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The Secret FD: An untrue and unfair view

The inconsistencies of FRS 17 calculations are not only illogical, but also cause unreasonable volatility in the accounts

LAST month, I referred in this column to the highly misused but little understood FRS 17 pension standard with which we created a national time-bomb liability despite some experts rejecting its underlying logic, and I am continuously vocal about this.

Pension issues are not only about George Osborne’s latest tax grab on lifetime allowances (which will hit everyone asleep but still of breathing age), but also the epic failure of FRS 102 to address the shortcomings of FRS 17 which seem to have been passively nodded through by many FDs.

Some historical context is helpful here. The slow death of defined benefit schemes started as long ago as 1988 when Nigel Lawson decided to tax pension fund surpluses to prevent companies using pension funds for tax avoidance. Norman Lamont reduced the value of tax credit on share dividends received by pension funds, and then Gordon Brown staged his £5bn raid on pension funds by abolishing ACT.

We know the rest, but what followed was the Robert Maxwell scandal, which led to the introduction of the Minimum Funding Requirement which was fudged by everyone, and now we have a ‘scheme specific funding requirement’, which puts companies under unnecessary financial pressure. The stock market crashes in 2000 and 2008 exacerbated the national pension deficit problem and the FD’s difficulties in explaining and managing the balance sheet became even more challenging, if not impossible.

The accountancy profession’s lame answer was to create FRS 17. It was applauded at the time as a spectacular improvement to pensions accounting, providing honesty and clarity of presentation, removing the old tricks of amortising pension losses over future years and, obviously, pension holidays became almost obsolete. However, the black art of the actuaries got in the way, and we FDs stood aside and allowed it to happen.

The CBI criticised FRS 17 for valuing pension assets in a deceptive way, and the TUC accused employers of using FRS 17 as an excuse to end good quality pensions. Balance sheet pension deficits (as reported) have undoubtedly hampered M&A activity, reduced borrowing capacity, caused cashflow pressures resulting from deficit recovery arrangements and, ironically, held back the flow of company dividends that many pension funds see as their life blood. Almost all defined benefit schemes are now closed to new members, and many no longer accrue for future benefits. The accounting for public sector schemes is beyond credible explanation, and some innocent long-serving members are now being punitively taxed on fictitious ‘deemed contributions’.

So, what is wrong with FRS 17 that should have been fixed? The legal concept of a pension fund deficit is fundamentally flawed in cases where the employer continues to make adequate contributions and no one should care about the deficit. To recognise this as a legal liability is inconsistent with reality because no one can demand the repayment of an FRS 17 deficit as it is defined and shown in the accounts. The trustees and the regulator can demand only the contributions as agreed and scheduled, except under s75 debt circumstances, which would assess the liability on a buyout basis, which is a significantly differently valuated but, usually, a contingent liability.

The inconsistencies of FRS 17 calculations are not only illogical, but also cause unreasonable volatility in the accounts. Actuaries were initially slow to update their mortality assumptions, not taking into consideration that pensions were never designed to provide for 30-plus years of retirement that may become normal in the 21st century. Another erroneous assumption is that all pension schemes are invested entirely in AA-rated corporate bonds, and FRS 17 allows returns above those AA-rated corporate bonds to be booked to the P&L. Liabilities are measured using a ‘projected method’, but a single day point estimate rather than any form of averaging is used for asset valuations, which causes volatility. These swings must have had an impact on the national deficit from one week to another, and the stock market crash in 2007 must have caused an enormous one-day increase in FRS 17 deficits, only for them to improve again later.

Section 28 of the recent FRS 102 deals with pensions but it has not addressed many of my concerns. Admittedly, it will no longer be possible to take P&L credit for asset performance above high-quality corporate bonds, but it has accidentally made recognition of surpluses more likely, and has added confusion to the disclosure of finance costs. It has not addressed the concept of any part of the pension deficit being a contingent rather than a real liability, and it has not recognised the inconsistencies in the fundamentals or actuarial aspects of deficit calculation. It continues to ignore the question of disclosing the liability under a s75 buy-back scenario, and it glosses over the issue of a long-term projection of the sponsoring company’s capacity to maintain adequate contributions to the scheme.

In my opinion, we missed the opportunity to repair this condition of an untrue and unfair view in many a company’s accounts.

Last month, the SFD spent an unusually large amount of time interviewing for new and replacement staff, suggesting that the jobs market is alive once again.

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