This Comment Letter was sent by BDO Global Coordination B.V. on behalf of BDO International, to the International Accounting Standards Board on 1 October 2009:
Dear Sir
IASB Exposure Draft ED 2009/10: Proposed amendments to IAS 19 Discount Rate for Employee Benefits
We are pleased to comment on the above exposure draft (the ED) issued by the International Accounting Standards Board (IASB), on behalf of BDO International.
We note that the amendment is being made as there are concerns (with which we agree) that there is not a deep market in high quality corporate bonds in some jurisdictions and the current requirements reduce comparability between entities as some entities will use a high quality corporate bond rate but others will need to use a government bond rate.
The amendment notes that it is not intended to pre-empt the IASBs plans for a more fundamental review of accounting for employee benefits. Such a fundamental review should consider whether or not the discount rate should reflect a margin for risk.
Purely in the interests of introducing consistency in the short-term, pending the IASB’s more fundamental review, we support an approach that requires a synthetic high quality corporate bond rate. To be consistent with the approach in IAS 37, risks that have been reflected in the discount rate should not be reflected in the estimate of future cash flows.
Looking ahead, we note that Europe’s ‘Pro-active Accounting Activities in Europe’ (PAAinE) initiative, which is a partnership between the European Financial Reporting Advisory Group (‘EFRAG’) and European standard-setters issued a discussion paper on the financial reporting of pensions in 2008. This recommended that the discount rate should reflect the time value of money only and therefore should be a risk-free rate.
Our responses to the specific questions raised in the ED are set out below.
Question 1 – Discount rate for employee benefits
Do you agree that the Board should eliminate the requirement to use government bond rates to determine the discount rate for employee benefit obligations when there is no deep market in high quality corporate bonds? Why or why not? If not, what do you suggest instead, and why?
We agree that an approach is required which will result in entities discounting their employee benefit obligations using consistent rates whether or not there is a deep market in high quality corporate bonds.
This might be done by mandating the use of a government bond rate in all instances or, as proposed, by requiring the use of a high quality corporate bond rate in all circumstances. Purely in the interests of introducing consistency in the short-term we support an approach that requires a (potentially synthetic) high quality corporate bond rate. The use of a government bond rate would introduce a fundamentally different measurement basis for employee benefit obligations, which could result in liabilities being reported at significantly higher amounts than at present. We believe that in the context of a short term amendment, rather than a fundamental review, it would be inappropriate to introduce such a change.
Where there is not a deep market in high quality corporate bonds, we note that the proposed approach will require a synthetic rate to be derived. However that does raise the question of how the proposed revision to paragraph 78 is to be applied as it requires rates to be estimated by reference to the yields on high quality corporate bonds denominated in the same currency and with the same term – but the reason for amending the standard is the lack of such bonds, which is acknowledged in paragraph BC5.
We note that the equivalent UK standard (FRS 17 Retirement benefits) also requires use of a high quality corporate bond rate when discounting defined benefit obligations, but notes that if there is no liquid market in bonds of this type or of the appropriate maturity, then a reasonable proxy should be used. It goes on to say that this may be based on government bonds plus a margin for assumed credit risk spreads derived from global bond markets. (FRS 17.33) We suggest that as a short term measure, pending the fundamental review of accounting for employee benefits, IAS 19 should also permit such an approach.
Question 2 – Guidance on determining the discount rate for employee benefits
For guidance on determining the discount rate, do you agree that an entity should refer to the guidance in IAS 39 Financial Instruments: Recognition and Measurement for determining fair value? Why or why not? If not, what do you suggest instead, and why?
The guidance in IAS 39 AG69 to AG82 is intended to address the valuation of a specific instrument. IAS 19 is looking to derive the liability valuation through the use of a market-based discount rate rather than an entity-specific rate and specifically excludes entity-specific credit risk (paragraph 79). We believe a rate based on government bonds plus a margin for assumed credit risk spreads derived from global bond markets would be a reasonable proxy for valuation purposes, pending the fundamental review of accounting for employee benefits (see our response to question 1).
Question 3 – Transition
The Board considered whether the change in the defined benefit liability (or asset) that arises from application of the proposed amendments should be recognised in retained earnings or as an actuarial gain or loss in the period of initial application (see paragraph BC10) Do you agree that an entity should:
apply the proposed amendments prospectively from the beginning of the period in which it first applies the amendment?
recognise gains or losses arising on the change in accounting policy directly in retained earnings?
Why or why not? If not, what do you suggest instead, and why?
We agree that the change should be applied prospectively.
However we believe that the change should be treated as a change in financial assumption so that any gain or loss is dealt with as a change in actuarial estimate in accordance with IAS 19 paragraphs 92 to 95, in the same way as a change in the defined benefit obligation arising as a result of changes in corporate bond rates. The approach in the existing paragraph 78 is to use the government bond rate as a proxy to the high quality corporate bond rate and we consider that changes in the defined benefit obligation as a result of the implementation of the proposed amendments should be treated in the same way.
We hope that our comments and suggestions are helpful. Should you wish to discuss any of the points we have raised, please contact either Tracey-Lee Massey at +32 2 778 0130 or Andrew Buchanan, our Global Head of IFRS, at +44 (0)20 7893 3300.
Yours faithfully,
BDO Global Coordination B.V