SESSION/SÉANCE: PS-2 Lessons from Actuarial Audits and

SESSION/SÉANCE:

PS-2 – Lessons from Actuarial Audits and Upcoming

IAS 19 Changes

SPEAKERS / CONFÉRENCIERS:

Martin Raymond, associate at Deloitte

Luc Marchand, senior advisor at National Bank of Canada


IAS 19 Changes

Presentation plan

1 Use of experts in audit procedures

2 Audit procedures followed

3 New IAS 19R standard

4 One company’s experience

Canadian audit standards NCA 500.8 stipulates:

• If information to be used as audit evidence has been prepared using the work of a management's expert, the auditor shall, to the extent necessary, having regard to the significance of that expert's work for the auditor's purposes:

• evaluate the competence, capabilities and objectivity of that expert;

• obtain an understanding of the work of the management’s expert; and

• evaluate the appropriateness of that expert's work as audit evidence for the relevant assertion.

NCA 620.7 stipulates: – An auditor needs to determine whether to use the work of an auditor’s expert if expertise

in a field other than accounting or auditing is necessary to obtain sufficient appropriate audit evidence.

– Considerations when deciding whether to use an auditor’s actuary may include:

• whether the entity has used an expert (e.g., actuary) in preparing the financial statements;

• the nature and significance of the matter, including its complexity; and

• the risks of material misstatement in the actuarially determined amounts to the financial statements taken as a whole.


IAS 19 Changes

Canadian audit standards: • More precise than previously when it comes to the use of experts • Auditor’s objective: to have sufficient evidence and reasonable

assurance about the actuarial results with respect to the financial statements (FS).

• Auditor will consider: – The need to have an actuary on his mission team – The nature and scope of the evidence required (actuary’s role)

• Auditors are supervised: – By the firm’s internal audits (sample) – By regulatory bodies, such as CPAB in Canada;

• “To contribute to public confidence in the integrity of financial reporting of reporting issuers in Canada by effective regulation and promoting quality, independent auditing.”

– Auditor does not want to have negative comments – Increased importance of audit documentation on pension plans and

benefits

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IAS 19 Changes

Risks for the auditor:

• Knowledge – Complex field; technical elements

– Generally limited knowledge

– Auditors often less familiar with standard

• Materiality – Often a major item on entity’s FS

– Depends on a number of assumptions, variability element possible

• Dependency on work of third party (outside actuary) – Despite CIA/CICA Joint Policy Statement

– Little control over results – risk of error?

– Unfamiliar discussions

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IAS 19 Changes

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Annual audit elements

Selection of assumption – discount rate

• Market comparison

• Explain the changes from last year

• Methodology selected

• Results sensitivity

Selection of assumption – asset return

• Building-block or other approach

• Market comparison

• Review assumptions on active management of managers

Other assumptions – mortality, retirement

• Reasonability and changes made

• Compare with pension plan terms

• Question on experience where required


IAS 19 Changes

Special events

• Modification, cut, regulations, termination benefits

Methodologies

Asset limit (inc. IFRIC 14)

Expenditure components (inc. review of current service)

Review of disclosures

Changes in obligation and assets

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IAS 19 Changes

Specific lines of questioning during annual audits

Methodology for choice of discount rate

Active management of assets in assumptions

Assets limit and IFRIC 14 application methodology

Health care assumption and recent experience

Special events inc. plan changes

Data processing (e.g., grouped data, extrapolation, corrections)

Methodology for smoothed value of assets (according to standard)

Leave that accumulates and/or is acquired

Improve the entity’s documentation

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IAS 19 Changes


IAS 19 Changes

0%

5%

10%

15%

20%

25%

30%

35%

< 4% 4.00% - 4.24%

4.25% - 4.49%

4.50% - 4.74%

4.75% - 4.99%

5.00% - 5.24%

5.25% - 5.49%

≥ 5.5%

Rate (%)

Selected discount rate – December 31, 2011


IAS 19 Changes

Expected rate of return on selected assets – December 31, 2011

Other work with accounting teams

Merger and acquisition with pension plans

Training sessions (internal/external)

Accounting opinions for employers

Quarterly financial statements

Other provision items on employers’ FS

Internal role – positioning on standards issues

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IAS 19 Changes

Your role during exchanges with auditor’s actuary

Have full communication (report)

Document the assumptions well

Be ready to provide elements in greater detail (e.g., IFRIC 14)

Have a good understanding of the changes in the obligation – be ready to explain it

Detail the expected return on the assets

Be able to provide estimated future cash flows

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IAS 19 Changes

Other observations – accounting office

Very structured and standardized environment

High level of fiduciary responsibility

Caring about a job well done, within the rules

Many exchanges between the audit firms

Sizable external resources – global firm

A few pension specialists among the accountants

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IAS 19 Changes

New IAS 19R standard

Objective Accomplished by

1. Full recognition of plan surplus/deficit on balance sheet

• Eliminating the “corridor” method of recognizing actuarial gains/losses

• Eliminating recognition of unvested past service costs over time

2. Recognize “net interest” cost in P&L

• Replacing the concept of recognizing in P&L the interest cost on the defined benefit obligation (DBO) and the expected return on plan assets with “net interest” cost

3. Reduce diversity in practice • Clarifying aspects of measurement of the DBO

4. Eliminate presentation options • Prescribing 3 new components of defined benefit cost and their presentation: service cost in P&L, net interest in P&L, and re-measurements in OCI

5. Enhance disclosure requirements • Providing disclosures focused on: - Explaining the characteristics of defined benefit plans and their associated risks - The amounts recorded in the FS and - Impact of the plans on entity’s future cash flows


IAS 19 Changes

Actuarial gains and losses

IAS 19 IAS 19R

Choice of accounting method to recognize actuarial gains/losses using: 1. Deferred recognition – corridor method OR

2. Immediate recognition – through P&L OR

3. Immediate recognition – through OCI

Change

• For those entities using the corridor method – increased balance sheet volatility • No known entity using approach 2 • Most entities already using approach 3 – no change • No requirement to transfer directly to retained earnings under IAS 19R, accounting convention to be

established

Eliminated

Eliminated

Required


IAS 19 Changes

Past service cost

IAS 19 IAS 19R

• Definition: Similar to IAS 19R, however, no reference to curtailments

• A change in the present value of the DBO for employee service in prior periods resulting from a plan amendment or curtailment

• Recognition: Recognize past service cost as an expense when incurred:

a) If unvested – on a straight-line basis over period benefits vest b) If vested – immediately

• Recognize all past service costs at the earlier of:

a) when plan amendment or curtailment occurs and b) when related restructuring costs or termination benefits are recognized

Change

• IAS 19R re-defines a past service cost to include curtailments • IAS 19R requires all past service costs to be recognized immediately in P&L • IAS 19R may result in earlier recognition of past service costs depending on the triggering event


IAS 19 Changes

Net interest

IAS 19 IAS 19R

• The finance cost recognized in profit or loss comprises: - Interest cost on obligation - Expected return on plan assets

• Takes into account any material changes in obligation during the period and for assets takes into consideration the changes from actual contributions and benefit payments

• Net interest recognized in profit or loss comprises: - Interest cost on the obligation - Interest income on plan assets - Interest on effect of asset ceiling

• Net interest = liability (asset) on the balance sheet x discount rate at the beginning of the annual period • Takes into account the effect of benefit payments and contributions during the period

Change

• IAS 19R eliminates the concept of “expected return on plan assets” and replaces it with a calculation using discount rate

• P&L advantage of riskier investments may be lost, leading to revisions of investment policies • IAS 19R takes into account effect of asset ceiling (vs. IAS 19, which does not) • Increase to be expected for many in profit or loss

PS2 – Lessons from Actuarial Audits and Upcoming

IAS 19 Changes

Example: Net interest calculation

Facts January 1, 201x

Defined benefit obligation $60,000

Fair value of plan assets $50,000

Expected return on plan assets 6%

Discount rate 4%

Net interest cost (income) for 201x IAS 19 IAS 19R Change

Interest cost on obligation (= 4% x $60,000) $2,400 -

Expected return on plan assets (= 6% x $50,000) (3,000) -

Net interest cost = (4% x ($60,000 - $50,000)) - $400

Net interest cost (income) recognized in profit or loss ($600) $400 $1,000


IAS 19 Changes

Presentation – Statement of comprehensive income

IAS 19R – Requirements

• Current service cost

• Past service cost resulting from plan amendment or curtailment

• Gains and losses on settlement

Profit or loss

Before interest

• Obligation interest cost

• Interest income on plan assets

• Interest on effect of asset ceiling

• Actuarial gains or losses on obligation • Difference between interest income and return

on plan assets (including costs for managing plan assets)

• Any change in effect of asset ceiling, excluding amounts included in calculating net interest

Service cost

Net interest

Re-measurements

Profit or loss

As part of interest

OCI in non-recycling section


IAS 19 Changes

New disclosures required by IAS 19R include:

• Narrative description of risks to which the plan exposes the entity – focused on any unusual risks or those peculiar to plan/entity

• Actuarial gains and losses arising from changes in demographic assumptions must be shown separately from changes in economic assumptions

• Significant actuarial assumptions used to determine obligations and how a reasonably possible change to the significant actuarial assumptions would affect the obligation (sensitivity analysis)

• Fair value of plan assets must be divided into classes that distinguish the nature and risks of those assets and sub-divided into assets that do and don’t have a quoted price

• Narrative description of asset-liability matching strategies such as annuities or longevity swaps

• Effect of the plan on entity’s future cash flows including a description of funding policy, information about the obligation’s maturity profile


IAS 19 Changes

Other aspects affected by change

• Administration costs; treatment of those relating to asset management vs. the others

• Risk sharing features and contributions by employees and third parties; possible difference in treatment of employee contributions – IFRIC proceedings

• Classification of other benefits between short and long term; definition of short-term benefit may lead to some being re-classified as “other long-term benefits”

• Termination benefits; clarification of benefit being linked to termination of employment vs. benefits to stay for short period (maintenance benefit), treatment is different for benefits when employees accept an offer


IAS 19 Changes

January 1, 2012 January 1, 2013

Effective for annual periods

beginning on or after January 1, 2013

Retrospective application except:

1) Entity need not adjust carrying amount of assets

outside scope of IAS 19R for changes in employee

benefit costs included in the carrying amount before

beginning of earliest period presented

2) In FS for periods beginning before January 1, 2014,

entity need not present comparative information for

sensitivity disclosures


IAS 19 Changes

An employer’s standpoint – Case of National Bank of Canada Portrait of future benefits at National Bank of Canada

4 pension plans in Canada, all funded

• $2.23 billion in obligations, $2.36 billion in assets (October 31, 2011)

2 group insurance plans upon retirement

• $178 million in obligations (October 31, 2011)

A few other post-employment benefits

2 actuaries in Canada

1 auditor

• Bank’s financial statements • Pension funds’ financial statements

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IAS 19 Changes

Employer’s standpoint Accounting of future benefits – annual exercise

Fiscal year: from November 1 to October 31

Preliminary budget : generally in mid-July

Final budget: September

Preparation of annual financial statements: November

Throughout year:

• Longer-term budgets • Sensitivity analyses • Analysis of changes to standards • Quarterly financial statements • Pension funds’ financial statements (generally in February/March)

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IAS 19 Changes

Employer's standpoint Relations with plan actuaries and with the auditor

Actuaries involved in practically all the above-noted steps

Many sensitivity analyses conducted with the actuaries between preliminary and final budget. Little leeway once final budget filed

Impact analysis relating to very significant changes to the standards. Need to sensitize management in advance

Auditors involved mainly in the final-budget phase and FS preparation stage

Validation of treatment of special situations with auditors during budget preparations

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IAS 19 Changes

Employer's standpoint Year-end procedures (inc. final budget for next year)

Lengthy, rigorous process

Assumptions decided upon

• Recommendation by benefits sector and actuaries on key assumptions

• Retirement age • Departure rate • Rate of salary increase

• Work with treasury sector to determine expected long-term return. • Analysis of interest rate and determination of discount rate • Assumptions documentation

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IAS 19 Changes

Employer's standpoint Year-end procedures (inc. final budget for next year)

Analysis of extraordinary events

• Work with actuaries, auditors, and internal standards specialists for treatment

Preparation of note to financial statements

• Compliance with standards (internal standards specialists) • Validation by benefits sector • Validation by actuaries and auditors

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IAS 19 Changes

Employer's standpoint Impact of future benefits on financial statements

2011 financial statements:

• Accounting expense for benefits: $48 million • Bank revenues: $4.5 billion • Salaries and benefits: $1.78 billion • Accounting surplus (deficit): $136 million in pension and ($178 million) for other benefits • Bank assets: $156 billion

Relatively small, but a great deal of importance is attached

Significant volatility: between 2002 and 2011, the pension cost has been between $18 million and $64 million.

Balance sheet volatility also represents an issue for the bank on account of the impact on capital ratios

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IAS 19 Changes

Employer's standpoint Change in IAS 19 standard

Increased volatility of results

• Discount rate also leads to changes in the return on assets

Increased balance sheet volatility in relation to corridor method

• Significant impact on capital ratios (already present under IAS 19 – OCI approach)

Investment policy must be thought through

• Practically no advantage on an accounting basis to make risky investments (assets grow faster, but risk premium not present in results)

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IAS 19 Changes

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IAS 19 Changes

Documents

SESSION/SÉANCE: PS-2 Lessons from Actuarial Audits and