Peter Black's Case Summary
Role: Investment Consultant? As we need to advise whether he should hold on to the bonds? Don’t know if we should include something like as the investment consultant we need to focus on the two different pension plans along with the conversion to IFRS standard and perform an assessment on whether Black should hold or sell the shares
Users and Objectives:
Peter Black – Need to review F/S and detailed analysis of the two pension plans to determine whether he should keep or sell the shares
Air Canada senior executive – Since they have a transition to the defined contribution pension plan + conversion to IFRS, shareholders of Air Canada may contemplate to sell their shares (as in Black’s case), in which it will affect Air Canada’s market share. Thus they might have to re-structure their strategic planning for the future years
Current shareholders of Air Canada – Same reason as Black as they need to understand the impact of the new …show more content…
pension plan and the IFRS conversion. This will help them assess whether they should keep their investment in Air Canada
Unions and retirees – Due to solvency issues, Air Canada was on the verge of defaulting their pension payments. With the new pension plan and conversion, the unions and retirees can use the additional information and analysis to determine if Air Canada still has a high risk of defaulting payments
CUPE, ACPA and CAW – All three parties were against the pension plan change which actually resulted in a major strike. This analysis will help them understand the impact and the rationale of why Air Canada proposed the pension plan change
Constraints/Bias:
As the case has mentioned Air Canada will be moving towards IFRS, therefore IFRS will definitely be a constraint. Also as with IFRS there is more flexibility, thus Air Canada will have more alternatives in deciding which accounting policy to employ. This could lead to user bias as they might adopt accounting policies that will benefit only themselves even though it may not violate the IFRS standard (i.e. not performing a fiduciary duty to the shareholders).
Issues # 1: Financial Risk of Defined Benefit Pension Plans
Air Canada has approximately 23,000 full-time employees whose collective pension plans are among the largest in the country. The company has had issues in the past to fund their employees ' defined benefit pension plan. Air Canada 's financial struggle is well documented, having recently emerged from bankruptcy after an organizational restructuring. It is also recovering from the aftermath of the recession which had a huge impact on the airline industry throughout the globe.
Implication: Over time, the contributions made to these plans may exceed or be insufficient for the pension obligations of the employer. This plan has a lot of uncertainty as the cost is dependent on uncertain future variables that include but is not limited to, employee turnover, mortality and inflation. In defined benefit plans like the one Air Canada has, the employer bears the investment risk or benefit from surpluses if any. As at Jan. 1, 2011, the company 's pension deficit stood at $2.1-billion, which was $600-million better than a year ago as a result of a strong fund performance1 in 2010. However, this deficit is not sustainable and has not been sustainable for most of the decade, as it puts at risk both the viability of the company and the pensions of all employees." Payments are forecast to soar further in 2014 because a cap on pension contributions previously negotiated with unions will lapse at the end of 2013.
Recommendation: It seems that the defined benefit pension plan for the 23,000 employees are putting significant strain on Air Canada 's financial statements. With the looming burden of pension funding, Air Canada is up against the labour unions as it will try to bargain the on the pension plans while the employees are looking for even heftier benefits. This does not seem likely to result in a happy workforce, resulting in further strikes in the near future. Therefore, keeping in mind the current economic and financial situation and the Air Canada 's vulnerability against the new and lowered-cost airlines, it is highly recommended that Mr. Black sells his shares.
Issues # 2: Transition to IFRS - Acuarial Gains and Losses
On January 1, 2011, many Canadian companies adopted IFRS voluntarily.
This resulted in various changes to accounting policies, having impact on the financial statements. It also had an effect on how the defined benefit pension plan were measured and presented in the financial statements. Under IAS 19, actuarial gains and losses could be :
Alternative 1: recognized in profit or loss under the corridor approach
This method allows for deferral of such gains and losses as it is not required to recognize all such gains and losses immediately. Recognition of such gains and losses are required only if the accumulated unrecognized actuarial gains and losses exceed 10% of the greater of the defined benefit obligation or the fair value of the plan assets.
Implications : The Actuarial gains and losses that do not breach the 10% limits described above need not be recognised. This directly impacts the income statement and the underlying asset/liability associated with benefit
plan.
Alternative 2: recognized in any systematic method
This method results in faster recognition of actuarial gains or losses but is required to be applied consistently form period to period.
Implications: See implications for Alternative 1
Alternative 3: recognized immediately in OCI
This method recognizes these gains and losses immediately in other comprehensive income that is reclassified to retained earnings. It has no impact on the income statement directly.
Implications: This is the only method that IFRS allows after the Exposure Draft proposed in June 2011. The corridor approach was eliminated and it was mandated that all re-measurement must be recognised in OCI. Once this method was adopted by Air Canada, it allowed the accumulated off-balance sheet gains and losses to be recognized directly in retained earnings. It resulted in an increase in reported liabilities and a decrease in reported equity2.
Recommendation:
In the adjustment described in alternative 3, the accumulated off-balance sheet actuarial losses will be recognized into equity for Air Canada. Unfortunately, given that there is a $2 billion deficit in the benefit plant, this will result in a higher pension liabilities and lower equity than reported on the balance sheet. The higher liability and the lower equity will have a negative impact on the value of the business and hence, lower the share price. Therefore, it is recommended that Mr. Black sell off all his shares.
Issues # 3: Transition to IFRS - Transparent Representation
The transition to IFRS also required more stringent disclosures. It necessitated that different types of gains and losses from these defined benefit plans be differentiated. Therefore, defined benefit plan is presented separately in terms of service cost, finance cost and re-measurement gain or loss (through OCI).
Recommendation: The result is a more transparent financial statement presentation. It will allow Air Canada to observe specific costs related to their benefit plans and improved on certain costs if possible.
Bibliography
1. http://www.theglobeandmail.com/globe-investor/air-canada-faces-16-billion-pension-bill/article582341/
2. http://iveybusinessjournal.com/topics/the-organization/the-transition-to-ifrs-erasing-pension-losses#.UmLWp_lJM8M
3. http://www.iasplus.com/en/standards/ias/ias19
Users and Objectives:
Peter Black – Need to review F/S and detailed analysis of the two pension plans to determine whether he should keep or sell the shares
Air Canada senior executive – Since they have a transition to the defined contribution pension plan + conversion to IFRS, shareholders of Air Canada may contemplate to sell their shares (as in Black’s case), in which it will affect Air Canada’s market share. Thus they might have to re-structure their strategic planning for the future years
Current shareholders of Air Canada – Same reason as Black as they need to understand the impact of the new …show more content…
pension plan and the IFRS conversion. This will help them assess whether they should keep their investment in Air Canada
Unions and retirees – Due to solvency issues, Air Canada was on the verge of defaulting their pension payments. With the new pension plan and conversion, the unions and retirees can use the additional information and analysis to determine if Air Canada still has a high risk of defaulting payments
CUPE, ACPA and CAW – All three parties were against the pension plan change which actually resulted in a major strike. This analysis will help them understand the impact and the rationale of why Air Canada proposed the pension plan change
Constraints/Bias:
As the case has mentioned Air Canada will be moving towards IFRS, therefore IFRS will definitely be a constraint. Also as with IFRS there is more flexibility, thus Air Canada will have more alternatives in deciding which accounting policy to employ. This could lead to user bias as they might adopt accounting policies that will benefit only themselves even though it may not violate the IFRS standard (i.e. not performing a fiduciary duty to the shareholders).
Issues # 1: Financial Risk of Defined Benefit Pension Plans
Air Canada has approximately 23,000 full-time employees whose collective pension plans are among the largest in the country. The company has had issues in the past to fund their employees ' defined benefit pension plan. Air Canada 's financial struggle is well documented, having recently emerged from bankruptcy after an organizational restructuring. It is also recovering from the aftermath of the recession which had a huge impact on the airline industry throughout the globe.
Implication: Over time, the contributions made to these plans may exceed or be insufficient for the pension obligations of the employer. This plan has a lot of uncertainty as the cost is dependent on uncertain future variables that include but is not limited to, employee turnover, mortality and inflation. In defined benefit plans like the one Air Canada has, the employer bears the investment risk or benefit from surpluses if any. As at Jan. 1, 2011, the company 's pension deficit stood at $2.1-billion, which was $600-million better than a year ago as a result of a strong fund performance1 in 2010. However, this deficit is not sustainable and has not been sustainable for most of the decade, as it puts at risk both the viability of the company and the pensions of all employees." Payments are forecast to soar further in 2014 because a cap on pension contributions previously negotiated with unions will lapse at the end of 2013.
Recommendation: It seems that the defined benefit pension plan for the 23,000 employees are putting significant strain on Air Canada 's financial statements. With the looming burden of pension funding, Air Canada is up against the labour unions as it will try to bargain the on the pension plans while the employees are looking for even heftier benefits. This does not seem likely to result in a happy workforce, resulting in further strikes in the near future. Therefore, keeping in mind the current economic and financial situation and the Air Canada 's vulnerability against the new and lowered-cost airlines, it is highly recommended that Mr. Black sells his shares.
Issues # 2: Transition to IFRS - Acuarial Gains and Losses
On January 1, 2011, many Canadian companies adopted IFRS voluntarily.
This resulted in various changes to accounting policies, having impact on the financial statements. It also had an effect on how the defined benefit pension plan were measured and presented in the financial statements. Under IAS 19, actuarial gains and losses could be :
Alternative 1: recognized in profit or loss under the corridor approach
This method allows for deferral of such gains and losses as it is not required to recognize all such gains and losses immediately. Recognition of such gains and losses are required only if the accumulated unrecognized actuarial gains and losses exceed 10% of the greater of the defined benefit obligation or the fair value of the plan assets.
Implications : The Actuarial gains and losses that do not breach the 10% limits described above need not be recognised. This directly impacts the income statement and the underlying asset/liability associated with benefit
plan.
Alternative 2: recognized in any systematic method
This method results in faster recognition of actuarial gains or losses but is required to be applied consistently form period to period.
Implications: See implications for Alternative 1
Alternative 3: recognized immediately in OCI
This method recognizes these gains and losses immediately in other comprehensive income that is reclassified to retained earnings. It has no impact on the income statement directly.
Implications: This is the only method that IFRS allows after the Exposure Draft proposed in June 2011. The corridor approach was eliminated and it was mandated that all re-measurement must be recognised in OCI. Once this method was adopted by Air Canada, it allowed the accumulated off-balance sheet gains and losses to be recognized directly in retained earnings. It resulted in an increase in reported liabilities and a decrease in reported equity2.
Recommendation:
In the adjustment described in alternative 3, the accumulated off-balance sheet actuarial losses will be recognized into equity for Air Canada. Unfortunately, given that there is a $2 billion deficit in the benefit plant, this will result in a higher pension liabilities and lower equity than reported on the balance sheet. The higher liability and the lower equity will have a negative impact on the value of the business and hence, lower the share price. Therefore, it is recommended that Mr. Black sell off all his shares.
Issues # 3: Transition to IFRS - Transparent Representation
The transition to IFRS also required more stringent disclosures. It necessitated that different types of gains and losses from these defined benefit plans be differentiated. Therefore, defined benefit plan is presented separately in terms of service cost, finance cost and re-measurement gain or loss (through OCI).
Recommendation: The result is a more transparent financial statement presentation. It will allow Air Canada to observe specific costs related to their benefit plans and improved on certain costs if possible.
Bibliography
1. http://www.theglobeandmail.com/globe-investor/air-canada-faces-16-billion-pension-bill/article582341/
2. http://iveybusinessjournal.com/topics/the-organization/the-transition-to-ifrs-erasing-pension-losses#.UmLWp_lJM8M
3. http://www.iasplus.com/en/standards/ias/ias19