Farquar
Inc. is in the process of going public. The company is in the Canadian oil and
gas industry but has decided that it would like to list its shares on the
London Stock Exchange. Currently, the company follows pre-2011 Canadian PE
GAAP.
Farquar
has a significant pension plan that is currently underfunded. For the year
ended December 31, 2011, the company (under PE GAAP) did not recognize this
large deficit as a liability since it related to past service costs. Farquar’s controller,
Perry Barta, has on his desk the new U.S. accounting standard and the almost
identical proposed Canadian PE Exposure Draft on employee future benefits.
Under the new U.S. standard, companies will have to recognize such unfunded
amounts through Other Comprehensive Income.
Perry
also has on his desk some information about the differences between PE GAAP and
IFRS.
Instructions
Adopt
the role of the controller and discuss the relative strengths and weaknesses of
the three differing views of accounting for the unfunded costs. Perry is very
concerned about the impact on the company’s debt-to-equity ratio and the earnings
per share numbers.
Overview
-
Company is going public and therefore IFRS will be a
constraint.
-
The controller is concerned about the impact of
accounting policies related to the pension plans will have on the debt to
equity ratio and EPS. Note that EPS is not required under PE GAAP. Note further
that PE GAAP is not a viable alternative for the company since as soon as the
company goes public, it will have to follow IFRS. Therefore, it would require
significant effort to change from pre 2011 GAAP to PE GAAP and then to IFRS.
Nonetheless, the accounting choices under ASPE are presented here as requested
by the controller.
Analysis and
recommendations
-
Pre 2011 Canadian standard ignores the deficit and
surplus and is therefore not transparent. It results in a significant
off-balance sheet liability. Although note disclosures are required regarding
the funded status of the plan, the real deficit or surplus is not recognized in
the balance sheet. Many users of financial statements do not read the notes
carefully and may miss this. The debt to equity ratio and EPS appear more
favourable using this accounting treatment.
-
Under ASPE, the company would have a choice to follow
essentially the same accounting as the pre 2011 GAAP noted above or use the
immediate recognition model whereby the unfunded deficit would be fully
recognized in the balance sheet. If the latter is used, the company would use a
funding valuation measure of the obligation (more conservative) which might
result in a higher deficit. The immediate recognition method would worsen the
debt to equity ratio and EPS.
-
Under IFRS, the company would use a deferral and
amortization method however, vested past service costs must be recognized
(which would worsen the debt to equity ratio and lower EPS). In addition, the
company would have the option to fully recognize changes in past service cost
and actuarial gains/losses immediately in income (or through other comprehensive
income for actuarial gains/losses). This
would worsen the debt to equity ratio and EPS although if the option to book
through OCI were taken, EPS would not be affected.
