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Gartner: More Happy 108 Results

Mar 16

Written by: Jack Ciesielski
3/16/2007 6:09 AM

The streak of favorable 108 adjustments continues...

Gartner, the technology consulting firm, came clean with its 10-K application of SAB 108, and increased its retained earnings by a bit less than 2%. More striking: some of the adjustments also affected additional paid-in capital, and in total, the SAB 108 adjustment increased stockholders' equity by 7%.

The biggest piece of the favorable increase to retained earnings - $7.4 million - came from a previously overstated income tax payable balance. According to the filing, "The adjustment was due to the carryover impact of an excess payable balance from prior years in the current taxes payable account which had accumulated over a period of years prior to 2000." What made the current taxes payable too large is still unclear.

The most curious item in the SAB 108 stew had to do with stock option pricing:

"Prior to October 1999, the exercise price of stock options granted to employees under the Company's stock option plans was equal to the average of the closing price of the Company's common stock for the five trading days immediately preceding the grant date. In 2006, the Company determined that for valuation purposes, the exercise price should have been the closing price on the date of grant (which is the formula used by the Company since October 1999). Accordingly, the Company revalued options granted prior to October 1999 using the closing price on the date of grant and determined that an additional $6.0 million of compensation expense should have been recorded. The cumulative effect of the adjustment resulted in a reduction in opening accumulated earnings of approximately $3.8 million, an increase to additional paid-in capital of $3.9 million, and a tax effect of less than $0.1 million."

Using SAB 108 to clear up stock option problems is not what the SEC probably had in mind when it published the bulletin. The Commission's intent, I believe, in developing SAB 108 was to motivate companies to eliminate known old errors that had accumulated on balance sheets for years. If a company just figured out in 2006 that there were problems in its option practices, restatement might be a more appropriate route, or at least the disclosures discussed in the recent letter sent from the Division of Corporation Finance to companies with known option reporting issues.

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Pension & Other Benefit Plans: A Look Ahead

Investors in firms with defined benefit pension plans always face the risk of suddenly being pushed farther back in line when it comes to being served their returns. Variability in plan assets and variability in benefit plan obligations are the reason: poor asset returns coupled with sinking interest rates always spell tough times for defined benefit plan funding. In that regard, this year’s asset returns combined with the Fed’s “Operation Twist” add up to “Operation Agony” for defined benefit pension plans. If trends continue along their current path, firms that may have anticipated moving to more realistic pension accounting - like Honeywell, AT&T and Verizon already have done - might forego that decision. It could be just too painful.

Pensions aren’t the only kind of benefit plan affected by Operation Twist. Other postemployment benefit (OPEB) plans share much the same accounting model as pensions, including the calculation of a projected benefit obligation that similarly incorporates a discount rate - one that will also be affected by Operation Twist. The net OPEB obligations were slightly less than pension obligations at the end of 2010, but also promise to grow in 2011. Investors perceive them as less threatening than pension obligations because they don’t require funding. Strangely, there are a number of firms that are recognizing income from these benefit plans - without ever creating a dime of cash for investors.

A recent edition of The Analyst’s Accounting Observer dissects these issues, and 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 “PENSIONS” in the subject line.

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