In February 2011, Seaton’s Limited filed for protection under the Companies’ Creditors Arrangement Act

In February 2011, Seaton’s Limited filed for protection under the Companies’ Creditors Arrangement Act due to liquidity problems. The act gives troubled companies time to restructure their debt and to hopefully avoid bankruptcy. As part of the restructuring process, Seaton’s approached its employees and pensioners to split the surplus in the pension plan and allow Seaton’s to withdraw a portion of the surplus in cash to help lessen the liquidity problems. In note 9 to the unaudited financial statements, the following was disclosed with respect to the company’s pension plan for the year ended December 31, 2011 (in thousands of dollars):

Plan assets at market ……………………………………………  $735,501

Plan assets—four-year moving average market basis ……………..600,662

Projected benefit obligations……………………………………….327,101

Pension surplus……………………………………………………..273,561

Unrecognized actuarial experience adjustment…………………….119,181

Pension surplus per financial statements…………………………..154,380

The company further notes that, effective January 1, 2011, the interest rate assumption changed from 9% to 8% to reflect more conservative long-term interest rate expectations.

Instructions

Adopt the role of the pensioners as well as the role of company management and discuss the financial reporting issues related to management’s desire to split and withdraw from the pension plan surplus. Assume that Seaton’s is a private company.

Overview

-       Seaton’s has several plans by which it provides pension and other benefits to its employees. Of relevance here are the defined benefit plans and the surplus related therein.

-       As an aside— legislation does not generally allow employers to access and “strip” pension surpluses from pension plans; however, it does allow for “surplus-splitting”. “Surplus-splitting” allows the employer or sponsor of the plan and the employees to negotiate a sharing of the surplus.

-       In this case, Seaton’s is looking for some extra funds to help with its cash flow deficiency during and after the restructuring period allowed under the Companies’ Creditors Arrangement Act. The surplus funds would also potentially be used to ease the burden on employees let go during the inevitable restructuring and downsizing. The measurement of the surplus is therefore very important within the context of this environment.

-       The employees/pensioners and the company will be looking for a reasonable assessment of the surplus on which to make this decision— noting of course that there will be a cash impact.

-       The pensioners do not want the fund to be stripped and will likely want a more conservative estimate whereas the company management may want a more aggressive estimate so that they can get more cash out.

-       The statements are unaudited and therefore care should be taken with the numbers. The respective parties would likely want audited GAAP statements. As a private entity, the company may use IFRS or ASPE.

Analysis and Recommendations

-       Per the note, with plan assets valued at market related values (four-year moving average market basis) the surplus is valued at $273,561. Note that only $154,380 is recorded as an asset on the consolidated financial statements, as GAAP has historically allowed a deferral of unrecognized actuarial experience adjustments. The full surplus of $273,561 is the relevant number.

o   ASPE and IFRS both use fair value to value the assets (as opposed to market related value which is a pre 2011 GAAP alternative) so both parties may wish to consider which value represents the true value of the assets.

o   Depending on how the assets are valued, the amount available to be shared or split could be higher than $273,561. Use of market value may increase the surplus.

-       Note also that the interest rate assumptions have been changed to 8% from 9%. This causes the obligation to increase and thereby reduces the surplus.

o   There are many assumptions used in valuing the obligation as well— mortality, turnover, inflation. These all add measurement uncertainty and should be looked at carefully.

o   The discount rate is a matter of judgement and should reflect interest rates for a similar liability of similar maturity.

o   Under ASPE - may use either a current yield on high-quality debt instruments or a current settlement rate. IFRS requires use of the former. Having said that, there is judgement used in determining these rates.

o   It may be of benefit to the employees/future pensioners to want to have the surplus understated so that the “hidden” surplus is retained in the plan. Employees who were to be “downsized” might want to have a higher surplus if they were to share in the “surplus splitting” up-front.

o   Seaton’s, on the one hand, may wish to show a higher surplus in order to have access to much needed cash in the surplus-splitting. On the other hand, Seaton’s might wish to show a lower surplus to protect the employees and possibly to save the excess to reduce future cash funding requirements.

-       Regardless of any intended or unintended bias, the measurement uncertainty is very high and, in this case, measurement is doubly important since it will result in an actual cash outflow from the plan. The economic reality of the status of the plan does not change – but the accounting policy choices will change the way the surplus is measured.