2. Significant Accounting Policies
a. Presentation
These consolidated financial statements are prepared in accordance with Canadian generally accepted accounting principles. The financial statements present the aggregate financial position of the Plan as a separate financial reporting entity independent of the participating employers, bargaining units, plan members and pensioners. Certain prior year financial information has been reclassified to conform with the presentation adopted in the current year.
b. Principles of Consolidation
The consolidated financial statements include the accounts of the Plan’s subsidiaries. All significant intercompany balances and transactions have been eliminated on consolidation. The subsidiaries were formed for the purpose of investing in certain real estate and private market assets.
c. Use of Estimates
In preparing these consolidated financial statements, management must make certain estimates and assumptions that primarily affect the reported values of assets and liabilities, income and expenses and related disclosures. Actual amounts could differ from these estimates.
d. Investments
Investments, investment receivables and investment payables are recognized on a trade date basis and are stated at fair value.
i) Valuation of investments
The fair value of investments is the consideration that would be agreed upon in an arm’s length transaction between knowledgeable willing parties who are under no compulsion to act. The determination of fair value is based on market conditions at a specific point in time and may not be reflective of future values. Fair values determined using valuation models and techniques require the use of assumptions that may not be supported by observable market transactions or available market data. In these cases, the fair values may be significantly impacted by the choice of assumptions. In periods of economic turmoil or when markets are illiquid, the determination of fair value may be more difficult to establish.
Fair values are determined as follows:
| CATEGORY | BASIS OF VALUATION |
| Short-term investments | Cost plus accrued interest where it approximates fair value, or the average of market quotes of closing bid and ask prices. Short-term investments comprise direct investments of the Plan and include reinvested cash collateral that is comprised of fixed rate instruments with maturities less than one year and floating rate instruments with maturities greater than one year. |
| Bonds, debentures and real return bonds |
Average of market quotes of closing bid and ask prices. Where quoted prices are not available, estimated values are calculated using discounted cash flows based on current market yields for comparable securities. |
| Public equity | Closing quoted market price. Where a market price is not available, market value is determined by reference to current market information. |
| Real estate assets and liabilities | Based on estimated fair values using appropriate valuation techniques and management’s and/or third party's best estimates. Income producing properties are valued based on independent appraisals that are conducted at least once every three years. Investments held through fund investments are valued using the carrying values reported by the external fund managers and updated for any specific market and other investment factors known to OPTrust that could affect the fair value of the investment.
Mortgages held on real estate investments are valued using discounted cash flows based on market yields of securities with comparable credit risk and term to maturity. |
| Private markets | Private markets include private equity and infrastructure investments that are held directly or through ownership in limited partnership arrangements or via fund investments. Fair value is determined using appropriate valuation techniques and management’s and/or third party's best estimates. For investments held through limited partnerships or funds, fair value is generally determined based on carrying values and other relevant information reported by the investment manager using accepted valuation methods. In the first year of ownership, cost is generally considered to be an appropriate estimate of fair value for private equity and infrastructure investments unless there is evidence of a significant change in value. |
| Commodities | Closing quoted market price. Where a market price is not available, market value is determined by reference to current market information. |
| Derivatives | Market prices are used for exchange traded derivatives such as futures. Where quoted market prices are not available, appropriate valuation techniques are used to determine fair value. Derivative contracts transacted by OPTrust either directly with counterparties in the over-the-counter (OTC) market or on regulated exchanges include the following types of contracts:
Interest rate swaps Foreign exchange forwards Commodity futures Equity futures Options |
ii) Income recognition
Investment income includes interest and dividends, net income from real estate and private market investments, realized gains and losses on disposal of investments, and unrealized gains and losses resulting from changes in the fair value of investments and undistributed income.
| CATEGORY | BASIS OF RECOGNITION |
| Interest income | Accrual basis |
| Dividend income | Accrual basis on the ex-dividend date |
| Net operating income for real estate and private market investments |
Available operating income from the investment manager |
| Realized gains
and losses for investments sold |
Difference between proceeds on disposal and the average cost |
| Unrealized gains and losses for investments held |
Change in the difference between estimated fair value and cost |
iii) Transaction costs
Transaction costs are incremental costs attributable to the acquisition, issue or disposal of investment assets or liabilities, and are expensed as incurred.
e. Actuarial Asset Value Adjustment
The actuarial asset value adjustment reflects the portion of gains or losses not yet recognized for purposes of determining the actuarial net assets available for benefits. The actuarial asset value adjustment provides for the smoothing of gains and losses, mitigates volatility and provides a more stable basis for determining surplus.
The actuarial value of net assets as at the reporting dates has been determined using a formula that smoothes out the effects of the changes in market values over a five-year period. The approach recognizes differences between the actual and the expected investment earnings, evenly over the current and following four years. Management’s best estimate of investment return was 6.75% as at December 31, 2010 (December 31, 2009 - 7.0 %).
f. Accrued Pension Benefits
The value of accrued pension benefits is determined based on actuarial valuations prepared by an independent actuarial firm. Actuarial valuations are prepared every year for financial statement reporting purposes (financial statement valuations) and at least every three years for purposes of determining funding requirements (funding valuations).
For financial reporting purposes, the Canadian Institute of Chartered Accountants (CICA) requires that pension plans report the actuarial value of accrued pension benefits using management’s best estimate assumptions and the projected unit credit method prorated on service. This method calculates the actuarial value of pension benefits accrued up to the financial reporting date, after the projected benefits have been attributed equally to each year of a member’s service. This method differs from the aggregate method used for funding purposes, which includes current members' expected future contributions and margins of conservatism in the setting of economic assumptions.
g. Contributions
Contributions from members and employers that are due at year-end, including those relating to purchases of credit for prior employment or leave, and transfers into the Plan, are recorded as a receivable.
h. Payments
Payments of pensions, refunds and transfers are generally recorded in the period in which they are incurred. Certain transfers to pension plans are accrued and recognized as an accrued liability.
i. Surplus
Surplus results from the excess of the actuarial value of net assets available for benefits over the accrued pension benefits. The actuarial value of net assets available for benefits comprises net assets available for benefits and the actuarial asset value adjustment. Plan sponsors have the option of allocating any portion of their share of the rate stabilization funds from a funding valuation as a reserve against future contribution increases. The rate stabilization funds form part of surplus and earn income at the funding valuation interest rate. Unallocated surplus is the remainder of surplus after considering the rate stabilization funds.
j. Property and Equipment
Property and equipment included in other assets are carried at cost less accumulated amortization. Amortization is provided on a straight-line basis over the estimated useful lives of the capital assets.
k. Foreign Currency Translation
Foreign currency transactions are translated into Canadian dollars at the rates of exchange prevailing at the dates of the transactions. The fair value of investments and cash balances denominated in foreign currencies are translated at the rates in effect at year-end. The resulting unrealized gain or loss is included in the consolidated statement of changes in net assets available for benefits.
l. Fair Value Disclosures
All financial instruments measured at fair value are categorized into one of three hierarchy levels, described below, for disclosure purposes. Each level is based on the transparency of the inputs used to measure the fair values of assets and liabilities:
| Level 1 – | inputs are unadjusted quoted prices of identical assets or liabilities in active markets. |
| Level 2 – | inputs are other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. |
| Level 3 – | one or more significant inputs used in a valuation technique are unobservable in determining fair values of the assets or liabilities. |
Determination of fair value and the resulting hierarchy requires the use of observable market data whenever available. The classification of a financial instrument in the hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. Refer to Note 4(a).
m. Future Accounting Changes
The Canadian Accounting Standards Board (AcSB) confirmed January 1, 2011, as the date International Financial Reporting Standards (IFRS) will replace Canadian GAAP for publicly accountable enterprises. In April 2010, the AcSB issued CICA Handbook Section 4600, Pension Plans. Under Section 4600, pension plans will adopt IFRS for accounting policies that do not relate to investment portfolio or pension obligations. IFRS and section 4600 will be effective for OPTrust for the year commencing January 1, 2011, including the disclosure of prior-year comparative figures. Management has reviewed the impact of the adoption of Section 4600 after which the actuarial asset value adjustment will no longer be deferred and amortized. All deferred gains/losses will be retroactively recognized. The new standards also require additional note disclosures.