In
February 2011, Seaton’s Limited filed for protection under the Companies’
Creditors Arrangement Act due to liquidity problems. The act gives troubled
companies time to restructure their debt and to hopefully avoid bankruptcy. As
part of the restructuring process, Seaton’s approached its employees and
pensioners to split the surplus in the pension plan and allow Seaton’s to
withdraw a portion of the surplus in cash to help lessen the liquidity
problems. In note 9 to the unaudited financial statements, the following was
disclosed with respect to the company’s pension plan for the year ended
December 31, 2011 (in thousands of dollars):
Plan
assets at market …………………………………………… $735,501
Plan
assets—four-year moving average market basis ……………..600,662
Projected
benefit obligations……………………………………….327,101
Pension
surplus……………………………………………………..273,561
Unrecognized
actuarial experience adjustment…………………….119,181
Pension
surplus per financial statements…………………………..154,380
The
company further notes that, effective January 1, 2011, the interest rate
assumption changed from 9% to 8% to reflect more conservative long-term
interest rate expectations.
Instructions
Adopt
the role of the pensioners as well as the role of company management and
discuss the financial reporting issues related to management’s desire to split
and withdraw from the pension plan surplus. Assume that Seaton’s is a private
company.
Overview
-
Seaton’s has several plans by which it provides
pension and other benefits to its employees. Of relevance here are the defined
benefit plans and the surplus related therein.
-
As an aside— legislation does not generally
allow employers to access and “strip” pension surpluses from pension plans;
however, it does allow for “surplus-splitting”. “Surplus-splitting” allows the
employer or sponsor of the plan and the employees to negotiate a sharing of the
surplus.
-
In this case, Seaton’s is looking for some
extra funds to help with its cash flow deficiency during and after the
restructuring period allowed under the Companies’ Creditors Arrangement Act.
The surplus funds would also potentially be used to ease the burden on
employees let go during the inevitable restructuring and downsizing. The
measurement of the surplus is therefore very important within the context of
this environment.
-
The employees/pensioners and the company will
be looking for a reasonable assessment of the surplus on which to make this
decision— noting of course that there will be a cash impact.
-
The pensioners do not want the fund to be
stripped and will likely want a more conservative estimate whereas the company
management may want a more aggressive estimate so that they can get more cash
out.
-
The statements are unaudited and therefore care
should be taken with the numbers. The respective parties would likely want
audited GAAP statements. As a private entity, the company may use IFRS or ASPE.
Analysis and Recommendations
-
Per the note, with plan assets valued at market
related values (four-year moving average market basis) the surplus is valued at
$273,561. Note that only $154,380 is recorded as an asset on the consolidated
financial statements, as GAAP has historically allowed a deferral of
unrecognized actuarial experience adjustments. The full surplus of $273,561 is
the relevant number.
o
ASPE and IFRS both use fair value to value the
assets (as opposed to market related value which is a pre 2011 GAAP
alternative) so both parties may wish to consider which value represents the
true value of the assets.
o
Depending on how the assets are valued, the
amount available to be shared or split could be higher than $273,561. Use of
market value may increase the surplus.
-
Note also that the interest rate assumptions
have been changed to 8% from 9%. This causes the obligation to increase and
thereby reduces the surplus.
o
There are many assumptions used in valuing the
obligation as well— mortality, turnover, inflation. These all add measurement
uncertainty and should be looked at carefully.
o
The discount rate is a matter of judgement and
should reflect interest rates for a similar liability of similar maturity.
o
Under ASPE - may use either a current yield on
high-quality debt instruments or a current settlement rate. IFRS requires use
of the former. Having said that, there is judgement used in determining these
rates.
o
It may be of benefit to the employees/future
pensioners to want to have the surplus understated so that the “hidden” surplus
is retained in the plan. Employees who were to be “downsized” might want to
have a higher surplus if they were to share in the “surplus splitting”
up-front.
o
Seaton’s, on the one hand, may wish to show a
higher surplus in order to have access to much needed cash in the
surplus-splitting. On the other hand, Seaton’s might wish to show a lower
surplus to protect the employees and possibly to save the excess to reduce
future cash funding requirements.
-
Regardless of any intended or unintended bias,
the measurement uncertainty is very high and, in this case, measurement is
doubly important since it will result in an actual cash outflow from the plan.
The economic reality of the status of the plan does not change – but the
accounting policy choices will change the way the surplus is measured.
