Question

How do U.S. GAAP and IFRS differ in their use of present values when measuring contingent liabilities? (explain)

Can presently accruing pension funds be parlayed into other investments like real estate, securities, or the likes? (explain with example)

Answer 1

As per IFRS: IAS 37 Provisions, Contingent Liabilities and Contingent Assets

This Standard sets out the required accounting treatment and disclosures for provisions, contingent liabilities and contingent assets. These are linked by their commonality as areas that require judgment at the end of an accounting period.

Example: Construction contracts (see IFRS 15 Revenue from Customer Contracts); Income taxes (see IAS 12 Income Taxes) etc.

Measurement: Best Estimate -The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the financial reporting date, that is, the amount that an entity would rationally pay to settle the obligation at the end of the financial reporting period or to transfer it to a third party. The estimate is made by the management of the entity but in light of all available evidence, including that received after the end of the financial reporting date, and may be supplemented by the evidence of independent experts

Present Value - When reimbursement of the amounts provided for is virtually certain (e.g. under an insurance contract), a separate asset should be recognised. In the statement of comprehensive income, the expense relating to the provision and the amount recognised as a reimbursement may be shown net. The discount rate(s) shall not reflect risks for which future cash flow estimates have been adjusted.

A provision under IFRS	A loss contingency under US GAAP
Recognize when all of the following criteria are met: A past event gives rise to a present obligation (legal or constructive). It is probable – i.e. more likely than not – that an outflow of resources (typically a payment) will be required to fulfil the obligation. The amount can be estimated reliably.	Recognize when all of the following criteria are met: Like IFRS, a past event gives rise to a present obligation. However, unlike IFRS, a constructive obligation is not recognized under the general model in ASC 450. It is probable that an outflow of resources (typically a payment) will be required to fulfill the obligation. Probable in this context means 'likely to occur', which is a higher threshold than IFRS. In many cases, this difference will not change the practical outcome and the threshold will be met under both frameworks. Like IFRS the amount can be estimated reasonably.
If any of these conditions is not met, no provision is recognized. Instead, the obligation is disclosed as a contingent liability unless its occurrence is remote.	Like IFRS, if any of these conditions is not met, no loss contingency is recognized. Instead, the obligation is disclosed as a loss contingency unless its occurrence is remote.

Pension fund assets need to be prudently managed to ensure that retirees receive promised retirement benefits. For many years this meant that funds were limited to investing primarily in government securities, investment-grade bonds, and blue-chip stocks.Changing market conditions and the need to maintain a high-enough rate of return have resulted in pension plan rules that allow investments in most asset classes. These are some of the most common investments to which pension funds allocate their substantial capital.

Income Investments

U.S. Treasury securities and investment-grade bonds are still part of pension fund portfolios. Investment managers seeking higher returns than available from conservative fixed-income instruments have expanded into high-yield bonds and well-secured commercial real estate loans.Portfolios of asset-backed securities, such as student loans and credit-card debt, are newer tools intended to boost overall returns.The largest pension plan in the U.S., the California Public Employees' Retirement System (CalPERS), seeks an annual return of 7.5%. Approximately 23% of its $365 billion portfolio was allocated to income investments as of June 2019.

Private Equity

Institutional investors, such as pension funds, and those classified as accredited investors invest in private equity—a long-term, alternative investment category suited for sophisticated investors. In fact, pension funds are one of the largest sources of capital for the private equity industry. In its purest form, private equity represents managed pools of money invested in the equity of privately-held companies with the intention of eventually selling the investments for substantial gains. Private-equity fund managers charge high fees based on promises of above-market returns.

Infrastructure

Infrastructure investments are a small part of most pension-plan assets, but they are a growing market of a diverse assortment of public or private developments involving power, water, roads, and energy. Public projects experience limitations due to budgets and the borrowing power of civil authorities. Private projects require large sums of money that are either expensive or difficult to raise. Pension plans can invest with a longer-term outlook and the ability to structure creative financing.

Typical financial arrangements include a base payment of interest and capital back to the fund, along with some form of revenue or equity participation. A toll road might pay a small percentage of tolls in addition to the financing payment. A power plant might pay a little bit for every megawatt generated and a percentage of the profits if another company buys the plant.

Real Estate

Pension fund real estate investments are passive investments made through real estate investment trusts (REITs) or private equity pools. Some pension funds run real estate development departments to participate directly in the acquisition, development, or management of properties.

Long-term investments are in commercial real estate, such as office buildings, industrial parks, apartments, or retail complexes. The goal is to create a portfolio of properties that combine equity appreciation with a rising stream of inflation-adjusted income to balance the ups and downs of the markets.