1 Employee Future Benefits – February 2004

Employee Future Benefits

Nancy Estey, Principal, Accounting Standards Board staff

February 23, 2004 4-7 pm; 7-10 pm

AK/ADMS 4510 M&N – Winter 2004

2 Employee Future Benefits – February 2004

Discussion Outline

Recent headlines Environment driving change Current financial statement impacts Background

– A compensation package– Types of employee future benefits– Financial statement objectives– Deferred compensation– Discount rate

3 Employee Future Benefits – February 2004

Discussion Outline

Developments in Canada Highlights of Canadian disclosure

improvements What’s Ahead Understanding “smoothing” The “Corridor” approach Move to presentation format

4 Employee Future Benefits – February 2004

Recent Headlines

Rates, high dollar erase pension gains (G&M, Jan 22/04)

Pensions seen as key factor in executive pay (G&M, Jan 7/04)

Pension smoothing hides the facts (G&M, Oct 15/03)

Pension shortfalls threaten to explode (G&M, May 12/03)

5 Employee Future Benefits – February 2004

Environment Driving Change

Significant losses sustained by many pension plans in the last few years + lower market interest rates

– Increased benefit obligation– Growing deficit position– Drain on cash flow– Increased pension costs

Post-Enron era– “Smoothing” results in off-balance sheet debt, which draws

attention– Poor plan performance increases this debt– Need for transparency

6 Employee Future Benefits – February 2004

Current Financial Statement Impacts

$0

$5

$10

$15

$20

$25

2000 2001 2002

Average Pension Expense ($ million)

Source: Towers Perrin review of financial statements of 90 major Canadian Companies that sponsor defined benefit plans.

7 Employee Future Benefits – February 2004

Current Financial Statement Impacts

-$150

-$100

-$50

$0

$50

$100

$150

$200

$250

Average Deferred Pension Cost ($ million)

Source: Towers Perrin review of financial statements of 90 major Canadian Companies that sponsor defined benefit plans.

2000 2001 2002

8 Employee Future Benefits – February 2004

A Compensation Package

This Year When Retired•Salary

•Fringe benefits

•Bonus

•Profit sharing

•Pension benefits

•Vision Care

•Drug Plan

•Life Insurance

Cash Paid

•Stock options

9 Employee Future Benefits – February 2004

Types of Employee Future Benefits

Accounting for future promises– promised pension and other benefits when they retire

Eligibility via age and service Pension Benefits

– Defined benefit plans now a major cost of doing business Low interest rates Decline in equity markets

Post-retirement benefits Life insurance Extended health care

– double-digit growth due to Rising drug costs, aging membership

10 Employee Future Benefits – February 2004

F/S Objectives

Plan performance affects– Financial Position (B/S)– Operating Results (I/S)– Changes in Financial Position (Cash flows)

Employee Future Benefits Accounting– CICA Section 3461– FAS 87, 88, 106, 112, 132(r) in the US

11 Employee Future Benefits – February 2004

Deferred Compensation

Estimate amounts to be paid out in the future (future benefit payments)

Discount those future payments to reflect the time value of money

Allocate the resulting amount “deferred compensation cost”

– Over the periods of service required of the employees in exchange for the promise of those future payments

So, cost of future benefits recognized as the employees render service to the company

12 Employee Future Benefits – February 2004

Discount Rate

Market-driven rate Controversial

– Revalue at each balance sheet date Discount rate Obligation Discount rate Obligation

– Volatility in I/S Corridor method (element of smoothing) helps But volatility unwelcome

13 Employee Future Benefits – February 2004

Developments in Canada

Long-term– Participate in global project

Start over from 1st principles

Short-term– Limited-scope disclosure enhancements – Revised disclosure requirements to be issued on

or about March 1, 2004

14 Employee Future Benefits – February 2004

Highlights of CDN Disclosure Enhancements

Disclosures related to the reporting entity’s financial statements

– Total cash payments – Balance sheet classification of the accrued benefit

asset/liability– Clarification on the accounting policy disclosures that

should be made– Components of costs recognized (in addition to the total) – Reconciliation of the accrued benefit obligation to the

balance sheet asset or liability– Effects of a one-percentage-point increase and decrease in

the assumed health care cost trend rates

An entity shall recognize

a liability and an expense

for post employment benefits

and compensated absences

that do not vest or accumulatewhen(a) the event obligating the

15 Employee Future Benefits – February 2004

Highlights of CDN Disclosure Enhancements (cont’d)

Disclosures related to the benefit plan– Description of the type of plans – Actual allocation of plan assets by major asset category– Date used to measure the plan assets and the benefit

obligations – Effective date of the last (as well as the next required)

actuarial valuation for funding purposes – Significant assumptions – Reconciliations - plan obligation and plan assets

An entity shall recognize

a liability and an expense

for post employment benefits

and compensated absences

that do not vest or accumulatewhen(a) the event obligating the

16 Employee Future Benefits – February 2004

Highlights of CDN Disclosure Enhancements (cont’d)

Distinction between “public” and non-”public” entity requirements

“Public” implies public enterprises, co-operative organizations, deposit-taking institutions or life insurance companies

Covers pension benefits, but also post-retirement and post-employment plans

Interim financial statements– Total benefit cost

An entity shall recognize

a liability and an expense

for post employment benefits

and compensated absences

that do not vest or accumulatewhen(a) the event obligating the

17 Employee Future Benefits – February 2004

What’s Ahead?

Developments Around the World UK – FRS 17, mark to market

– Aborted; punted to IASB

IASB– Plans to issue ED of improvements to IAS 19 in Q2 2004 with

final standard Q1 2005 the removal of options for the deferred recognition of actuarial

gains and losses enhancing disclosure

18 Employee Future Benefits – February 2004

What’s Ahead?

Developments Around the World (cont’d) US FASB

– Disclosure ‘quick fix’ – Final statement issued with effective date for fiscal years

ending after December 15, 2003 more complete information about plan assets, obligations, cash

flows, and net cost assists users of f/s in assessing the market risk of plan assets, the

amount and timing of cash flows, and reported earnings.

19 Employee Future Benefits – February 2004

Understanding “Smoothing”

Delayed recognition of events (spread changes over the future)

– Amortize to expense over a period of time rather than immediate recognition

Past service costs Actuarial gains/losses [also corridor approach]

Treatment of returns on pension plan assets– Expected return, not actual return (difference amortized to

expense over time)– Market-related value of plan assets deferring recognition of

recent investment gains and losses for up to 5 years

20 Employee Future Benefits – February 2004

The “Corridor” approach

21 Employee Future Benefits – February 2004

Move to Presentation format

Debate “smoothing” i.e., deferred recognition of events