Perspectives

Pension costs reported by higher education institutions

Understanding the pension costs reported in the financial statements of higher education institutions

Introduction

Higher education institutions (HEIs) have a legal and regulatory obligation to prepare, for each financial year, a set of financial statements (or ‘annual accounts’). The annual accounts are the primary publicly-available source of information about an HEI’s finances, and they are designed to be used by a broad range of individuals and organisations to learn about the institution and to inform their interactions with it. Such users include the institution’s Governing Body, regulators and funding bodies, employees and students, lenders and creditors, grant-awarding bodies and the general public.

Reporting pension cost

For many HEIs, the annual accounts for the year ended 31 July 2019 will reflect large pension adjustments which will have a significant impact on the institution’s reported performance and its financial position. Reporting such significant pension costs will be a major concern, but how have the costs been measured and what do they actually tell us?

A pension actuary will be involved, either directly or indirectly, in measuring the pension cost. Going back a number of years, we may not have sought a deeper meaning because it was sufficient to know that the numbers had been calculated correctly. However, the Higher Education sector (HE sector) is now reporting pension costs which have increased significantly and this has created a need to assess and explain the holistic impact of pension cost on the overall performance and financial position of the institution.

This relatively new development in relation to HE sector pensions means that:

1. Preparers of the annual accounts will need a level of pension knowledge, and an understanding of how pension cost is reported, which is sufficient to allow them to discuss and explain the transactions and adjustments disclosed in the financial statements.

Undoubtedly there will be variations in the level of understanding across the HE sector. However, in general, I don’t presume that finance professionals in the HE sector will be comfortable with pensions reporting. Whilst training as an accountant I certainly don’t recall anything more than a passing reference to pensions.
 

2. Users of the annual accounts will need to interpret the impact of the pension adjustments on the HEI’s reported performance and year-end financial position.

If users don’t understand the pension adjustments, then I believe that there is a significant risk that they will misinterpret the financial performance and financial position of the institution, with the effect that any decisions or actions taken based on the annual accounts will be poorly informed, and potentially wrong.

Reporting pension cost – an example

To give context to this matter, we can consider an example based on an illustrative medium sized institution. This institution has generated an income of £400m in 2018-19. I have assumed that the institution has a financial strategy which aims to deliver a 4% surplus each year, based on budgeted staff costs being 55% of income and other expenditure being 41% income.

The pension aspect of the example is based on the main pension scheme available in the HE sector, the Universities Superannuation Scheme (USS), and it will be helpful to know that the recognition and measurement of the USS cost reported in the annual accounts is comprised of the following three components:

  • An expense relating to the value of contributions paid by an entity
    (Staff costs - Statement of Comprehensive Income and Expenditure);
  • A liability calculated on the basis of future deficit contributions required under the most recently completed actuarial valuation (Other provisions - Balance sheet);
  • An expense representing the net change in liability during the period
    (Staff costs - Statement of Comprehensive Income and Expenditure).

To highlight the impact of this expense (referred to as the ‘movement on USS provision’), I have stripped it out of staff costs and shown it separately, and also presented the surplus (deficit) for the year both including and excluding this expense. Note that this expense is not within the costs which have been budgeted to deliver a 4% surplus, since it is determined by events during the reporting period, and by the economic conditions at the reporting date – all of which are outside the control of the reporting institution.
 

The example aims to highlight the relative size of the pension adjustments, the lack of consistency and comparability between reporting periods, and the impact on the reported performance of the reporting entity.

The pension cost for all three periods shown in the example will appear in the 2018-19 annual accounts as: current period results (2018-19); prior period comparatives (2017-18); and, in a post-balance sheet event disclosure note (2019-20). Therefore, within a single set of annual accounts the preparer and reader are faced with:

  • One year in which the movement in the USS provision has a relatively insignificant impact on the surplus (deficit) for the year (2017-18);
  • One year in which the movement in the USS provision has a hugely significant adverse impact on the surplus (deficit) for the year, being mainly responsible creating a deficit of £54m (2018-19);
  • One year in which the movement in the USS provision has a hugely significant positive impact on the surplus (deficit) for the year, mainly responsible for creating a surplus of £57m (2019-20).

Conclusion

This simple* example is based on an underlying assumption that the institution will generate a 4% surplus, and arriving at such a position can be well justified and explained. However, I am suggesting that the pension cost, which can fundamentally change the expected financial performance and create a large deficit (2018-19) or a large surplus (2019-20), is not well understood by most stakeholders. Noting the impact of pension cost on the financial performance and financial position, this issue needs to be understood better than it is now.

The British Universities Finance Directors Group (BUFDG) recently issued, “Understanding University Finance”, which included a section on pensions, and this will be followed up with the, “Guide to Accounting for Pensions in Higher Education Institutions”, in early 2020. I am pleased to have the opportunity to be involved with both publications, and believe that they will help to significantly improve the understanding of pensions in the HE sector. I am also pleased to have regular discussion with the pension experts at Universities UK (UUK) and the Universities and Colleges Employers Association (UCEA), and if any readers wish to discuss any matter related to HE pensions I’d be happy to have a chat, and please feel free to get in touch.
 

* The example only considers the impact of one pension scheme available in the HE sector. Most institutions will participate in two, three or four different schemes, and it is likely that the approach to recognising and measuring pension cost will differ across these schemes. This introduces even more complexity, which further increases the difficulty in understanding the impact of pension cost on the performance and financial position of HEIs.

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