"While companies continue to be focused on working with trustees to tackle their pension scheme funding deficits, we suspect the introduction of the revised IAS 19 in January 2013 is slipping under the radar of many financial directors," said Simon Robinson, principal at Aon Hewitt, this week.

His comment followed the news that the Aon Hewitt 350 index showed an aggregate accounting deficit of the FTSE 350's final salary pension schemes of £86bn on 28 August – the same as the previous month.

The changes to IAS 19 mean that companies will no longer be able to record a profit on the expected return on their pension scheme investments. With pension schemes traditionally invested in riskier assets such as equities, this has often offset the corresponding interest cost on their liabilities. Although the changes are unlikely to have a major effect on the accounting deficit of UK defined benefit (DB) pension schemes, it is anticipated by Aon that they will have a significant impact on the profit and loss (P&L) charge of individual companies. The firm estimates that these changes will increase P&L charges annually for UK businesses by £10bn in total.

In the short term, Aon Hewitt says, financial directors should review their accounting assumptions, as this can help lower their P&L charge and balance sheet liability.

"Companies are required to make a number of assumptions to calculate their liabilities", Robinson said. "While the majority of companies will make a reasonable best estimate for the key assumptions such as life expectancy, there are a number of ancillary assumptions such as retirement patterns, or the proportion of members with spouses, on which they may unintentionally be taking a 'prudent' view.

"We estimate that more accurate assumptions could reduce liabilities by as much as 5%. Therefore, as a priority, financial directors should review all their accounting assumptions, as this is an effective way for companies to offset the impact of these changes."

Robinson says that while it would be unlikely in most cases to move pension schemes from deficit to surplus, a review of all accounting assumptions should be an important exercise for ensuring that companies are not reporting larger deficits than is necessary. Over the long term, changes to IAS 19 are also said to impact discount rates. "To date, the discount rate used might have had an effect on the balance sheet, but had a relatively small effect on the P&L," Robinson said.

"In the future the opposite will be true, with the discount rate having a much bigger effect on the P&L. Schemes will have to ensure that it is not lower than they can justify and financial directors will need to make certain that they keep this constantly under review."

First published 03.09.2012

azeevalkink@wilmington.co.uk