Company Valuation Under IFRS : Interpreting and Forecasting ...

Company valuation under IFRS
4.2 What is current GAAP under IFRS for pensions?
In relation to financial reporting there are two key issues: the income statement
charge and the balance sheet asset/liability. Neither of these is straightforward.
Before proceeding to these let us deal with a few of the fundamental aspects of
pensions.
4.2.1 Forms of pension scheme:
Category 1: Defined contribution schemes
These schemes define the contributions that the employer will make to the fund
on behalf of the employee. The contributions are typically expressed as a
percentage of gross salary. Once the transfer is made by the employing company
then no further obligations rest with the company. The residual risk remains with
the employee.
Accounting for these schemes is very straightforward and simply involves
charging the contributions as an operating expense. They are in effect extra
salary. There would not normally be any balance sheet obligation save for some
delay in making the contributions.
Category 2: Defined benefit
These schemes define the target benefits to be paid to employees on retirement
in the future. Normally the target is expressed as a fraction of final salary (i.e
salary on leaving the company or retiring). The fraction normally changes as
extra years of service are completed. So a scheme might provide that an
employee would generate an annual pension of 2 per cent of his final salary for
each year of employment. So if he worked for 10 years then he would receive an
annual pension of 20 per cent of his final salary.
We can see that as the company has made a promise to pay the risk resides with
it. This risk is not easy to control as there are so many uncertainties associated
with the ultimate outcome. For example, how long will the employee be in
service? What will the final salary level be? How much should be invested now
to meet the estimate of the obligation? It is these uncertainties that make the
accounting complex.
4.2.2 Funded and unfunded schemes
A certain level of confusion also emanates from the fact that pension schemes
may be funded or unfunded. In the US and the UK it is mandatory for defined
benefit plans to be funded. This means that any contributions that the actuary
determines are necessary must be made to a separate funding vehicle. Therefore
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