Following Mercer's concerns that changes to the IAS 19 company accounting standards for employee benefits would significantly alter asset allocation decisions, Hewitt Associates has said that the new proposals for the standard could increase reported pension costs.

The International Accounting Standards Board's (IASB) proposals will increase profit and loss (P&L) charges for most UK defined benefit (DB) pension schemes, and will significantly increase the volatility of the balance sheet liability for some, according to the consultant.

"At present, there are three key components of pension cost in P&L," commented Simon Robinson, pension consultant at Hewitt Associates. "First is service cost, which is the cost of benefits accruing to pension scheme members during the year. Second, is interest cost, which is the increase to the value of previously accrued benefits because retirement is one year closer. Third, is the expected return on assets, which is a P&L credit reflecting that the company has at least partially funded accrued benefits in advance."

Robinson said he expected most UK companies to see an increase to their income statement charge for pensions under the new draft IAS19 structure, because the typical investment strategy of pension plans targets a return higher than the discount rate.

"However, we do welcome this proposal as it is less painful than an approach the IASB was considering in which no credit whatsoever would be given in the income statement for advance funding of pension plans; where the expected rate of return on assets would have been considered to be nil. Using that - thankfully discarded - approach, the charge to the income statement in the example would have changed from a £1million credit to a £21million charge."

Principal consultant at Hewitt, Martin Lowes, added that another change will be the option to defer recognition of gains and losses, the 'corridor', being removed.

"Although relatively rare in the UK, around ten per cent of large companies do use this option and it can mean that the balance sheet asset or liability disclosed bears little resemblance to the current financial position of the pension plan.

"This beings IAS 19 into line with other accounting standards for pensions, such as US and UK standards. Plus, in our experience, analysts tend to adjust for the actual financial position anyway, ignoring the use of the corridor."

Lowes said companies that do use the corridor should think about the effect this has on their balance sheets, and that, for many companies, liabilities when it comes to pensions will increase significantly.

"Perhaps this would also encourage companies to de-risk the investment strategy of the pension plan, particularly where the plan is material to the supporting company."

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