At first blush, pension accounting doesn’t appear to be a subject that could raise temperatures. But in speaking to our global experts, it’s hard not to get caught up in the issues. Only one standard will eventually rule supreme—it’s drama on the world stage.

Not too long ago, most major economies had their own accounting standards boards and ways of accounting for pensions. Yet as the globalization of economies accelerated, the advantages of converged pension accounting standards became increasingly clear. After years of inconsistencies, similarities began to emerge.

The heavyweights in the ongoing struggle have been the International Financial Reporting Standards (IFRS) and U.S. and UK generally accepted accounting principals (GAAP). IFRS is the current leader. All listed EU companies have been required to use IFRS since 2005; well over 100 countriesnow require or permit IFRS reporting.

A comparative review of the major accounting standards for pension accounting reveals far more similarities than differences. The U.S., UK and Canadian standards are all very similar to the international standard, IAS 19, Accounting for Employee Benefits. European accounting standards converged a number of years ago. The Japanese standard is nearly identical to IAS 19 and plans to be fully convergent with international standards by 2011, as does India’s.

Yet, under current rules it is still possible to have a benefit pension plan that is valued as a liability under U.S. GAAP, but as a corporate asset under UK GAAP or IFRS. Complete convergence of accounting standards would end such anomalies.

The Corridor—The Final Frontier

Having read so far, you might be fooled into thinking that the international standards have won the battle and it is only a matter of time before all other global standards concede and fall into line. The major final hurdle, however, provides a final twist.

IAS 19 permits companies to use a “corridor” to hold some pension assets and liabilities off the balance sheet rather than showing them at face value. While this approach was once common, IAS 19 is now one of the few standards to retain it. The UK led the world in 2001 by pushing to have the full pension scheme surplus or deficit fall directly on the employer in FRS 17; the early phasing out of the corridor approach can be seen as a direct result of their influence. The U.S. followed suit in 2006 with FAS 158, which made a similar adjustment, leaving only IAS 19 clinging to the corridor.

The International Accounting Standards Board (IASB) has, however, announced that it will abolish the corridor and insist that companies show their pension scheme assets and liabilities in full on the balance sheet. Changes in net pension assets or liabilities, which used to flow through off balance sheet, will now be channelled directly into the Profit and Loss (P&L) statement.

In view of the billions of euros, dollars and pounds that are currently held off the balance sheet, the proposed changes may be far more than an arcane argument for actuaries. As just one example of the fallout, senior executives whose compensation is based on P&L results may find that the new rules will have a direct and significant effect on their income. As another, investment analysts will have to adjust their evaluation of organizations based on the different results we will see. Pension plan sponsors may be influenced toward choosing more stable asset classes or change their plan design to lessen potential P&L volatility.

Advocates of the corridor argue that pensions, which are by nature long-term obligations, should not be so sensitive to short-term economic variations. Detractors argue that the corridor artificially suppresses gains and losses—creating a misleading balance sheet that doesn’t accurately reflect deficits or surpluses.

IAS 19 Update—Phase One

It would seem that the international accounting standard is dragging the others toward its approach. It seems pertinent, therefore, to look at how IAS 19 intends to progress, to predict whether the other standards will follow.