Accounting for the plan assets of retirement benefit schemes under IFRS

By Kelvin Chungu

One of the key peculiarity of the retirement pension plans assets is that they tend to be heavy on financial instruments, and therefore in the advent of IFRS 9 Financial Instrument (IFRS 9), and the sustained focus on this standard in the past year, a lot of questions were raised around the applicability of IFRS 9 requirements to the pension plan’s assets.

It is not that the standard relating to retirement benefit schemes was not specific about the measurement criteria to be followed for the plan assets. Infact in January 1987, the International Accounting Standards Committee (IASC), the predecessor to the International Accounting Standards Board (IASB) issued IAS 26 Accounting and Reporting by Retirement Benefit Plans (IAS 26) which outlines the recognition, measurement and presentation requirements in the preparation of financial statements of retirement benefit plans, and which became applicable to annual period beginning 1988. IAS 26 requirement is that the retirement benefit plan investments be carried at fair value.

Here is the conundrum however, the standard’s requirement that assets are valued at fair value, means that Pension Administrator must understand how to calculate fair value using acceptable valuation methodologies for investments without a publicly available market as well. However, many pension administrators in Zambia, in the past have often chosen to utilise a cost approach in measuring their investments portfolio on the basis the investment is short-term in nature utilising an escape clause in the standard that permits the assumption that carrying value is consistent with fair value, if it relates to an fixed income investment that is short tail.  It was an easy option that did the trick in many cases because a majority of pension administrators had a portfolio of fixed income investment that were of a duration of 1 year and below.

IFRS 9, (although it is not the standard that should been the focus), by its requirement that first an investment had to meet certain criteria as the basis for the classification, enabled a second look by the Pension Fund Administrators in Zambia of whether the accounting and measurement principles were done right, in light of the requirements of IFRS 9, which ideally is meant to force entities to take a fair value approach.

Here is why. IFRS 9 takes a much more nuanced approach than IAS 39 by requiring that all financial assets are divided into two classifications; those measured at amortised cost and those measured at fair value. To qualify for the amortisation classification, IFRS 9 requires an assessment of two folds; first, whether contractual cash flows arising from the investments give rise to solely payments of principal and interest (‘SPPI test’). The standard idea for an instrument that meets this test is a basic lending arrangement.

Secondly, the IFRS 9 requires another question to be asked; i.e. are the investment held with a view to realising the principal and interest, i.e. to maturity or are they also sold as a part of the general approaches for managing the financial assets (the “Business Model test”). A failure in that classification assessment means the measurement basis will be fair value to be either presented in profit or loss or in other comprehensive income.

Therein lies the problem that forced the Pension Administrators to now confront the open question, which has always been percolating. How do we classify our investments and therefore how do we measure our investments?

So what should the approach be?

IAS 26 as noted above is very clear that the retirement benefit plan investments must be carried at fair value.

But there was also another attendant question that the various other Pension Funds Administrator were faced with, including elsewhere in the world. How does the requirements of IAS 39 Financial Instrument (later replaced by IFRS 9) interlink with those of IAS 26 given some seemingly divergent requirements for financial instruments.

The International Financial Reporting Interpretation Committee (IFRIC) faced these mounting questions and in 2010 issued two important decisions that still hold today, giving reasons why the IFRIC did not think there were any conflicts in the requirements of the standard, and therefore did not see the need to proceed with an annual improvement in the standard.

First, the IFRIC clarified that the pre-sen-ta-tion of changes in the fair value of plan assets, must be in line with the requirement of IAS 26 as the standard provides a complete guidance on the recog-ni-tion, mea-sure-ment, pre-sen-ta-tion, and dis-clo-sure of plan assets in the financial state-ments of re-tire-ment benefit plans and thus the clas-si-fi-ca-tion of these assets in ac-cor-dance with IAS 39 (replaced by IFRS 9) would be in-ap-pro-pri-ate.

This was to answer a question of whether the requirement in IAS 26 to present the changes in the fair value of plan assets in the statement of changes in net assets available for benefits and the requirement in IAS 39 (replaced by IFRS 9) to present them in profit or loss or in ‘other comprehensive income’ depending on classification of the assets, was an inconsistency that needed to be addressed.

In the same breadth, the IFRIC disagreed with any com-pre-hen-sive scope exemption requirements in  IAS 39/IAS 32 or IFRS 7 as it believed that some guidance that did not conflict with IAS 26 re-quire-ments but com-ple-ments it would be useful (for example, fair value mea-sure-ment).

Subsequently in May 2010, the IFRIC faced with another question to clarify the interaction between IAS 26 and IAS 39 (replaced by IFRS 9) relating to the accounting for retirement benefit plan investments in the financial statements of retirement benefit plans prepared in accordance with IAS 26, noted, and consistent with the decision above, the Committee in its decision not to recommend an improvement, concluded that the IFRSs are clear and that divergent interpretations are not expected in practice.

The IFRIC in this regard reasserted that the guidance in paragraph 32 of IAS 26 is clear that plan assets are carried at fair value, and that the changes in the fair value of plan assets should be presented and disclosed in ac-cor-dance with paragraph 35 of IAS 26 in the statement of changes in net assets available for benefits.

Since the two decision above, IAS 39 has been replaced by IFRS 9 and therefore any reference to IAS 39 above relate to IFRS 9, because no other guidance has been issued since then to overturn this IFRIC guidance.

In short, the IFRIC guided that IAS 26 provides a complete guidance on recognition, measurement, presentation and disclosure for pure plan assets and therefore no other guidance ought to be applied in the measurement of the plan asset of a retirement benefit plan.