A comparison and contrast of German and international
financial reporting issues. Accounting for pensions –
IAS 19 versus German law

by: Stefan Tzschentke

Contents

1 Introduction  1

1.1 Economic problem  1
1.2 Objective and structure of the paper  1

2 Bases 2

2.1 Definitiones 2
2.2 Forms of company pension schemes 3
2.3 General problems in accounting for pensions  4

3 Accounting for pensions – German law 6

3.1 Recognition  6
3.2 Appraisal  7

3.2.1 Actuarial bases  7
3.2.2 Valuation methods  8

3.3 Further aspects  9

4 Accounting for pensions - IAS 19 10

4.1 Recognition  10
4.2 Appraisal  10

4.2.1 Actuarial bases  11
4.2.2 Valuation method 11
4.2.3 Plan assets  12

4.3 Cost recognition  12
4.4 Further aspects  14

5 Economic analysis of HGB and IAS pension regulations  15

5.1 Comparison  15
5.2 Conclusion  17

Bibliography  IV

List of statute law and jurisdiction VIII

Other sources VIII

List of abbreviations

BFH = Bundesfinanzhof (surpreme tax court)
BetrAVG = Gesetz zur Verbesserung der betrieblichen Altersversorgung (Employee Pension Act)
BStBl. = Bundessteuerblatt
DBO = Defined Benefit Obligation
DBL = Defined Benefit Liability
DRS = German Accounting Standard(s)
DRSC = German Accounting Standard Committee
DStZ = Deutsche Steuer-Zeitung (periodical)
DStR = Deutsches Steuerrecht (peridical)
EGHGB = Einführungsgesetz zum Handelsgesetzbuch
HFA = Hauptfachausschuß of the IDW
IAS = International Accounting Standard(s)
IASC = International Accounting Standards Committee
IDW = Institute der Wirtschaftsprüfer in Deutschland e.V.
IFRS = International Financial Reporting Standards
IFRSC = International Financial Reporting Standards Committee
KPMG = Klynfeld Peat Marwick Goerdler
PUC = Projected Unit Credit
SIC = Standing Committee on Interpretations (of the IASC)
GAAP = Generally Accepted Accounting Principles
 

1 Introduction

1.1 Economic problem

Although accounting for company pension schemes is one of the most controversial topics of discussion in the international accounting trade¹, many investors do not pay it due attention. In future, even more so than now, annual results will be influenced by latent reserves and obligations, resulting from different ways of accounting for pension benefit schemes². German financial statements and those following either IAS or US-GAAP often differ significantly on this point.³ The International Accounting Standards and the German Commercial Code are based on different principles. Whereas German regulations are dominated by the imperative of the protection of creditors, IAS lay the focus of accounting on a true and fair view of financial statements in order to provide a suitable basis for investment decisions.⁴ These divergent priorities are reflected in the accounting for pensions as well. The two main problems in accounting for pensions are the recognition and the appraisal of pension provisions. Eventually both accounting systems face the same problems and each one has a different way of resolving them. On the other hand, HGB and IAS unanimously agree on the fact that company pension schemes that do not require pension provisions, do not represent an accounting problem.

1.2 Objective and structure of the paper

The objective of the treatise on hand is the depiction of the difference between IAS amd HGB regarding the recognition and accounting for pension as well as the resulting accounting-effects on the balance-sheet. The paper will first try to give an overview of the term “pensions” as it is used in German law⁵ and in the IAS, and then – in the second part of the bases– explain the underlying problematic nature of accounting for pensions. In the third and fourth part the respective regulations, first according to German law and then IAS, will be particularized. The conclusion will provied an extensive comparison between the two systems as well as a critical appraisal of the differences and possible financial effects.

2 Bases

2.1 Definitions

Different way exist for businesses in which to provide for an employee’s retirement. This chapter will try to enclose the provisions for retirement, first according to German regulations and then according to IAS. German income tax law provides a legal definition of the term “pension reserves” in § 6a EStG by defining “reserves for a pension obligation”.⁶ The HGB however, lacks an exact definition. Instead, pension obligations are commonly described as all “obligations for company pension schemes”.⁷ According to § 1, I of the Employee Pension Act (BetrAVG)⁸ this includes all provisions for retirement-, disability- and survivor’s benefits an employer grants his employees and that arise out of the employment condition. Following the German Federal Labour Court three characteristics for company pensions schemes can be deduced:⁹

• The benefits a (former) employee receives must have provisionary character,
• they have to be connected to a biological incident such as age, invalidity or death and
• they must arise out of the employment condition.

In contrast, the International Accounting Standards provide detailed definitions of employee benefits and retirement provisions. IAS 19 provides rules for the accounting, recognition and appraisal of employee benefits which are divided up into five categories¹⁰:

• Short-term benefits due in 12 months after the reporting period, such as wages and bonuses;
• post-employment benefits, especially company pension schemes;
• other long-term benefits such as sabbatical leave;
• termination benefits, including severance pay, job training and counselling;
• equity compensation arrangements, which include stock option plans, employee share ownership and similar compensation schemes.

Whereas IAS 19 includes accounting directions on all of the above, the most detailed instructions are given for post-employment benefits.¹¹

2.2 Forms of company pension schemes

In order to comply with pension obligations towards its employees an enterprise can choose to make the necessary allocations itself, or to contract the services of an external pension fund – to a large extent this decision will depend on how the business is best funded.¹² Furthermore can a businesses’ pension obligations be divided into running pension payments and future pension obligations.¹³ The following figure summarizes the possibilities an enterprise has:

Fig. 1: Types of Company Pension Schemes [figure only in downloadfile]

Direct Commitments make it binding for the employer to provide the contractual obligation himself at maturity. Company Welfare funds periodically receive a certain amount of money from the respective enterprises in order to provide the pension payments. Neither has the enterprise an obligation to pay the welfare fund nor has the beneficiary any claim against the latter. This type of pension scheme thus is equivalent to a direct commitment. Independent pension funds are similar, yet in this case the beneficiary has a claim against the fund. External funding means that an enterprise transfers assets to a third, legally independent party in order for it to provide pensions for the beneficiaries. An enterprise using direct insurance policies buys life insurance policies for its employees and has to pay the life underwriter.¹⁴

[...]

1 See Schmidtbauer, R. (2003), p. 795.

2 For a detailed analysis of this influence see Zimmermann/Schilling (2003), p. 865 ff.

3 See Wolz, M. (2000), p. 1390. The paper on hand will focus on HGB and IAS regulations, however, regarding pensions most IAS regulations agree with US-GAAP.

4 See IAS 1.7 ff.

5 Although the regulations in the German Commercial Code are often influenced significantly by income tax law because of the authoritative principle, this paper will focus mainly on the HGB.

6 See, Heubeck, K. (1987), p. 9.

7 See, Thoms- Meyer, D. (1996), Petersen, J. (2002), p. 11.

8 Gesetz zur Verbesserung der betrieblichen Altersvorsorge, dating from 19.12.1974, BGB1. I 1974, p. 3610.

9 Compare with judgments from the 08.05.1990 – 3 AZR 121/89 in: Der Betrieb (1990), p. 2375 and rom 25.10.1994 – 3AZR 279/94, in: Der Betrieb (1995), p. 573 f.

10 See IAS 19.4.

11 See Förschle et al. (2003), p. 57.

12 See Trägner, G. (1977), p. 28.

13 See, for example, Eggloff, F. (1999), p. 30.

14 For further details see, for example, Kremin-Buch, B. (2002), p. 191 ff.; Petersen, J. (2002), p. 16 ff.