Conflicting Formulas Emerge On Pension Reforms

Now that accounting rulemakers are planning to require companies to move their pension obligations from the footnotes to the balance sheet, companies are appealing for a new measurement formula to determine what they will report as a pension liability—one that would lower the value of the reported cost.

The Financial Accounting Standards Board has proposed in the first phase of its two-part project to improve pension disclosures to require companies to make no substantive change in the way they calculate their existing pension obligations, but to move those figures from the footnotes of the financial statements onto the face of the balance sheet. The Board’s goal is an expedited rule change to make a big improvement in the visibility of a company’s pension status with as little disruption to the reporting process as possible.

Yet dozens of comments to the Board on its proposed rule change say FASB should require companies to use a new formula to measure pension obligations—one that would set aside any future pension liability and establish a value for the pension obligation based only on what employees have earned to date.

Financial Accounting Statement No. 87, Employers’ Accounting for Pensions, issued in 1985, is the existing rule that governs pension accounting (see box at left for FAS 87 and other resources). It requires companies to establish a pension liability figure based on a formula that calculates the “projected benefit obligation.”

The PBO is a measure that sets a liability figure on the calculation date assuming the plan is ongoing and will not terminate any time in the foreseeable future. It takes into account projected future earnings for covered employees and factors them into the total liability.

PBO vs. ABO

FASB issued an exposure draft in late March proposing amendments to FAS No. 87 and other rules that would not change the way pension liabilities are measured, but would require companies to move the figures from footnotes to the balance sheet. The comment period for the proposed rule closed last week.

A number of companies and consulting firms say if FASB wants to move the figure to the balance sheet, the Board should require companies to measure the liability based on the “accumulated benefit obligation.” The ABO is a formula that measures a company’s present liability, making no assumption about any future compensation levels for employees covered under the plan.

EXCERPT

Below is an excerpt of FASB's exposure draft on reforming accounting of pension costs.

An employer that sponsors one or more defined benefit pension or other postretirement benefit plans shall:

Recognize in its statement of financial position the overfunded or underfunded status of the defined benefit postretirement plan measured as the difference between the fair value of plan assets and the benefit obligation. For a pension plan, the benefit obligation shall be the projected benefit obligation; for any other postretirement benefit plan, such as a retiree health care plan, the benefit obligation shall be the accumulated postretirement benefit obligation.

Aggregate the statuses of all overfunded plans and recognize that amount as an asset in its statement of financial position. It also shall aggregate the statuses of all underfunded plans and recognize that amount as a liability in its statement of financial position. An employer electing to present a classified statement of financial position shall separately report the current and noncurrent portions of that asset or liability in accordance with existing standards.

Recognize as a component of other comprehensive income, net of tax, the actuarial gains and losses and the prior service costs and credits that arise during the period but pursuant to Statements 87 and 106 are not recognized as components of net periodic benefit cost. Amounts recognized in accumulated other comprehensive income shall be adjusted as they are subsequently recognized as components of net periodic benefit cost pursuant to the recognition and amortization provisions of Statements 87 and 106.

Recognize as an adjustment to the opening balance of retained earnings, net of tax, any transition asset or transition obligation remaining from the initial application of Statement 87 or 106. Those amounts shall not be subsequently amortized as a component of net periodic benefit cost.

Apply the provisions of FASB Statement No. 109, Accounting for Income Taxes, to determine the applicable income tax effects of items (a)–(d) above …

Recognition of a Plan’s Funded Status

For all entities, both public and nonpublic, the requirement to recognize the funded status of a defined benefit postretirement plan and the disclosure requirements shall be effective for fiscal years ending after December 15, 2006. Earlier application is encouraged. The requirements of this Statement shall be applied retrospectively for all financial statements presented pursuant to the requirements of FASB Statement No. 154, Accounting Changes and Error Corrections,

unless it is impracticable to do so pursuant to paragraph 16 below. To apply this Statement retrospectively, an employer shall:

Recognize as a component of other comprehensive income, net of tax, those actuarial gains and losses and those prior service costs and credits not yet included in net periodic benefit cost for each year for which a statement of income is presented.

Recognize as an adjustment of the opening balance of accumulated other comprehensive income (or other appropriate components of equity or net assets in the statement of financial position), net of tax, those actuarial gains and losses and those prior service costs and credits not yet included in net periodic benefit cost as of the beginning of the first period presented.

Recognize as an adjustment of the opening balance of retained earnings (or other appropriate component of equity), net of tax, the portion of the transition asset or transition obligation related to the initial adoption of Statements 87 and 106 that is unrecognized as of the earliest date to which this Statement is applied retrospectively as of the beginning of that first period presented. The recognized transition asset or transition obligation shall not be subsequently

amortized as a component of net periodic benefit cost. Additionally, any previous reported amortization of the transition asset or transition obligation shall be eliminated as a component of net periodic benefit cost for any period presented. The effect of eliminating that amortization shall be recognized without affecting any net periodic benefit cost that may have been capitalized as inventory or other productive assets.

Source

Financial Accounting Standards Board

Ethan Kra, a chief actuary for Mercer Human Resource Consulting, says the accumulated benefit is the more appropriate measure because it’s a current figure, applicable to the moment in time that a company reports the obligation as a liability on its books.

Kra

“It is not a legal obligation of the company to provide that benefit” beyond the date it reports the figure in its financial statements, he says. “It may never be a legal obligation. I don’t book an expense today for next year’s pay increases. Why should I book an expense today for the effect of next year’s pay increase on pensions?”

Charles Mulford, director of the Georgia Tech Financial Analysis Lab, which conducts research intended to identify reporting practices that may be misleading to investors, says companies are justified to seek a moment-in-time measurement if the figure will be reported as a liability on the balance sheet.

Mulford

“The question to answer is: What is the value to be assigned to this liability for future pension promises?” Mulford says. “How much do I need to have as of right now to meet those future claims? You’re measuring an obligation. A liability is what it would take to absolve myself of responsibility right now. Really, it’s the accumulated benefit obligation.”

One Step At A Time

FASB project manager Peter Proestakes said the Board has considered and already dismissed changing the measurement at least in this first phase of its plan to overhaul pension accounting rules.

“We’re using the same measurement of liability that already exists,” he says. “This Board has said it would take such a major undertaking and would take such a long time to resolve [a debate over measurement] that it would prevent us from making incremental improvements now.”

Kra at Mercer says the PBO calculation produces a smoother pattern of expenses over time, which may explain why it was the accepted measurement when FAS No. 87 was adopted to require only footnote disclosure of liabilities. Now that the figure is moving to the balance sheet, companies want a more current, precise number.

“If we’re going to an environment where everything is marked to market, then we’re asking, ‘What do I owe?’" he says. “The ABO is the right number.”

Kra said it’s difficult to define the precise difference for companies if they must report pension liabilities using the formula for PBO versus using ABO, but for some companies that difference will be significant.

“For some companies, the PBO could mean technical insolvency,” he says. “The difference between the ABO and the PBO would vary from a non-event to a 50 percent increase in the liability. For an unfunded liability, it could be the difference between a surplus and a deficit. You’re looking probably at hundreds of billions of dollars.”

Proestakes said the Board will hear live comments at a June 27 public roundtable and then “redeliberate key issues to see if they’ve learned anything new they should act upon.” He said the Board is committed to issuing a final statement in September with the major provisions taking effect by the end of the year.

If FASB decides to stay with the existing measurement requirement for the change in accounting rules—which is what Proestakes predicts—the Board likely would revisit the question in the longer, second phase of the project. “There are a lot who want to assume it’s an ABO vs. PBO issue, but there’s a lot more that will go into the evaluation,” he says.

Mulford predicts companies will work hard to make their case for a change in the measurement. “FASB would argue that ultimately you will owe that projected amount,” he says. “Companies will say that over time, as the obligation grows, we’ll reflect it. That’s the debate, and I think it will get more heated.”