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Pension Accounting Redux

Nov 11

Written by: Jack Ciesielski
11/11/2005 7:44 AM

Yesterday, the FASB announced the addition of a pension project to its agenda. It'll be in two parts: a short-term project to be completed by the end of 2006 (and likely effective for 2007 financial statements, by my guess) aimed at changing the geography of existing pension information. It will move some of the pension information out of the footnotes and into the balance sheet, specifically making the net over or underfunding of a firm's plans more plainly visible to investors.

The second phase will home in on measurement issues: it'll take on issues like whether or not such plans deserve to be consolidated at all in the sponsor's balance sheet; the construction of discount rates employed in figuring the present value of the obligation; and components of pension and other postemployment benefit cost. (Do we really need an "expected return on assets" component in such costs, for example?) Much, much more on the second phase is in the appendix to the handouts for yesterday's board meeting. Click here if you want them.

Critics of the short-term project will carp that it doesn't do enough, and that it will take FASB too long to accomplish the long-term project. Maybe.

Consider this, however. The long-term project will likely contain issues pertaining to measurement (discount rates, for example) and presentation (consolidation of plans with sponsors). It's conceivable that issues like consolidation and and changing the cost components, which will be part of the long-term project, could be handily completed in the short-term project, with existing measurement guidance in place. Investors can do this for themselves right now; I've shown how in Analyst's Accounting Observer reports. (Not free, subscribers only.) If the FASB were to correct these flaws in the short-term project, there would likely be two consequences: one, corporate push-back would likely morph the short-term project into a long-term project, and two, once the measurement project was complete, it would likely make for major changes in a reporting system that would still be rather new. In short, it would cause changes in a system that was still digesting the changes from the (amplified) short-term project. Not that there's anything wrong with that - but not everyone might be willing to be disrupted again for something they thought was already fixed once.

[Side note: it's the long-term project that the bond market will be watching. Any changes FASB makes to the construction of the discount rate might make certain bonds and/or maturities more - or less - popular. Also, depending on the degree to which pension plan volatility will be displayed in earnings or equity, there could be a shift in funding vehicles. Sponsors might shy away from stocks and more towards bonds if there's going to be more volatile changes in earnings brought by changes from the long-term project.]

Another consideration: the FASB is undertaking a "Financial Performance Reporting" project at the same time - a worthy project in its own right, and it covers much more than just pension reporting. Overhauling the pension reporting will change a lot of the financial performance reporting all by itself. The two projects will probably trade riffs very frequently. Maybe FASB could do a rush job on the pension project in one year - but if you have to re-do later, much of the standard-setting done in a rush job, are you really going to be doing investors much of a service?

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Unexplored Obligations: Other Postretirement Benefits

Defined benefit pension plans take center stage in the pantheon of investors’ fears when it comes to worrying about liquidity effects or earnings distortions. Yet they rarely consider the cash demands and earnings distortions resulting from other postretirement benefit plans.

Since they’ve been required to measure - and display - a figure expressing the value of the promises made for providing employee health care benefits, managers have dealt vigorously with the obligations. Their growth has been held in check while pension obligations have grown ever higher. Yet even as they’ve become more controlled, other postretirement benefit plans are worth investor attention. As the benefit plans become less fearsome, the accounting principles involved have helped an increasing number of companies recognize phantom earnings - negative benefit costs - even while they’re putting cash into benefit payments under these plans. It’s better to be alert to such a trend early: firms may not always bring it to the attention of investors.

A recent edition of The Analyst’s Accounting Observer looks at the problematic reporting, with an eye focused on the "phantom income" results shown by 42 companies having negative OPEB costs. While the report is available only to paid subscribers, a condensed version is available for free upon request. To receive it, send an e-mail to Brenda Rappold at brappold@accountingobserver.com, with “OPEB Costs” in the subject line.

For information about subscribing to The Analyst’s Accounting Observer, click here.