The International Accounting Standards Board's (IASB) proposed changes to the pensions accounting standards could take more than £25 billion off the balance sheets of FTSE 350 companies and £1 billion (US$1.6 billion) from their annual profits, warns Aon Hewitt.
About 25% of FTSE 350 companies, the largest 350 companies by capitalization which have their primary listing on the London Stock Exchange, have an accounting surplus in relation to their pension scheme that is recognised on their balance sheet.
Under the proposed changes to the IFRIC14 guidance that supports the international accounting standard IAS19, this surplus would no longer be recognised unless there is a realistic expectation that the company will eventually be able to have access to the surplus.
This would have a significant impact on balance sheet calculations.
"The big change being proposed is that in the future, when assessing the funding position of a pension scheme, companies will have to take into account the expected behaviour of the trustees," said Simon Robinson, principal consultant at Aon Hewitt.
This means that they will need to recognise trustees’ potential future actions, such as de-risking exercises, that might reduce the calculated accounting surplus.
“We expect that most companies with schemes which already have a surplus will not be able to recognise it under the new proposal – which would reduce the balance sheets of the FTSE 350 by £8 billion," says Robinson.
Robinson adds, however, that the proposal also affects companies committed to ongoing deficit contributions that are currently expected to deliver an accounting surplus in the future.
These contributions would now need to be recognized as liabilities on corporate balance sheets which would amount to a further £20 billion hit for FTSE 350 companies.
”This is not just a balance sheet problem; it also negatively affects the P&L account of companies by increasing the finance charges relating to pension schemes – which would rise by more than £1 billion each year across the FTSE 350.”
While these proposals are at a relatively early stage and not expected to take effect before at least 1 January 2017, Aon Hewitt is recommending that companies and schemes bear them in mind in current funding discussions.
"In order to control the size of their accounting problem in 2017, companies will not want to get any closer to an accounting surplus than they are already and should look for ways to manage this,” says Robinson.
Aon Hewitt believes that in order to achieve pensions stability in an uncertain situation such as this, schemes may well need to utilise alternative financing to bridge the difference in views between sponsors and trustees.
"If companies are not willing to put cash into their pension scheme to make up deficits, then the trustees need to seek other forms of security," says Lynda Whitney, partner at Aon Hewitt.
Whitney explains that this potential change to how the pension scheme is accounted for is another reason why schemes may want to explore non-cash funding methods such as escrow, a surety bond or charges over assets.
"Such options will allow companies to offer security against pension funding positions without committing cash directly into the scheme and moving it further towards or into accounting surplus," she adds.