Multi-employer defined benefit plans: Amendments to FRS 102 - What are the implications?

Multi-employer defined benefit plans – The FRC has issued new requirements to account for a transition from defined contribution to defined benefit accounting, so why have they done this and what are the implications?

The FRC has issued Amendments to FRS 102 – Multi-employer defined benefit plans (May 2019) which set out new and explicit requirements regarding how an entity should account for a transition from applying defined contribution (“DC”) accounting to defined benefit (“DB”) accounting when the entity participates in a multi-employer defined benefit plan.  The amendments are effective for accounting periods beginning on or after 1 January 2020, with early application permitted.

Why – what’s the background?

FRS 102 requires that when an entity participates in a multi-employer defined benefit plan and there is not sufficient information available to account for the plan using DB accounting, then the entity should apply DC accounting instead. This exemption provides favourable relief in many ways including, interalia, because of removing the need to understand and apply the, often considered, complex DB accounting and disclosure requirements of Section 28 Employee Benefits (“Section 28”), and instead apply the simpler DC accounting that solely impacts administrative expenses within profit or loss.

The reasons for the amendments therefore is because: (a) some multi-employer defined benefit pension schemes, notably in the social housing sector, are carrying out exercises to be able to provide sufficient information to entities in order for them to determine the required DB accounting for the plan; and (b) FRS 102 did not previously set out clear requirements to address how such a transition should be accounted for when sufficient information becomes available; this therefore leading to diversity of accounting in practice.

The amendments have therefore been progressed by the FRC to ensure consistency is applied by different entities that participate in multi-employer pension schemes when sufficient information for allocating the scheme surplus or deficit becomes available.

Importantly, however, it is not the amendments that mandate whether a DB liability, or asset, should or should not be recognised; FRS 102 has always required DB accounting if sufficient information is available to do so. What the amendments clarify is how to apply DB accounting for the first time should sufficient information become available to do so. The amendments therefore have been led by the changes in the availability of the information provided by the multi-employer pension schemes.

What do the amendments state?

The amendments, which insert new paragraphs 28.11B to 28.11D into Section 28 of FRS 102, require that:

• An entity shall apply DB accounting to the plan from the ‘relevant date’;
• The ‘relevant date’ is defined as: “the later of the first day for which sufficient information to use DB accounting becomes available and the first day of the current reporting period”;
• An entity shall, at the relevant date, recognise in other comprehensive income the difference between:
  • the net defined benefit liability, or asset, as determined in accordance with Section 28, and
  • the carrying value of any previously recognised liability, whether arisen from contributions payable from an agreement to fund a deficit, and/or for contributions payable for the period; and
• An entity shall present the difference as a separate line item in other comprehensive income; this is so that the impact of the transition is clearly presented and can be easily seen by shareholders and other stakeholders.

What does this mean in practice?

Entities will firstly need to understand from their multi-employer pension scheme whether they will be providing sufficient information for the plan to be accounted for as a DB plan rather than a DC plan (for some entities, particularly in the social housing sector, the information may have already been provided). It is recommended that this is established as soon as possible so that businesses can begin to prepare for the implications of the transition and the subsequent accounting changes.

Where it is established that a transition is required, entities will need to:

• Determine the ‘relevant date’ from which to apply the transition accounting;
• Calculate and apply the DB accounting from that ‘relevant date’ in the accounting records;
• Determine the difference upon transition to be accounted for through other comprehensive income, and the subsequent impact on retained earnings and distributable profits;
• Update any internal systems and management reports to take account of the new DB accounting;
• Understand what impact the new DB accounting will have on key metrics, such as EBITDA, operating profit and profit for the period (for example profit or loss will now be impacted by the employee service cost and the net interest cost calculated on the net defined benefit liability, with any remeasurements of actuarial gains or losses being accounted for through other comprehensive income); and
• Communicate the resulting financial impact to shareholders and other key stakeholders.

One, and possibly the most, obvious implication from applying DB accounting is the impact of remeasurements on profit or loss (“PL”) and balance sheet (“BS”) volatility. Where an entity previously only recognised a liability in respect of an agreement to fund a scheme deficit, then the entity would likely have been subject to remeasurements every three years from triennial valuations; thereby impacting the BS liability and PL expense every three years. Under DB accounting, however, remeasurement of the scheme deficit or surplus is required to be considered annually, which therefore increases BS volatility. On a positive note, changes arising from remeasurements of actuarial estimates and assumptions will be recognised through other comprehensive income, which will therefore likely reduce PL volatility. But, in addition, depending on how the newly recognised share of scheme liabilities, or assets, compares to any previously recognised liability, it could result in a reduction, or increase, to retained earnings and distributable profits.

Other implications and considerations for applying the amendments

There are three other key areas that entities should keep in mind when applying the new requirements for the first-time:

1. The significance of the ‘relevant date’ – The transition, and subsequent accounting, must be applied from the ‘relevant date’, so this hinges on the date for which sufficient information becomes available to the entity. See the illustrative examples below.
2. Calculating the difference upon transition – Care must be taken to ensure that the difference upon transition, which is recognised through other comprehensive income, excludes any changes associated with the DB plan itself, such as curtailments or settlements that occur at, or after, the ‘relevant date’, or any changes associated with any agreement to fund the deficit that were made prior to the ‘relevant date’.
3. Disclosure – The amendments do not include any specific new disclosure requirements (other than to disclose if the amendments have been adopted early), but this is because FRS 102 already includes sufficient disclosure requirements that are relevant for this situation, such as those relating to accounting policies, significant judgements, defined benefit plans, amounts to be recognised in other comprehensive income and general requirements to provide information that is relevant to an understanding of the financial statements.

Illustrative examples for applying the ‘relevant date’

If information becomes available for a date during the current period, then the change in accounting must take place from that date (which may not therefore be the first day of the reporting period). If, however, the information becomes available for a date during a prior period, after the financial statements for that period have been authorised for issue, then the change in accounting must take place from the first day of the current period, with no restatement of comparatives. Finally, if the information becomes available for a date during a prior period, before those financial statements have been authorised for issue, then the change in accounting must take place from that date.

For example, an entity prepares its accounts for the year ending 31 December 2020 and applies the amendments for the first-time as from 1 January 2020 (its current period is therefore for the year ending 31 December 2020). Sufficient information for the DB plan becomes available as at 1 February 2020. Because sufficient information became available during the current period, then the change in accounting must take place on 1 February 2020.

By contrast, an entity prepares its accounts for the year ending 31 December 2019 and applies the amendments for the first-time as from 1 January 2019 because it has chosen to apply the amendments early (its current period is therefore for the year ending 31 December 2019). Sufficient information for the DB plan became available as at 1 December 2018. Because sufficient information is available as at a date during a prior period and the prior period accounts have been authorised for issue, then the change in accounting must take place as at 1 January 2019.

Conclusions

The FRC has issued these amendments in response to the changes being made by multi-employer pension schemes. However, whilst the accounting for transition to DB accounting, as set out by the amendments, is relatively straightforward and simple to apply, there will be several other accounting and commercial challenges associated with having to account for participation in a multi-employer pension scheme as a DB scheme. For instance, the on-going requirement to understand and apply DB accounting to the plan, including the more onerous disclosure requirements associated with such accounting, dealing with the resulting (possibly negative) impact on retained earnings and distributable profits, and depending on each entities’ specific circumstances managing any consequential implications on key metrics. Therefore, as always with new accounting requirements, it is key that businesses act early to understand the amendments and the associated impact that the changes will have.

By Jessica Howard, Financial Reporting Advisory Director