Impact of negative interest rates on accounting for pension obligations in accordance with IAS 19
What effect do negative interest rates have on accounting for pension plans in accordance with IAS 19? What discount rate should be applied to these obligations? We share some thoughts with you.
IFRS accounting for Swiss pension plans in a negative interest rate environment
IAS 19 specifies that the discount rate used to calculate the defined benefit obligation (DBO) should be determined as at the reporting date by reference to market yields on high-quality corporate bonds with the same term as the pension obligations. As interest rates have fallen again in the last few months, discount rates for some DBO durations have actually entered negative territory. IAS 19 does not explicitly state whether a DBO should be calculated using negative discount rates, but this is implied given the reference to the capital market mentioned above.
When accounting for pension obligations, this initially results in an increase in the DBO, which should be captured in remeasurement and recorded under other comprehensive income (OCI). For subsequent periods, this means pension costs will include a higher service cost on the one hand, but also interest income from the “unwinding” of the liability on the other.
There is another aspect to consider when preparing accounting for Swiss pension plans in accordance with IFRS in a negative interest rate environment. The DBO calculation also requires an assumption about the future interest rate on the retirement savings. In the past, many preparers have set this rate to match the discount rate for the DBO. If discount rates are negative, this practice cannot be continued, because such an assumption is not consistent with the pension law provisions. Various factors need to be taken into account when making an assumption about the future interest rate on the retirement savings, such as the statutory minimum interest rate (for 2020: 1% for BVG retirement savings), the plan’s current financial position and expected returns on the assets.
