The discount rate is the single most sensitive assumption in an IAS 19 valuation. In Saudi Arabia it is also the most debated. A practical derivation that auditors accept.
Key takeaways
- IAS 19 requires a high-quality corporate bond rate, falling back to government bonds where no deep market exists, and the fallback must be justified.
- Match the rate to the duration of the obligation; a single long-bond yield overstates or understates the liability.
- Document the derivation once and re-run it each period from the same sources.
IAS 19 paragraph 83 requires post-employment benefit obligations to be discounted using market yields on high-quality corporate bonds, in the currency of the obligation and with a term consistent with the estimated term of the obligation. Where there is no deep market in such bonds, the yield on government bonds is used. That single paragraph generates more discussion in Saudi valuations than any other, because reasonable practitioners disagree about whether a deep corporate bond market exists in riyals.
Is there a deep market in high-quality Saudi corporate bonds?
Our position, shared by most auditors in the Kingdom, is that there is not yet a deep market for the purposes of IAS 19. Riyal-denominated corporate sukuk exist, and issuance has grown, but the number of investment-grade issuers, the range of maturities and the secondary market liquidity are not sufficient to construct a reliable yield curve across the durations that end-of-service obligations require. The consequence is that the government bond yield is the reference. The judgement should be stated in the actuarial report and revisited annually as the market develops; an entity that silently switches basis between years will be asked why.
Constructing the rate
The Saudi government issues riyal sukuk across a range of maturities, and yields are observable from the Saudi Exchange and from the Ministry of Finance's issuance programme. From these we construct a yield curve at the valuation date. The obligation's cash flows, produced by the valuation model, are then discounted along the curve to derive a single equivalent rate. In practice this means the rate reflects the duration of the specific workforce: an entity with a young, high-turnover workforce will have a shorter duration and typically a lower rate than an entity with long-serving employees.
Where a full curve approach is disproportionate, a common shortcut is to select the yield at the maturity closest to the obligation's duration. That is acceptable for smaller entities if the duration is calculated rather than assumed. Taking the ten-year yield because it is easy to find is not a derivation.
Frequent errors
- Using US dollar corporate bond yields on the grounds that the riyal is pegged. The currency of the obligation is the riyal; the peg does not change that, and dollar corporate spreads reflect issuers with no bearing on Saudi obligations.
- Using a rate from a different date. The rate must be at the reporting date; a rate from the prior valuation or from the date the report was drafted is not acceptable.
- Applying the same rate across group entities in different countries. Bahraini dinar and Jordanian dinar obligations have their own reference curves.
- Failing to disclose the sensitivity. IAS 19 requires disclosure of the effect of a reasonably possible change; the report should show the impact of a 50 and 100 basis point movement.
What auditors want to see
A short memorandum, updated each year, that sets out the source of the yields, the date, the duration of the obligation, the derived rate and the reasons for the government bond basis. When that memorandum exists, the discount rate discussion in the audit takes ten minutes. When it does not, it can take weeks.