The new balance sheet impact of charity pensions
With the introduction of new UK Generally Accepted Accounting Practice (UK GAAP), and subsequently, the introduction of Financial Reporting Standard 102 (which replaces Financial Reporting Standard 17 as the financial reporting standard in the UK and Ireland) charity employers should be considering the impact this may have on their P&L and balance sheet, and be noting some actions they can take to limit this impact.
The most significant change under the new UK GAAP for defined benefit pension schemes is in relation to non-segregated multi-employer arrangements where employers are unable to identify their share of the assets and liabilities in the scheme.
Under old UK GAAP (and hence FRS 17) there was an exemption that allowed employers in this position to account for their pension costs on a defined contribution basis, by recording the contributions paid to the scheme in the profit and loss account. No account had to be taken of any pension deficit which may have existed at that date.
Two options
Under new UK GAAP this is no longer an option and employers which were previously "exempt" under the old rules have two options:
- If it is possible to reasonably identify your share of the assets and liabilities in the scheme then you must produce a full FRS 102 disclosure.
- If it is not possible to identify your share of the assets and liabilities in the scheme then you must record the Net Present Value of your future deficit reduction contributions in your balance sheet. An allowance must also be made in the profit and loss account for the interest accruing on the deficit over the year.
So what does this mean for charity employers? Charity employers participating in non-segregated multi-employer pension schemes that previously used the exemption under old UK GAAP will now have to disclose a potentially significant balance sheet item in their accounts. The effect of this will depend largely on the size of the pension scheme deficit in relation to the net current assets of the entity as a whole. In many cases however this is likely to be significant, as follows:
- Reduction in net assets – potentially moving to a ‘net current liability’ position.
- May impact on the ability to obtain new funds for charities if the future of the charity seems "unviable".
- May be an impact on the PPF levy payable by employers if insolvency ratings rise.
- Could potentially lead to insolvency.
Clearer disclosure
From an overall perspective, these changes will lead to clearer disclosure across organisations with those disclosing under the exemption in the old rules now being on a level playing field with all other organisations. It will also lead to greater consistency within organisational groups, where entities within the group were both exempt and non-exempt under the old rules.
However, there may still be some cases where groups have inconsistencies – for example where there are employers accounting under the full disclosure method and NPV method within the same group.
What should you do if you are a charity employer? Understanding your position and understanding the potential impact are key. If you are a "small entity" you have the option of deferring this change to 1 January 2017 as the accounting standard for small entities will still reference the old UK GAAP until this date when it is then expected to be revised. For charity employers affected, it is about limiting the impact as much as possible. If such a charity employer you can do the following:
- Ensure the assumptions used to value your liabilities reflect your "best estimate" of the future taking into account your own charity's future business plans. Consider especially the salary increase assumption, which can often be overstated in "standard" assumptions. It is ultimately the responsibility of the trustees/directors of the charity to set the assumptions – ensure they reflect your future plans.
- Develop a strategy for managing your liabilities going forward. Further accrual is likely to result in a larger, more volatile deficit over time and hence a more volatile balance sheet position. There are ways to reduce your deficit and the volatility of your deficit over time, such as: liability management exercises; ceasing future accrual; limiting the membership; exiting the scheme.
The changes to UK GAAP are most likely to affect charities participating in large non-segregated schemes such as the Pension Trust arrangements (SHPS, SHAPS, Growth Plan, SVSPS etc) and any employers participating in the Universities Superannuation Scheme, and any other non-segregated arrangements.
Explain risks
The Charity Commission requires that any charities showing a "net current liability" position in the annual accounts explain the risks attached – this will include pension risks and it is important therefore that charities have a strategy in place for managing these risks.
Charity employers should also understand the non-pension aspects of FRS 102 as there are many other changes coming into force that may improve, or worsen, your balance sheet position. For example, one charity early adopted FRS 102 - despite it adding £20m to its balance sheet – as the revaluation of its fixed assets under FRS 102 more than offset this increase.
It is recommended that all charity employers engage with the necessary advisers to understand their obligations, the potential impact of these and any possible mitigation to ensure there are no surprises when the new rules come into force.
