ACCOUNTING: Appearances are very important, as any accountant will tell you. The introduction of the FRS 17 accounting standard is focusing more attention on the financial position of companies' pension schemes at a time when the prevailing conditions for assets and liabilities are negative.
The backdrop of a sharp fall in equity returns, low interest rates and a longer living population is already putting the squeeze on private pension provision.
The FRS 17 measure has revealed the extent of underfunding of many British corporate pension funds. This has not only undermined investor confidence but has been used by some British firms as the justification for abandoning the traditional defined-benefit pension scheme. This remedial action could be the dawn of a leaner, meaner pensions environment.
Irish pension schemes are much smaller, relative to company size, than their British counterparts but the new regime is also in force here. The average pension cost for Irish plcs is just 3.9 per cent of total employment costs. It is predicted that this will rise to as much as 6 or 7 per cent as certain accounting flexibilities are eliminated.
The first stage of the new accounting standards kicked in last summer. Publicly quoted companies whose financial year-end came after June 2001 have been obliged to apply FRS 17 standards to their annual reports. These present the assets and liabilities of the pension funds in a more unflattering light than previously.
The liability forecast, which used to be linked to historic equity market returns, is now based on the yields on corporate bonds. These are lower than the traditional return on equities, which means the assessment of future liabilities under FRS 17 is more costly.
When fully implemented next year, FRS 17 will mean pension assets and liabilities will appear on the company balance sheet, affecting the financial strength of the company. Some Irish companies have already gone ahead and fully introduced the new regime.
If the news is bad, it's a question of how market sentiment reacts to that information and how the firm reacts to market sentiment.
Most Irish pension funds invest mainly in equities, which have performed poorly in the past two years. This mismatch between the investment policy and the value of liabilities is what gives rise to the volatility. And no-one wants a large deficit on their books.
So why are we doing this to ourselves? Because pension cost accounting in the Republic and Britain was seriously out of line with US and international practice. With the increasing trend towards international harmonisation, that position was no longer tenable. The new standards provide transparency and consistency, while increasing the volatility of results reported in companies' accounts.
Balance sheets will become more volatile, as companies reflect changes in market values of pension fund assets as they happen rather than smoothing out shifts over many years. The changes must be registered in the income statement as gains and losses - although they have no effect on cashflow or on key financial measures such as pre-tax profits and earnings per share.
Of course, companies could say they don't care, ignore the change and carry on as before.
Alternatively they could be influenced by the negative market perception of their balance sheet and invest their pension fund in bonds rather than equities to remove the mismatch and volatility. The lower return would probably cost them more in the long run and this might provide the impetus to move from defined benefit to defined contribution.
It is not FRS 17 alone that's causing companies to move away from defined-benefit schemes - it's just another nail in the coffin.
