Accounting for GMP equalisation under UK GAAP by sponsoring employers
Companies with 31 December 2018 year-ends preparing their accounts under UK Generally Accepted Accounting Practice (GAAP) are due to file these by 30 September 2019.
For sponsoring employers with a formerly contracted-out defined benefit pension scheme, this will be the first year that the Lloyds judgement is likely to have an impact on the net defined benefit pension liability they report in their accounts.
The ICAS Pensions Panel has prepared guidance for sponsoring employers on accounting for the impact of Guaranteed Minimum Pension (GMP) equalisation under UK GAAP. It draws on the findings from a review of the sample of FTSE 100 company accounts. However, the guidance is tailored to and refers directly to the relevant aspects of UK GAAP.
The guidance is based on the full requirements of FRS 102: sponsoring employers applying Section 1A of FRS 102 should refer directly to Section 1A and consider the appropriateness of applying any available presentation and disclosure exemptions, bearing in mind that the accounts are still required to give a true and fair view.
Accounting by sponsoring employers
Sponsoring employers need to account for the impact of the Lloyds judgement by recognising obligations relating to the back-dating of pension benefits arising from GMP equalisation, where these can be measured.
Sponsoring employers are required by accounting standards to recognise a net defined benefit liability which reflects the difference between the present value of defined benefit pension obligations and the fair value of scheme assets, adjusted for, among other things plan changes and changes in underlying assumptions.
The guidance is tailored to reflect the two methods permitted by the Lloyds judgment, which are emerging as the most common:
- Method C2. This is an administratively complicated annual check that members’ pensions paid to date would not have been greater if they were of the opposite sex and, if pensions paid would have in fact been greater, these are uplifted.
- Method D2. This is a one-off value-based uplift and conversion of the GMPs typically into ‘main scheme’ benefits.
The guidance is set out under the following headings:
- Retrospective or prospective accounting?
- Recognition.
- Measurement.
- Presentation.
- Narrative disclosures.
Our approach to setting out guidance on how sponsoring employers should account for GMP equalisation following the Lloyds judgement is to focus on employers who are accounting for the impact of GMP equalisation for the first time. This is likely to be the position most employers find themselves in.
1. Retrospective or prospective accounting?
It is likely that any impact on a sponsoring employer’s net defined benefit liability (or asset) arising from the application of one of the measurement methods set out in the Lloyds judgement, is not a change in accounting policy or a prior period error requiring correction. Prospective rather than retrospective accounting will most likely be appropriate.
This, however, does not address the question of whether the application of one of the methods set out in the Lloyds judgement is a change in accounting estimate requiring compliance with the requirements of paragraphs FRS 102.10.15 to FRS 102.10.18.
Based on commentary from KPMG and PWC, which is based on treatment of the impact of the Lloyds judgement as a plan amendment (for example, when method C2 is applied), treatment as a change in accounting estimate may be appropriate where the impact of GMP equalisation had been accounted for in an earlier accounting period but not otherwise.
However, the findings from the review of FTSE 100 accounts, where the impact of the Lloyds judgement is treated as a revision of assumptions (for example, when method D2 is applied), treatment as a change in accounting estimate in the first accounting period that the impact of GMP equalisation is accounted for could also be appropriate.
FRS 102 defines a change in accounting estimate in the glossary as:
“An adjustment of the carrying amount of an asset or a liability, or the amount of the periodic consumption of an asset, that results from the assessment of the present status of, and expected future benefits and obligations associated with, assets and liabilities. Changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors.”
Treatment of the impact of applying one of the methods set out in the Lloyds judgement for the first time as a change in accounting estimate will therefore depend on: the individual circumstances of the sponsoring employer (i.e. whether the additional costs are considered to arise from a plan amendment or from a change in assumptions); and professional judgement.
FRS 102: key references
Section 10 on accounting policies, estimates and errors paragraphs:
- FRS 102.10.15 to FRS 102.10.18 on changes in accounting estimate.
2. Recognition
Sponsoring employers impacted by the Lloyds judgement i.e. those sponsoring schemes which were contracted-out between 17 May 1990 and 5 April 1997 should now be recognising the impact of GMP equalisation on the present value of defined benefit obligations and the net defined benefit liability (or asset) where the impact can be measured.
Recognition in the accounts of sponsoring employers should not be delayed until the individual benefits of scheme members and other beneficiaries have been updated by scheme administrators.
Within FRS 102, there is a general recognition principle which applies to all employee benefits.
Paragraph FRS 102.28.3 states that:
“An entity shall recognise the cost of all employee benefits to which its employees have become entitled as a result of service rendered to the entity during the reporting period:
(a) As a liability, after deducting amounts that have been paid either directly to the employees or as a contribution to an employee benefit fund
(b) As an expense, unless another section of this FRS requires the cost to be recognised as part of the cost of an asset such as inventories or property, plant and equipment.”
Paragraph FRS 102. 28.14 states that, in relation to defined benefit plans:
“In applying the general recognition principle in paragraph 28.3 to defined benefit plans, an entity shall recognise:
(a) a liability for its obligations under defined benefit plans net of plan assets – its ‘net defined benefit liability’; and
(b) the net change in that liability during the period as the cost of its defined benefit plans during the period.”
A liability is defined in the glossary of FRS 102 as:
“A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.”
Expenses are defined in the glossary of FRS 102 as:
“Decreases in economic benefits during the reporting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity investors.”
FRS 102: key references
Section 28 on employee benefits paragraphs:
- FRS102.28.3 on the general recognition principle.
- FRS 102.28.14 on the recognition of post-employment benefits.
3. Measurement
Sponsoring employers with defined benefit pensions will be familiar with receiving information at each balance sheet date from the scheme actuary (or an employer appointed actuary) setting out the accounting information needed to record their net defined benefit liability at the balance sheet date.
The method for assessing the impact of GMP equalisation selected by the sponsoring employer from the methods set out in the Lloyds judgement will impact on the accounting information supplied by the actuary on changes to the net defined benefit liability.
Method C2 is emerging as the most common method employers intend schemes to use to adjust scheme benefits, with method D2 also expected to be used.
Under method C2, the change in the net defined benefit liability arises from benefit changes accounted for through profit or loss whereas under method D2 the change could arise from the revision of assumptions expensed through other comprehensive income.
FRS 102.28.23 states that:
“An entity shall recognise the cost of a defined benefit plan, except to the extent that another section of this FRS requires part or all of the cost to be recognised as part of the cost of an asset, as follows:
(a) the change in the net defined benefit liability arising from employee service rendered during the reporting period in profit or loss;
(b) net interest on the net defined benefit liability during the reporting period in profit or loss;
(c) the cost of plan introductions, benefit changes, curtailments and settlements in profit or loss; and
(d) remeasurement of the net defined benefit liability in other comprehensive income.”
FRS 102: key references
Section 28 on employee benefits paragraphs:
- FRS 102.28.15 and 15A on measurement of the net defined benefit liability.
- FRS 102.28.21 on plan changes.
- FRS 102.28 23, 25 and 25A on the cost of a defined benefit plan including remeasurement.
FRS 102 does not require an independent actuary to perform the comprehensive actuarial valuation needed to calculate its defined benefit obligation but given the complexity of the calculation in all likelihood sponsoring employers will receive the calculation from a qualified actuary each year.
4. Presentation
The impact on presentation of GMP equalisation needs to be tailored to the method selected for adjusting pension benefits.
Under method C2, the impact should be treated as an expense through profit or loss in the first year of recognition. In future years, the adjustment to the net defined benefit liability could be a credit through profit or loss, reducing the net defined benefit liability.
Consideration should be given to whether the impact on profit or loss should be emphasised in the statement of comprehensive income (or profit and loss account or income statement, where a dual statement approach is taken). FRS 102 does not use the term ‘exceptional item’. However, the accounting regulations for companies refer to the separate presentation of individual items of income or expenditure which are of exceptional size or incidence and FRS 102 requires greater granularity ‘when such presentation is relevant to the understanding of the entity’s financial performance’.
Paragraphs FRS 102.5.5.9 and FRS 102.5.5.9A state the following:
“An entity shall present additional line items, headings and subtotals in the statement of comprehensive income (and in the income statement, if presented), when such presentation is relevant to an understanding of the entity’s financial performance.
When items included in total comprehensive income are material, an entity shall disclose their nature and amount separately, in the statement of comprehensive income (and in the income statement, if presented) or in the notes.”
Consideration should be given to how to describe the impact in the pensions note of the presentation of movements in the net defined benefit liability. FRS 102 does not use the term ‘past service costs’. However, the impact of GMP equalisation, under method C2, does give rise to plan changes which relate to past service, and can reasonably be classified as such.
Under D2 presenting the impact of GMP equalisation in the accounts is likely to be more complex. The impact will be across several main statements and notes.
In presenting the impact of GMP equalisation in the main statements and notes, care should be taken to use consistent terminology, including in any related or accompanying narrative disclosures.
It may be appropriate to treat the impact as an expense through other comprehensive income in the first year of recognition. In future years, the adjustment could therefore be a credit to owners’ equity and a debit to the net defined benefit liability, thus reducing the net defined benefit liability.
The key presentational aspects to consider are:
- The classification of movements in other comprehensive income: these may be appropriate to classify as the ‘remeasurement of the retirement benefit scheme’. Related movements in the statement of changes in net equity, should be classified consistently with movements in other comprehensive income.
- The classification of movements in the net defined benefit liability, presented in the pensions note as an adjustment to other comprehensive income, may be appropriate to describe as adjustments to ‘actuarial financial assumptions’.
FRS 102: key references
Section 5 on the statement of comprehensive income and the income statement paragraphs:
- FRS 102.5.5.9 and FRS 102.5.5.9A
Section 28 on employee benefits paragraph:
- Paragraph 28.41 (e), (f) and (g) on disclosures about defined benefit plans
The reconciliations in (e) and (f) above need not be presented for prior periods.
5. Narrative disclosures
The extent of any narrative disclosures about the impact of GMP equalisation on the accounts of the sponsoring employer will depend on their individual circumstances. Nevertheless, these must be sufficient for the accounts to give a true and fair view and may therefore need to go beyond the specific disclosure requirements which apply.
For example, it would be desirable to:
- Clarify if the impact of GMP equalisation had been accounted for in any accounts authorised for issue before the date of Lloyds judgment.
- State which method permissible by the Lloyds judgement had been used to assess the impact given that this directly affects the accounting. The method for assessing the impact of GMP equalisation selected by the sponsoring employer following the Lloyds judgement will influence whether it is accounted for through profit or loss or through other comprehensive income.
The terminology used to explain the impact of GMP equalisation should be consistent throughout the accounts and accompanying management commentary, if relevant.
In addition, the following key disclosure requirements set out in FRS 102 should be complied with, as considered appropriate.
Disclosure of a change in accounting estimate:
Paragraph FRS 102.10.18 state that:
“An entity shall disclose the nature of any change in an accounting estimate and the effect of the change on assets, liabilities, income and expense for the current period. If it is practicable for the entity to estimate the effect of the change in one or more future periods, the entity shall disclose those estimates.”
Disclosure of ‘exceptional items’:
Paragraph FRS 102.5.9A states that:
“When items included in total comprehensive income are material, an entity shall disclose their nature and amount separately, in the statement of comprehensive income (and in the income statement, if presented) or in the notes.”
Disclosures about defined benefit plans:
Paragraph FRS 102.28.41 bullet points (d) and (k) state that:
“An entity shall disclose the following information about defined benefit plans….:
(d) The date of the most recent comprehensive actuarial valuation and, if it was not as of the reporting date, a description of the adjustments that were made to measure the defined benefit obligation at the reporting date.
(k) The principal actuarial assumptions used, including, when applicable:
(i) the discount rates;
(ii) [deleted][meaning no longer used]
(iii) the expected rates of salary increases;
(iv) medical cost trend rates; and
(v) any other material actuarial assumptions used.”
FRS 102: key references
Section 5 on the statement of comprehensive income and the income statement paragraph:
- FRS 102.5.9A
Section 10 on accounting policies, estimates and errors paragraph:
- FRS 102.10.18 disclosure of a change in accounting estimate
Section 28 on employee benefits paragraph:
- Paragraph 28.41 on disclosures about defined benefit plans
Please note that this guidance is published by the Policy Leadership Board of The Institute of Chartered Accountants of Scotland (ICAS). The views expressed in this publication are those of the ICAS Pensions Panel and do not necessarily represent the views of the ICAS Council.
This article gives general guidance only and should not be relied upon as appropriate or comprehensive in respect of any particular set of circumstances. Reference should be made at all times to the appropriate legislation or publication. Users should also consider taking specific advice from their own professional advisers.
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