Ash Shaw's key observations on the revision to The Statement of Recommended Practice, Financial Reports of Pension Schemes ("the SORP")

The Statement of Recommended Practice, Financial reports of Pension Schemes ("the SORP") is currently under revision. An exposure draft ('ED') has been issued for comment, with the finalised document expected to be in issue in May 2007. The recommendations will be applicable for all scheme years commencing on or after 6 April 2007 but early adoption is recommended.

Below is a summary of the key changes which are proposed in the exposure draft.

Presentational points

There are a few points of presentation to note:

• headings in the Fund Account have changed from 'contributions receivable' to 'contributions' and from 'benefits payable' to 'benefits';
• for schemes with derivative investments, the note which analyses investment movements will have new column headings - "purchases at cost and derivative payments" and "sales proceeds and derivative receipts";
• separate disclosure is to be made in the net assets statement of investment liabilities - for use with derivative contracts and any other 'negative' investment balances;
• inclusion of a new caption in the Net Assets Statement - 'assets due in more than one year', with an example of its contents being in relation to contributions due from the employer;
• income from annuity policies which is initially paid to the trustees in order to fund the pension paid by the scheme to the pensioner, should be included in investment income and the pensions paid to the pensioners included in pension payments. There should be no netting off of these amounts. Previously these amounts could be netted off with disclosure of the value of annuity income if this was material;
• where the corresponding amounts in the financial statements are not directly comparable with the amount to be shown in respect of the current year they should be adjusted and particulars of the adjustment and the reasons for it should be disclosed in the notes to the accounts. This implies that changes made as a result of this SORP (e.g. transaction costs, investment valuation) will result in a restatement of the comparatives; and
• the explanation that the accounts do not take account of liabilities to pay pensions and other benefits after the scheme year end should be given more prominence and so is being moved to the foot of the net assets statement rather than the basis of preparation paragraph in the notes.

Contributions

The key changes here recognise the varying methods of funding scheme contributions and so seek to clarify the related disclosures:

1. Terminology for certain types of employer contributions will change:-
   • 'augmentation' rather than special;
   • 'deficit funding' instead of additional contributions. For deficit funding contributions in respect of past service benefit accruals, the notes should explain why and for how long they are payable. If past service contributions are initially recognised at the total amount receivable, even though receipts may be spread over several years, the time value of money should be taken into account; and
   • 'other' contributions which may be paid for example to contribute towards the administration costs or life assurance premiums.
2. Contributions payable in respect of section 75 debt are payable when each employer ceases to be a participating employer in a scheme and the scheme actuary determines there is a past service deficit for members who are or were employees of the employer. The section 75 debt should be accounted for when determined by the scheme actuary and should be recognised in full with any provisions for recoverability or time value of money as appropriate. This may result in contributions being due after more than one year, and so be accounted for under the new net assets statement caption of 'assets due in more than one year'.
3. If employer normal contributions include contributions payable under flexible benefit arrangements where members sacrifice some of their salary which is then paid into the scheme as an employer contribution, the notes to the accounts should explain that employer contributions include such amounts. Trustees may wish to disclose the value of the employer contributions which arise in this way, although this is not a requirement of the SORP.
4. If the normal employer contribution rate includes an element for deficit funding, the notes to the accounts should say so and the amount should be quantified and disclosed in the notes.

Investments

The key change for investments is the use of bid prices rather than mid prices. So for quoted securities, investments should be included at the closing price - these may be the last traded price or bid price depending on the convention of the stock exchange or other market on which they are quoted, rather than last traded or mid. Pooled investment vehicles should be included at the closing bid price if both bid and offer prices are published, or if single priced then at the closing single price.

Another change to investment disclosures is that investment transaction costs should be separately included in investment management expenses in the Fund Account, rather than being netted against sale proceeds of investment transactions or included in purchase cost. Transaction costs include fees, commissions and duties. This does not apply to indirect transactions costs included within spread costs of pooled investment vehicles.

Derivatives

The previous SORP provided guidance for accounting for futures and options but this has been widened in the latest revision to cover all derivative contracts. The SORP provides and overview of the accounting and disclosure requirements, and more detailed guidance in this area is expected to be issued by PRAG at the same time as the SORP.

Key points to note are:

• derivative contracts must be disclosed by their main types e.g. futures, options, swaps, forward foreign currency contracts, and further analysed between exchange traded and over the counter;
• derivative investments with positive values should be included in the net asset statement as assets and those with negative values should be included in the net asset statement as liabilities. These balances should not be offset unless there is a legal right of offset;
• For schemes with derivative investments, the note which analyses investment movements will have new column headings - "purchases at cost and derivative payments" and "sales proceeds and derivative receipts"; and
• if material, any income from derivatives will be separately analysed in the investment income note.

Money purchase assets

A new distinction has been made for money purchase assets depending on where the 'designation' of assets takes place i.e. at the investment managers or the administrators:

• where the individual member's contributions are invested separately (rather than in a common fund) the assets are 'designated' as being solely for the benefit of the names members;
• where money purchase investments are held on a pooled basis by the investment manager (i.e. the manager cannot identify investments by member) and the administrator keeps records of the allocation of investments by the member the investments are 'allocated' to members.
• The notes to the financial statements should disclose investments designated to members, investments allocated to members and investments not designated or allocated to members i.e. held for the trustees. The ED then goes on to say, rather contradictorily, that these categories may be grouped together and described as investments allocated to members and investments not allocated to members.

For non-investment current assets and liabilities, the explicit note disclosure of the make-up of current assets/liabilities between allocated and not allocated to members has been removed. However we suggest that, for clarity, this is an area where additional disclosure would be useful.

Going concern

For all types of pension schemes, the basis of preparation note should disclose the trustees' opinion of the going concern status of the scheme i.e. are the accounts prepared on a going concern or scheme cessation basis. As detailed below, in some situations this will require judgements to be made by the Trustees.

If the accounts are prepared on a scheme cessation basis, the reasons (both scheme-related and employer-related) behind their opinion and the impact, if any, on the bases of valuing the scheme's assets and liabilities should be disclosed in the notes to the accounts.

Where a defined benefit scheme is significantly underfunded, as disclosed in its actuarial statements, it should still continue to be treated as a going concern for accounting purposes, provided the sponsoring employer(s) are willing and able to continue funding the scheme to the recommended levels.

If a decision is made to wind up the scheme the trustees should review the going concern status of the scheme and the bases of valuation of assets and liabilities should be examined to ensure that they are consistent with the intended method and timescale for wind up.

In some cases, information may already be in the public domain which leads the trustees of a defined benefit scheme to believe that the employer(s) may encounter difficulties in continuing to fund the scheme to the recommended levels. Such circumstances would normally be significant enough for the trustees to disclose details of these circumstances in the annual report but would not normally require a change to accounting for the scheme's assets and liabilities on a going concern basis.

If the scheme enters a PPF assessment period, and the probable outcome of the assessment period is that the scheme will enter the PPF, then for financial statements prepared during the assessment period, the basis of valuation of assets and liabilities should be examined to ensure that are consistent with the intended timescale and method of entry into the PPF. If the probable outcome of the assessment process is that the scheme will be proven adequately funded to meet its PPF liabilities, the financial statements should continue to be prepared on a going concern basis.

Contingent assets

Contingent assets include arrangements put in place with the employer which provide certainty that the employer can make further deficit funding contributions to the scheme in certain circumstances by making the assets available via a secure arrangement, for example through letters of credit, guarantees and escrow accounts. Details of theses arrangements should be disclosed in the trustees report. Contingent assets are not recognised in the accounts until realisation of the gain is virtually certain. But a contingent asset should be disclosed in a note to the accounts when an inflow of economic benefit is probable. Disclosure should be made of the contingent asset at the net asset date and an estimate of its financial effect.