When is a surplus not a surplus?

Well, when it is under-pinned by a Minimum Funding Requirement was the response provided by the International Financial Reporting Interpretations Committee (IFRIC) in July when it issued IFRIC 14 a steer which unfortunately left specialists in the UK still pondering over the exact implications for UK pension schemes on company balance sheets.

IFRIC 14

IFRIC 14, IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction was issued by IFRIC to give guidance on the extent to which companies could recognise a scheme surplus as an asset and to consider how a pension balance sheet asset or liability could be affected by statutory or contractual minimum funding requirements.

The interpretation confirms that the extent to which a company can reflect a scheme surplus on its balance sheet is limited to the present value of the economic benefits available to the company in the form of refunds from the scheme or reductions in future contributions to the scheme. It then goes on to define under what circumstances refunds and reductions can be deemed “available” and further how any such available surplus is affected by the existence of a minimum funding requirement.

Availability of Economic Benefits  

Contribution Reductions

In the absence of a minimum funding requirement the economic benefit available as a contribution reduction will be the lower of the surplus in the scheme and the present value of the employer’s share of the future service cost over the expected lifetime of the Scheme or company if less, as per the existing standard.

Where there is a minimum funding requirement the maximum economic value that can be recognised from the surplus is restricted to the excess of the future service cost above the minimum future contributions payable in respect of future service (subject to a minimum of zero).

Refund

A refund is only available if the company has an unconditional right to a refund:       

a) During the life of the plan
b) Assuming gradual settlement of the plan liabilities over time until all members have left the plan  or
c) Assuming the full immediate settlement of the plan liabilities including expenses

Consideration of Deficit Contributions

The restrictions to the surplus however are not the worst news. Going back to the original question (“When is a surplus not a surplus?”), where a company is contractually committed to pay deficit contributions which when added to the balance sheet asset or liability will generate a surplus that cannot be reclaimed, the balance sheet asset shall be reduced or the liability increased to that extent.

One can envisage the situation therefore in the UK where the Trustees have requested that the scheme be funded prudently and to a greater extent than the accounting basis. If in this situation a combination of rising bond yields and strong asset performance gives rise to an accounting surplus but yet the company is committed to paying deficit contributions over the scheme’s recovery period the company will effectively have to recognise the funding deficit in their accounts.

The implications of this particular interpretation are significant for companies and should not be overlooked. The situation described above is only one instance where the interpretation could have an effect. Consideration will be required not only in the initial negotiations with Trustees on deficit contributions but also on the process by which the situation will be reviewed and monitored and how Schedules of Contributions might be structured to ensure that Companies are not endlessly committed to paying deficit contributions where in actual fact surpluses exist.

Conclusion 

Although the full implications of the interpretation are not yet clear here in the UK, the interpretation does give rise to several issues that should be considered. Companies should be mindful of the clauses on surplus return in the rules of their schemes and sponsors should take advice from their actuarial advisors before agreeing to a level of scheme funding which is more prudent than their accounting basis.  The treatment should also be discussed with company auditors.

If you would like further information on this topic or have a specific query please contact Richard Jones (020) 7533 6967 or Lesley-Anne Cameron (020) 7533 6966.