IAS19 Changes to Effect Canadian Plan Sponsors

Plan sponsors reporting under IFRS will have to comply with the accounting years commencing on or after January 1, 2013.

A Sibson Canada Spotlight report says the changes include:

Reported profits for most companies will be lower. The removal of the expected return on assets concept will reduce profits where the expected return on assets assumption would have been higher than the discount rate. Profits for the sponsor of a typical plan with assets of $100 million could be $1.5 million lower as a result of this change alone (based on typical 2011 assumptions). Further, being forced to move away from the corridor method may also hurt some employers’ reported profits because existing unrecognized gains will bypass the profit and loss statement (P&L). Lastly, even if future investment returns are higher than the discount rate, those “gains” will never flow through annual P&L.

Some balance sheets will be more volatile. A key reason for retaining the corridor method through the initial transition to IAS 19 was that it often smoothes changes in the balance sheet from year to year. Under the revised IAS19, the balance sheet will reflect the funded status of the plan and, consequently, will be fully exposed to volatility in assets and liabilities. This could be particularly problematic for companies with cash-flow restrictions or solvency requirements.

Canadian companies may look worse compared to their U.S. competitors. U.S. companies will not suffer from the potential hit to profits described above because they are not typically subject to IFRS. On the face of it, otherwise identical firms reporting under U.S. Generally Accepted Accounting Principles (GAAP) may appear to do better than those reporting under Canadian GAAP.

A brighter light will shine on pension risks. Investor awareness of pension costs and risks has been slowly increasing in recent years, a trend that is expected to continue. Sibson says it will be interesting to see how markets react to the increased pension disclosure in company accounts.

Pension fund investment strategies may become more conservative. Under the amended IAS19, investment strategy will no longer directly affect reported profits. This makes a high risk/reward investment strategy less attractive from an accounting perspective. The increased risk disclosures in the accounts may also lead to a preference for a reduction in investment risk even though this might be expected to increase the real cost of the plan.

According to the Sibson Canada Spotlight report, companies reporting under IFRS can start to take the following actions now:

Analyze the effect on P&L and the balance sheet. Both the relative change and the impact on volatility should be considered, together with the implications for other key financial metrics and debt covenants.

Assess communication needs. Key stakeholders, such as investment analysts and rating agencies, need to understand the effect of the accounting changes.

Review investment strategy. The risk/reward profile of the investment portfolio will need to be re-examined. With no P&L credit for taking investment risk, and greater disclosure around investment risks, risky investment strategies may seem less attractive. These factors, combined with increased balance sheet volatility, may make new investment options that transfer risk to another entity appear more attractive.

Review risk management strategy. The strategy should look beyond investment risk and consider such factors as longevity, inflation, regulatory, and administration risks.

Begin collecting any additional information needed. Examples include preparing a template for the additional disclosure requirements.