Review of public sector accounting of retirement and post-employment benefits
In 2014, the Public Sector Accounting Board (PSAB) identified, as part of a survey, the review of Section 3250 (Retirement Benefits) and Section 3255 (Post-employment Benefits) as one of the top priorities in its agenda. Given past revisions to accounting rules for other types of employers, as well as the introduction of new types of pension plans in Canada, it is a good opportunity to review the provisions of PS 3250 and PS 3255 and determine if changes are required. PSAB established the Employee Benefits Task Force (“Task Force”) in 2015 to undertake the project. The Task Force decided to split the review process into two phases:
- Phase One will address the deferral of experience gains and losses and the determination of the discount rate assumption, which could lead to amendments to the current standards.
- Phase Two will focus on how to account for new types of pension plans in Canada (shared risk plans, target benefit plans), multi-employer defined benefit pension plans and vested sick leave benefits. This phase will ultimately lead to the replacement of the existing PS 3250 and PS 3255 sections with a completely new comprehensive section.
Public sector entities can currently defer the recognition of actuarial gains and losses to future years, with gains and losses being amortized over the estimated average remaining service life (EARSL) of active members of the plan. In addition, an entity can use a market-related approach when valuing the plan assets, which essentially smooths the investment gains and losses over a period not to exceed five years. However, other accounting standards bodies have decided in the last few years to eliminate such deferral provisions, mostly because many feel that the net pension liability (or asset) reported in the balance sheet does not fairly represent the obligation (or asset) of the entity when actuarial gains and losses are not immediately recognized. Furthermore, combining amounts arising from the activities of the current period with the amortization of gains and losses of prior periods in the determination of the plan expense can be difficult to understand.
There are valid arguments to justify eliminating the deferral of gains and losses approach, the most obvious of which are full transparency of financial statements and enhanced comparability between public sector entities. Nonetheless, the Task Force is also cognizant of the environment in which these entities operate, namely that many of them are required to have a balanced budget in every reporting period and that any additional volatility in the surplus/deficit will be difficult to budget for, due to the size of th liability and expense. Also, the general consensus is that public sector entities are different from those in the private sector, because in many cases of their power to tax and low risk of default, which may suggest that it is less imperative to report the gains and losses in the period in which they arise.
PSAB is using a “components approach” when looking at the various types of actuarial gains and losses. They include changes in the actuarial assumptions (economic and demographic), experience adjustments, and unexpected investment return. The nature of each component of the changes in the defined benefit obligation and the value of plan assets needs to be understood, before evaluating which recognition treatment is the most appropriate. PSAB identified three recognition options:
- Immediate recognition in the annual surplus/deficit as it arises;
- No recognition in the annual surplus/deficit when it arises or in subsequent periods (no recycling); or
- Deferred recognition in the annual surplus/deficit in subsequent periods (recycling).
It is important to note that PSAB has not yet established a preliminary view on the most appropriate financial reporting model, which is one of the main reasons why the ITC is seeking stakeholder input. Therefore, the recognition options are not limited to those listed above.
The effective date of any potential amendment to the standards will likely be a few years away as a result of PSAB’s due process. It will be interesting to see in the coming months how the stakeholders will respond to the ITC and how the various public sector entities will reconcile the practical nature of employee benefits reporting with the need for full transparency and comparability of financial statements.
The Task Force published the first Invitation to comment (ITC) in November 2016, which is focused on the deferral provisions of the standards. Stakeholders may send their comments until March 3, 2017. The second Invitation to Comment, which will focus on the discount rate assumption, is scheduled for later in 2017.