Save content
Have you found this content useful? Use the button above to save it to your profile.
AIA

FRS 17 ' fundamentally flawed?

by
24th Aug 2005
Save content
Have you found this content useful? Use the button above to save it to your profile.

A new report has re-opened the debate on the pension accounting standard FRS 17, claiming its discount rate of the AA corporate bond yield 'overestimates the true pension deficit or underestimates the surplus'.

The report, 'The failings of FRS 17 and the impact of pensions on the UK stock market', was produced by SEI Investments (Europe) in conjunction with Laurence Copeland, Professor of Finance at the Cardiff Business School.

'Pension liabilities are a charge on the firm's assets in the same way as any other liabilities,' says the report. 'If pensions have a potential call on the totality of the firm's assets, not simply those nominally owned by the pension fund, their value should be computed in a way consistent with this approach.'

The report points out that in the four years since FRS 17 first came to light, the majority of UK pension schemes have closed to new entrants, asking if this can just be coincidence ' although it does concede FRS 17 was introduced at the same time as a number of other measures.

The authors argue that the previous SSAP24 accounting standard was a better measure because it was based on the belief that 'pensions are a long term liability and the cost of the pension provision should be accounted for across the period over which it was incurred'.

According to the authors, the change to FRS 17 meant: 'The long-term perspective was replaced with the short-term mindset of the markets. By bringing the market value of the scheme at a given point in time into company accounts, market volatility has the potential to lead to wildly fluctuating and misrepresentative data, greatly impacting the perception of the company's financial health.'

One thing that does win praise is FRS 17's reporting standards, which are much improved when compared to SSAP24. The report says information that was previously difficult or costly to collect will now be more readily available.

However, the report also says that one result of the short-term nature of reporting may be that 'predators' will be put off making takeovers.

It adds: 'This 'poison pill' effect will be welcomed by those who view takeovers as the result of investor short-termism combined with executive greed, but should worry anyone who thinks they have a vital role to play in preserving the competitiveness of the UK corporate sector.'

The report says FRS17 is more likely to cause share valuations to fall if investors have previously tended to undervalue pension liabilities or overvalue pension assets.

The authors say the problem can be resolved by using the disclosure from FRS 17 and the methodology of SSAP24 to create a new standard.

'The irony is that they so nearly got it correct the first time. The faults in the previous UK pension accounting standard, SSAP24, were not to do with its calculation methodology but its abysmally poor disclosure requirements. With FRS 17, the accountants corrected the disclosure but when it came to the detail of the calculations they were swept along with the cult of financial economics.'

Tags:

Replies (0)

Please login or register to join the discussion.

There are currently no replies, be the first to post a reply.