Due to the long timescales involved, post-employment benefit obligations are discounted. Also, the whole obligation should be discounted, even if some falls due within a year. The standard requires that the discount rate reflect the time value of money but not the actuarial orinvestment risk. Furthermore, the discount rate should not reflect the entity-specific credit riskborne by the entity's creditors, nor should it reflect the risk that future experience may differ from actuarial assumptions. The discount rate should reflect the estimated timing of benefit payments. For example, an appropriate ratemay be quite different for a payment due in, say, ten years as opposed to one due in twenty. The standard observes that in practice, an acceptable answer can beobtained by applying a single weighted average discount rate that reflects the estimated timing and amount of benefit payments and the currency in which the benefits are to be paid.
The rate used should be determined ‘by reference to’ the yield (at the balance sheet date) on high quality corporate bonds of currency and term consistent with the liabilities. In countries where there is no deepmarket in such bonds, the yields on government bonds should be used instead.
In our view, the requirement that the rate be determined ‘by reference to’ high quality bond rates adds an important nuance — in particular, it is very different from requiring the rate to be that of an observable instrument. It means that observed current market yields may need to form the starting point for thisdetermination.
The standard gives an example of this in the context of the availability of bonds with sufficiently long maturities. It observes that in some cases, there may be no deepmarket in bonds with a sufficiently long maturity to match the estimated maturity of all the benefit payments. In such cases, the standard requires the use of current market rates of the appropriate term to discountshorter-term payments, and estimation of the rate for longer maturities by extrapolating current market rates along the yield curve.It goes on to observe that the total present value of a defined benefit obligation is unlikely to be particularly sensitive to the discount rate applied to the portion of benefits that is payable beyond the final maturity of the available corporate or government bonds.To us this last observation seems to belong more in the basis ofconclusions rather that the standard itself as it appears to try and justify the rule rather than simply set it out. Furthermore, we remain to be convinced that it is in facttrue, as the standard sets out no evidence supporting the assertion.
Of the three characteristics of corporate bonds stipulated by the standard (quality,currency and term) the above example is making an adjustment to observed yields with respect to term. In our view, a credible case could be made that it would be equally acceptable for adjustments to observable market data to be made in respect of the othercharacteristics if that would produce a reliable and appropriate rate still ‘determined by reference to’ corporate bonds. In June 2005 IFRICdiscussed such an approach and published an explanation as to why it decided not to take the issue onto its agenda and hence not progress an interpretation. The question considered was, when there is no deep market in high quality corporate bonds in a country, whether the discount rate could be determined by reference to a synthetically constructed equivalent insteadof using the yield on government bonds?IFRIC concluded that the standard ‘is clear that a synthetically constructed equivalent to a high quality corporate bond by reference to the bond market in another country may not be used to determine the discount rate.’ IFRIC further observed that the reference to ‘in a country’ could reasonably be read as including high quality corporate bonds that are available in a regional market to which...