Accounting for settlements and curtailments: an amendment too far?
Estimated reading time: 8 minutes
On 7 February 2018, the International Accounting Standards Board (IASB) issued amendments to IAS19. These amendments further complicate the requirements and, in particular, have a particularly onerous knock-on effect on some Local Government Pension Scheme (LGPS) employers.
In summary, the amendments affect employers with past service costs or settlements over the accounting period. If such events have occurred then all assets and liabilities are to be ‘re-measured’ using assumptions applicable at the time of each of the events.
On the face of it, this might seem like a simple and sensible enough change. Indeed, the IASB’s view is that this amendment will provide more useful information to users and enhance their understanding of financial statements.
However, as we set out in this article, the amendment complicates the preparation of accounting disclosures considerably. We therefore question whether it has any real benefit for LGPS employers and, in particular, the users of their accounts.
The amendment changes the required accounting treatment for settlements, curtailments and any other past service costs that may occur over the accounting period. For example, a settlement might arise in the LGPS after a new admission body outsourcing or an academy conversion. A common form of curtailment is a member retiring early with no reduction to their benefits, such as on the grounds of redundancy.
As many of you will be aware, these types of events are not uncommon for LGPS employers and multiple ‘re-measurements’ may be required over an accounting period as a result. The more re-measurements we need to do, the more complicated things get. (We explain further below.)
These amendments are therefore particularly onerous for major local authority councils, who experience these types of events frequently throughout the year.
Previous to the amendment, the amounts recognised in the profit and loss statement (P&L) – such as the service cost and net interest cost – were all calculated based on assumptions at the beginning of the accounting period.
This meant that we could calculate the amounts at the start of the year and any settlement/curtailment events could be dealt with separately, outside of the main roll-forward calculations, all using a single set of assumptions.
The amendment requires additional calculations to determine the employer’s assets and liabilities on the date of each event, then rebase these onto the assumptions applicable at the event date. This applies to every ‘material’ event that occurs over the year. (See below for more on ‘materiality.’)
This means that we end up with lots of mini accounting periods for which we need to calculate the P&L items separately, then add them all up at the end.
So, for example, if an employer has five events over the year we essentially have to prepare accounts for six separate periods and then collate them all together. Rather you than me, you might say!
Although the balance sheet position won’t change, the amounts recognised in the P&L and re-measurements in other comprehensive income (ROCI) will. So we’ve included an example towards the end of this article to help illustrate the changes.
As an added complication, the projected pension expense will also now be less accurate, under the amended approach, if a material event is expected to occur. It’s impossible (even for us actuaries) to allow for future changes in market conditions until that date has actually passed.
When does the amended approach need to be used?
The amendment is effective for all accounting periods commencing on or after 1 January 2019 – so it will apply to all employers that are due to receive accounts at 31 March 2020 (for the period commencing 1 April 2019) and thereafter.
- It affects any employers reporting under IAS19 (typically the major councils)
- For employers that report under FRS102 (typically colleges and academies), there is no explicit requirement to adopt a similar approach yet, although the precedent is to follow suit
- The amendment does not need to be applied where its application is immaterial. In that instance the old simple approach can be used
The assessment of materiality will therefore be key and is subject to each employer’s individual circumstances and auditor’s discretion. We can assist by providing additional information to help assess the materially of each event. However, we cannot conclude whether it’s actually material or not in our role as actuaries. This is an auditor decision.
The Chartered Institute of Public Finance & Accountancy (CIPFA) is due to publish its Code of Practice on Local Authority Accounting in the United Kingdom 2020/21 in April 2020. This will incorporate changes relating to these amendments. We also hope it will provide more guidance on the assessment of materiality of an event.
We recommend that all employers consider whether they wish to allow for this amended treatment, discuss it with their auditors, and let their actuary know!
Due to the tight timescales put on employers to finalise their accounts, it will be much easier if the approach can be agreed in advance.
Let's look at an example
We can take a look at an employer with an accounting period from 1 April 2019 to 31 March 2020. The employer outsourced a number of their employees to a cleaning contractor, for example, half way through the accounting period (on 30 September 2019).
In this example, £1m of liabilities and £0.8m of assets were transferred from the employer to the new contractor using accounting assumptions determined at the start of the year.
Assumptions
The impact of adopting the amended approach is affected because of the difference between the assumptions applicable at the last accounting date (31 March 2019) and the assumptions applicable at the event date (30 September 2019).
For our example we’ve assumed the following assumptions are applicable at these dates. Please note, however, they are for illustration purposes only and do not represent market conditions at the respective times.
| Assumptions as at | 31 March 2020 | 30 September 2019 | 31 March 2019 |
| Discount rate | 1.7% | 2.0% | 2.6% |
| Pension increases | 2.3% | 2.3% | 2.3% |
The balance sheet
The statement of financial position (aka ‘the balance sheet’) at the accounting date is not affected by the amendment. This is because we are still valuing the same set of assets and liabilities at the accounting date, based on the assumptions applicable at that accounting date, derived in the same way as before.
P&L statement
The amounts recognised in the P&L do change, however. The service cost and interest cost are now calculated based on a combination of the March and September 2019 assumptions, instead of just those at March 2019, as would have previously been the case under the old simple approach.
This could either increase or decrease these items. That depends on the direction of change in assumptions and the relative value of the assets and liabilities involved.
In our example, the discount date has decreased and pension increases have stayed the same, increasing the service cost and decreasing the net interest cost as shown below.
| The amount recognised in the profit and loss statement are: | (old simple approach) Year to 31 March 2020 £000s | (Amended approach) Year to 31 March 2020 £000s | Comment on movement |
| Service cost | 85 | 89 | Increase - due to decrease in discount rate from 2.6% to 2.0% the cost of benefits increases |
| Net interest on the defined liability (asset) | 120 | 113 | Decrease - we are now applying a lower interest rate of 2.0% to the net liability position |
| Administration expenses | - | - | |
| Total loss/profit | 205 | 202 |
The magnitude of the effect here does really depend on the size of the event and the extent of the change in the assumptions applicable at the various dates. So this will be important to consider when assessing materiality. It is worth noting that the change in assumptions is actually more important than the actual size of the event when assessing materiality.
This is because the change in assumptions will have a greater financial effect, due to the fact that we end up ‘rebasing’ the service cost and interest cost so that they are based on the revised assumptions.
Re-measurements
These changes in the amounts recognised in the P&L are offset elsewhere in the accounts to result in the unchanged balance sheet position at the year end. In particular, the ‘return on assets less interest’ and the ‘change in financial assumptions’ (both recognised in the ROCI), will both move. This is as a result of recalculating the assets and liabilities using the relevant assumptions at each event date.
These items, together with the ‘liabilities assumed on settlements’ item that goes directly into the defined benefit obligation reconciliation, will generally absorb the full amount of the P&L change. Essentially, this amendment moves items between the P&L and other areas of the accounts.
Is all the extra work worth it?
This will depend on your outlook and we would be interested to hear your views.
- The balance sheet figures are unaffected by the amendment so if those are the figures you are most concerned about, do you really want to complicate the adding up?
- For users who are more concerned about the amounts recognised in the P&L and the ROCI, do you believe the benefit of incorporating various changes in assumptions throughout the accounting period outweigh the additional work involved?
What are our views?
Given the added level of complexity we’d be surprised if these amendments don’t actually make it even harder for the layperson to understand what’s going on. Also, because of the nil-impact on the balance sheet and relatively small impact on the P&L this will have for the majority of cases, we’re currently sitting on the ‘more hassle than it’s worth’ side of the fence.
However, we are happy to give employers the information they need to help determine the materiality of the changes. Given the complexity (and the fact that the amendment is now in place), we’re also putting together a webinar with the aim of helping employers through these issues and other key points to note for this year’s accounting exercises. (Unfortunately this isn’t the only complication. We haven’t even mentioned McCloud or Guaranteed Minimum Pensions (GMP) yet!) Further details will be released on our website shortly, so watch this space.
As always, we are happy to talk to Funds or employers (and their auditors) about any accounting queries. We would always recommend that as much as possible is agreed with auditors before the year-end in order to ensure employers’ deadlines are met.
For more information about any of the topics discussed, please contact your usual Barnett Waddingham consultant or get in touch with me here.
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