Bulletins | January 27, 2016

“Now, where did I put that deficit?” Company balance sheets and underfunded pension schemes…

The requirements of Financial Reporting Standard 102 (FRS102) could have a dramatic, yet largely unforeseen impact on the accounts of corporate groups where an underfunded final salary pension scheme still exists. But just what is all the fuss about?

Much Ado About Nothing

“Way back when”, in the days of manual typewriters and carbon paper (at least in the legal profession), FRS17 caused something of a stir when it required pension scheme deficits to be shown on company balance sheets for the first time.  But the prophecies of doom and gloom (and the imminent negative capitalisation of every single UK limited company) failed to materialise; many soothsayers found themselves in possession of their P45 quicker than they could say “Lehman Brothers”; and Corporate Britain lived happily ever after.

Until now.  Enter FRS102, at stage right.  In something of a hurry.  And with rather a menacing grin on its face…

The Scottish Play

Financial Reporting Standard 102 took effect upon the introduction of new UK GAAP (Generally Accepted Accounting Practice), in relation to the accounting periods of unlisted UK companies commencing on or after 1 January 2015.  It replaces a number of earlier Standards including the well-known FRS17, “Retirement Benefits” and requires, in particular, an operating company to show the DB deficit as a balance sheet debit.  No longer can the buck simply be allowed to keep going ‘up the chain’ until it stops with TopCo.

The first wave of victims, whose accounts are prepared in line with calendar year-end, are already grappling with the requirements of FRS102.  For some it means no change from the status quo.  For others it brings considerable uncertainty and, potentially, the need to take steps (at little or no notice) to reinforce the balance sheet of under-capitalised group members.

‘Carpe diem’.  Seize the day, boys.  Make your lives extraordinary…

Although FRS17 required corporate groups to show their DB pension scheme’s deficit on the balance sheet, a carve-out – the so-called “multi-employer exemption” – allowed this reporting to take place at group level in the consolidated accounts.  At individual company level, each entity was simply required to account for its contributions to the scheme on a DC basis (i.e. focusing essentially on amounts actually paid, albeit with one or two disclosure requirements relating to the fact that an ultimate DB liability existed elsewhere within the group).

The only pre-requisite for this exemption to apply was the fact that “the employer is unable to identify its share of the underlying assets and liabilities in the scheme on a consistent and reasonable basis”.  Which, unless you have a sectionalised scheme, is pretty-much always going to be the case.


Now, under new UK GAAP[1], unless there is an explicit agreement or policy for charging the net DB cost to individual group entities, the deficit is required to be shown in the accounts of the company that is “legally responsible” for the scheme.  Which is unlikely to be the top company in the group, as it often has no staff (and certainly none who earn benefits in the pension scheme).  But then if that’s the case, which company is it that takes the hit on its distributable reserves?

The difficulty here is that there is very often no single company that is legally responsible (whatever that actually means) for a pension scheme.  Even if the scheme rules require a partial winding-up to take place when an employer exits, responsibility for the scheme is shared amongst all participating employers.  And if by contrast (as is the case with many of the UK’s remaining DB schemes) it is a true “last-man standing” arrangement, then the responsibility is genuinely joint and several.

The Ace Of Spades

But maybe an answer – or at least the makings of one – can be found in the world inhabited by those corporates who report under International Financial Reporting Standards (which means, in the case of their DB pension schemes, IAS19): in other words UK listed companies, who have been subject to such a requirement since 1 January 2013 (i.e. for two full accounting periods already).  The equivalent IAS19 requirement, to show the deficit on its balance sheet, rests with the sponsoring employer (rather than the rather more vague concept under FRS102 of the employer that is “legally responsible” for the scheme).  But isn’t it the case that it is, in fact, the sponsoring employer that has just such responsibility?

Financially, it’s not possible to say that it’s just one entity which is responsible for a scheme – we’ve known this ever since the Pensions Regulator’s focus on statutory employers started some 3 or 4 years ago.  But from a legal perspective, consider this.  Which company, if it fails, brings about the winding-up of the entire scheme?  Which company is – generally speaking – the only one which is required to be party to a deed of amendment?  Which company, above all others, is likely to hold powers and discretions under an occupational pension scheme?  And which company is – without exception – a necessary party to deeds of adherence, or to those appointing or removing trustees from office.

Yes, you’ve got it: the sponsoring employer!  And there, at least in my opinion, Endeth The Lesson.  These are all legal issues, and it is the sponsoring employer which is pivotal to all of them.  And as well as the fact that this conclusion brings about a logical contiguity between IFRS and UK GAAP, I personally cannot see how – even as a question in itself – the entity that is “legally responsible…” can be anything other than the sponsoring employer.

Others may disagree.  And at the end of the day, the decision will rest with the group’s auditors (and, in particular, what they are prepared to sign off).  But to those auditors, I would just say one thing: think about this carefully, before following the herd; and don’t be overly prudent, just for the sake of being overly prudent.  That’s how “lowest common denominator syndrome” comes about, and it benefits no-one.  You naturally have to manage your own risk (as any professional these days needs to do); but your primary responsibility is actually to your clients, and in that respect your role is to give sign-off to accounts that are true and fair (and properly prepared, etc etc), rather than ones which simply give the greatest amount of protection to those who’ve audited them…


And now for a little light entertainment.  I would like to know how many of our readers can tell me the connection between the five sub-headings used in this article, hence which one is the odd one out (and why).  Email your answer to kweber@wedlakebell.com by no later than midnight on Thursday 17 March 2016, with the title “Bulletin – Competition”.  First correct answer out of the hat wins two bottles of the finest Austrian wine (and believe me, it’s good: they don’t normally export their best stuff, but I managed to sneak some out a fortnight ago).  Enter as many times as you wish.  The Editor’s decision (about who goes into the hat) is, of course, final.  And there will also be a separate prize (again determined using the Editor’s skill and judgment) for the most amusing answer.  I look forward immensely to your emails!


[1] Insofar as FRS102 relates to “group plans”, by which is meant traditional UK defined benefit schemes set up for employers associated by ownership or control.  We are not concerned with what the Standard calls “multi-employer schemes”, which is something of a misnomer as it actually refers to centralised arrangements for non-associated employers.