UK businesses must take action now to avoid potentially dire consequences of accounting standard FRS 17, a firm of accountants has warned.

Accountancy firm PKF warned that FRS17 ‘Retirement benefits’ obliges UK businesses within its scope to account for any surplus or deficit in a defined benefit pension scheme.

“Until now,” PKF said, “these have merely had to be disclosed in the notes to the accounts. But for periods beginning on or after 1 January 2005 they will have to be included in the balance sheet.”

The firm says this could result in a solvent business “suddenly appearing insolvent when it has to include its pension scheme deficit – which may be huge – in its accounts.”

PKF adds that while accounting for a surplus or deficit does not, of itself, improve or worsen the employer’s financial position, consequences may include:

• causing breaches of borrowing covenants
• affecting management remuneration schemes that are based on results; and
• precluding a company from paying dividends

Philip Long, head of corporate recovery at PKF, said: “FRS 17 surpluses or deficits should be included in balance sheets for accounting periods beginning on or after 1 January 2005, and while the majority of businesses have included these figures in the notes to previous accounts, they haven’t yet affected the bottom line.”

He added, “Many business owners may be surprised to find they are insolvent on paper when they do and by this time it may be too late. If enough businesses fail to act it could spell disaster for UK insolvency rates.”

The surplus or deficit calculated under FRS17 is based on the estimated cost of providing the benefits earned to date by employees. The volatility of such estimates, along with the lack of understanding about the rule, is leading to nervousness across the business community.

One business which has disclosed FRS17 figures in its accounts for the last three years has seen the pension scheme deficit almost double over this period, even though it has experienced good investment returns on the scheme assets and has increased contributions into the scheme.

The warning from PKF signals the end of the transitional arrangements set out when the standard was first published in 2001. Because of the European Union’s decision to apply IFRS from 1 January 2005, the ASB decided to extend the transitional arrangements until that date.

As PKF noted, the shift from notes in the accounts to the balance sheet revives all of the concerns that were voiced during the standard’s development over the impact of volatile pension fund assets on the rest of the company.

Over the weekend of 12-13 February, for example, campaigners lobbied Downing Street and the Labour Party spring conference about the problems faced by employees who found their pension contributions were worthless when companies became insolvent – often because of the scale of their pension liabilities.