November 11, 2013

Defined-benefit pension provisions for corporates, particularly in Germany, may rise in 2013 year-end results as new accounting rule changes come into effect, Fitch Ratings says. But as there would be no change to the economics of a company’s pension obligation, the new rules should not change our analysis or ratings.

The IFRS rule revisions make a number of changes to how companies account for defined-benefit pension schemes. One key change is the removal of the “corridor” method, which allowed a portion of pension liability to remain off balance sheet to reduce its volatility. The pension provisions of companies that previously took advantage of this option are likely to rise under the new rules. [EXPAND Read more]

The exemption is not widely used in Europe, as defined-benefit arrangements are typically only used in Germany and the UK. The “corridor” method is more popular in Germany. A sample of 19 large German corporates showed that six had used this accounting option. The pension provision for Daimler and Deutsche Post would more than double if the new rules are applied to end-2012 results. In contrast, UK corporates have generally not adopted the exemption, with only two out of 20 large companies using this method.

Another accounting change is the adoption of a single interest calculation on the net position of a scheme in the income statement. Previously interest income from the expected return on plan assets was calculated and recorded separately from interest expenses on pension liabilities. This typically raises pension costs because companies will now have to use the ‘AA’ bond yield to calculate asset returns instead of using their own assumptions. However, we expect the increases to be relatively small for most entities.

A number of other revisions may also affect the amounts recognised in the income statement. For example, elimination of the “corridor” option will remove any amortisation of actuarial losses and gains previously required. But we expect the impact on earnings to be minor for most companies.

Large pension provisions arising from the new standard should not materially alter the pension-adjusted leverage metric we use to determine whether further modelling of pension obligations is necessary. We already include unrecognised pension liabilities in our assessment.

Fitch-calculated EBITDA is not affected by the changes to interest calculations because the metric is measured before interest income and expenses. Other income statement changes might affect EBITDA, although these are likely to be immaterial. Funds from operations is derived from cash flow, so should not be affected.

The revised International Accounting Standard 19 on Employee Benefits is effective for end-2013 annual accounts. Enforcing consistency in how defined-benefit schemes are accounted for should improve transparency and disclosure. [/EXPAND]