How to account for social benefits?
Proposals to account for social benefits including the state pension, unemployment and disability benefits have been published by the International Public Sector Accounting Standards Board (IPSASB).
This would be the first time an accounting standard addresses this complex area yet it is a significant area of government expenditure. Currently, these benefits are reported in the accounts as they are paid which means we do not have a complete picture of the longer-term liability.
The proposals were discussed at a recent ICAS Public Sector Panel roundtable with IPSASB. Some of the issues raised are discussed below. Paul Mason presented IPSASB’s perspective:
Accounting for social benefits is a complex and contentious subject, as there are a wide range of views as to when a liability should be recognized and the impact of the different approaches on the balance sheet. At one extreme, almost no liability would be recognized (with expenses recognized as they fall due). At the other extreme, all future lifetime benefits would be recognized as a liability (with expenses being recognized many years before the benefits are paid).
The IPSASB is seeking feedback from stakeholders as it seeks to balance the competing views and develop a Standard that is both conceptually sound and practical to implement.
Paul Mason, Principal, IPSASB
What is proposed?
There are two approaches:
- Obligating event – a present obligation is recognised for an outflow resulting from a past event and all eligibility criteria are met (so it cannot be extended beyond the next criteria milestone). This is likely to create a short-term liability. An alternative obligating event is that the event should be dependent on the economic substance of the social benefit scheme. This means that the liability may be recognised earlier or later than fulfilment of all eligibility, depending on the scheme. This could generate a longer liability over time as contributions are made.
- Insurance approach – this only applies to benefits which are fully funded from contributions (not tax) and are managed in the same way as insurance contracts. These would follow IFRS 17.
What are the challenges?
Achieving a conceptually sound and pragmatic approach to accounting for these activities is challenging. It has taken 15 years to produce this exposure draft and opinions are still divided.
An international standard seeks to achieve consistency to aid comparability yet benefit schemes operate very differently across the world. Even within the UK, the state pension is a different commitment compared to other benefits such as jobseeker’s allowance which is shorter-term.
When is a constructive obligation created?
If we take the state pension as an example, views are divided as to whether this starts when one enters the workplace and starts paying national insurance contributions (with the understanding that this creates an entitlement to certain benefits including jobseeker’s allowance and state pension) or on retiral when all the eligibility criteria are met. The former is likely to create a large liability and is subject to far greater uncertainty and measurement challenges; the latter creates a more certain, short-term liability which does not offer the longer-term perspective necessary for a better understanding of national financial health.
Improving understanding and increasing transparency
Accounts need to be understandable and useful; there is a risk that they become less so if the balance sheet is swamped with massive longer-term liabilities. There has been a move to bring more items onto the balance sheet from FRS 17 pension liabilities to leases. The aim is to increase transparency and provide a more realistic view of economic impact. Yet government activities operate over far longer time horizons and policy or legislation changes can make measurement challenging and increase uncertainty. Should the ability to tax be a contingent asset?
Pensions once payable, are for life and a short one-month liability (to the next eligibility date) does not reflect this long-term obligation. Statistics can establish how many people on average reach retirement age and are likely to draw a state pension or the average time other benefits are claimed for. However, the cost-benefit ratio of acquiring this information needs to be taken into account.
A more complete picture of the nation’s long-term liabilities informs understanding of a nation’s longer-term financial health. However, understanding the longer-term financial sustainability of governments involves projections and economics which is beyond the scope of financial statements. Ultimately, users are interested in what obligations exist, projected income, projected cash outflow, any funding gap and what a government plans to do to address this.
To attempt to meet all these needs is beyond the scope of financial statements. It may require a combination of methods such as a separate sustainability report, a liability in the accounts (short or long-term?) and perhaps also an off-balance sheet contingent liability note for the longer-term impact. A note could identify all the social benefits and explain how they will be funded as they fall due to offer information on the longer-term perspective. Any note would need to be highlighted in the Strategic Report (or equivalent) to ensure it is given appropriate profile and explanation.
ICAS supports alignment with IFRS as far as possible to minimise over specialisation unless there is a significant public sector matter which has not been addressed by IFRS and omission would affect the true and fair view. We will need to consider whether social benefit transactions are of such significance that a different approach is merited.
What is the expected impact?
IPSASB has estimated that the impact of applying the obligating event approach on national accounts will be significant and the alternative method – very significant. There are as yet, no official UK figures available estimating the impact on the balance sheet however if we have 32.2 million people in work and with life expectancy increasing, the figures are huge. This challenges the ability to meet the qualitative characteristics for useful financial information in the Conceptual Framework for Financial Reporting.
IPSASB expects that few schemes will meet all the criteria for complying with the insurance approach.
