Provisions
B1ȱ IASȱ37,ȱProvisions,ȱContingentȱLiabilitiesȱandȱContingentȱAssets,ȱdefinesȱaȱprovisionȱasȱ‘aȱliabilityȱofȱ uncertainȱtimingȱorȱamount’.ȱȱȱ
B2ȱ IASȱ37ȱrequiresȱaȱprovisionȱtoȱbeȱmeasuredȱatȱ‘theȱbestȱestimateȱofȱtheȱexpenditureȱrequiredȱtoȱ settleȱtheȱpresentȱobligationȱatȱtheȱbalanceȱsheetȱdate’.ȱȱȱ
B3ȱ TheȱIASBȱisȱpresentlyȱreviewingȱtheȱmeasurementȱprincipleȱinȱIASȱ37.ȱȱTheȱexposureȱdraftȱofȱ proposedȱamendmentsȱtoȱIASȱ37ȱ(Juneȱ2005)ȱproposesȱtoȱclarifyȱthat:ȱ
(i) aȱprovisionȱshouldȱbeȱmeasured,ȱbothȱinitiallyȱandȱsubsequently,ȱatȱȱ
ȱ “theȱamountȱthatȱanȱentityȱwouldȱrationallyȱpayȱtoȱsettleȱtheȱpresentȱobligationȱorȱtoȱtransferȱitȱtoȱaȱ thirdȱpartyȱonȱtheȱbalanceȱsheetȱdate”ȱȱ
andȱȱ
(ii) theȱmeasurementȱshouldȱreflectȱaȱcurrentȱdiscountȱrate.
B4ȱ TheȱIASBȱisȱpresentlyȱrefiningȱtheȱproposalȱinȱ(i)ȱabove,ȱtoȱclarifyȱthat,ȱdespiteȱusingȱtwoȱtermsȱ–ȱ
‘amountȱtoȱsettle’ȱandȱ‘amountȱtoȱtransfer’ȱ–ȱonlyȱoneȱmeasurementȱattributeȱwasȱintended,ȱwhichȱisȱaȱ
‘currentȱsettlement’ȱnotion.ȱȱHowever,ȱtheȱIASBȱhasȱmadeȱitȱclearȱthatȱIASȱ37ȱdoesȱnotȱrequireȱprovisionsȱ toȱbeȱreportedȱatȱfairȱvalue.ȱȱȱ
Share-based payments
B5ȱ ForȱcashȬsettledȱshareȬbasedȱpaymentȱtransactions19,ȱIFRSȱ2,ȱShareȬbasedȱPayment,ȱrequiresȱtheȱ goodsȱorȱservicesȱacquiredȱandȱtheȱliabilityȱincurredȱtoȱbeȱmeasuredȱatȱtheȱfairȱvalueȱofȱtheȱliability.ȱȱTheȱ fairȱvalueȱofȱtheȱliabilityȱshouldȱbeȱremeasuredȱatȱeachȱbalanceȱsheetȱdateȱuntilȱitȱisȱsettled.ȱȱȱ
19 A share-based payment transaction in which an entity acquires goods or services by incurring a liability to pay cash or other assets to the supplier of those goods or services for amounts that are based
Financial liabilities
B6ȱ Aȱliabilityȱtoȱpayȱretirementȱbenefitsȱhasȱcharacteristicsȱofȱaȱfinancialȱliabilityȱbecauseȱitȱisȱaȱ contractualȱobligationȱtoȱpayȱcashȱtoȱemployees,ȱformerȱemployeesȱorȱtheirȱdependents.ȱ
B7ȱ Withȱexceptions,ȱIASȱ39,ȱFinancialȱInstruments:ȱRecognitionȱandȱMeasurement,ȱrequiresȱfinancialȱ liabilitiesȱtoȱbeȱmeasuredȱatȱamortisedȱcostȱusingȱtheȱeffectiveȱinterestȱmethod:ȱ
(a)ȱ theȱcarryingȱamountȱofȱaȱliabilityȱisȱadjustedȱifȱanȱentityȱrevisesȱitsȱestimatesȱofȱcashȱflows,ȱtoȱ reflectȱrevisedȱestimatedȱcashȱflowsȱ
(b)ȱ inȱcontrast,ȱtheȱcarryingȱamountȱofȱaȱliabilityȱisȱnotȱadjustedȱtoȱreflectȱchangesȱinȱmarketȱratesȱofȱ interest.ȱȱ
B8ȱ Derivativesȱandȱfinancialȱliabilitiesȱheldȱforȱtradingȱareȱmeasuredȱatȱfairȱvalue.ȱȱȱ
B9ȱ TheȱIASB’sȱprojectȱupdateȱonȱfinancialȱinstrumentsȱsetsȱoutȱlongȬtermȱobjectivesȱagreedȱbyȱtheȱ IASBȱandȱFASBȱboardsȱtoȱimproveȱandȱconvergeȱtheirȱaccountingȱstandardsȱonȱfinancialȱinstruments.ȱȱ Oneȱofȱthoseȱobjectivesȱisȱtoȱrequireȱthatȱallȱfinancialȱinstrumentsȱbeȱmeasuredȱatȱfairȱvalueȱwithȱrealisedȱ andȱunrealisedȱgainsȱandȱlossesȱrecognisedȱinȱtheȱperiodȱinȱwhichȱtheyȱoccur.ȱȱ
Insurance contracts
B10ȱ Inȱitsȱprojectȱtoȱdevelopȱaȱnewȱaccountingȱstandardȱforȱinsuranceȱcontracts,ȱtheȱIASBȱhasȱ tentativelyȱdecidedȱthatȱtheȱmeasurementȱattributeȱforȱallȱinsuranceȱliabilitiesȱshouldȱtheȱamountȱtheȱ insurerȱwouldȱhaveȱtoȱpayȱifȱitȱtransferredȱallȱitsȱremainingȱcontractualȱrightsȱandȱobligationsȱ
immediatelyȱtoȱanotherȱentity.ȱȱThisȱamountȱisȱreferredȱtoȱinȱtheȱDiscussionȱPaperȱasȱ‘currentȱexitȱvalue’.ȱȱȱ B11ȱ Determiningȱaȱ‘currentȱexitȱvalue’ȱmakesȱuseȱofȱtheȱfollowingȱinputs:ȱ
x currentȱunbiasedȱprobabilityȬweightedȱestimatesȱofȱfutureȱcashȱflowsȱ
x currentȱmarketȱdiscountȱratesȱthatȱadjustȱtheȱestimatedȱfutureȱcashȱflowsȱforȱtheȱtimeȱvalueȱofȱ moneyȱȱ
x explicitȱandȱunbiasedȱestimateȱofȱtheȱmarginȱtheȱmarketȱparticipantsȱrequireȱforȱbearingȱriskȱ(aȱriskȱ margin)ȱandȱforȱprovidingȱotherȱservices,ȱifȱanyȱ(aȱserviceȱmargin).ȱ
B12ȱ Theȱprojectȱreportsȱnoteȱthatȱmeasurementȱatȱcurrentȱexitȱvalueȱisȱnotȱintendedȱtoȱimplyȱthatȱanȱ insurerȱcan,ȱwillȱorȱshouldȱactuallyȱtransferȱaȱliabilityȱtoȱaȱthirdȱparty.ȱȱHowever,ȱtheȱbasisȱforȱchoosingȱ thatȱmeasurementȱattributeȱisȱstatedȱtoȱbeȱthatȱitȱprovidesȱusersȱwithȱusefulȱinformationȱthatȱwillȱhelpȱ themȱmakeȱeconomicȱdecisions.ȱȱThisȱisȱbecauseȱinterȱaliaȱitȱemphasisesȱcurrentȱestimatesȱofȱcashȱflowsȱ
andȱtheȱappropriateȱpriceȱforȱthoseȱcashȱflowsȱandȱmakesȱuseȱofȱobservableȱmarketȱinputsȱtoȱtheȱextentȱ theyȱexist.ȱȱȱ
B13ȱ TheȱDiscussionȱPaperȱnotesȱthatȱtheȱIASBȱisȱnotȱyetȱinȱaȱpositionȱtoȱdetermineȱwhetherȱtheȱnotionsȱ ofȱcurrentȱexitȱvalueȱandȱfairȱvalueȱareȱtheȱsame.ȱȱThatȱisȱbecauseȱdefiningȱfairȱvalueȱisȱstillȱworkȬinȬ progressȱinȱitsȱprojectȱonȱfairȱvalueȱmeasurement.ȱȱHowever,ȱitȱnotesȱthatȱtheȱIASBȱhasȱnotȱidentifiedȱ significantȱdifferencesȱbetweenȱthem.ȱȱȱ
APPENDIX C Illustrative example – credit risk
EntitiesȱAȱandȱBȱhaveȱsimilarȱcreditworthiness.ȱ
x EntityȱAȱborrowsȱcashȱofȱCUȱ100,000,ȱrepayableȱwithȱinterestȱofȱCUȱ34,000ȱinȱ5ȱyears.ȱȱTheȱ‘riskȬ inclusive’ȱrateȱofȱinterestȱisȱ6%.ȱȱ
x EntityȱBȱreceivesȱservicesȱinȱexchangeȱforȱtheȱpromiseȱofȱaȱlumpȱsumȱcashȱpaymentȱofȱCUȱ134,000ȱ inȱ5ȱyears.ȱ
x TheȱriskȬfreeȱrateȱofȱinterestȱforȱthatȱtermȱisȱ5%.ȱȱ
x TheȱcreditȱriskȱpremiumȱforȱbothȱAȱandȱBȱincreasesȱtoȱ2%ȱafterȱoneȱyear,ȱi.e.ȱaȱ‘riskȬinclusive’ȱrateȱ isȱnowȱ7%.ȱȱTheȱriskȬfreeȱrateȱofȱinterestȱremainsȱatȱ5%.ȱȱȱ
TheȱaccountingȱforȱAȱandȱB’sȱrespectiveȱobligationsȱunderȱvariousȱpossibilitiesȱforȱinitialȱrecognitionȱandȱ subsequentȱremeasurementȱ–ȱincludingȱorȱexcludingȱcreditȱriskȱfromȱmeasurementsȱ–ȱisȱillustratedȱinȱtheȱ followingȱtable.ȱȱȱ
ȱ Yearȱ0:ȱ
includeȱ creditȱriskȱ
Yearȱ1:
excludeȱ changeȱinȱ creditȱrisk
Yearȱ1:
includeȱ changeȱinȱ creditȱrisk
Yearȱ0:ȱ excludeȱ creditȱriskȱ
Yearȱ1:
excludeȱ changeȱinȱ creditȱrisk
EntityȱAȱ ȱ ȱ
Liabilityȱ 100ȱ 106 102 105ȱ 110
Profitȱ(loss)ȱ ȱ (6) (2) (5)ȱ (5)
EntityȱBȱ ȱ ȱ
Liabilityȱ 100ȱ 106 102 105ȱ 110
Profitȱ(loss)ȱ (100)ȱ (6) (2) (105)ȱ (5)
APPENDIX D Fair Value Discussion Paper
D1ȱ InȱNovemberȱ2006,ȱtheȱIASBȱissuedȱaȱDiscussionȱPaperȱ‘FairȱValueȱMeasurements’ȱwhichȱincludesȱ theȱtextȱofȱSFASȱ157ȱ‘FairȱValueȱMeasurements’.ȱȱTheȱpurposeȱofȱtheȱIASB’sȱprojectȱisȱtoȱestablishȱaȱsingleȱ sourceȱofȱguidanceȱforȱallȱfairȱvalueȱmeasurementsȱrequiredȱbyȱIFRSs.ȱȱȱSFASȱ157ȱdefinesȱfairȱvalueȱas:ȱ
“Theȱpriceȱthatȱwouldȱbeȱreceivedȱtoȱsellȱanȱassetȱorȱpaidȱtoȱtransferȱaȱliabilityȱinȱanȱorderlyȱ transactionȱbetweenȱmarketȱparticipantsȱatȱtheȱbalanceȱsheetȱdate.”ȱȱȱ
D2ȱ SFASȱ157ȱemphasisesȱthatȱtheȱobjectiveȱofȱaȱfairȱvalueȱmeasurementȱisȱaȱmarketȬbasedȱ measurement,ȱnotȱanȱentityȬspecificȱmeasurement.ȱȱTheȱassumptionsȱthatȱunderlieȱaȱfairȱvalueȱ measurementȱinȱrelationȱtoȱliabilitiesȱinclude:ȱ
(a)ȱ Theȱtransactionȱtoȱtransferȱtheȱliabilityȱoccursȱinȱtheȱprincipalȱmarketȱforȱtheȱliabilityȱ(theȱmarketȱ withȱtheȱgreatestȱvolumeȱandȱlevelȱofȱactivityȱforȱtheȱliability)ȱor,ȱinȱtheȱabsenceȱofȱaȱprincipalȱmarket,ȱtheȱ mostȱadvantageousȱmarketȱ(theȱmarketȱinȱwhichȱtheȱentityȱwouldȱtransferȱtheȱliabilityȱtoȱminimiseȱtheȱ amountȱthatȱwouldȱbeȱpaid).ȱȱIfȱthereȱisȱaȱprincipalȱmarket,ȱtheȱpriceȱinȱthatȱmarketȱshouldȱbeȱusedȱevenȱifȱ thereȱisȱaȱmoreȱadvantageousȱmarket.ȱ
(b)ȱ TheȱfairȱvalueȱofȱtheȱliabilityȱshouldȱreflectȱtheȱnonȬperformanceȱriskȱrelatingȱtoȱthatȱliability.ȱȱȱ (c)ȱ Theȱliabilityȱisȱtransferredȱtoȱaȱmarketȱparticipantȱatȱtheȱmeasurementȱdateȱ(theȱliabilityȱtoȱtheȱ counterpartyȱcontinues;ȱitȱisȱnotȱsettled)ȱandȱthatȱtheȱnonȬperformanceȱriskȱrelatingȱtoȱtheȱliabilityȱisȱtheȱ sameȱbeforeȱandȱafterȱitsȱtransfer.ȱ
(d)ȱ Inputsȱtoȱvaluationȱtechniquesȱareȱassumptionsȱthatȱmarketȱparticipantsȱwouldȱuseȱinȱpricingȱtheȱ liability,ȱincludingȱassumptionsȱaboutȱrisk.ȱȱȱ
(e)ȱ Valuationȱtechniquesȱshouldȱmaximiseȱtheȱuseȱofȱobservableȱinputsȱandȱminimiseȱtheȱuseȱofȱ unobservableȱinputs.ȱȱȱ
D3ȱ TheȱIASBȱhighlightsȱinȱitsȱdiscussionȱpaperȱthreeȱspecificȱdifferencesȱbetweenȱtheȱdefinitionȱofȱfairȱ valueȱinȱSFASȱ157ȱandȱtheȱdefinitionȱinȱIFRSs:ȱ
(a)ȱ TheȱdefinitionȱinȱSFASȱ157ȱisȱexplicitlyȱanȱexitȱ(selling)ȱpriceȱ–ȱreflectingȱthatȱtheȱobjectiveȱofȱaȱfairȱ valueȱmeasurementȱisȱtoȱdetermineȱtheȱpriceȱthatȱwouldȱbeȱreceivedȱforȱanȱassetȱorȱpaidȱtoȱtransferȱaȱ liabilityȱatȱtheȱmeasurementȱdate.ȱ
TheȱIASBȱnotesȱthatȱaȱfairȱvalueȱmeasurementȱwithȱanȱexitȱpriceȱobjectiveȱisȱappropriateȱbecauseȱitȱreflectsȱ currentȱmarketȬbasedȱexpectationsȱofȱflowsȱofȱeconomicȱbenefitȱintoȱorȱoutȱofȱtheȱentity.ȱ
(b)ȱ TheȱdefinitionȱinȱSFASȱ157ȱexplicitlyȱrefersȱtoȱmarketȱparticipantsȱ–ȱtheȱimplicationȱbeingȱthatȱaȱ fairȱvalueȱmeasurementȱshouldȱbeȱbasedȱonȱtheȱassumptionsȱthatȱmarketȱparticipantsȱ(ratherȱthanȱtheȱ entity)ȱwouldȱuseȱinȱpricingȱtheȱassetȱorȱliability,ȱregardlessȱofȱtheȱentity’sȱintentionȱorȱabilityȱtoȱsellȱtheȱ assetȱorȱtransferȱtheȱliabilityȱatȱtheȱmeasurementȱdate.ȱ
(c)ȱ Forȱliabilities,ȱtheȱdefinitionȱofȱfairȱvalueȱinȱSFASȱ157ȱrestsȱonȱtheȱnotionȱthatȱtheȱliabilityȱisȱ transferredȱtoȱaȱmarketȱparticipantȱ(theȱliabilityȱtoȱtheȱcounterpartyȱcontinues;ȱitȱisȱnotȱsettledȱwithȱtheȱ counterparty).ȱȱȱ
Thereforeȱinȱaȱfairȱvalueȱmeasurement,ȱanyȱadvantagesȱorȱdisadvantagesȱthatȱtheȱentityȱholdingȱaȱliabilityȱ mayȱhaveȱrelativeȱtoȱtheȱmarketȱthatȱwouldȱmakeȱitȱmoreȱ(orȱless)ȱbeneficialȱforȱtheȱentityȱtoȱsettleȱtheȱ liabilityȱinȱtheȱnormalȱcourseȱofȱbusinessȱȱwouldȱnotȱbeȱreflectedȱinȱtheȱmeasurementȱofȱtheȱliability.ȱȱ Instead,ȱifȱtheȱentityȱcouldȱsettleȱitsȱliabilityȱmoreȱcheaplyȱinȱtheȱnormalȱcourseȱofȱbusiness,ȱtheȱgainȱfromȱ doingȱsoȱwouldȱbeȱreflectedȱinȱprofitȱorȱlossȱinȱlaterȱperiodsȱuntilȱsettlement.ȱȱInȱcontrast,ȱentityȬspecificȱ measurementsȱofȱliabilitiesȱ(suchȱasȱanȱentityȬspecificȱsettlementȱamountȱorȱvalueȱinȱuse)ȱwouldȱreflectȱtheȱ entity’sȱexpectationsȱofȱcashȱoutflows.ȱȱȱ
Fair value hierarchy
D4ȱ SFASȱ157ȱestablishesȱaȱthreeȬlevelȱhierarchyȱthatȱprioritisesȱtheȱinputsȱtoȱvaluationȱtechniquesȱ usedȱtoȱmeasureȱfairȱvalueȱ(valuationȱtechniquesȱareȱusedȱtoȱconvertȱfutureȱcashȱflowsȱtoȱaȱsingleȱpresentȱ amountȱ(discounted)):ȱ
Levelȱ1ȱinputs:ȱȱQuotedȱpricesȱinȱactiveȱmarketsȱforȱidenticalȱliabilitiesȱthatȱtheȱentityȱhasȱtheȱabilityȱtoȱ access.ȱ
Levelȱ2ȱinputs:ȱȱOtherȱinputsȱthatȱareȱobservable,ȱeitherȱdirectlyȱorȱindirectly,ȱincluding:ȱ
x quotedȱpricesȱforȱsimilarȱliabilitiesȱinȱactiveȱmarketsȱ
x quotedȱpricesȱforȱidenticalȱorȱsimilarȱliabilitiesȱinȱmarketsȱthatȱareȱnotȱactiveȱ x otherȱobservableȱinputsȱ(suchȱasȱinterestȱrates)ȱ
x marketȬcorroboratedȱ inputsȱ (inputsȱ thatȱ areȱ derivedȱ principallyȱ fromȱ orȱ corroboratedȱ byȱ observableȱmarketȱdata)ȱ
Levelȱ3ȱinputs:ȱȱUnobservableȱinputsȱthatȱreflectȱtheȱentity’sȱownȱassumptionsȱaboutȱtheȱassumptionsȱthatȱ marketȱparticipantsȱwouldȱuseȱinȱpricingȱtheȱliabilityȱ(includingȱassumptionsȱaboutȱrisk).ȱȱUnobservableȱ inputs,ȱwhichȱmightȱincludeȱtheȱentity’sȱownȱdata,ȱmightȱbeȱusedȱinȱsituationsȱinȱwhichȱthereȱisȱlittle,ȱifȱ any,ȱmarketȱactivityȱforȱtheȱliability.ȱȱȱ
APPENDIX E IAS 19 BC: discount rate
26ȱ Oneȱofȱtheȱmostȱimportantȱissuesȱinȱmeasuringȱdefinedȱbenefitȱobligationsȱisȱtheȱselectionȱofȱ theȱcriteriaȱusedȱtoȱdetermineȱtheȱdiscountȱrate.ȱAccordingȱtoȱtheȱoldȱIASȱ19,ȱtheȱdiscountȱrateȱ assumedȱinȱdeterminingȱtheȱactuarialȱpresentȱvalueȱofȱpromisedȱretirementȱbenefitsȱreflectedȱ theȱlongȬtermȱrates,ȱorȱanȱapproximationȱthereto,ȱatȱwhichȱsuchȱobligationsȱareȱexpectedȱtoȱbeȱ settled.ȱTheȱBoardȱrejectedȱtheȱuseȱofȱsuchȱaȱrateȱbecauseȱitȱisȱnotȱrelevantȱforȱanȱentityȱthatȱ doesȱnotȱcontemplateȱsettlementȱandȱitȱisȱanȱartificialȱconstruct,ȱasȱthereȱmayȱbeȱnoȱmarketȱforȱ settlementȱofȱsuchȱobligations.ȱ
27ȱ Someȱbelieveȱthat,ȱforȱfundedȱbenefits,ȱtheȱdiscountȱrateȱshouldȱbeȱtheȱexpectedȱrateȱofȱreturnȱ onȱtheȱplanȱassetsȱactuallyȱheldȱbyȱaȱplan,ȱonȱtheȱgroundsȱthatȱtheȱreturnȱonȱplanȱassetsȱ representsȱfaithfullyȱtheȱexpectedȱultimateȱcashȱoutflowȱ(i.e.ȱfutureȱcontributions).ȱTheȱBoardȱ rejectedȱthisȱapproachȱbecauseȱtheȱfactȱthatȱaȱfundȱhasȱchosenȱtoȱinvestȱinȱcertainȱkindsȱofȱ assetȱdoesȱnotȱaffectȱtheȱnatureȱorȱamountȱofȱtheȱobligation.ȱInȱparticular,ȱassetsȱwithȱaȱhigherȱ expectedȱreturnȱcarryȱmoreȱriskȱandȱanȱentityȱshouldȱnotȱrecogniseȱaȱsmallerȱliabilityȱmerelyȱ becauseȱtheȱplanȱhasȱchosenȱtoȱinvestȱinȱriskierȱassetsȱwithȱaȱhigherȱexpectedȱreturn.ȱ
Therefore,ȱtheȱmeasurementȱofȱtheȱobligationȱshouldȱbeȱindependentȱofȱtheȱmeasurementȱofȱ anyȱplanȱassetsȱactuallyȱheldȱbyȱaȱplan.ȱ
28ȱ TheȱmostȱsignificantȱdecisionȱisȱwhetherȱtheȱdiscountȱrateȱshouldȱbeȱaȱriskȬadjustedȱrateȱ(oneȱ thatȱattemptsȱtoȱcaptureȱtheȱrisksȱassociatedȱwithȱtheȱobligation).ȱSomeȱargueȱthatȱtheȱmostȱ appropriateȱriskȬadjustedȱrateȱisȱgivenȱbyȱtheȱexpectedȱreturnȱonȱanȱappropriateȱportfolioȱofȱ planȱassetsȱthatȱwould,ȱoverȱtheȱlongȱterm,ȱprovideȱanȱeffectiveȱhedgeȱagainstȱsuchȱanȱ obligation.ȱAnȱappropriateȱportfolioȱmightȱinclude:ȱȱ
ȱȱ
(a)ȱȱ fixedȬinterestȱsecuritiesȱforȱobligationsȱtoȱformerȱemployeesȱtoȱtheȱextentȱthatȱtheȱ obligationsȱareȱnotȱlinked,ȱinȱformȱorȱinȱsubstance,ȱtoȱinflation;ȱ
(b)ȱȱ indexȬlinkedȱsecuritiesȱforȱindexȬlinkedȱobligationsȱtoȱformerȱemployees;ȱandȱ (c)ȱȱ equityȱsecuritiesȱforȱbenefitȱobligationsȱtowardsȱcurrentȱemployeesȱthatȱareȱlinkedȱtoȱ
finalȱpay.ȱThisȱisȱbasedȱonȱtheȱviewȱthatȱtheȱlongȬtermȱperformanceȱofȱequityȱsecuritiesȱ isȱcorrelatedȱwithȱgeneralȱsalaryȱprogressionȱinȱtheȱeconomyȱasȱaȱwholeȱandȱhenceȱwithȱ theȱfinalȬpayȱelementȱofȱaȱbenefitȱobligation.ȱ
ȱ
ȱ
Itȱisȱimportantȱtoȱnoteȱthatȱtheȱportfolioȱactuallyȱheldȱneedȱnotȱnecessarilyȱbeȱanȱappropriateȱ portfolioȱinȱthisȱsense.ȱIndeed,ȱinȱsomeȱcountries,ȱregulatoryȱconstraintsȱmayȱpreventȱplansȱ fromȱholdingȱanȱappropriateȱportfolio.ȱForȱexample,ȱinȱsomeȱcountries,ȱplansȱareȱrequiredȱtoȱ holdȱaȱcertainȱproportionȱofȱtheirȱassetsȱinȱtheȱformȱofȱfixedȬinterestȱsecurities.ȱFurthermore,ȱifȱ anȱappropriateȱportfolioȱisȱaȱvalidȱreferenceȱpoint,ȱitȱisȱequallyȱvalidȱforȱbothȱfundedȱandȱ unfundedȱplans.ȱȱ
29ȱ ThoseȱwhoȱsupportȱusingȱtheȱinterestȱrateȱonȱanȱappropriateȱportfolioȱasȱaȱriskȬadjustedȱ discountȱrateȱargueȱthat:ȱȱ
ȱȱ
(a)ȱȱ portfolioȱtheoryȱsuggestsȱthatȱtheȱexpectedȱreturnȱonȱanȱassetȱ(orȱtheȱinterestȱrateȱ inherentȱinȱaȱliability)ȱisȱrelatedȱtoȱtheȱundiversifiableȱriskȱassociatedȱwithȱthatȱassetȱ(orȱ liability).ȱUndiversifiableȱriskȱreflectsȱnotȱtheȱvariabilityȱofȱtheȱreturnsȱ(payments)ȱinȱ absoluteȱtermsȱbutȱtheȱcorrelationȱofȱtheȱreturnsȱ(orȱpayments)ȱwithȱtheȱreturnsȱonȱ otherȱassets.ȱIfȱcashȱinflowsȱfromȱaȱportfolioȱofȱassetsȱreactȱtoȱchangingȱeconomicȱ conditionsȱoverȱtheȱlongȱtermȱinȱtheȱsameȱwayȱasȱtheȱcashȱoutflowsȱofȱaȱdefinedȱbenefitȱ obligation,ȱtheȱundiversifiableȱriskȱofȱtheȱobligationȱ(andȱhenceȱtheȱappropriateȱ
discountȱrate)ȱmustȱbeȱtheȱsameȱasȱthatȱofȱtheȱportfolioȱofȱassets;ȱ
(b)ȱȱ anȱimportantȱaspectȱofȱtheȱeconomicȱrealityȱunderlyingȱfinalȱsalaryȱplansȱisȱtheȱ
correlationȱbetweenȱfinalȱsalaryȱandȱequityȱreturnsȱthatȱarisesȱbecauseȱtheyȱbothȱreflectȱ theȱsameȱlongȬtermȱeconomicȱforces.ȱAlthoughȱtheȱcorrelationȱisȱnotȱperfect,ȱitȱisȱ sufficientlyȱstrongȱthatȱignoringȱitȱwillȱleadȱtoȱsystematicȱoverstatementȱofȱtheȱliability.ȱ Also,ȱignoringȱthisȱcorrelationȱwillȱresultȱinȱmisleadingȱvolatilityȱdueȱtoȱshortȬtermȱ fluctuationsȱbetweenȱtheȱrateȱusedȱtoȱdiscountȱtheȱobligationȱandȱtheȱdiscountȱrateȱthatȱ isȱimplicitȱinȱtheȱfairȱvalueȱofȱtheȱplanȱassets.ȱTheseȱfactorsȱwillȱdeterȱentitiesȱfromȱ operatingȱdefinedȱbenefitȱplansȱandȱleadȱtoȱswitchesȱfromȱequitiesȱtoȱfixedȱinterestȱ investments.ȱWhereȱdefinedȱbenefitȱplansȱareȱlargelyȱfundedȱbyȱequities,ȱthisȱcouldȱ haveȱaȱseriousȱimpactȱonȱshareȱprices.ȱThisȱswitchȱwillȱalsoȱincreaseȱtheȱcostȱofȱ pensions.ȱThereȱwillȱbeȱpressureȱonȱcompaniesȱtoȱremoveȱtheȱapparentȱ(butȱnonȬ existent)ȱshortfall;ȱȱ
(c)ȱȱ ifȱanȱentityȱsettledȱitsȱobligationȱbyȱpurchasingȱanȱannuity,ȱtheȱinsuranceȱcompanyȱ wouldȱdetermineȱtheȱannuityȱratesȱbyȱlookingȱtoȱaȱportfolioȱofȱassetsȱthatȱprovidesȱcashȱ inflowsȱthatȱsubstantiallyȱoffsetȱallȱtheȱcashȱflowsȱfromȱtheȱbenefitȱobligationȱasȱthoseȱ cashȱflowsȱfallȱdue.ȱTherefore,ȱtheȱexpectedȱreturnȱonȱanȱappropriateȱportfolioȱmeasuresȱ theȱobligationȱatȱanȱamountȱthatȱisȱcloseȱtoȱitsȱmarketȱvalue.ȱInȱpractice,ȱitȱisȱnotȱpossibleȱ toȱsettleȱaȱfinalȱpayȱobligationȱbyȱbuyingȱannuitiesȱsinceȱnoȱinsuranceȱcompanyȱwouldȱ insureȱaȱfinalȱpayȱdecisionȱthatȱremainedȱatȱtheȱdiscretionȱofȱtheȱpersonȱinsured.ȱ However,ȱevidenceȱcanȱbeȱderivedȱfromȱtheȱpurchase/saleȱofȱbusinessesȱthatȱincludeȱaȱ finalȱsalaryȱpensionȱscheme.ȱInȱthisȱsituationȱtheȱvendorȱandȱpurchaserȱwouldȱnegotiateȱ aȱpriceȱforȱtheȱpensionȱobligationȱbyȱreferenceȱtoȱitsȱpresentȱvalue,ȱdiscountedȱatȱtheȱ rateȱofȱreturnȱonȱanȱappropriateȱportfolio;ȱ
(d)ȱȱ althoughȱinvestmentȱriskȱisȱpresentȱevenȱinȱaȱwellȬdiversifiedȱportfolioȱofȱequityȱ securities,ȱanyȱgeneralȱdeclineȱinȱsecuritiesȱwould,ȱinȱtheȱlongȱterm,ȱbeȱreflectedȱinȱ decliningȱsalaries.ȱSinceȱemployeesȱacceptedȱthatȱriskȱbyȱagreeingȱtoȱaȱfinalȱsalaryȱplan,ȱ theȱexclusionȱofȱthatȱriskȱfromȱtheȱmeasurementȱofȱtheȱobligationȱwouldȱintroduceȱaȱ systematicȱbiasȱintoȱtheȱmeasurement;ȱandȱ
(e)ȱȱ timeȬhonouredȱfundingȱpracticesȱinȱsomeȱcountriesȱuseȱtheȱexpectedȱreturnȱonȱanȱ appropriateȱportfolioȱasȱtheȱdiscountȱrate.ȱAlthoughȱfundingȱconsiderationsȱareȱdistinctȱ fromȱaccountingȱissues,ȱtheȱlongȱhistoryȱofȱthisȱapproachȱcallsȱforȱcarefulȱscrutinyȱofȱ anyȱotherȱproposedȱapproach.ȱ
ȱ
30ȱ ThoseȱwhoȱopposeȱaȱriskȬadjustedȱrateȱargueȱthat:ȱȱ
ȱȱ
(a)ȱȱ itȱisȱincorrectȱtoȱlookȱatȱreturnsȱonȱassetsȱinȱdeterminingȱtheȱdiscountȱrateȱforȱliabilities;ȱ (b)ȱȱ ifȱaȱsufficientlyȱstrongȱcorrelationȱbetweenȱassetȱreturnsȱandȱfinalȱpayȱactuallyȱexisted,ȱaȱ
marketȱforȱfinalȱsalaryȱobligationsȱwouldȱdevelop,ȱyetȱthisȱhasȱnotȱhappened.ȱ
Furthermore,ȱwhereȱanyȱsuchȱapparentȱcorrelationȱdoesȱexist,ȱitȱisȱnotȱclearȱwhetherȱtheȱ correlationȱresultsȱfromȱsharedȱcharacteristicsȱofȱtheȱportfolioȱandȱtheȱobligationsȱorȱ fromȱchangesȱinȱtheȱcontractualȱpensionȱpromise;ȱ
(c)ȱȱ theȱreturnȱonȱequityȱsecuritiesȱdoesȱnotȱcorrelateȱwithȱotherȱrisksȱassociatedȱwithȱ definedȱbenefitȱplans,ȱsuchȱasȱvariabilityȱinȱmortality,ȱtimingȱofȱretirement,ȱdisabilityȱ andȱadverseȱselection;ȱ
(d)ȱȱ inȱorderȱtoȱevaluateȱaȱliabilityȱwithȱuncertainȱcashȱflows,ȱanȱentityȱwouldȱnormallyȱuseȱ aȱdiscountȱrateȱlowerȱthanȱtheȱriskȬfreeȱrate,ȱyetȱtheȱexpectedȱreturnȱonȱanȱappropriateȱ portfolioȱisȱhigherȱthanȱtheȱriskȬfreeȱrate;ȱ
(e)ȱȱ theȱassertionȱthatȱfinalȱsalaryȱisȱstronglyȱcorrelatedȱwithȱassetȱreturnsȱimpliesȱthatȱfinalȱ salaryȱwillȱtendȱtoȱdecreaseȱifȱassetȱpricesȱfall,ȱyetȱexperienceȱshowsȱthatȱsalariesȱtendȱ notȱtoȱdecline;ȱ
(f)ȱȱ theȱnotionȱthatȱequitiesȱareȱnotȱriskyȱinȱtheȱlongȱterm,ȱandȱtheȱassociatedȱnotionȱofȱlongȬ termȱvalue,ȱareȱbasedȱonȱtheȱfallaciousȱviewȱthatȱtheȱmarketȱalwaysȱbouncesȱbackȱafterȱaȱ crash.ȱShareholdersȱdoȱnotȱgetȱcreditȱinȱtheȱmarketȱforȱanyȱadditionalȱlongȬtermȱvalueȱifȱ theyȱsellȱtheirȱsharesȱtoday.ȱEvenȱifȱsomeȱcorrelationȱexistsȱoverȱlongȱperiods,ȱbenefitsȱ mustȱbeȱpaidȱasȱtheyȱbecomeȱdue.ȱAnȱentityȱthatȱfundsȱitsȱobligationsȱwithȱequityȱ securitiesȱrunsȱtheȱriskȱthatȱequityȱpricesȱmayȱbeȱdownȱwhenȱbenefitsȱmustȱbeȱpaid.ȱ Also,ȱtheȱhypothesisȱthatȱtheȱrealȱreturnȱonȱequitiesȱisȱuncorrelatedȱwithȱinflationȱdoesȱ notȱmeanȱthatȱequitiesȱofferȱaȱriskȬfreeȱreturn,ȱevenȱinȱtheȱlongȱterm;ȱandȱ
(g)ȱȱ theȱexpectedȱlongȬtermȱrateȱofȱreturnȱonȱanȱappropriateȱportfolioȱcannotȱbeȱdeterminedȱ sufficientlyȱobjectivelyȱinȱpracticeȱtoȱprovideȱanȱadequateȱbasisȱforȱanȱaccountingȱ standard.ȱTheȱpracticalȱdifficultiesȱincludeȱspecifyingȱtheȱcharacteristicsȱofȱtheȱ
appropriateȱportfolio,ȱselectingȱtheȱtimeȱhorizonȱforȱestimatingȱreturnsȱonȱtheȱportfolioȱ andȱestimatingȱthoseȱreturns.ȱȱ
ȱ
31ȱ TheȱBoardȱhasȱnotȱidentifiedȱclearȱevidenceȱthatȱtheȱexpectedȱreturnȱonȱanȱappropriateȱ portfolioȱofȱassetsȱprovidesȱaȱrelevantȱandȱreliableȱindicationȱofȱtheȱrisksȱassociatedȱwithȱaȱ definedȱbenefitȱobligation,ȱorȱthatȱsuchȱaȱrateȱcanȱbeȱdeterminedȱwithȱreasonableȱobjectivity.ȱ Therefore,ȱtheȱBoardȱdecidedȱthatȱtheȱdiscountȱrateȱshouldȱreflectȱtheȱtimeȱvalueȱofȱmoneyȱbutȱ
shouldȱnotȱattemptȱtoȱcaptureȱthoseȱrisks.ȱFurthermore,ȱtheȱdiscountȱrateȱshouldȱnotȱreflectȱ theȱentity’sȱownȱcreditȱrating,ȱasȱotherwiseȱanȱentityȱwithȱaȱlowerȱcreditȱratingȱwouldȱ recogniseȱaȱsmallerȱliability.ȱTheȱrateȱthatȱbestȱachievesȱtheseȱobjectivesȱisȱtheȱyieldȱonȱhighȱ qualityȱcorporateȱbonds.ȱInȱcountriesȱwhereȱthereȱisȱnoȱdeepȱmarketȱinȱsuchȱbonds,ȱtheȱyieldȱ onȱgovernmentȱbondsȱshouldȱbeȱused.ȱ
APPENDIX F FRS 17, Appendix IV: discount rate
13ȱ InȱtheȱUK,ȱactuariesȱhaveȱtraditionallyȱdiscountedȱtheȱliabilitiesȱinȱaȱdefinedȱbenefitȱschemeȱatȱtheȱ expectedȱrateȱofȱreturnȱonȱtheȱassetsȱinȱtheȱschemeȱ(prudentlyȱestimated).ȱIASȱ19ȱ(revised)ȱandȱSFASȱ 87ȱrequireȱtheȱuseȱofȱaȱhighȱqualityȱcorporateȱbondȱrate.ȱ
14ȱ TheȱBoardȱbelievesȱthatȱtheȱdiscountȱrateȱshouldȱreflectȱtheȱtimeȱvalueȱofȱmoneyȱandȱtheȱriskȱ associatedȱwithȱtheȱliability.ȱTheȱviewȱputȱforwardȱinȱtheȱDiscussionȱPaperȱpublishedȱinȱ1998ȱwasȱ thatȱsuchȱaȱrateȱcouldȱbeȱdeterminedȱbyȱlookingȱatȱtheȱrateȱofȱreturnȱonȱmatchingȱassets.ȱ(Ifȱtheȱassetsȱ exactlyȱmatchedȱtheȱliabilityȱtheyȱmustȱhaveȱtheȱsameȱfairȱvalueȱandȱhenceȱtheȱdiscountȱrateȱ
appropriateȱforȱtheȱliabilityȱmustȱbeȱtheȱsameȱasȱtheȱrateȱofȱreturnȱonȱtheȱasset.)ȱMatchingȱassetsȱ wereȱexpectedȱtoȱbe:ȱ
ȱȱ (a)ȱ forȱpensionsȱfixedȱinȱmonetaryȱterms,ȱfixedȱrateȱgovernmentȱbonds;ȱ
ȱȱ (b)ȱ forȱindexȬlinkedȱpensionsȱinȱpaymentȱandȱdeferredȱpensions,ȱindexȬlinkedȱgovernmentȱbonds;ȱ ȱȱ (c)ȱ forȱfinalȱsalaryȱliabilities,ȱaȱportfolioȱcontainingȱsomeȱelementȱofȱequityȱinvestments.ȱ
15ȱ However,ȱlaterȱresearchȱconductedȱbyȱtheȱFacultyȱandȱInstituteȱofȱActuariesȱdemonstratedȱfromȱpastȱ dataȱthatȱtheȱcorrelationȱbetweenȱequitiesȱandȱsalariesȱhadȱnotȱbeenȱcloseȱandȱthatȱtheȱbestȱmatchȱforȱ finalȱsalaryȱliabilitiesȱwasȱprobablyȱindexȬlinkedȱbonds.ȱ
16ȱ Someȱargueȱthatȱevenȱifȱthereȱisȱnoȱcloseȱcorrelationȱbetweenȱequityȱandȱsalaryȱgrowth,ȱitȱisȱ appropriateȱtoȱuseȱtheȱexpectedȱreturnȱonȱequitiesȱasȱtheȱdiscountȱrateȱifȱtheȱschemeȱisȱinvestedȱ thereinȱbecause,ȱoverȱtheȱlongȱterm,ȱthatȱreturnȱisȱrelativelyȱsecure.ȱHowever,ȱtheȱhigherȱreturnȱ expectedȱonȱequitiesȱisȱaȱrewardȱforȱtheȱriskȱinvolvedȱinȱequityȱinvestment.ȱUnlessȱtheȱriskȱmatchesȱ thatȱassociatedȱwithȱtheȱliabilities,ȱdiscountingȱtheȱliabilitiesȱatȱtheȱhigherȱreturnȱanticipatesȱtheȱ expectedȱbenefitȱofȱequityȱinvestmentȱwithoutȱrecognisingȱtheȱrisksȱinvolved.ȱTheȱhigherȱreturnȱ shouldȱinsteadȱbeȱrecognisedȱasȱitȱisȱearnedȱoverȱtheȱperiodȱtheȱequitiesȱareȱheld.ȱ
17ȱ Onȱtheȱotherȱhand,ȱalthoughȱindexȬlinkedȱbondsȱseemȱtoȱhaveȱbeenȱaȱbetterȱmatchȱforȱfinalȱsalaryȱ liabilities,ȱtheyȱareȱnotȱaȱperfectȱmatchȱandȱanȱindexȬlinkedȱbondȱdiscountȱrateȱwouldȱignoreȱsomeȱ importantȱaspectsȱofȱaȱfinalȱsalaryȱpensionȱliability,ȱforȱexampleȱtheȱuncertaintyȱofȱtheȱamountsȱ ultimatelyȱtoȱbeȱpaidȱout.ȱTheȱBoardȱhasȱthereforeȱdecidedȱnotȱtoȱtryȱtoȱfindȱmatchingȱassetsȱbutȱtoȱ buildȱupȱtheȱdiscountȱrateȱfromȱitsȱcomponents.ȱAsȱnotedȱabove,ȱitȱbelievesȱthat,ȱifȱpossible,ȱtheȱ discountȱrateȱshouldȱreflect:ȱ
ȱȱ (a)ȱ theȱtimeȱvalueȱofȱmoneyȱ(givenȱbyȱtheȱrateȱofȱreturnȱonȱanȱinvestmentȱregardedȱasȱbeingȱriskȬ free);ȱandȱ
ȱȱ (b)ȱ theȱrisksȱassociatedȱwithȱtheȱliabilityȱbecauseȱofȱtheȱuncertaintyȱsurroundingȱtheȱultimateȱcashȱ paymentsȱdue.ȱ
18ȱ TheȱFRSȱrequiresȱtheȱassumptionsȱtoȱreflectȱtheȱbestȱestimateȱofȱtheȱultimateȱcashȱflows.ȱTheȱ
resultingȱliabilityȱisȱclearlyȱsubjectȱtoȱuncertaintyȱȬȱtheȱultimateȱcashȱflowsȱareȱnotȱcontractuallyȱfixedȱ andȱwillȱdependȱonȱfinalȱsalaries,ȱlengthȱofȱretirementȱetc.ȱTheȱuncertaintyȱofȱtheȱfutureȱcashȱ
outflowsȱmightȱbeȱexpectedȱtoȱmakeȱtheȱliabilityȱmoreȱonerousȱȬȱmostȱentitiesȱareȱriskȬaverseȱandȱ wouldȱpreferȱtoȱavoidȱtheȱpossibilityȱthatȱtheȱcashȱflowsȱmightȱbeȱmoreȱthanȱexpected.ȱ
19ȱ However,ȱinȱmanyȱdefinedȱbenefitȱschemes,ȱtheȱemployerȱhasȱtheȱoptionȱofȱpreventingȱtheȱcashȱ flowsȱbeingȱgreaterȱthanȱexpectedȱandȱevenȱofȱreducingȱtheȱcashȱflowsȱifȱnecessaryȱ(e.g.ȱifȱ
investmentȱperformanceȱhasȱbeenȱconsistentlyȱpoorȱforȱaȱlongȱperiod).ȱTheseȱoptionsȱexistȱbecauseȱ theȱbestȱestimateȱofȱtheȱcashȱflowsȱwillȱincludeȱexpectedȱbenefitȱincreasesȱlikelyȱtoȱbeȱgrantedȱbyȱtheȱ employerȱsuchȱasȱ(i)ȱincreasesȱinȱpensionsȱinȱpaymentȱandȱdeferredȱpensionsȱatȱaboveȱtheȱminimumȱ requiredȱbyȱstatuteȱorȱtheȱschemeȱrulesȱandȱ(ii)ȱincreasesȱinȱbenefitsȱarisingȱfromȱsalaryȱincreasesȱforȱ activeȱmembersȱoverȱandȱaboveȱtheȱrateȱapplicableȱifȱtheyȱleftȱserviceȱ(itȱisȱassumedȱthatȱanȱ
employerȱwould,ȱoverȱanyȱsubstantialȱperiod,ȱhaveȱtoȱincreaseȱsalariesȱbyȱatȱleastȱtheȱindexingȱrateȱ appliedȱtoȱdeferredȱpensions).ȱAlthoughȱtheȱemployerȱexpectsȱtoȱgiveȱtheseȱincreases,ȱtheyȱareȱnotȱ guaranteed.ȱIfȱnecessaryȱtheȱemployerȱcould,ȱinȱmanyȱcases,ȱgiveȱlowerȱthanȱexpectedȱincreasesȱinȱ benefitsȱandȱgiveȱlowerȱthanȱexpectedȱsalaryȱincreases.ȱInȱextremis,ȱtheȱemployerȱcouldȱevenȱcloseȱ theȱschemeȱdown.ȱ
20ȱ TheseȱoptionsȱareȱaȱcrucialȱfactorȱinȱtheȱoperationȱofȱUKȱdefinedȱbenefitȱschemesȱandȱtheȱlevelȱofȱ benefitsȱthatȱisȱgiven.ȱEmployersȇȱwillingnessȱtoȱprovideȱtheȱexpectedȱbenefitsȱisȱoftenȱbased,ȱatȱleastȱ partly,ȱonȱtheȱassumptionȱthatȱtheȱliabilityȱcanȱbeȱfundedȱinȱequities.ȱTheȱexpectationȱisȱthatȱaȱhigherȱ returnȱonȱequitiesȱcomparedȱwithȱthatȱonȱlessȱriskyȱinvestmentsȱwillȱmakeȱsuchȱpromisesȱaffordable.ȱ Theȱemployerȱcanȱbearȱtheȱriskȱassociatedȱwithȱtheȱhigherȱreturnȱbecause,ȱifȱequitiesȱwereȱtoȱ
underperformȱforȱaȱlongȱperiod,ȱtheȱoptionsȱdescribedȱaboveȱallowȱtheȱemployerȱtoȱtakeȱactionȱtoȱ mitigateȱtheȱfinancialȱimpact.ȱ
21ȱ Theseȱoptionsȱmakeȱtheȱliabilityȱlessȱonerousȱandȱcanȱbeȱreflectedȱbyȱusingȱaȱdiscountȱrateȱhigherȱ thanȱaȱriskȬfreeȱrate.ȱInȱprinciple,ȱtheȱpremiumȱoverȱtheȱriskȬfreeȱrateȱshouldȱvaryȱfromȱschemeȱtoȱ schemeȱ(andȱwithinȱschemes),ȱreflectingȱtheȱdifferingȱlevelsȱofȱdiscretionȱthatȱexistȱforȱdifferentȱ schemeȱliabilities.ȱHowever,ȱassessingȱtheȱappropriateȱpremiumȱisȱdifficultȱandȱsubjective.ȱInȱtheȱ interestsȱofȱobjectivityȱandȱinternationalȱharmonisation,ȱtheȱBoardȱhasȱthereforeȱdecidedȱtoȱadoptȱaȱ standardȱdiscountȱrate:ȱtheȱrateȱofȱreturnȱonȱaȱhighȱqualityȱcorporateȱbond,ȱi.e.ȱoneȱratedȱatȱtheȱlevelȱ ofȱAAȱorȱequivalentȱstatus.ȱThisȱincludesȱaȱsmallȱpremiumȱaboveȱtheȱriskȬfreeȱrate,ȱwhichȱcanȱbeȱ regardedȱasȱreflectingȱtheȱoptionsȱopenȱtoȱtheȱemployerȱtoȱlimitȱtheȱpensionȱschemeȱliabilities.ȱ 22ȱ Reflectingȱtheseȱoptionsȱinȱtheȱdiscountȱrateȱisȱnotȱinconsistentȱwithȱtheȱproposalȱinȱparagraphȱ31ȱofȱ
theȱFRSȱthatȱitȱisȱnotȱappropriateȱtoȱassumeȱaȱreductionȱinȱbenefitsȱbelowȱthoseȱcurrentlyȱpromised.ȱ Itȱisȱnotȱappropriateȱtoȱassumeȱthatȱaȱcurtailmentȱofȱtheȱschemeȱwillȱtakeȱplaceȱinȱtheȱfutureȱbutȱitȱisȱ appropriateȱtoȱreflectȱtheȱvalueȱofȱtheȱoptionȱtoȱmakeȱthatȱcurtailment.ȱ
1.1ȱ Chapterȱ3ȱdiscussesȱwhatȱassetsȱandȱliabilitiesȱmightȱbeȱreportedȱbyȱeachȱreportingȱentityȱthatȱisȱ involvedȱinȱaȱpensionȱplanȱwhenȱassetsȱareȱsetȱasideȱtoȱprovideȱsecurityȱforȱpromisedȱbenefitsȱandȱfundsȱ forȱtheirȱpayment.ȱȱInȱsomeȱarrangementsȱassetsȱareȱheldȱinȱaȱseparateȱtrustȱorȱsimilarȱentity;ȱinȱotherȱ arrangementsȱassetsȱareȱheldȱbyȱtheȱemployingȱentityȱitself.ȱ
1.2ȱ Conventionalȱtypesȱofȱassetsȱheldȱinȱtheseȱarrangementsȱareȱfinancialȱassetsȱ(includingȱ governmentȱsecurities,ȱcorporateȱbonds,ȱequities,ȱinsuranceȱcontracts)ȱandȱpropertyȱinterests.ȱȱLessȱ conventionalȱ(butȱincreasinglyȱused)ȱtypesȱofȱassetsȱincludeȱderivativeȱcontractsȱandȱinterestsȱinȱprivateȱ equityȱandȱinfrastructure.ȱȱ
1.3ȱ AppendixȱAȱlistsȱaȱvarietyȱofȱmethodsȱofȱmeasurementȱusedȱinȱIFRSȱforȱtheȱtypesȱofȱassetsȱthatȱ mightȱbeȱexpectedȱtoȱbeȱheldȱinȱarrangementsȱforȱtheȱfundingȱofȱpensionȱplans.ȱȱTheȱmethodsȱareȱmainlyȱ basedȱonȱeitherȱhistoricalȱcostȱorȱfairȱvalue.ȱȱMoreover,ȱdifferentȱmodelsȱexistȱinȱIFRSȱforȱreportingȱgainsȱ andȱlossesȱinȱrespectȱofȱchangesȱinȱassetsȱ–ȱforȱexample,ȱchangesȱinȱfairȱvaluesȱofȱsomeȱassetsȱareȱrequiredȱ toȱbeȱreportedȱinȱprofitȱandȱloss,ȱothersȱareȱrequiredȱtoȱbeȱreportedȱasȱchangesȱinȱequity.ȱȱȱ
1.4ȱ Accountingȱstandardsȱonȱpensions,ȱhowever,ȱdistinguishȱassetsȱheldȱtoȱfundȱliabilitiesȱtoȱpayȱ pensionsȱfromȱotherȱsimilarȱassetsȱheldȱbyȱanȱentity.ȱȱIASȱ19ȱdoesȱthisȱbyȱcreatingȱaȱseparateȱclassȱofȱassetȱ –ȱplanȱassetsȱ–ȱwhichȱitȱrequiresȱtoȱbeȱmeasuredȱatȱfairȱvalue.ȱȱTheȱrequirementsȱofȱIASȱ19,ȱSFASȱ87ȱandȱ FRSȱ17,ȱtogetherȱwithȱtheirȱexplanation,ȱareȱsetȱoutȱinȱAppendixȱB.ȱȱȱȱ
1.5ȱ Chapterȱ3ȱidentifiesȱfourȱpossibilitiesȱforȱreportingȱassetsȱandȱliabilitiesȱinȱanȱemployer’sȱfinancialȱ statements:ȱȱ
(a)ȱ Showȱtheȱunderlyingȱinvestmentsȱasȱassetsȱ(andȱshowȱseparatelyȱtheȱliabilityȱtoȱpayȱbenefits)ȱ–ȱ whenȱtheȱentityȱhasȱtheȱobligationȱtoȱpayȱbenefitsȱandȱassetsȱareȱsegregatedȱtoȱfundȱthemȱbutȱheldȱ withinȱtheȱreportingȱentityȱ(seeȱparagraphȱ2.27ȱofȱChapterȱ3).ȱ
(b)ȱ Showȱaȱrightȱtoȱreimbursementȱfromȱaȱpensionȱfundȱasȱanȱassetȱ(andȱshowȱseparatelyȱtheȱliabilityȱ toȱpayȱbenefits)ȱ–ȱwhenȱtheȱentityȱhasȱaȱdirectȱobligationȱtoȱpayȱbenefitsȱandȱtheȱassetsȱthatȱfundȱ themȱareȱheldȱbyȱaȱseparateȱentityȱ(seeȱparagraphȱ2.34ȱofȱChapterȱ3).ȱȱȱ
(c)ȱ Showȱaȱnetȱliabilityȱorȱassetȱ–ȱwhenȱtheȱentityȱhasȱanȱobligationȱtoȱsupportȱaȱtrustȱthatȱholdsȱtheȱ assetsȱandȱhasȱtheȱliabilityȱtoȱpayȱbenefitsȱ(seeȱparagraphȱ2.39ȱofȱChapterȱ3).ȱ
(d)ȱ Showȱtheȱunderlyingȱinvestmentsȱasȱassetsȱinȱtheȱemployingȱentity’sȱconsolidatedȱfinancialȱ statementsȱ(andȱshowȱseparatelyȱtheȱliabilityȱtoȱpayȱbenefits)ȱ–ȱwhenȱtheȱassetsȱandȱtheȱliabilityȱtoȱ
payȱbenefitsȱareȱheldȱbyȱaȱseparateȱentityȱwhichȱfallsȱtoȱbeȱconsolidatedȱbyȱtheȱemployingȱentityȱ (seeȱsectionȱ3ȱofȱChapterȱ3).ȱȱȱ
1.6ȱ Inȱeachȱofȱtheȱcircumstancesȱsetȱoutȱabove,ȱtheȱeconomicȱbenefitsȱfromȱtheȱunderlyingȱinvestmentsȱ thatȱareȱavailableȱtoȱtheȱemployingȱentityȱareȱsimilarȱ(subjectȱtoȱanyȱrestrictionȱonȱrecoveringȱsurplusȱ assetsȱwhenȱtheyȱareȱnotȱheldȱbyȱtheȱentity).ȱȱInȱotherȱwordsȱtheȱeconomicȱeffectȱisȱsimilarȱwhetherȱtheȱ assetsȱareȱreportedȱonȱaȱgrossȱorȱnetȱbasis.ȱȱThisȱsuggestsȱthatȱitȱmightȱbeȱpresumedȱthatȱaȱsimilarȱ
measurementȱmethodȱshouldȱbeȱadoptedȱinȱeachȱcase,ȱwhetherȱorȱnotȱaȱseparateȱentityȱexistsȱtoȱholdȱtheȱ assets.ȱȱChapterȱ7ȱdiscussesȱfurtherȱtheȱmeasurementȱofȱemployerȱinterestsȱwhenȱaȱnetȱliabilityȱorȱassetȱisȱ shown.ȱȱ
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