Willie Duncan, a restructuring partner at RSM discusses the likely impact on some charities of recent changes in accounting standards.
Results of last year’s annual charity survey identified that over three quarters of the respondents had a pension scheme with almost 15 per cent operating a defined benefit (DB) scheme. Open DB schemes may be more common in the voluntary sector due to many organisations taking on contracts or undertakings from local authorities where associated employees are members of multi-employer DB schemes. 44 per cent of respondents expected to have to increase contributions over the next 12 months, partly in response to increasing DB scheme deficits and partly as a result of auto-enrolment.
Impact of new reporting standards
The introduction of Financial Reporting Standard 102 could have a major impact on some charities’ financial statements, particularly those who participate in multi-employer DB pension schemes.
Previous accounting treatment (under the ‘old’ standard FRS17) meant that many employers were able to account for them as defined contribution schemes because they could not determine their share of the underlying assets and liabilities in the scheme on a consistent and reasonable basis. Under FRS17 their accounts would only recognise the contributions paid into the scheme over the financial year as an expense in the profit and loss or income and expenditure account and there would be no deficit liability on the balance sheet.
However, for accounting periods on or after 1 January 2015, where an employer is unable to identify its share of assets and liabilities of a multi-employer scheme, and it has a funding agreement in place to eliminate a scheme deficit, it must recognise on its balance sheet an amount equal to the net present value of future deficit reduction payments, and in its profit and loss account an amount equal to the unwinding of the discount rate.
Schemes suffering deficit
Most multi-employer schemes are likely to be in deficit, so there will be a large number of employers who will have to fully recognise DB pension scheme liabilities in their accounts for the first time. Those employers may also experience more volatility in the income and expenditure account as deficit funding plans are revised with each triennial actuarial valuation.
Many trustees’ response might be 'So what – isn’t this just a technical accounting issue?.' Such a response would not recognise the likelihood that these accounting changes could raise real practical issues with many charity trustees who for the first time may be forced to think about the sustainability of the pension schemes they sponsor, and may cause some real concerns about their own balance sheet strength and ability to access future funding.
Restrictions of financial support
How many donors or funders will wish to provide a charity with financial support to fund a pension deficit rather than to further the charitable aims of the organisation? Future funding support may come with strings attached for restricted purposes, rather than for use at the trustees’ discretion. Over time this may leave the charity with an increasing problem of funding its pension deficit from an ever decreasing general reserve fund.
Know your pension liabilities
Where a charity is heavily reliant on winning new sources of income and actively pursues outsourcing or partnering opportunities, the impact of pension risk and liabilities can be easy to overlook. It is vital that those involved in winning new contracts have a full understanding of the potential risks posed by pension obligations under those contracts and avoid taking on unsustainable new pension liabilities.
Attempts to restructure the charity to avoid or ‘ring fence’ pension liabilities may unintentionally increase the risks that trustees are seeking to avoid. Organisations may find that as a result of a restructure they have created an employment cessation event and accidentally crystallised substantial pension liabilities.
Seek professional advice
Charity trustees with concerns about the impact of the new accounting standard on their balance sheet or the increasing risk, impact and cost of pension schemes should seek appropriate professional advice.
If you would like any more information please contact Willie Duncan or your usual RSM contact.