May/June 2011

Financial Reporting Update

Changes ahead for pension accounting: IASB issues amended IAS 19 Employee Benefits (2011)

The amended IAS 19 Employee Benefits (2011) introduces a number of significant changes for the recognition, presentation and disclosure of pension costs and assets/liabilities. Many UK companies reporting under IFRS will see a reduction in reported profit as a result of the removal of long-term expected returns on plan assets from profit or loss. Those using the corridor method will see their reported pension liability change.

The International Accounting Standards Board (IASB) has issued its amended IAS 19 Employee Benefits (2011) with an effective date of annual periods beginning on or after 1 January 2013.

The amended standard introduces a number of significant changes for the recognition, presentation and disclosure of post-employment (including pension) defined benefit costs and assets/liabilities. Many UK entities will see a reduction in reported profit as a result of the removal of long-term expected returns on plan assets from profit or loss; those using the corridor method will see their recognised pension liability change. Entities will need to consider the implications of the amended requirements for covenants or performance-related pay, for example. Entities should also note the expanded disclosure requirements which might require them to collate more information than at present; this may involve considerable additional work.

Although we are not at this stage expecting equivalent changes to FRS 17 Retirement Benefits (as this is not a fully converged standard), entities applying UK GAAP should still take note. Should the ASB finalise its proposal to adopt a standard based broadly on the IFRSs for SMEs into UK GAAP, and should the revised IAS 19 in due course be reflected in the IFRS for SMEs, this might affect UK GAAP.

The table below sets out the key changes.

In addition, the amendment stipulates that all past service costs are recognised immediately in profit or loss, rather than gradually over their vesting period as at present.

Curtailments and plan amendments (together, past service costs) are now recognised in profit or loss at the earlier of when the past service cost occurs and when the entity recognises costs for a related restructuring within the scope of IAS 37 Provisions, contingent liabilities and contingent assets or related termination benefits. Depending on the details of the arrangement, this might change slightly the timing of recognition.

Presentation
The presentation changes are expected to reduce reported profits for many UK entities.

The amended standard does not change the total return on plan assets but does change the split between the amount of that return reported in profit or loss and the amount reported in OCI. It does this by changing the calculation of the interest figure in profit or loss.

Currently, interest income on plan assets is calculated using the expected long-term rate of return on the actual assets held. The amended standard calculates interest on plan assets instead at the liability discount rate – generally, a high-quality corporate bond rate. This means that reported profits will fall for many UK entities as the liability discount rate is generally lower than the expected long-term rate of return on their plan asset portfolio, due to the make-up of that portfolio. The excess or shortfall of actual returns on plan assets against the amount taken to profit or loss is recognised in OCI.

While set out as a presentation change, to many this will look like a measurement change. A further measurement change included in the amended IAS 19 concerns the allocation of administration costs depending on their nature. Currently, entities have a choice of including estimated total pension administration costs either as a component of the expected return on plan assets or within the defined benefit obligation. Most UK entities use the first option.

Following the amendment, all pension administration costs are recognised as the administration services are provided. The costs of managing plan assets are presented as part of the return on plan assets; this means that they are reported within OCI. Other pension administration costs may not be deducted from the return on plan assets. This marks a change from the ED, which proposed that these other costs should be reflected in the measurement of the defined benefit obligation.

Disclosure
The objective of the amended standard is for entities to provide more information about their exposure to risk through operating a defined benefit pension plan. This information comprises both narrative and quantitative elements.

The amended disclosures are based around three objectives, being to identify and explain:

• the characteristics of, and risks associated with, defined benefit plans;
• the amounts in the financial statements arising from defined benefit plans; and
• how defined benefit plans may affect the amount, timing and uncertainty of future cash flows.
  

The standard includes a list of disclosures but also states that additional information should be provided if necessary to achieve the objectives. Particularly for entities with a number of schemes, detailed planning of the appropriate level of aggregation or disaggregation will be key.

Short-term and other long-term benefits
In order to clarify the distinction between short-term and other long-term employee benefits, the amended standard has changed the definitions to focus on the entity’s expectation of when the benefits will be wholly settled. This change might result in some short-term benefits being reclassified as other long-term benefits, for which the measurement, recognition and disclosure requirements differ.

The amended standard is available here and further guidance is available from In the Headlines, issued by KPMG IFRG Limited.

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Lease accounting: IASB's continuing reassessment

The IASB and US FASB continue to debate lease accounting and the latest proposals include the abandonment of 'other-than-finance' lease accounting and the application of a single right of use model by lessees. The future of lessor accounting is still somewhat uncertain at present.

The IASB and US Financial Accounting Standards Board's (FASB) debate on the lease accounting project has continued since our article in the March/April Update.  These discussions have led to the reversal of certain tentative decisions made previously. Notably, the Boards have reverted to a single lease accounting model for lessees, under which lessees recognise the amortisation of the right-to-use asset and finance expense arising on the liability.  This reverses the earlier tentative decision that lessees recognise a straight line lease expense for ‘other-than-finance’ leases.  Reverting to a single model will reinstate the concern that many lessees had regarding  the front end loading of the lease expense (under the original ED proposals, although other changes to the ED regarding lease term and contingent rentals have, to some extent, lessened the effect of this issue.

The Boards also returned to the topic of short term leases, in light of their latest decisions on lessee accounting. The Boards tentatively agreed that lessees would not be required to recognise assets and liabilities arising from leases with a maximum possible term of 12 months or not; in such cases, lessees will typically recognise rental expense on a straight-line basis. The Boards will discuss further the disclosure requirements for short term leases.

The overall approach to lessor accounting has been discussed further but no decisions have been taken.  The IASB currently prefers an approach based on the derecognition approach being applied to all leases in scope.  Under that approach the lessor would derecognise the underlying asset and instead recognise a lease receivable and a residual asset.  The subsequent measurement of the residual asset will be based on an accretion approach based on the rate charged by the lessor. The FASB, on the other hand, prefers an approach similar to the current IAS 17 model.

The IASB work plan still indicates that a new standard is planned to be issued in the Fourth Quarter of 2011.  The remaining deliberations required to publish a final standard (or even a revised ED) are significant and in particular the lessor accounting issue will need to be resolved or a decision taken to remove lessor accounting from the scope of the standard.  The IASB progress report in April indicated that once the redeliberations were completed the Boards will consider whether re-exposure of the proposals is needed.  If they do not re-expose the proposals formally then some form of draft standard will be made available for use in outreach and review. It is worth noting that the Boards decided in June to re-expose formally their revised proposals on revenue.

Other notable tentative decisions affecting the ED proposals made since our last update are:

• lessor lease receivables may be included in the scope of IAS 39 Financial instruments: recognition and measurement, subject to a further review of the accounting consequences;
• substantive contract modifications will result in the contract being accounted for as a new lease;
• discount rates in a lease will not be re-assessed unless there are changes in payments or re-assessments or exercise of options to extend or purchase;
• reassessment of residual value guarantees will be required when events indicate there has been a significant change in the amount expected to be payable.  Changes should be recognised in net income to the extent that those changes relate to current or prior periods and as adjustment to the right-of-use asset to the extent those changes relate to future periods.

This is brief summary of certain aspects of the current discussions.  Further details are set out in the IFRS - Leases Newsletter May 2011.

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News in Brief

ASB announces changes to its proposals for the future of UK GAAP

At its meeting on 16 June 2011, the Accounting Standards Board (ASB) tentatively agreed to make the following changes to its proposals for the future of UK GAAP as set out in FREDs 43 and 44:

• to remove the requirement for publicly accountable entities (for example pension schemes, insurers and building societies) to apply EU-adopted IFRS. The application of EU-adopted IFRS will not be extended beyond the current requirements in law. Consequently, publicly accountable entities that are not listed on an EU-regulated market will apply the Financial Reporting Standard for Smaller Entities (FRSME) although they may choose to apply full EU-IFRS as currently;
• to change the principles for amending the IFRS for SMEs (the basis of the FRSME) to permit or require the use of accounting options that currently exist in UK GAAP, where these are consistent with full EU-IFRSs.  The full detail of this tentative decision is not yet known, although we expect that this may include permitting the revaluation of property, plant and equipment, and the capitalisation of borrowing and development costs; and
• to defer the effective date to periods commencing on or after 1 January 2014.
  

At its next meeting the ASB will consider, among other matters, amending the FRSME to include increased disclosures for financial institutions and publicly-held entities.  The summary of each meeting is available on the ASB’s website.

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2011 UK GAAP Checklist

Our bi-annual UK GAAP checklist for 2011 is now available for download from our web site http://www.kpmg.co.uk/ or may be downloaded here.

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IFRS newsletters and other publications

KPMG in the UK publishes Financial Reporting Matters, a short newsletter to alert you to key changes in UK and International Financial Reporting Standards and UK Company Law.  It is available for download here. Alternatively, you may subscribe by sending an email to Financial Reporting Matters.

KPMG IFRG Limited has published the following since the March/April 2011 Update, which are available on its Web site at http://www.kpmgifrg.com/:

First Impressions: Fair Value Measurement (June 2011)
First Impressions: Consolidated Financial Statements – IFRS 10 (May 2011)
First Impressions: Joint arrangements – IFRS 11 (May 2011)
IFRS Disclosure checklist: interim financial statements (May 2011)
Illustrative condensed interim financial statements (May 2011)

KPMG IFRG Limited also publishes In the Headlines, which provide information in relation to new exposure drafts and standards issued by the IASB, as well as any other relevant developments affecting current and future IFRS reporters, including summaries of IASB meetings on a monthly basis.

In the Headlines Issue 12 – April 2011 IASB meetings
In the Headlines Issue 13 – Second public consultation on Trustees’ strategy review 
In the Headlines Issue 14 – Consolidation: a new single control model 
In the Headlines Issue 15 – No more proportionate consolidation 
In the Headlines Issue 16 – Extensive disclosures about interests 
In the Headlines Issue 17 – Unified fair value measurement and disclosure guidance for IFRS 
In the Headlines Issue 18 – May 2011 IASB meetings
In the Headlines Issue 19 – Presentation of other comprehensive income
In the Headlines Issue 20 – Employee benefits accounting revised
In the Headlines Issue 21 – Reminder: Effective dates of IFRSs
In the Headlines Issue 22 – New cycle of improvements to IFRSs

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