AC116 - may you live in interesting times

Accountancy SA,  Jun 2002  by Wielligh, Pieter von,  West, Craig

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In the May 2002 issue of Accountancy SA, we published an article on the practical auditing implications of the application of the revised accounting standard AC116 Employee Benefits. This article further explores certain issues identified in the aforementioned article.

The saying: "may you live in interesting times," is what accountants and auditors alike are facing with the constantly changing accounting standards. One standard in particular appears to be of concern to actuaries, and that is AC116 Employee Benefits as it applies to defined benefit plans. An example of a defined benefit plan is a pension fund. The scope of this article excludes the application of AC116 to defined contribution plans, an example of which is a provident fund, as this area is less problematic.

Recently, during a presentation to actuaries on the role of the auditor and particularly the application of SAAS620 Using the Work of an Expert, we were asked what the practical implications of applying AC116 are for the actuary. In other words, what does the actuary need to provide to the auditor to enable the auditor to satisfy him/herself that the valuation result complies with the provisions of the new statement? This single question has led to further discussions regarding the application of this standard both from a business perspective for fund administrators in serving their clients, and from an employer company reporting perspective.

It has become apparent from these discussions that actuaries and accountants alike often misinterpret the provisions of AC1 16. Actuaries sometimes see the wording of the statement from a different perspective as a result of inherent differences between the perspectives of an accountant/auditor and an actuary. Financial reporting staff of audit clients sometimes have not had sufficient exposure to the statement to understand the practical implications thereof.

Actuarial concerns

Liability valuation

The main concerns of defined benefit fund actuaries about the application of AC116, followed by our responses thereto, were:

* A valuation would be required every year in terms of the revised statement.We do not believe that this is a valid concern. The statement refers to valuations with sufficient regularity to ensure that the amounts in the financial statements do not differ materially from those that would have been determined through an actuarial valuation at balance sheet date. Retaining the status quo, i.e. a valuation performed every three years in terms of slb of the Pension Funds Act 24 of 1956, combined with the fund actuary performing a high level actuarial review on an annual basis to evaluate the reasonability of the actuarial assumptions applied as compared to actual experience over the year under review, should often be sufficient to achieve this. The use of estimates is expressly allowed by the statement.

* Two valuations would be required, as the valuation currently prepared for the trustees of the fund is based on a conservative long-term approach whereas the revised AC116 requires the use of an unbiased realistic (or best estimate) value when accounting for the surplus or deficit in the financial statements of the employer.

The valuation result is highly sensitive to the principal assumptions used. These assumptions determine the nature (conservative or aggressive) of the valuation result. The statement merely requires the assumptions used by the actuary to be unbiased (i.e. neither imprudent nor excessively conservative). This definition allows the use of professional judgement by the actuary in setting the assumptions. The actuary would be required to convince the auditor that the assumptions applied yield a realistic (or best estimate) fund valuation. This audit requirement should serve as a deterrent from over-conservatism and aggressiveness in setting the assumptions, provided the auditor has the necessary knowledge and experience to evaluate the representations of the actuary.

The actuaries' concerns above stem from the fact that an actuarial valuation takes approximately six to twelve months to complete. This period includes the gathering of data, testing the data for reasonability and performing the valuation. Of these steps, the first two consume the bulk of the actuary's time.

Asset valuation

A further concern raised by the actuaries is the application of a blanket rate to discount future cash flows of the assets and liabilities using market yields for high quality corporate bonds. The concern was that a discount rate of this nature would fail to take into consideration the implications of a different asset mix within the fund and detracts from the "realistic approach" that the actuaries' feel is apparent from the statement. Various factors are taken into account in determining an appropriate discount rate for a fund by the actuaries and a blanket application of a rate of this nature may not be appropriate for the particular circumstances (including asset mix) of the fund being valued and may project an inappropriate economic view of the fund in the financial statements.