FRS 17. The whole board ought to be thinking about it" />

SSAP 24, Accounting for Pension Costs, has been around for 13 years, requiring the effect of surpluses or deficits in defined benefit (final salary) pension schemes to be 'spread' over employees' remaining service lives. This is achieved by adjustments to the 'regular' pension cost in the employer's financial statements. In theory, at least, SSAP 24 is familiar and understood. In practice, in many reporting entities only one or two individuals understand how it works, with the actuary providing the figures, and the disclosures being updated from those in the previous year's financial statements. This limited understanding has not presented significant problems because pension costs have not tended to vary greatly from year to year and SSAP 24 balance sheet items have largely been regarded as a quirk of the standard.

The publication of

FRS 17, Retirement Benefits, in November 2000 heralded a significant change in UK GAAP. The employer is now required to include any surplus or deficit in a defined benefit scheme, subject to certain limitations, as an asset or liability in its own balance sheet. Movements in this asset or liability from one year to another are recognised in the p&l account and statement of total recognised gains and losses (STRGL).

The advent of

FRS 17 requires not just a fundamental change in the accounting treatment for retirement benefits, but a sea-change in the attitude to understanding what its implications are. Implementation of the standard brings a challenge to those responsible for financial statements that is more onerous and far-reaching than was presented by SSAP 24. This first of two articles considers some of these implementation challenges. The second will examine practical accounting issues arising from implementing FRS 17. Who is responsible for implementing FRS 17?

The financial statements of any reporting entity are the responsibility of its directors (or their equivalents in respect of unincorporated entities); accordingly the responsibility for

FRS 17 implementation must also rest with them. Unlike SSAP 24, FRS 17 is not a matter that can be left to the finance director, to in turn delegate to an appointed individual to collate the necessary information. The whole board, including non-executive directors, needs to understand that FRS 17 is not simply an accounting adjustment, but a development that may have a major impact on the entity's financial statements. Some of the implications they need to understand are examined below. Extended transitional period - no need to worry yet?

Accounting for retirement benefits under

FRS 17 is not fully mandatory until accounting periods ending on or after 22 June 2003. In the meantime, SSAP 24 continues to be the applicable standard in the primary accounting statements unless the entity opts for early adoption.

There is a real danger that this extended transitional period is lulling directors into a false sense of security, believing there is no need to worry about

FRS 17 yet. But FRS 17 requires disclosure of key information in the notes to the financial statements for periods ending on or after 22 June 2001 and 2002. While these disclosures, which build up over the two years, are only in the notes, they are of much greater significance than 'just disclosures'. This information will form the basis of the FRS 17 entries on full implementation. In particular, the disclosures for the period ending on or after 22 June 2002 will form the comparative information for 2003, with the assumptions determining the current service cost, interest cost and expected returns in the 2003 p&l account. Errors in the transitional disclosures will be carried through to the financial statements on implementation.

Transitional disclosures fall within-the scope of the audit. Failure to comply with the requirements, or material inaccuracies in the disclosures, could result in a qualified audit report, which may flow through to the report on the 2003 statements. This is a situation directors should seek to avoid - FRS 17 needs to be taken seriously now.

Impact on the financial statements

Recognition of scheme assets and liabilities on the employer's balance sheet will change the overall picture of the entity's financial position and probably subject it to volatility not experienced in the past.

FRS 17 debits and credits in the performance statements will affect reported profits and other gains and losses in ways that may significantly alter trends. The disclosure requirements are considerable. Movements from year to year will depend on the actuarial and investment assumptions, changes in the scheme and its membership, and the actual experience in the fund's assets and obligations.

It is impossible to indicate the impact of

FRS 17 on a typical reporting entity: there is no typical scenario. The effect on each entity will vary according to the size of the net pension asset or liability relative to the entity balance sheet. The financial position of two previously similar entities may suddenly appear very different if one has to record a large pension liability and the other a pension asset.

As a priority, directors of each affected entity must estimate the impact of FRS 17 and understand how a range of changed scenarios would affect the financial statements. In particular, in view of recent stock market movements, they should assess the probable impact of falls in asset values on the

FRS 17 net pension asset or liability. Assessing the impact will involve an actuary - one of several professionals essential to the FRS 17 implementation process. Who else needs to get involved?

The directors will need to involve the following parties in obtaining the information

FRS 17 requires: actuary scheme trustees investment manager custodians scheme auditor insurance companies.

Clear lines of responsibility and an overall understanding of the process should be agreed and documented well in advance of the reporting entity's year-end. In particular, the timetable needs to be realistic and agreed by all parties, including the entity auditors who must audit the

FRS 17 items presented by the directors. Directors need to be mindful of factors that may be critical to the timetable. Timing and valuation issues Valuation of scheme liabilities

Under SSAP 24, a triennial actuarial valuation, usually performed at the scheme's year-end date, forms the basis of accounting for pension costs. Accordingly, SSAP 24 items may be based on actuarial information up to four years old.

FRS 17 also specifies a full formal valuation every three years, but a qualified actuary must update the most recent valuation to the entity balance sheet date. FRS 17 requires liabilities to be valued using the projected unit method, whereas under SSAP 24 various methods were acceptable.

Directors therefore need to ensure that a suitable actuarial valuation, using the prescribed method, is available as at the balance sheet date. As part of this process, the directors must be actively involved with the actuary in determining the actuarial assumptions used in valuing the liabilities. These assumptions, which in turn determine the current service and interest cost in the following period's profit and loss account, are the responsibility of the directors, not the actuary.

FRS 17 specifies the discount rate for calculating the present value of pension obligations as the current rate of return on a high-quality corporate bond (AA rated or equivalent). This discount rate will typically be lower than one reflecting general expectations of the long-term return on equities. Rates used in evaluating liabilities for SSAP 24 purposes would generally have included an equity-related element. Hence, even before taking into account general downward movements in interest rates, liabilities are likely to be higher under FRS 17 than under previous valuations.

FRS 17 applies to all retirement benefits, both funded and unfunded, formal commitments and constructive obligations. At the outset it is essential to identify all such benefit obligations that an entity is committed to. For example, have any commitments been made to provide defined benefits, such as pensions or medical benefits, to individuals outside the main pension schemes? Valuation of scheme assets

Scheme assets must also be valued at the entity balance sheet date. Frequently this date differs, often by many months, from the scheme year-end. The directors must liaise with the scheme trustees to obtain details of the scheme's assets, including their valuations at this date. This may place considerable additional demands on the trustees, scheme advisers and administrative functions, which are typically geared up to the scheme's year-end. Verifying the assets and their values will probably require additional work by the scheme auditor.

Scheme assets for

FRS 17 include net current assets of the scheme, and insurance policies exactly matching some or all of the benefits payable under the scheme. Such policies may be excluded from the scheme's financial statements under pension scheme regulations, but they must be valued for FRS 17 at an amount equal to the related obligations. Reporting timetable

Typically, actuarial valuations have not been finalised until approaching a year after their effective date. Scheme accounts have a seven-month reporting deadline. Clearly these timescales will not be appropriate if

FRS 17 information is to be available in time for tighter entity reporting deadlines. Managing this timetable expectation gap is a further challenge to the directors. The early implementation option

In common with other new standards, the wording of

FRS 17 encourages early adoption. The transitional arrangements, which build up the comparative information to be disclosed on adoption of the standard for the period ending on or after 23 June 2003, suggest that in practice the Accounting Standards Board does not expect to see widespread early adoption. Indeed, early adoption would necessitate obtaining the necessary information at prior year dates, a process that would be difficult in many cases. However, the directors should still consider whether early adoption is appropriate for their entity according to its circumstances.

There may be distinct reasons why early implementation would be advantageous or otherwise. For example:

• Is there a material FRS 17 net pension asset to 'boost' the balance sheet?
• Is there a material FRS 17 net pension liability that would 'erode' it?
• Are there plans to increase past service benefits out of a scheme surplus? (Under FRS 17 this would be charged to p&l immediately if benefits vest straight away.)
• Is a significant actuarial gain or loss likely in the year before mandatory implementation?

While few entities are expected to opt for full implementation in the first year, directors should continue to review the option to adopt early in the second transitional year, as changes in circumstances may make it advantageous.

Henrietta Thompson is a senior manager in Deloitte & Touche's National Assurance & Advisory Department. Next month she will examine some technical issues being raised in respect of

FRS 17 implementation, together with some concerns about communicating the impact of the standard to users of the financial statements.