Discount rates on Saudi and Bahraini government bonds rose sharply through 2022 and 2023. For IAS 19 valuations that means smaller obligations, gains in OCI and a set of questions from auditors.
Key takeaways
- A rise of 200 basis points in the discount rate reduces a typical Gulf end-of-service obligation by 10 to 15 percent, depending on duration.
- The resulting gain is a remeasurement in OCI, not profit or loss, and must be separated from experience adjustments.
- Higher rates raise next year's interest cost, so the P&L effect is the reverse of the balance sheet effect.
Because the Saudi riyal and Bahraini dinar are pegged to the US dollar, local government bond yields followed the Federal Reserve's tightening cycle upward through 2022 and 2023. Discount rates used in IAS 19 valuations of end-of-service benefits, which reference those government bond yields, rose by around two percentage points over the period. For finance teams that had grown used to stable or falling rates, the 2023 year-end valuation produced results that needed explaining.
The balance sheet effect
The defined benefit obligation is the present value of projected benefits. A higher discount rate lowers that present value; the sensitivity depends on the duration of the obligation, which for Gulf workforces is typically five to nine years because employees leave before retirement and gratuity is paid at exit. A 200 basis point rise in the rate therefore reduces the obligation by roughly 10 to 15 percent, other things equal. For an entity with a SAR 50 million obligation, that is a reduction of SAR 5 to 7 million.
Where the gain goes
The reduction arising from the change in the financial assumption is an actuarial gain, recognised in other comprehensive income as a remeasurement and never recycled to profit or loss. It should be reported separately from experience adjustments, which arise when actual salary increases, leavers and benefits paid differ from the prior assumptions. A common error is to present the whole movement as a single remeasurement without this split; auditors will ask for it and IAS 19 requires the disclosure.
The profit or loss effect is the opposite
Net interest cost for the following year is calculated by applying the discount rate at the start of the year to the obligation. A higher rate means a higher interest cost, even though the obligation is smaller. Service cost also changes because it is measured at the new rate. Budgeting for the employee benefit expense in 2024 must therefore use the year-end 2023 rate, not the previous year's.
Questions to prepare for
Auditors in this cycle asked three things: whether the rate was taken at the reporting date from the correct government bond curve and duration; whether the salary growth assumption was revisited in the light of inflation rather than left unchanged from prior years; and whether the OCI gain was correctly split and disclosed with sensitivities. Entities that maintain a short assumptions memorandum and a reconciliation of the obligation answered all three without difficulty.