group in 1999 could come with was Question and Answer 88 in the implementation guide and I’m going to discuss that later. So we dealt with and maybe something about that long what IFRIC takes, you know, a dozen pages or so to deal with but certainly as an accountant, I appreciate the difficulty of writing standards for the world. Because historically we’ve just had to worry about and I have drafted a couple of accounting pronouncements in my time but I knew when I was drafting it what the Canadian facts and circumstances were. I didn’t have to worry about facts and circum-stances that might exist in the U.K. or the U.S. or in Asia, so my job was much simpler at the time but I think basically it’s boiled down to minimum funding requirements are for future service are generally represented in Canada by normal cost contributions and then for past services, we sometimes have catch-up contributions for shortfalls due to adverse experience we can have experience deficiencies or we can also have solvency deficiencies which require catch-up contributions in terms of the services that had been provided prior to the reporting date. Speaker Gignac: So what’s meant by a minimum funding requirement? IFRIC 14 does state “the calculation of the future minimum funding contributions in respect of future service accruals is to take into account the effect of any existing surplus or deficit on a minimum funding requirement basis” so in Canada going-concerns or solvency
you also take into account “any changes expected as a result of the company paying the minimum contributions due” so if you’re currently making solvency special payments once you make them chances are you’re building up a going-concern surplus but the calculation of future minimum contributions is “not to take into account the effect of expected changes in the terms and conditions of the minimum funding requirement that are not substantially enacted or contractually agreed upon at the balance sheet date”. So you can’t anticipate that there’s going to be changes in the statutory minimum funding requirement rules, as an example.
So based on the words in IFRIC 14 and in talking to various people both in Canada and outside of Canada, I’ve come to the conclusion I’ve seen in play at least these three interpretations and there’s probably more varia-tions on the theme. The first interpretation is that the minimum funding requirement is based on the schedule of contributions set out in the most recent funding report. So as Alan said, you know, maybe that’s the one to three years that a Canadian valuation report is good for or in the U.K. maybe it’s the period covered by the schedule of contributions that have been agreed upon by the trustees.
The second interpretation is along the lines that if a company is currently contributing its current service cost because there’s either a going-concern or a solvency deficit, that once the deficit is fully amortized you’re at break even and at break even you can’t take a contribution holiday so basically if you’ve got any sort of going-concern or solvency deficiency now, you’re going to be making your current service cost every year in the future.
The third interpretation is along the lines that surplus derived from the best estimate expected rate of return that you’re using in the calculation of pension expense in most cases that best estimate expected rate of return on assets will exceed the going-concern discount rate or the solvency discount rate and as such gains or surpluses will build up and if the legislation in the plan terms so permit, that surplus could then be used to reduce contributions in future years.
So let’s take a closer look at each of these interpretations and see, you know, where they’re coming from and what applicability they might have in Canada. Interpretation One where the minimum funding requirement is deemed to be limited to the current schedule of contributions, I’m not sure that is particularly relevant in Canada, it would be relevant, say in the U.K., excuse me, where they do have a schedule of contributions. But, you know, looking at Canadian legislation there is a requirement to make your current service cost every year unless you’ve got sufficient surplus to take a contribution holiday, you know, plan provisions so permitting.
So then let’s look at interpretation two, which basically is saying that, you know, if you’ve got a deficit now you’ll always be making your current service cost because at best you’re going to get to break even. An economic benefit in the form of future reduction in contributions is not considered available in this circumstance. The consequence of this interpretation is you pretty much now turning to accounting on a cash basis. If you’ve got a deficit now, your expense is going to be pretty much your funding contributions and, Alan you can comment on this, but I don’t think this was ever the intention of accountants to back into accounting funding contributions. Speaker van weeldern: Well I would go back to the standard itself which in the basis for conclusions for IAS 19, the board said that the limit was likely to come into play only when a plan is very mature and has a very large surplus that’s more than enough to eliminate all future contributions and the surplus cannot be returned to the entity. So they were looking for the plan really that’s grossly overfunded and it’s overfunded to the extent that you’d never have to worry about making another normal cost contribution because the earnings on that surplus are going to more than cover your future normal cost calculations, so it was looking at identifying these fat plans. I think under interpretation two, we haven’t introduced the topic of a minimum liability but basically you’re going to be pushed into setting up a liability for your future solvency payments and given the number of Canadian plans that are presently under water and are subject to solvency payment requirements, it would apply to a majority of Canadian defined benefit registered pension plans and I don’t think that that is consistent with the board’s idea of how this limit was supposed to apply.
Speaker Gignac: So then let’s move on to interpretation three, that’s the interpretation that says that you should reflect the build up of a surplus due to the expected rate of return on assets exceeding the minimum funding
requirement discount rate. If we looked to wording within IFRIC 14, we’ll find that the basis for conclusion Paragraph number nine says that “an economic benefit may be available even if it is not realizable immediately at the balance sheet date”, sorry that’s Paragraph 14.8 and that “a reduction in future contributions is available if it could be realized at some point during the life of the plan”, okay.
IFRIC 14 basis for conclusion Paragraph 10 goes on to say that “in general the employer’s right to obtain a reduction in future contributions exist under Canadian pension legislation, has been established by the Supreme Court of Canada and does not require negotiation with the plan members or trustees or the approval of the plan members or trustees or the pension regulators”.
“The minimum funding requirement should take into account the effect of any existing surplus on a minimum funding requirement basis”, that’s Paragraph 21 of IFRIC 14 and “the calculation shall include any changes expected as a result of the entity paying the minimum contributions”, again in Paragraph 21. So I read those various sections of IFRIC 14 and personally come to the conclusion that to do these calculations, you should do a projection of your assets using the expected rate of return of assets that you’re using for pension expense purposes, do a projection of your going-concern and solvency liabilities and indeed determine if at some point, not withstanding that you’re currently in a deficit position on a going-concern or solvency, but if at some point when you compare your assets that have grown with the best estimate rate of return compared to your projected solvency or going-concern liabilities, do you have a surplus that would enable you to take a contribution holiday in future years such that you can set your minimum funding requirement in those future years to zero such that when you take the present value of the minimum funding requirement, it’s a lower number than it would have otherwise been and determine your economic benefit accordingly.
So we’ve presented three very different interpretations, with three very different outcomes. At the end of the day these calculations have to be owned by the plan sponsors and have to be agreed upon between management of the company and their auditors. As actuaries we perform the calculations but we do not necessarily have to opine on the method used, the methods are the accounting methods and they’re management’s interpretation of the accounting standards and they need to get agreement from their auditors on the selection of those interpreta-tions. So with that perhaps Alan can share with us what the auditors’ accounting firms are thinking in terms of IFRIC 14.
Speaker van weeldern: Okay, thank you. First thing I want to admit, on the very first slide we pointed out that IFRIC 14 started to be applied for annual periods beginning on or after January 1, 2008. And I remember when I first saw the exposure draft for IFRIC 14, probably sometime in the summer of 2007, I sort of flipped through it and I thought, oh IFRS is catching up with Canadian GAAP and I chirped, I could pick out some minor differences for example where we might use the expected rate of return as a discount rate in the ceiling test, they wanted to use the IAS 19 discount rate but, you know, I’m not going to trouble myself over small details like that, so I sort of parked it away. It was only late last year and really early this year that I became aware of some of the interpretations of IFRIC 14 that were in play and I was concerned about the direction, not so much internationally I mean I’m not really worried how it’s being applied in the Netherlands or in the U.K. or any other country for that matter, I’m particularly interested in how it’s going to apply to our typical registered defined benefit pension plan.
So I was concerned about the interpretations and I took the initiative of forming an ad hoc group of pension accounting representatives of the big four accounting firms plus two more, the plus two more being BDO Dunwoody and the other being Raymond Chabot Grant Thornton. So we had our first meeting in I think late March and basically prepared a discussion paper that was in line with our experience and understanding of how the limit provisions under Canadian GAAP have worked for the past two decades. Canadian GAAP certainly had the economic benefit test and we felt that the Canadian approach was essentially consistent with the objec-tives of IFRIC 14.
Well it’s a different world for Canadian accounting firms now because while I have the authority to sign off on a Canadian GAAP treatment in my areas of specialization when it comes to IFRS, KPMG has a global process,
what they don’t want is IFRS in Canada and IFRS in U.K. and IFRS as interpreted by the U.S. firms and IFRS as interpreted by the Australian firms. So we are trying to get to common ground, common views on a world-wide stage and that’s the case for the other firms as well. So we floated our discussion paper to our international accounting desks and basically it came back to us full of bullet holes. A couple of common things, one they don’t really understand the Canadian facts and circumstances that we face and they weren’t particularly interested in becoming expert in the Canadian pension regulations.
Speaker Gignac: Few people are.
Speaker van weeldern: (laughter) So we had some trouble getting their attention. What was the second thing? The second thing was because they’d been applying it already in 2008, they’d applied it largely in the European Union countries which adopted IFRS; they were the first wave of countries to adopt IFRS. So they already had some entrenched positions and they also had understood it in the context of their local rules and regulations and I saw in the feedback we got just some assumptions in their thinking that, you know, our process was a lot like the U.K.’s, for example.
So I personally, I spent a long time drafting a very long rebuttal letter but in the end I didn’t send it because I saw something in our international, our published international materials that I felt I could work with and that brought back, had a number of the concepts I guess that we had in mind over the years in Canadian GAAP. And this guidance effectively accepted a projection that in respect of the services received to a particular reporting date, a reduction in future contributions will be available in the future based on the expected return on plan assets, future expected service costs and the current minimum funding requirements. And the question posed to our international group was, given that this refund was going to come at some point in the future, could it be considered available to the entity? And our conclusion was yes. It can be considered available even though it’s not immediately realizable at the reporting date but as long as it’s available in the future an asset can be recognized.
So I began to work with that model and I never saw a ceiling test that included a withdrawal of surplus so I tended to ignore the provisions in IFRIC 14 about a refund of surplus because that, as Lorraine said, that would be rare in today’s environment but I did look very closely at IFRIC 14 Paragraph 15 and that talks about a circum-stance where you can get a refund, it’s just you can’t get it until some future date and it says, by the way you don’t have to take the time value of money into account and I thought, um so if I’ve got a surplus of a, you know, ten million today and I don’t think I can get a refund until 30 years from now, why don’t I have to discount it? Well the answer is in the basis for conclusions IFRIC 14 Paragraph BC16 and it says “both the obligation and the fair value of assets are present value measurements” So the implicit assumption in leaving my 100 million dollars of surplus intact is that, we know the obligation that we’ve incurred to date, this is going to grow by interest but IFRIC 14 says so will your pension assets because it’s a present value number and it also can reasonably be assumed to grow at a rate of return and I would argue that return is the best estimate of the return on assets.
So even in a surplus withdrawal circumstance, a return on the existing surplus is a reasonable assumption. And as you will note in the interpretation three and in the little excerpt I read from KPMG’s international guidance, we would allow the client to take into consideration this calculation a return, a future return on the existing asset base.
Now going back to our ad hoc committee, I presented a model to the committee based on concepts similar to the concepts that Lorraine outlined in interpretation three, KPMG Canada has decided that we will recom-mend to clients an approach based on interpretation three. One of my colleagues from a big four who supports interpretation three, told me today he is making a presentation within his national group which is the same thing I did last week and he hopes to, as I did, obtain support for interpretation three. However, I know another big four firm that represented on our committee who has looked at these issues and they concluded that they can only accept interpretation two. The remaining three members from our firm represented on our committee are still undecided on the matter. So that is the current state of affairs.
Speaker Gignac: And Alan, didn’t you indicate to me that it may be the situation that the accounting firms simply agree to disagree? And in which case the Canadian Accounting Standards Board will not intervene, they do not see it as their role to decide how this is to be interpreted. That is left up to each accounting firm and so if they agree to disagree, that will be what it is.
Speaker van weeldern: In the past an issue like this would have been pushed forward to the Emerging Issues Committee that was its role in Canada to clarify. Now lots of complaints were raised even this summer in the response to a very narrow amendment to IFRIC 14 but I don’t think IFRIC is amenable to completely re-opening IFRIC 14 and I know the Accounting Standards Board in Canada recognizes it does not have any authority to issue interpretative guidance on IFRS, that’s the job of the IASB, that’s the job of IFRIC. They do provide input; they will provide comment letters on all exposure drafts or proposals for amended standards but they, as a matter of policy, will not be issuing authoritative guidance on IFRS.
Speaker Gignac: So it could very well be that the different auditors have different directives from their accounting firm and I think our clients need to be made aware of that and have discussions with their auditors at an early date as to, you know, what the appropriate interpretation of IFRIC 14 is to be so they can get on with their transition plans.
Speaker van weeldern: And it certainly isn’t for lack of trying because my wife will tell you when we’re sitting out at the trailer in the summer, what are you thinking about ? I guess, IFRIC 14. (laughter) My kids visit, Dad what do you think? Oh we know Dad, IFRIC 14. It’s been on my mind. It’s been the bane of my existence since I tackled the topic. In fact even before I tackled it, I knew it would be a difficult topic to take on and I have a colleague I won’t name her but we have a long history in pension accounting that goes back into the 1980’s, she is also very well versed in IFRS and I presented some of my ideas to her, used her as a sounding board and, you know, “do you think I’m nuts to start down this path?” And she said “not at all” and “go for it.” So I did. Speaker Gignac: I think the other relevant accounting concept is accounting generally on a going-concern basis. Accounting is typically not assuming that the plan or the entity is being wound up unless that is the fact situation. So interpretation two kind of leads you to, well if you’ve got a deficit, you’ve got a deficit and you’ll always have a deficit. That is more of a current wind-up scenario as opposed to a going-concern type of concept which, correct me if I’m wrong, is generally the way accountants view the world.
Speaker van weeldern: Yes.
Speaker Gignac: Okay, one final note on this before we move on is that, in its meeting in October of this year the International Accounting Standards Board has said that no further clarification is forthcoming so we have all that we’re going to get in IFRIC 14. So in terms of clarification on what constitutes an unconditional right to a surplus refund or what constitutes a minimum funding requirement, you can expect to receive no further clarification from IFRIC or the IASB.
So IFRIC 14 goes one step further than 3461 did and it says that there may be situations where not only do you have to limit a balance sheet asset, you may have to hold an additional minimum liability. If a plan currently has a going-concern and/or solvency deficiency such that special payments are required and if once those special payments are made the company cannot either take a refund of the surplus or take a contribution holiday then the present value of the special payments forms an additional minimum liability that is either netted against the balance sheet asset or if there’s a balance sheet liability, the balance sheet liability is adjusted to include the present value of those special payments. So in the extreme case, you’ve got a closed plan, no current service cost, no ability to withdraw surplus and you currently have say a solvency deficiency, so you’re making special payments
as required by law. Once you make those special payments, you can’t use them because there’s no contribution holiday to take and there’s no refund of surplus. In that case that corporation would have to show on their balance sheet a liability equal to the present value of the special payments where the present value is calculated using the IAS 19 discount rate. So it’s not exactly equal to the solvency deficiency but it’s pretty darn close.
Again if there is a minimum additional liability, that amount is recorded in P&L expense if the company is issuing the ten percent corridor to recognize gains and losses or it’s recognized in OCI views and the OCI approach for recognizing gains and losses. And any year over year change in the additional minimum liability is reported the same way.
So just summing up here. The magnitude of the impact of IFRIC 14 depends on surplus ownership provi-sions, contributions holiday provisions and what’s your interpretation of a minimum funding requirement. On the spectrum, if the company has an unconditional right to refund a surplus, IFRIC 14 is not an issue. The other end of the spectrum, if a company has no ability to take a contribution holiday and no ability to withdraw surplus, IFRIC 14 will have a significant impact. And then in between you’ve got all the other plans. So really it really depends and a key component is what’s your interpretation of a minimum funding requirement.
Speaker van weeldern: I thought it’d be worthwhile to try and compare IFRIC 14 or the significance of that compared to existing Canadian GAAP and in my view Canadian GAAP has been dominated by the thinking in the Employee Future Benefits implementation guide, specifically question and answer 88 which provided a perpetuity formula that was considered to be useful as providing an early indication to an entity that a valuation allowance might be required. And that perpetuity formula was essentially your future service cost divided by the expected rate of return on assets. Now implicit in the working group’s thinking was that for most, for the typical defined benefit, registered defined benefit pension plan, it doesn’t have any minimum funding requirements that have to be made regardless of surplus. Or to say it in another way, there was an implicit assumption that future contribution holidays were available and that circumstances we were worried about like IAS 19 and the Board was the plan is way overfunded and the only other plans that had to worry about a limit would be those that had perhaps bargained away their right to a future contribution holiday. So they sat down with the employees and said okay, we will not take contribution holidays. In that case they would have minimum funding requirements to be made regardless of how much surplus was accumulated in the plan.
Now whether we use interpretation one, two or three, I think the bottom line is, what will change, we’re going to have to do some calculations. In a lot of cases because of the ceiling and EIC 88, if the surplus was nowhere near that ceiling, you were done, there was no use sharpening the pencil, you were so far away from that early indicator there was no limit concern. I think under IFRIC 14, until we get a number of years of experience, we’re going to have to be doing calculations to support the economic benefit for an IAS surplus or an adjusted surplus in the case where you’re presently having a deficiency that’s being funded through a solvency payment schedule.
Speaker Gignac: As Alan mentioned there are some proposed changes to IFRIC 14, there was an exposure draft issued in May of this year which dealt with economic benefit would include any pre-payment of a minimum funding requirement in respect to future service funding contributions, the exposure draft does not deal with the pre-payment of a minimum funding requirement in respect to past service, since such a pre-payment will naturally be reflected in the calculation of the additional liability. So given that these proposed changes to IFRIC 14 only deal with the pre-payment of a current service cost, I don’t think it’s going to be an important issue in Canada because, correct me if I’m wrong, I don’t think you can pre-pay a current service cost, you can accelerate the payment of your past service payments but that’s not dealt with in this exposure draft. And last I heard is this exposure draft is going to be put through without change.
So just to conclude, IFRIC 14 may be very significant. The impact of IFRIC 14 should be considered in developing a plan for transitioning to IFRS. IFRIC 14 could impact both plans with a balance sheet asset or a balance sheet liability. So unlike 3461, where you only had to be concerned if you had a balance sheet asset, you
have to now be concerned in all plans because you may have to adjust the asset or adjust the liability for an addi-tional minimum liability if you’re making special payments on a going-concern or solvency basis.
As an actuary, I believe it’s the plan sponsor who is responsible for deciding if they have an unconditional right to surplus refund under one of the scenarios and are responsible for stating their accounting policy in terms of what they consider to be a minimum funding requirement. As I said earlier, I believe as actuaries we do the calculations but we need to rely on management having discussed their accounting policies with their auditors.
The possibility of there being an IFRIC 14 issue could and should impact a company’s decision as to how they’re going to amortize gains or losses under IAS 19. Because if you use the corridor approach then any changes in your valuation allowance or your additional liability year over year goes directly into your P&L expense. If you want to keep that type of volatility out of your P&L expense then you’re best to adopt the OCI approach for recognizing gains and losses. Then that in turn has an impact on your transition approach whether you fresh start or do a retroactive application. The only reason you would go through the pain of doing retroactive approach for transitioning to IAS 19 is because you want to keep some of the unrecognized amounts on your balance sheet which means you’re going to be using the ten percent corridor approach going forward but then that means IFRIC 14 changes will go through P&L. So it’s almost like you start with IFRIC 14 as your yardstick of volatility and then back in to your approach for recognizing gains and losses which then backs you into your approach for transitioning to IAS in the first place.
The calculation of future minimum requirements is subject to interpretation and as I indicated we’re not going to get any further clarification which in a sense is fair because international financial reporting standards are meant to be principle-based accounting standards. So I believe the position of the IASB and IFRIC 14 is they give certain amount of clarification and guidance but not to the point of being prescriptive as this is how thou shall do the calculations. Alan, further comments?
Speaker van weeldern: I had a discussion with my next door neighbour who’s in the office who’s our national director of accounting standards and he’s active in IFRS and a variety of other topic areas and he said it’s quite common under IFRS in a number of areas that we’re having emerging discussions where there are alternative views and in the end we are ending up in some areas with a number of different acceptable alternatives. So he said don’t feel bad but…
moderator vary: That concludes the formal presentation, are there any questions from the floor?
brian Jenkins: It wouldn’t be right without some questions. (laughter) Brian Jenkins. Yes, I did have a couple of questions. First of all, I would point out that for the minimum funding requirements that Canada does have a number of plans who use things like entry age normal aggregate method in order to determine what the normal costs are which are different from the unit credit cost that are currently part under 3461. So there are a number of plans who currently do contribute more under the laws than what would necessarily be the type of basis that you’d use on a union type of basis. So we do have those types where the minimum funding is higher than the other way of doing things.
The one thing that I’m curious about, when I read IFRIC 14 and I only read it very cursedly I’m sorry and sort of dismissed it, we also have in this country for most pension plans maximum funding rules. We say once the surplus reaches a certain level, the employer has to take a contributions holiday, it’s not a choice, he has to take it, is that not the entitlement to surplus that IFRIC 14 is really looking at? It’s just the plans that don’t subject to that?
Speaker van weeldern: The way I look at it is that’s our right to a future contribution holiday, that’s the foun-dation I…
brian Jenkins: But you see, that’s not a right, that’s a requirement. Speaker van weeldern: Okay, so it’s even better than a right, isn’t it?
Speaker Gignac: IFRIC 14 talks about statutory, not contractual. The Income Tax Act says that once your surplus gets to more than two times or…
brian Jenkins: You have to take a contribution holiday. Speaker Gignac: You have to take a contribution holiday.
brian Jenkins: So is that not that implicit right that you have to take it? Isn’t that what sort of makes IFRIC 14 to make sure that that surplus stays as an economic benefit? Or are you trying to partition the surpluses? Not that anybody except my plans have excess surpluses. (laughter)
Speaker van weeldern: I’m not partitioning. brian Jenkins: Okay, thank you.
Speaker van weeldern: I mean it is a difference that I noted with our U.K. firm. Our U.K. firm was initially arguing as some U.K. firms did that their minimum funding requirements stopped at the end of the schedule but they also had circumstances where midway through you’d had such tremendous gains, it looked pretty obvious that you’d be able to negotiate some future reductions but the problem was the word “negotiate”.
brian Jenkins: Your problem that you do have in some of those sorts of things, when you have a union plan often you’ll negotiate a contribution rate that runs for the length of time of the union plan, which may have implicit increases in it which may have contractual increases, you’ll have other plans and well the teachers’ plan is one but there’s certainly a number of universities that basically say that the employer and the employee contributions always match as a percentage of salary and that continues on until the indefinite future okay? And I’d say that one comes down to a long discussion with your accountant as to how the contributions work. So there’s a lot of exceptions in between I would agree with that but you do have both those sort of time limited schedules of contributions and you have the ones that may be indefinite into the future whether there is sharing of the surplus between the two entities and those sorts of circumstances. And unfortunately most of those plans still are subject to the ITA rules for maximum funding as well.
moderator vary: Any other questions from the floor?
Jerry loterman: Say a client where let’s say it’s a European Union parent and we want the plan sponsor to make this determination like, do we go to the parent? Which auditing firm would be the international auditor? A Canadian auditor? You know, it’s very confusing that way in terms of trying to come up with the right inter-pretation. And do we talk to the local plan sponsor? The international plan sponsor? You know, they may have different views on that and I would imagine it would be the international one but it’s not very clear.
Speaker Gignac: My experience has been the European parent company, more often than not, has a policy on asset recognition and it’s dictated to the Canadian subsidiary how the calculations are to be done because it hits the bottom line of the parent company. So correct me if I’m wrong that would mean it’s the European auditor that…
Speaker van weeldern: It’s the European auditor that’s got to sign the reports so ultimately they are the ones that have to be satisfied, so the auditor of the Canadian subsidiary would…we generally have a reporting package, we would bring attention to the signing office of matters, issues that we’ve identified but in the end it’s their responsibility to address them and make the decisions in consultation with their client in Europe.
Jerry loterman: I guess that would address Brian’s question too about the excess surplus I mean I think it’s still under Canadian laws as long as you have a dollar of solvency deficiency you don’t have any even if the going-concern valuation shows you have an excess surplus you’re still allowed to make contributions.
Speaker Gignac: Except in Alberta.
Jerry loterman: Okay, well most jurisdictions. Speaker Gignac: Most jurisdictions.
moderator vary: Okay, thank you very much to our presenters Lorraine and Alan and that concludes our session.
