Employee Future Benefits

1. Employee Future Benefits Nancy Estey, Principal, Accounting Standards Board staff AK/ADMS 4510 M&N – Winter 2004 February 23, 2004 4-7 pm; 7-10 pm

2. Discussion Outline • Recent headlines • Environment driving change • Current financial statement impacts • Background • A compensation package • Types of employee future benefits • Financial statement objectives • Deferred compensation • Discount rate

3. Discussion Outline • Developments in Canada • Highlights of Canadian disclosure improvements • What’s Ahead • Understanding “smoothing” • The “Corridor” approach • Move to presentation format

4. Recent Headlines • Rates, high dollar erase pension gains (G&M, Jan 22/04) • Pensions seen as key factor in executive pay (G&M, Jan 7/04) • Pension smoothing hides the facts (G&M, Oct 15/03) • Pension shortfalls threaten to explode (G&M, May 12/03)

5. Environment Driving Change • Significant losses sustained by many pension plans in the last few years + lower market interest rates • Increased benefit obligation • Growing deficit position • Drain on cash flow • Increased pension costs • Post-Enron era • “Smoothing” results in off-balance sheet debt, which draws attention • Poor plan performance increases this debt • Need for transparency

6. Current Financial Statement Impacts Average Pension Expense ($ million) Source: Towers Perrin review of financial statements of 90 major Canadian Companies that sponsor defined benefit plans.

7. Current Financial Statement Impacts Average Deferred Pension Cost ($ million) 2001 2002 2000 Source: Towers Perrin review of financial statements of 90 major Canadian Companies that sponsor defined benefit plans.

8. A Compensation Package Cash Paid This Year When Retired • Salary • Pension benefits • Fringe benefits • Vision Care • Bonus • Drug Plan • Profit sharing • Life Insurance • Stock options

9. Types of Employee Future Benefits • Accounting for future promises • promised pension and other benefits when they retire • Eligibility via age and service • Pension Benefits • Defined benefit plans now a major cost of doing business • Low interest rates • Decline in equity markets • Post-retirement benefits • Life insurance • Extended health care • double-digit growth due to Rising drug costs, aging membership

10. F/S Objectives • Plan performance affects • Financial Position (B/S) • Operating Results (I/S) • Changes in Financial Position (Cash flows) • Employee Future Benefits Accounting • CICA Section 3461 • FAS 87, 88, 106, 112, 132(r) in the US

11. Deferred Compensation • Estimate amounts to be paid out in the future (future benefit payments) • Discount those future payments to reflect the time value of money • Allocate the resulting amount “deferred compensation cost” • Over the periods of service required of the employees in exchange for the promise of those future payments • So, cost of future benefits recognized as the employees render service to the company

12. Discount Rate • Market-driven rate • Controversial • Revalue at each balance sheet date • Discount rate  Obligation  • Discount rate  Obligation  • Volatility in I/S • Corridor method (element of smoothing) helps • But volatility unwelcome

13. Developments in Canada • Long-term • Participate in global project • Start over from 1st principles • Short-term • Limited-scope disclosure enhancements • Revised disclosure requirements to be issued on or about March 1, 2004

14. An entity shall recognize a liabilityandan expense for post employment benefits and compensated absences that do not vestor accumulate when (a) the event obligating the Highlights of CDN Disclosure Enhancements • Disclosures related to the reporting entity’s financial statements • Total cash payments • Balance sheet classification of the accrued benefit asset/liability • Clarification on the accounting policy disclosures that should be made • Components of costs recognized (in addition to the total) • Reconciliation of the accrued benefit obligation to the balance sheet asset or liability • Effects of a one-percentage-point increase and decrease in the assumed health care cost trend rates

15. An entity shall recognize a liabilityandan expense for post employment benefits and compensated absences that do not vestor accumulate when (a) the event obligating the Highlights of CDN Disclosure Enhancements(cont’d) • Disclosures related to the benefit plan • Description of the type of plans • Actual allocation of plan assets by major asset category • Date used to measure the plan assets and the benefit obligations • Effective date of the last (as well as the next required) actuarial valuation for funding purposes • Significant assumptions • Reconciliations - plan obligation and plan assets

16. An entity shall recognize a liabilityandan expense for post employment benefits and compensated absences that do not vestor accumulate when (a) the event obligating the Highlights of CDN Disclosure Enhancements(cont’d) • Distinction between “public” and non-”public” entity requirements • “Public” implies public enterprises, co-operative organizations, deposit-taking institutions or life insurance companies • Covers pension benefits, but also post-retirement and post-employment plans • Interim financial statements • Total benefit cost

17. What’s Ahead? Developments Around the World • UK – FRS 17, mark to market • Aborted; punted to IASB • IASB • Plans to issue ED of improvements to IAS 19 in Q2 2004 with final standard Q1 2005 • the removal of options for the deferred recognition of actuarial gains and losses • enhancing disclosure

18. What’s Ahead? Developments Around the World (cont’d) • US FASB • Disclosure ‘quick fix’ • Final statement issued with effective date for fiscal years ending after December 15, 2003 • more complete information about plan assets, obligations, cash flows, and net cost • assists users of f/s in assessing the market risk of plan assets, the amount and timing of cash flows, and reported earnings.

19. Understanding “Smoothing” • Delayed recognition of events (spread changes over the future) • Amortize to expense over a period of time rather than immediate recognition • Past service costs • Actuarial gains/losses [also corridor approach] • Treatment of returns on pension plan assets • Expected return, not actual return (difference amortized to expense over time) • Market-related value of plan assets deferring recognition of recent investment gains and losses for up to 5 years

20. The “Corridor” approach

21. Move to Presentation format • Debate “smoothing” i.e., deferred recognition of events