Joint ventures and defined-benefit pensions will be most affected by new accounting rules in upcoming 2013 financial statements, according to Fitch Ratings.
Fresh disclosures on pension liabilities and group structure could be relevant to credit analysis and may affect ratings.
Enhanced disclosure is a core part of the revised standards, so 2013 annual reports are likely to have fresh details that could be relevant to our ratings analyses, for example new details of groups’ interests in other entities, including risks from structured vehicles and the transferability of cash flows. Incremental information on future cash flows and a sensitivity analysis should give a clearer picture of the likely future cash contributions necessary to meet the pension obligation.
There will be substantial changes in group accounting in 2013 annual results. Rules have been overhauled regarding the entities that have to be included in group accounts and those that can remain off balance sheet. The new rules also deal with interests in joint arrangements, where control is shared with another party. These arrangements are split into ones where the parties have rights to the net assets of an investment (joint venture) and ones where the parties have specific rights to assets or obligations for liabilities (joint operations).
The greatest change is the prohibition of proportionate consolidation for “joint ventures”. Instead of the income statement and balance sheet reflecting the entity’s share in the joint venture line by line, its share of profits and net assets will be shown as a single line item under the equity method. Revenue, expenses, gross assets and liabilities are likely to reduce, even though there may be little impact on net profit or assets. Conversely, for entities with interests in “joint operations”, a method similar to proportionate consolidation will now have to be applied. This might increase revenue, expenses, gross assets and liabilities where these interests were previously accounted for under the equity method.
“We expect many large European companies to adopt these group accounting changes in their 2013 financial statements, even though the effective date in the EU was extended by one year to end-2014. The revisions to the scope of consolidation are likely to be more material for financial institutions that hold interests in structured entities held off balance sheet. For other corporates, it is likely to have an effect in isolated cases only.
“Defined-benefit pension liabilities will also rise for some entities that previously took advantage of an option to keep some actuarial losses off balance sheet to reduce volatility. The revised standard removes the choice to use this “corridor” method. Some large corporates in Germany and the UK, where defined-benefit pension schemes are common, had previously taken advantage of this option. Many companies will also have a modest increase in pension costs because they will now have to use the ‘AA’ bond yield to calculate asset returns instead of their own assumptions. We expect the increases to be relatively small for most.