IFRS Accounting of Pension Obligations

Pensions
IFRS Accounting
of Pension
Obligations
Understand. Act.
PortfolioPraxis: Akademie
2
Pensions
Content
5
Introduction
5
Defined Contribution vs.
Defined Benefit Plans
6
Defined Contribution Plans
8
Defined Benefit Plans
Imprint
Allianz Global Investors GmbH
Bockenheimer Landstr. 42 – 44
60323 Frankfurt am Main
Global Capital Markets & Thematic Research
Hans-Jörg Naumer (hjn)
Ann-Katrin Petersen (akp)
Stefan Scheurer (st)
Data origin – if not otherwise noted:
Thomson Reuters Datastream
Allianz Global Investors
www.twitter.com/AllianzGI_VIEW
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Pensions
IFRS Accounting
of Pension Obligations
International accounting, in particular on the basis of International Financial Reporting Standards (IFRS), has become
increasingly important in recent years. This development
dates back at least to the so-called IAS Regulation of the European Union of 19 July 2002 (No. 1606 / 2002). This regulation
requires European enterprises listed on a European exchange
to prepare their consolidated financial statements in accordance with International Financial Reporting Standards,
beginning financial year 2005.
Dr. Martina Bätzel has been working in the Pensions department of Allianz
Global Investors KAG since mid-2007 and was appointed Managing Director
of Allianz Treuhand GmbH in September 2010. Following an apprenticeship in
banking with Deutsche Bundesbank, she studied economics as well as business/
economics education in Mainz. After having obtained her doctorate in economic
policy, she worked from 2001 to 2007 as consultant and executive assistant at
Dr. Dr. Heissmann GmbH (now Towers Watson).
Michael Heim is a DAV actuary and an IVS-examined actuarial expert for
pension schemes at Allianz Global Investors Pensions department. After his
studies in business mathematics at Ulm University he started his career
with Allianz in 1997. He has more than 15 years experience in the field of
occupational pension schemes.
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1. Introduction
Within IFRS, Standard IAS 19 “Employee Benefits” (IAS: International Accounting Standard)
governs the accounting of employee benefits.
Employee benefits include:
 short-term benefits
(e. g. wages, salaries, paid annual leave),
 long-term post-employment benefits
(e. g. retirement benefits),
 other long-term benefits
(e. g. jubilee benefits, claims from
working-life time accounts), and
 termination benefits (e. g. termination
payments).
The majority of the content of IAS 19
addresses post-employment benefits, i. e.
requirements that pensions be accounted
for under IFRS.
Pensions in Germany can be classified according to the five ways of implementing them
– pension commitment, direct insurance,
German Pensionskasse, pension funds and
support funds (Unterstützungskasse).
As part of employee remuneration or as a
supplement to pensions, increasing use has
also been made in recent years of so-called
working-life time accounts. Among other
reasons, against the background of this very
diverse and sometimes complex array of
pension schemes, it is always a challenge
for German IFRS adopters to properly and
yet practically apply the accounting rules in
IAS 19, which are heavily influenced by
Anglo-American accounting rules, to the
specific German situation.
The aim of this presentation is to outline
the basic features of the regulatory content
of IAS 19 for long-term post-employment
benefits, while providing a means of classifying and applying the regulations taking
into account the situation in Germany.
For selected topics, explanations will be provided on specific national accounting features
for the German balance sheet in accordance
with the German Accounting Law Modernization Act (Bilanzrechtsmodernisierungsgesetz
– BilMoG) and German tax accounting
pursuant to the German Income Tax Act
(Einkommensteuergesetz – EStG). In an
explanatory note, Contractual Trust Arrangements (CTA) will be introduced as an alternative liquidity-friendly solution for the external
funding of pension obligations in accordance
with both the German Commercial Code
(HGB) and IFRS.
2. Defined Contribution vs.
Defined Benefit Plans
While a distinction is made in German
accounting between direct and indirect
pension obligations, the important distinction
under IAS 19 is between:
 Defined Contribution Plans and
 Defined Benefit Plans.
In a defined contribution plan, the contributions (e. g. to a pension fund) are recognised
as an expense in the period in which they
are incurred. If the employer matches the
amount and timing of his contributions to
obligations for each accounting period, it is
not necessary to recognise further liabilities.
The accounting for defined benefit plans
is more complex: using actuarial assumptions and methods, pension obligation and
expenses are identified and compared with
the separated assets or resulting return used
to meet the obligation.
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Pensions
3. Defined Contribution Plans
Example
In the US, ABC company promises its
employees an annual contribution of 2 %
of pensionable salaries into the XYZ pension fund. The company does not incur
any risks or obligations (e. g. negative
investment performance) beyond the
contributions.
3.1 Definition
Under IAS 19.7, a defined contribution plan is
defined using the three following cumulative
requirements:
1. Fixed contributions: The company only
has the obligation to make contributions
to the plan. The amount of the benefits is
based on these contributions, including the
resulting investment return.
2. Separate entity: The contributions are
paid to an external pension provider
(e. g. a pension fund) that is legally
separate from the company.
3. No legal or constructive obligation for
further contributions: The company must
not have any subsidiary responsibility or
supplementary contribution liability, e. g.
in the case of negative investment performance. Similarly, a positive investment
performance may not lead to reductions in
contributions or refunds of contributions.
In a defined contribution plan under IAS 19.7,
the company consequently bears no risks,
neither biometric risks nor investment risks,
nor any other obligations associated with
the pension plan.
3.2 Accounting
The IFRS accounting for defined contribution plans is comparatively simple: For each
accounting period, the amount recognised and
presented in the notes as pension expense is
the contribution amount resulting from the
underlying pension plan formula (in exchange
for the employee’s service in the same period).
Because the company’s liability, consisting
of this contribution, can be clearly identified,
and the company then fulfils this obligation
by making the contribution, accounting for
defined contribution plans in general does
not require any actuarial assumptions or
assessments. Only if the contribution is due
more than a year after the end of the accounting period in which the employee rendered
the service the future payment must be discounted. This discount is based on the actuarial
interest rate of defined benefit plans.
Figure 1: Structure of defined contribution plans
Company
Service
Contributions
Wages and
contribution commitment
Benefits
Employee
Risks and rewards lie
with the employee
Source: Own research, Allianz Global Investors Pensions
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Pension Fund
The balance sheet is impacted by defined
contribution plans only if the company has not
matched the timing and amount of its contributions to obligations during the accounting
period:
 A liability is incurred when the plan is underfunded, i. e. the amount paid is lower than
the contributions due (deferred liability).
 An asset is recognised when the plan is overfunded, i. e. the amount paid is greater than
the contributions due (prepaid expense).
Once a company’s commitment to (matching) contribution payments has finally been
fulfilled, no further consideration regarding
the recognition of liabilities is necessary.
Contributions are paid to a legally separate
entity. This entity is exclusively responsible
for the future payments to beneficiaries. The
company itself no longer has access to the
plan assets after payment of the contributions.
The company is then no longer to be considered the legal or economic beneficiary of the
assets, which are attributable to the eligible
employees and are not to be recognised on
the balance sheet of the company.
3.3 Practice: Do Defined Contribution Plans Exist in Germany?
Due to the employer’s subsidiary responsibility (see § 1 para. 1 German Company Pension
Act), there are no defined contribution plans
in Germany following a strictly formal interpretation of IAS 19.7. A word of caution: this
means that the term “Defined Contribution
Plan”, which we will be using throughout this
document, is not directly applicable in any
discussion concerning the German system
of pension plans. In many instances, a more
accurate term might be “ContributionOriented Plan”.
Even contribution-oriented plans should
initially be classified as defined benefit plans.
However, in specified circumstances, IAS 19
permits the treatment of these commitments
as defined contribution plans. This applies, in
particular, for so-called insured plans according to IAS 19.39.
An insured plan is defined as a pension plan
whose benefits are financed through the
payment of insurance premiums. Plans of
this type can be treated as defined contribution plans unless the company has a legal or
constructive obligation to:
 pay the employee benefits directly when
they fall due, or
 pay further amounts if the insurer does not
pay all future employee benefits relating to
employee service in the current and prior
periods.
Question: Do the insurance-based solutions
in Germany, such as direct insurance, meet
the conditions for insured plans?
The prevailing opinion of the accounting
working group of the DAV / IVS Committee
(DAV: German Actuarial Association; IVS:
German Institute of Actuarial Experts) is that,
in insurance-based solutions, the final liability
is to be considered only as a contingent
liability. Direct insurance, German Pensionskasse and pension funds can in general be
classified as insured plans in accordance with
IAS 19.39, and thus as defined contribution
plans, if the following criteria are met:
 The company is the policyholder and
thus is liable for the contributions.
 The employee is the insured person
and has the right to the benefits.
 The employee has a legally enforceable
right vis-à-vis the pension provider.
 The pension provider guarantees the
benefits in compliance with regulatory
requirements.
 The guaranteed benefits are based solely
on the contributions paid, plus any guaranteed interest, less cost and risk premiums.
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Pensions
 The surplus will be credited to
the employee.
 Fully vested benefits are fully funded upon
termination of employment.
 The amount of the post-employment
benefits is determined by the amount of
capital reserves.
 Pension adjustments depend on
policyholder bonus.
Finally, the classification of an insurancebased solution as defined contribution plan
requires approval by the company’s auditor.
4. Defined Benefit Plans
4.1 Definition
Defined benefit plans are characterized by the
fact that – as opposed to defined contribution
plans – the risks and obligations of the pension commitment remain with the company
even after the accounting period.
Example
The company XYZ Inc. grants retirement
benefits to its employees. The lifelong
pension benefit amounts to 1 % of last
gross salary before retirement for each
eligible year of service. The company
bears all risks and obligations from the
pension commitment, such as the investment and longevity risk.
4.2 Accounting
In general, every pension plan is a defined
benefit plan unless it definitely meets the
requirements for classification as a defined
contribution plan. Pursuant to IAS 19.25,
if there is any doubt, this distinction which
is sometimes not that simple must be
made based on the “economic substance
of the plan”.
While it is relatively simple to determine the
expense of contributions for each accounting period for defined contribution plans, the
(unknown) expense for each period, i. e. the
contribution required for financing the pension benefit, must be determined actuarially
on the basis of the (known) benefit when
Figure 2: Structure of defined benefit plans
Indirect commitment
Direct commitment
Company
Risks lie with
the company
Company
Risks lie with
the company
Service
Benefits
Wages and benefit
commitment
Employee
Service
Wages and benefit
commitment
Employee
Source: Own research, Allianz Global Investors Pensions
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Funding
Pension Fund
Benefits
accounting for defined benefit plans. When
these actuarial calculations are made, the
following accounting principles in particular
must be taken into consideration:
actuarial assumptions must be established in
such a way that they meet the best estimates.
 Suitable probabilities for the occurrence of
biometric risks of death, disability, etc.
 Discounting of future benefits using an
actuarial interest rate appropriate for the
maturity
 Economic assumptions for trends and
adjustments of pension benefits (e. g. cost
of living and income)
The primary goal of demographic assumptions is to describe the current status and
the expected development of the number of
people to be covered by the pension plan.
The most important parameters for demographic assessment are the probabilities
for the occurrence of the biometric risks of
death and disability. Although these probabilities could, in principle, be determined
individually for each set of people to be
assessed, due to insufficient set size and
excessive cost, statistical analyses are usually
based on generally accepted actuarial tables
for probabilities of death and disability. In Germany, the so-called Heubeck actuarial tables
(current actuarial tables: Heubeck 2005 G
by Klaus Heubeck) are customarily used for
IFRS accounting of pension liabilities. These
actuarial tables can also be customised for an
individual company by applying modifications
(increase or reduction of probabilities).
4.2.1 Accounting principles
Under IFRS accounting for defined benefit
plans, a basic distinction is made between
demographic valuation assumptions and
economic valuation assumptions. While
demographic assumptions reflect the
characteristics of the pension plan participants who are entitled to benefits, economic
assumptions are determined by macroeconomic as well as company-specific indicators
and trends. In accordance with IAS 19.73, all
Demographic Valuation Assumptions
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Pensions
Other demographic assessment parameters
to be taken into consideration include
employee fluctuation and assumptions about
retirement age or the retirement behaviour of
pension beneficiaries. Fluctuation probabilities are generally derived individually for each
company as a function of gender, age and
service time. Actuarial analyses have shown
that taking fluctuation probabilities into consideration may reduce pension obligations by
up to about 0.5 %, which means that it has a
rather small impact on the valuation of pension obligations.
Retirement age for valuation purposes must
be in accordance with the provisions of the
pension plan (fixed / earliest age from which
retirement benefits may be drawn). In practice, the most likely retirement age is very
often used as the basis for the assessment.
The German Income Tax Directive R 6 a EStR
states in paragraph 11 that “for some or all
pension obligations, the earliest possible date
for early retirement claims from statutory
pension can be used as the date of entry into
the benefit plan.” This guideline is often
followed in the IFRS valuation of pension
obligations.
Economic Valuation Assumptions
The central economic assumption is the
discount rate at which future benefits are discounted to the valuation date. The discount
rate should, in principle, reflect the time value
of money and be based on the yields of high
quality fixed-income corporate bonds on the
valuation date. In practice, “high quality corporate bonds” usually means corporate bonds
rated at least AA (using the terminology of
Standard & Poor’s). The maturity and currency of the bonds and the pension obligation
should also match. Since the introduction
of the Eurozone, there has generally been a
sufficiently liquid market for corporate bonds
denominated in Euro to determine the discount rate. If, however, there is no sufficiently
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liquid market for such corporate bonds, the
market yield on government bonds may be
used alternatively (taking into account a risk
premium to compensate for the difference in
credit quality). If there is no sufficiently active
market for very long-term bonds (which is
a particular issue for maturities longer than
30 years), the discount rate is derived using
mathematical extrapolation methods. Historically, discount rates in accordance with IAS 19
have periodically been subject to significant
fluctuations over time because of the closing
date principle, with corresponding effects
on the amount of the pension obligation: A
higher discount rate ceteris paribus reduces
the pension obligation, while a lower discount
rate ceteris paribus increases the pension
obligation.
National accounting
While the determination of the discount rate under IAS 19 grants a certain
amount of leeway for calculation and
interpretation, the German Accounting
Law Modernization Act clearly states that
the discount rates determined and published monthly by the Deutsche Bundesbank, based on a market-oriented average interest rate corresponding to the
predicted residual maturity of the obligation, are to be applied for discounting
pension obligations in the HGB balance
sheet. The only option granted is that, for
simplification purposes, a uniform interest rate may be used for the entire pension plan based on a maturity of 15 years.
Among the economic evaluation parameters,
the IFRS financial reporting of pension obligations also subsumes trend assumptions and
the return on plan assets. In contrast with the
closing date principle under German tax law,
the valuation of pension obligations under
IAS 19 explicitly calls for taking into account
the expected future changes and trends in
the valuation bases for pension benefits. In
particular, dynamic effects of current pension
benefits (so-called pension trends) are to be
included in the calculations, and dynamic
salary trends must be taken into account for
salary-linked pension plans.
With the revised version of IAS 19 rev. 2011
published on 16 June 2011, the return on
plan assets (“expected return on plan assets”
in the terminology prior to IAS 19 rev. 2011)
was substantially revised. For accounting periods starting from 1 January 2013, the applicable discount rate for the calculation of the
pension obligation is implicitly used as return
rate for the plan assets as well. Accordingly,
the return on plan assets will no longer be
determined individually for the company, and
the allocation of the plan assets is irrelevant to
its determination.
4.2.2 Defined Benefit Obligation
Definition
The value of the pension obligation on closing date is designated in IFRS accounting of
defined benefit plans as the defined benefit
obligation (DBO). In actuarial terms, the
defined benefit obligation represents the total
present value of the accrued pension obligation that results from the services rendered by
the employee during the accounting period
and in previous periods.
Figure 3: Accounting principles pursuant to IAS 19 rev. 2011
Accounting principles pursuant to IAS 19 rev. 2011
Demographic Valuation Assumptions
(company-specific assumptions)
Biometric assumptions (in particular death, disability)
Economic Valuation Assumptions
(company-specific assumptions and
macroeconomic assumptions)
Discount rate
Fluctuation probabilities
=
Return on plan assets
Retirement age/retirement behaviour
Trend assumptions (e. g. pension and wage trend)
Objective: Realistic valuation through …
… unbiased and mutually compatible assumptions,
… assumptions that are neither imprudent nor excessively conservative,
… assumptions that reflect the economic relations.
Best estimate principle
in accordance with
IAS 19.73
Source: Own research, Allianz Global Investors Pensions
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Pensions
Valuation / Determination
The objective of actuarial valuation methods
is to determine the value of the pension
obligation or of the premium required for
financing the pension obligation during the
appropriate period.
the pension obligation increases over time,
as the discount period continues to shorten.
A particular characteristic of the Projected
Unit Credit Method is that the value of the
pension claims on each reporting date is not
based on reporting date assumptions, but
instead is anticipated or determined (hence
„projected“) by taking into account future
changes of the key valuation parameters, such
as salary and pension trends.
Under IAS 19, since 31 December 1999, the
Projected Unit Credit Method (PUC method)
has been explicitly required as the actuarial valuation method for the IFRS balance
sheet. The Projected Unit Credit Method is a
valuation procedure from the aggregation
methods class. Under aggregation methods,
the amount of the pension obligation is calculated as the sum of the expected future benefit payments discounted on the respective
closing dates and weighted with their probabilities, provided they have been accrued by
the reporting date. Based on the individual
obligation resulting from a classic defined
benefit plan, the premium required to fund
National accounting
While the German Accounting Law
Modernization Act does not require an
explicit evaluation method for the HGB
balance sheet, in German tax accounting
pursuant to Section 6 a EStG, only the
so-called partial valuation method (Teilwertverfahren) may be applied.
Pension obligations (cumulative)
Figure 4: DBO process using the PUC method and
increase in funding premium over time
Premium y
Premium x
x
Source: Own research, Allianz Global Investors Pensions
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x+1
y
y+1
65
Age
4.2.3 Plan Assets
While pension obligations in Germany are
traditionally often financed internally through
investments that are not matched with the
obligation, but instead used for the core
business of the company (so-called internal
financing), in the Anglo-American world the
primary method used is external financing
of the obligation (so-called outside funding).
With outside funding of pension obligations,
designated assets protected against the insolvency of the sponsor are accumulated outside
the company; these assets are exclusively
“reserved” for fulfilling pension obligations
(so-called plan assets).
Definition
IAS 19 refers to assets as plan assets, i. e.
assets that must be offset or netted against
the underlying pension obligation, if the following three criteria are cumulatively met:
1. Separation (“… held by an entity (a fund)
that is legally separate from the reporting
enterprise …”). The assets must be outsourced to an independent entity (e. g. a
trust / CTA solution), which has the sole purpose of financing, paying out and ensuring
benefits. Repayments to the company may
only be made if:
 there is excess funding, i. e. if the pension liabilities can be fully serviced by the
remaining plan assets, or if
 the external entity reimburses the company for benefits that the company has
already paid to the pension beneficiaries
(known as Reimbursement).
2. Exclusivity of purpose (“… available to be
used only to pay or fund employee benefits
…”) The plan assets are used exclusively for
payment or financing of benefits.
3. Availability in case of insolvency (“… are
not available to the reporting enterprise’s
own creditors (even in bankruptcy) …”)
The assets must be unavailable to the creditors of the company – particularly in the
case of bankruptcy.
The plan assets consist of the funding provided by the company and the returns earned
less benefit payments. The assets may comprise financial assets (e. g. shares, bonds,
mutual funds, qualifying insurance policies),
property, plant and equipment (e. g. machinery) or real estate. Financial instruments
issued by the company itself (i. e. treasury
shares) may be suitable as plan assets if they
are transferable. In particular, the criterion of
transferability is satisfied when the assets are
freely tradable.
National accounting
In contrast to the three criteria under
IAS 19, for balance sheets in accordance
with German HGB, plan assets must
only meet two requirements: exclusivity
of purpose and insolvency-protection.
A transfer of assets to an independent
entity is not necessary – in contrast to
IAS 19. As a result, there may be a balance sheet effect in the HGB balance
sheet through the pledging of a securities account, e. g. for the purpose of
covering a managing partner pension
commitment. For exclusivity of purpose,
the Accounting Law Modernization Act
requires that plan assets be liquid at
all times to cover pension obligations,
which excludes operating assets (such as
owner-occupied real estate) from use as
plan assets for the HGB balance sheet.
The approval of plan assets under IFRS and
HGB always depends on close coordination
with the responsible auditor.
The classification of plan assets under IFRS
and HGB and the consequences of these
different definitions can be summarised as
follows:
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Pensions
Figure 5: Different definitions of plan assets under IFRS and HGB
Requirements
1. Separation
2. Exclusivity of Purpose
3. Insolvency-Protection
Plan assets under IFRS
Plan assets under HGB
Transfer to a legally
separate entity
No requirement
Availability (liquidity)
for fulfilling pension obligations
Assets must be available exclusively
and at all times for pension liabilities
(no assets that are necessary
for operations)
Identical requirement under IFRS and HGB
Source: Own research, Allianz Global Investors Pensions
Figure 6: Consequences of the different definitions
of plan assets under IFRS and HGB
Plan assets under IFRS
No plan assets under IFRS
Plan assets under HGB
Securities (e.g. special or mutual
fund units) in CTA solutions
Pledged
securities account
No plan assets under HGB
Owner-occupied real estate or
loan to the sponsoring company
in CTA solutions
Unpledged
securities account
Source: Own research, Allianz Global Investors Pensions
Valuation / Determination
Under IAS 19, plan assets are to be measured
at fair value as of the reporting date. Fair value
generally corresponds to the observed market
value or value on a securities exchange, which
is usually easily determined, particularly for
an investment in the form of financial instruments. Difficulties in determining fair value
may occur for some assets, such as property,
plant and equipment or real estate. In such
cases, fair value is to be determined in the
best possible way, e. g. through appropriate
valuation procedures and expert opinions.
For qualifying insurance policies that secure
the benefit commitments by fully matching
the amount and timing of those benefits,
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the fair value of the insurance contract is
equivalent to the present value of the commitments made for future benefits (Defined
Benefit Obligation) (so-called corresponding measurement). Therefore, an economic
effect in the IFRS balance sheet comparable
to a defined contribution plan is achieved
through this full offsetting. Nevertheless,
in this case as well, disclosure requirements
for the notes to the balance sheet continue
to be relevant for the defined benefit plan.
If the promised benefits and the benefits
secured through qualifying insurance policy
do not match, the asset value of the insurance
contract is usually presented as fair value and
offset with the pension obligation.
National accounting
With the Accounting Law Modernization Act, the valuation of plan assets at fair value
(rather than at cost) is also applicable for the first time in the HGB balance sheet.
Trusts
A trust solution (Contractual Trust Arrangement, CTA) can be used to hold assets as plan
assets for funding pension obligations: As a vehicle set up by a single company or – often
more efficient – by making use of a multi-employer trust, such as Allianz Treuhand GmbH.
Using a multi-employer trust, companies can participate regardless of their affiliation, size,
and the scope of their existing obligations, and achieve a balance sheet effect by offsetting
benefit obligations and plan assets in both IFRS and the HGB balance sheets.
How does a trust work, in particular in the multi-employer form? For external funding and
insolvency protection of pension obligations, the company enters into a trust agreement
with the trustee, and on this basis, transfers the assets necessary to cover these obligations.
The actual administration of the trust assets is usually outsourced to a separately appointed
asset manager. According to the trust agreement, the trustee becomes the legal owner of
the transferred assets. He may only use the assets in order to provide or finance the benefits
promised in the pension plan, i. e. the trust assets are strictly reserved to the defined purpose.
This applies even if the employer / trustor should become insolvent. In this case, the employee
can apply directly to the trust to receive the promised benefits. However, the trust does not
provide any guarantee, but pays out the benefits only if and insofar as the necessary funds
were transferred from the employer. The trust structure is called “double-sided,” because
the trustee acts both as administrative trustee for the employer as well as security trustee for
the employee. However, a contractual relationship exists only between the company and the
trustee; the security trust is a contract for the benefit of third parties, i. e. the beneficiaries of
the pension plan.
Using a trust solution for creating plan assets offers a number of advantages:
Foremost is flexibility, because there are no set guidelines in a trust solution as to amount
or timing of contributions by the employer. The funding of the trust may be based on the
individual circumstances of the company, depending, for example, on the intended level of
external funding or the available liquidity.
The netting of trust assets and pension obligations of the trustor company is possible
because while the trust assets do legally belong to the trust, economically they remain allocated to the trustor company. The criteria for plan assets, which are set according to international accounting rules and the German Commercial Code, are fulfilled by an appropriately
designed trust agreement. The final approval for offsetting the trust assets with the pension
obligations lies with the auditor of the company.
In German tax accounting, the pension obligation is not offset with the pension assets; the
trust remains invisible for tax purposes, in a manner of speaking. This leaves the tax holiday
effect of the provision in place. Important for the employees: The external funding of the
trust will not affect the tax treatment of employee contributions or benefits. Since the
pension plan remains untouched under labour law by external funding through the trust,
no consent of the individual employees or of the works council is required for the implementation of a trust solution.
15
Pensions
In addition, a trust solution also improves the insolvency protection for the benefit commitments. While a statutory insolvency protection for occupational pensions in Germany already
exists in the form of the German Pension Protection Association (Pensions-SicherungsVerein – PSV), this applies only to statutory vested rights within the scope of pension law
and benefits in the payout-phase. This means, in turn, that occupational benefit claims are
not protected against insolvency if, for example, they are only contractually vested or if they
exceed the protection limits of the PSV. Even accrued benefits from deferred compensation
in the last two years before insolvency – if exceeding the contribution threshold of 4 % of
statutory pensionable salary – are not legally protected against insolvency. The benefit claims
of individuals who are not subject to the pension law, such as the controlling owner-manager
of an enterprise, remain completely unprotected. In all these cases, private law insolvency
protection can be set up by the trust. In addition, the trust can be used for providing insolvency protection for other obligations vis-à-vis the employees, e. g. from time accounts or
part-time retirement.
In multi-employer models, a broad range of capital investment structures (including hybrid
structures) can be put in place with investment funds and insurance products. Biometric risks
can also be hedged through the integration of the appropriate insurance components into
the overall concept.
Figure 7: Contractual Trust Arrangement
Company
Benefit obligation
Benefit entitlement
Transfer of assets
Trust agreement
Treuhand GmbH
or e. V.
Benefit claim
Employee
Claim procedure
Source: Own research, Allianz Global Investors Pensions
16
Investment
Asset
manager
4.2.4 Pension Expense
Service Cost
Service cost will be recognised in profit and
loss and calculated prospectively by the
actuary. It includes:
 Current service cost
 Past service cost and
 Settlements.
Past service cost may result from the subsequent improvement or deterioration of a pension plan. Unlike original current service cost,
which reflects the benefit components newly
accrued in the current accounting period,
past service cost always relates to previous
accounting periods. As a rule, past service
cost was previously recognised over a certain
period of time as a separate item in pension
expense. Under IAS 19 rev. 2011, it is now
subsumed as part of service cost and is to be
fully and immediately recognised in the year of
the plan change. The definition of past service
cost was also expanded under IAS 19 rev. 2011
and now also includes effects associated with
curtailments. Curtailments can arise at the
closure of an operation, during restructuring
or closures of pension plans. In the case of a
curtailment, the company must be committed
to substantially reducing the circle of persons
entitled to benefits or to altering the pension
plan so that significant portions of future
years of service or salary increases lead only
to reduced pension claims or to no pension
claims.
The current service cost is determined using
the Projected Unit Credit Method. It corresponds to the actuarial cash value of the
benefit components that are newly accrued by
the (active) employees during the accounting
period. Analogous to the defined benefit obligation, the following applies: All other things
being equal, a higher discount rate reduces
current service cost, and a lower discount rate
increases current service cost.
With a settlement, the company transfers,
without any extended liability, the pension obligation for which it is responsible
to another entity (e. g. another company or
pension provider), or the pension obligation is
extinguished by the payment of a termination
indemnity. In accordance with IAS 19.113, the
conclusion of an insurance contract does not
lead to a settlement, if the employer remains
subject to the extended liability to pay benefits.
In the past, the structure and recognition of
pension expense under IAS 19 was characterized by numerous accounting options that
sometimes were contrary to the IFRS accounting principle of “true and fair view.” The
revised version of IAS 19 rev. 2011 brought
many changes in this area, with the objective of making classification as unambiguous
as possible and improving comparability of
income and expense components. Pension
expense can now be categorised as:
 Service cost
 Net interest
 Remeasurement.
17
Pensions
The new IAS 19 rev. 2011 provides no guidelines regarding the explicit presentation of
the individual pension expense items in the
income statement. Service cost is, in practice,
usually presented as personnel expense and
recognised as part of operating profit in profit
and loss.
Net Interest
Net interest, which is also recognised in profit
and loss, represents the interest income or
expense resulting from the net liability or
from the net assets (so-called net defined
benefit liability / asset as the difference
between pension obligations and plan assets).
In the terminology of the previous version
of IAS 19, net interest comprised the sum of
the interest cost and the expected return on
plan assets, while under IAS 19 rev. 2011 the
discount rate used to calculate the benefit
obligation is now to be applied to both figures
(see 4.2.1 Accounting principles). Expected
changes during the accounting period due to
pension payments or funding of plan assets
are taken into account. A simple mathematical expression of net interest is:
Net interest = (plan assets – pension
obligation) x discount rate
In practice, net interest is generally optionally included in operating results or in the
financial results of the income statement.
Therefore, with regard to the income and
expense components of pension obligations,
comparisons of annual financial statements of
different companies continue to be of limited
value. Although it was questionable in business terms, the presentation of interest cost
in financial results and expected returns on
plan assets in operating result was previously
18
possible –, it will no longer be possible in the
future because of the net perspective.
By combining the interest expense with the
return on plan assets, all the risks and rewards
of the actual investment of plan assets are
now no longer recognised as an income component of net interest, but are now presented
on the balance sheet within the framework of
remeasurement described below.
Remeasurement
At the end of the accounting period, deviations naturally occur between the prospectively measured values (i. e. the expected
values) and the actual values for the pension
obligation, plan assets, etc. The reasons for
this can, for example, be found in changed
discount rates, the occurrence of biometric
risks or unexpected developments of plan
assets. These discrepancies between the
expected and actual values are referred to as
remeasurement.
The valuation changes basically include all
the changes in the pension obligation and the
fair value of plan assets, as far as these are not
included in service cost or net interest, i. e.
they include in particular:
 actuarial gains and losses on the liability
side (e. g. conditioned by changes in the
discount rate) and
 deviations in the actual development of plan
assets from the corresponding part of the
net interest allocated to plan assets (based
on the discount rate).
In contrast to the recognition of service cost
and net interest in the profit and loss statement, the remeasurement is immediately and
completely recorded in equity, specifically
in the statement of comprehensive income
in accordance with IAS 1.81 (other compre-
hensive income (OCI)). There is no longer
any provision for deferred recognition in
income of these amounts, such as in the
framework of the corridor method, which
was done away with in IAS 19 rev. 2011.
The recognition of the remeasurement in
other comprehensive income protects the
income statement from excessive volatility.
This approach is, in practice, often referred
to as OCI or SoRIE method (SoRIE: Statement
of Recognised Income and Expense), an
approach that has been in the standard since
2004, and which had already been applied
in Germany before the introduction of IAS
19 rev. 2011. It has been used by about twothirds of DAX companies and has found broad
acceptance.
The following figure presents the classification and allocation of pension expense
for defined benefit plans pursuant to IAS 19
rev. 2011:
National accounting
In accordance with the provisions of
German commercial and tax law, the
pension provision is determined at the
end of each accounting period. The difference between the pension provisions
of the previous year, including benefits
paid in the accounting period determines
the pension expense to be recognised in
income.
4.2.5 Balance Sheet Approach
The revised version of IAS 19 rev. 2011
improves the comprehensibility, transparency and comparability of the balance sheet
approach of defined benefit plans. In particular, this main goal of the new standard was
achieved with the abolition of controversial
accounting options (e. g. corridor method).
Figure 8: Classification and allocation of pension expense pursuant to IAS 19 rev. 2011
Pensions expense pursuant to IAS 19 rev. 2011
Service cost
Net interest
Remeasurement
• Current service cost
• Interest cost
• Past service cost
• (Expected) Return
on plan assets
All changes to DBO or fair value
of plan assets, provided they are
not taken into consideration in
service cost or net interest
• Settlements
On the basis of the discount
rate for calculation of the DBO
Recognition in profit and loss
Recognition in OCI
(Other comprehensive income)
Source: Own research, Allianz Global Investors Pensions
19
Pensions
The IFRS balance sheet recognition of
defined benefit plans is now the result of the
net difference between the benefit obligation and plan assets (so-called net defined
benefit liability / asset). Thus, both changes in
the benefit obligation and developments of
plan assets will, in the future, be immediately
recognised in each accounting period, as part
of full balance sheet recognition. The resulting fluctuations on the balance sheet, which
may be substantial, are not, however, directly
expressed in the income statement of the
company, but are recorded in equity using the
OCI or SoRIE method (cf. explanations on pension expense). The volatility of net obligations
or net assets to be recognised and the equity
implications may very well be subject to significant increase. If there are plan assets, the
offsetting or netting of pension obligations
and plan assets is mandatory, not optional.
In simple terms, under IAS 19 rev. 2011, most
accounting options were abolished in the
accounting approach to defined benefit plans.
IAS 19 follows the HGB accounting approach
already familiar from the German Accounting
Law Modernization Act, i. e. the net difference
of the pension obligation is presented net of
plan assets.
Example
The pension obligation is EUR 300,000.
a. Plan assets total EUR 200,000
→ The company has a Net Defined
Benefit Liability amounting to
EUR 100,000.
b. Plan assets total EUR 350,000
→ The company has a net defined
benefit asset amounting to EUR 50,000
(at this point, information on the
special provisions concerning the
so-called asset ceiling under IAS
19.58 will be omitted).
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4.2.6 Notes
The information disclosed in the notes of an
IFRS balance sheet (known as disclosures)
should enable the reader of the balance sheet
to understand and assess the economic fundamentals of the pension plan (IAS 19.120).
Among other things, the following information is to be included in the disclosures:
 A general description of the type of pension
plan (e. g. length-of-service plan), including
the legal framework
 The main actuarial assumptions (e. g. discount rate, trend assumptions)
 A reconciliation from the beginning to the
end of the accounting period for, among
other items, the pension obligation, plan
assets and balance sheet recognition
 A breakdown of pension expense into its
individual components, including those
items in which they are recognised in the
income statement.
Within the scope of IAS 19 rev. 2011, the
disclosures on defined benefit plans have
also been subjected to various changes which
are intended to present, in more detail, the
characteristics and risks associated with the
pension plan. The following changes are
examples:
 Sensitivity analyses of the pension obligation for any significant actuarial assumption,
including explanations (sensitivity analyses
for example concerning the discount rate,
trends, retirement age and mortality rates;
only one assumption should be varied in
each case, i. e. there are no interactions
required among the various assumptions)
 Information on the maturity profile of the
pension obligations
 Information about any financial instruments
and strategies in the pension plans (e. g.
asset-liability matching).
The new disclosure requirements are not to
be considered a final “check list,” but rather
to complement the comprehensive nature
of the disclosures. With regard to the level of
detail of the disclosures, the company can still
decide on whether the objective of disclosure
of information has been sufficiently fulfilled.
4.3. Practice: Case Study on Accounting of Defined Benefit Plans
At the beginning of the accounting period,
the pension obligation amounting to 1,000
monetary units is opposed to plan assets of
800 monetary units. The company, accordingly,
presents a pension obligation amounting to
200 monetary units in the balance sheet.
The changes and developments during the
accounting period and the resulting implications for the balance sheet approach, liquidity
and pension costs are shown in the table below:
Figure 9: Case study on IFRS accounting of defined benefit plans
Begin of period
actual
Defined Benefit
Obligation (DBO)
begin of period
expected
End of period
(actual/recognized)
Balance
sheet
Pension cost
P&L
OCI
Liquidity
–1.000
Service cost
–100
–100
–100
Interest cost (5 %)
– 50
– 50
–50
Benefit payments
50
50
Remeasurements
50
– 40
Defined Benefit Obligation (DBO) end of period
– 40
–1.100
–1.140
Contributions
100
100
100
Benefit payments
– 50
– 50
– 50
Return on
plan assets (5 %)
40
40
Plan assets begin of
period
–1.140
800
Remeasurements
Plan assets end of period
40
20
890
910
20
910
–230
–110
–20
100
Source: Own research, Allianz Global Investors Pensions
21
Pensions
The balance sheet value of the pension plan
at the end of the accounting period is the
net difference between pension obligation
and plan assets. The company now presents
a pension obligation in the amount of 230
monetary units.
In the income statement portion of the pension expense, the service cost and net interest
are both taken into consideration (consisting of the interest expense for the pension
obligation and the interest income from plan
assets, in each case based on the discount
rate for calculating pension obligations). In
the income statement, a pension expense
amounting to 110 monetary units is recognised as income.
22
The company records valuation changes at
the end of the accounting period resulting
from the pension obligations and the plan
assets in the amount of –20 monetary units
in equity in other comprehensive income
(OCI). In the terminology of IAS 19 rev. 2011,
a negative (positive) sign implies an actuarial
loss (gain).
Pension payments to beneficiaries, which
the company withdraws in full from the plan
assets, impact liquidity, as well as the funding
of the plan assets in the amount of 100 monetary units.
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