SESSION/SÉANCE:
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
SPEAKERS / CONFÉRENCIERS:
Martin Raymond, associate at Deloitte
Luc Marchand, senior advisor at National Bank of Canada
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Presentation plan
1 Use of experts in audit procedures
2 Audit procedures followed
3 New IAS 19R standard
4 One company’s experience
Canadian audit standards NCA 500.8 stipulates:
• If information to be used as audit evidence has been prepared using the work of a management's expert, the auditor shall, to the extent necessary, having regard to the significance of that expert's work for the auditor's purposes:
• evaluate the competence, capabilities and objectivity of that expert;
• obtain an understanding of the work of the management’s expert; and
• evaluate the appropriateness of that expert's work as audit evidence for the relevant assertion.
NCA 620.7 stipulates: – An auditor needs to determine whether to use the work of an auditor’s expert if expertise
in a field other than accounting or auditing is necessary to obtain sufficient appropriate audit evidence.
– Considerations when deciding whether to use an auditor’s actuary may include:
• whether the entity has used an expert (e.g., actuary) in preparing the financial statements;
• the nature and significance of the matter, including its complexity; and
• the risks of material misstatement in the actuarially determined amounts to the financial statements taken as a whole.
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Canadian audit standards: • More precise than previously when it comes to the use of experts • Auditor’s objective: to have sufficient evidence and reasonable
assurance about the actuarial results with respect to the financial statements (FS).
• Auditor will consider: – The need to have an actuary on his mission team – The nature and scope of the evidence required (actuary’s role)
• Auditors are supervised: – By the firm’s internal audits (sample) – By regulatory bodies, such as CPAB in Canada;
• “To contribute to public confidence in the integrity of financial reporting of reporting issuers in Canada by effective regulation and promoting quality, independent auditing.”
– Auditor does not want to have negative comments – Increased importance of audit documentation on pension plans and
benefits
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Risks for the auditor:
• Knowledge – Complex field; technical elements
– Generally limited knowledge
– Auditors often less familiar with standard
• Materiality – Often a major item on entity’s FS
– Depends on a number of assumptions, variability element possible
• Dependency on work of third party (outside actuary) – Despite CIA/CICA Joint Policy Statement
– Little control over results – risk of error?
– Unfamiliar discussions
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
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Annual audit elements
Selection of assumption – discount rate
• Market comparison
• Explain the changes from last year
• Methodology selected
• Results sensitivity
Selection of assumption – asset return
• Building-block or other approach
• Market comparison
• Review assumptions on active management of managers
Other assumptions – mortality, retirement
• Reasonability and changes made
• Compare with pension plan terms
• Question on experience where required
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Special events
• Modification, cut, regulations, termination benefits
Methodologies
Asset limit (inc. IFRIC 14)
Expenditure components (inc. review of current service)
Review of disclosures
Changes in obligation and assets
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Specific lines of questioning during annual audits
Methodology for choice of discount rate
Active management of assets in assumptions
Assets limit and IFRIC 14 application methodology
Health care assumption and recent experience
Special events inc. plan changes
Data processing (e.g., grouped data, extrapolation, corrections)
Methodology for smoothed value of assets (according to standard)
Leave that accumulates and/or is acquired
Improve the entity’s documentation
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
0%
5%
10%
15%
20%
25%
30%
35%
< 4% 4.00% - 4.24%
4.25% - 4.49%
4.50% - 4.74%
4.75% - 4.99%
5.00% - 5.24%
5.25% - 5.49%
≥ 5.5%
Rate (%)
Selected discount rate – December 31, 2011
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Expected rate of return on selected assets – December 31, 2011
Other work with accounting teams
Merger and acquisition with pension plans
Training sessions (internal/external)
Accounting opinions for employers
Quarterly financial statements
Other provision items on employers’ FS
Internal role – positioning on standards issues
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Your role during exchanges with auditor’s actuary
Have full communication (report)
Document the assumptions well
Be ready to provide elements in greater detail (e.g., IFRIC 14)
Have a good understanding of the changes in the obligation – be ready to explain it
Detail the expected return on the assets
Be able to provide estimated future cash flows
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Other observations – accounting office
Very structured and standardized environment
High level of fiduciary responsibility
Caring about a job well done, within the rules
Many exchanges between the audit firms
Sizable external resources – global firm
A few pension specialists among the accountants
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
New IAS 19R standard
Objective Accomplished by
1. Full recognition of plan surplus/deficit on balance sheet
• Eliminating the “corridor” method of recognizing actuarial gains/losses
• Eliminating recognition of unvested past service costs over time
2. Recognize “net interest” cost in P&L
• Replacing the concept of recognizing in P&L the interest cost on the defined benefit obligation (DBO) and the expected return on plan assets with “net interest” cost
3. Reduce diversity in practice • Clarifying aspects of measurement of the DBO
4. Eliminate presentation options • Prescribing 3 new components of defined benefit cost and their presentation: service cost in P&L, net interest in P&L, and re-measurements in OCI
5. Enhance disclosure requirements • Providing disclosures focused on: - Explaining the characteristics of defined benefit plans and their associated risks - The amounts recorded in the FS and - Impact of the plans on entity’s future cash flows
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Actuarial gains and losses
IAS 19 IAS 19R
Choice of accounting method to recognize actuarial gains/losses using: 1. Deferred recognition – corridor method OR
2. Immediate recognition – through P&L OR
3. Immediate recognition – through OCI
Change
• For those entities using the corridor method – increased balance sheet volatility • No known entity using approach 2 • Most entities already using approach 3 – no change • No requirement to transfer directly to retained earnings under IAS 19R, accounting convention to be
established
Eliminated
Eliminated
Required
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Past service cost
IAS 19 IAS 19R
• Definition: Similar to IAS 19R, however, no reference to curtailments
• A change in the present value of the DBO for employee service in prior periods resulting from a plan amendment or curtailment
• Recognition: Recognize past service cost as an expense when incurred:
a) If unvested – on a straight-line basis over period benefits vest b) If vested – immediately
• Recognize all past service costs at the earlier of:
a) when plan amendment or curtailment occurs and b) when related restructuring costs or termination benefits are recognized
Change
• IAS 19R re-defines a past service cost to include curtailments • IAS 19R requires all past service costs to be recognized immediately in P&L • IAS 19R may result in earlier recognition of past service costs depending on the triggering event
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Net interest
IAS 19 IAS 19R
• The finance cost recognized in profit or loss comprises: - Interest cost on obligation - Expected return on plan assets
• Takes into account any material changes in obligation during the period and for assets takes into consideration the changes from actual contributions and benefit payments
• Net interest recognized in profit or loss comprises: - Interest cost on the obligation - Interest income on plan assets - Interest on effect of asset ceiling
• Net interest = liability (asset) on the balance sheet x discount rate at the beginning of the annual period • Takes into account the effect of benefit payments and contributions during the period
Change
• IAS 19R eliminates the concept of “expected return on plan assets” and replaces it with a calculation using discount rate
• P&L advantage of riskier investments may be lost, leading to revisions of investment policies • IAS 19R takes into account effect of asset ceiling (vs. IAS 19, which does not) • Increase to be expected for many in profit or loss
PS2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Example: Net interest calculation
Facts January 1, 201x
Defined benefit obligation $60,000
Fair value of plan assets $50,000
Expected return on plan assets 6%
Discount rate 4%
Net interest cost (income) for 201x IAS 19 IAS 19R Change
Interest cost on obligation (= 4% x $60,000) $2,400 -
Expected return on plan assets (= 6% x $50,000) (3,000) -
Net interest cost = (4% x ($60,000 - $50,000)) - $400
Net interest cost (income) recognized in profit or loss ($600) $400 $1,000
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Presentation – Statement of comprehensive income
IAS 19R – Requirements
• Current service cost
• Past service cost resulting from plan amendment or curtailment
• Gains and losses on settlement
Profit or loss
Before interest
• Obligation interest cost
• Interest income on plan assets
• Interest on effect of asset ceiling
• Actuarial gains or losses on obligation • Difference between interest income and return
on plan assets (including costs for managing plan assets)
• Any change in effect of asset ceiling, excluding amounts included in calculating net interest
Service cost
Net interest
Re-measurements
Profit or loss
As part of interest
OCI in non-recycling section
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
New disclosures required by IAS 19R include:
• Narrative description of risks to which the plan exposes the entity – focused on any unusual risks or those peculiar to plan/entity
• Actuarial gains and losses arising from changes in demographic assumptions must be shown separately from changes in economic assumptions
• Significant actuarial assumptions used to determine obligations and how a reasonably possible change to the significant actuarial assumptions would affect the obligation (sensitivity analysis)
• Fair value of plan assets must be divided into classes that distinguish the nature and risks of those assets and sub-divided into assets that do and don’t have a quoted price
• Narrative description of asset-liability matching strategies such as annuities or longevity swaps
• Effect of the plan on entity’s future cash flows including a description of funding policy, information about the obligation’s maturity profile
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Other aspects affected by change
• Administration costs; treatment of those relating to asset management vs. the others
• Risk sharing features and contributions by employees and third parties; possible difference in treatment of employee contributions – IFRIC proceedings
• Classification of other benefits between short and long term; definition of short-term benefit may lead to some being re-classified as “other long-term benefits”
• Termination benefits; clarification of benefit being linked to termination of employment vs. benefits to stay for short period (maintenance benefit), treatment is different for benefits when employees accept an offer
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
January 1, 2012 January 1, 2013
Effective for annual periods
beginning on or after January 1, 2013
Retrospective application except:
1) Entity need not adjust carrying amount of assets
outside scope of IAS 19R for changes in employee
benefit costs included in the carrying amount before
beginning of earliest period presented
2) In FS for periods beginning before January 1, 2014,
entity need not present comparative information for
sensitivity disclosures
PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
An employer’s standpoint – Case of National Bank of Canada Portrait of future benefits at National Bank of Canada
4 pension plans in Canada, all funded
• $2.23 billion in obligations, $2.36 billion in assets (October 31, 2011)
2 group insurance plans upon retirement
• $178 million in obligations (October 31, 2011)
A few other post-employment benefits
2 actuaries in Canada
1 auditor
• Bank’s financial statements • Pension funds’ financial statements
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Employer’s standpoint Accounting of future benefits – annual exercise
Fiscal year: from November 1 to October 31
Preliminary budget : generally in mid-July
Final budget: September
Preparation of annual financial statements: November
Throughout year:
• Longer-term budgets • Sensitivity analyses • Analysis of changes to standards • Quarterly financial statements • Pension funds’ financial statements (generally in February/March)
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Employer's standpoint Relations with plan actuaries and with the auditor
Actuaries involved in practically all the above-noted steps
Many sensitivity analyses conducted with the actuaries between preliminary and final budget. Little leeway once final budget filed
Impact analysis relating to very significant changes to the standards. Need to sensitize management in advance
Auditors involved mainly in the final-budget phase and FS preparation stage
Validation of treatment of special situations with auditors during budget preparations
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Employer's standpoint Year-end procedures (inc. final budget for next year)
Lengthy, rigorous process
Assumptions decided upon
• Recommendation by benefits sector and actuaries on key assumptions
• Retirement age • Departure rate • Rate of salary increase
• Work with treasury sector to determine expected long-term return. • Analysis of interest rate and determination of discount rate • Assumptions documentation
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Employer's standpoint Year-end procedures (inc. final budget for next year)
Analysis of extraordinary events
• Work with actuaries, auditors, and internal standards specialists for treatment
Preparation of note to financial statements
• Compliance with standards (internal standards specialists) • Validation by benefits sector • Validation by actuaries and auditors
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Employer's standpoint Impact of future benefits on financial statements
2011 financial statements:
• Accounting expense for benefits: $48 million • Bank revenues: $4.5 billion • Salaries and benefits: $1.78 billion • Accounting surplus (deficit): $136 million in pension and ($178 million) for other benefits • Bank assets: $156 billion
Relatively small, but a great deal of importance is attached
Significant volatility: between 2002 and 2011, the pension cost has been between $18 million and $64 million.
Balance sheet volatility also represents an issue for the bank on account of the impact on capital ratios
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
Employer's standpoint Change in IAS 19 standard
Increased volatility of results
• Discount rate also leads to changes in the return on assets
Increased balance sheet volatility in relation to corridor method
• Significant impact on capital ratios (already present under IAS 19 – OCI approach)
Investment policy must be thought through
• Practically no advantage on an accounting basis to make risky investments (assets grow faster, but risk premium not present in results)
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes
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PS-2 – Lessons from Actuarial Audits and Upcoming
IAS 19 Changes