Amid crumbling pension plans and cries for fair value accounting and plain English disclosure, accounting standard setters have decided to take a look at overhauling the rules governing pension accounting.
The Financial Accounting Standards Board said it will begin with a short-term project to bring footnote disclosures onto the balance sheet, to cast more light on whether a company’s pension plan is adequately funded to meet its pension obligations. The Board set a timeline to complete that phase by the end of 2006.
The longer-term goal will be to examine all other pension reporting issues, including how pension and other post-retirement benefits are reported in income statements, how pension obligations are measured and defined, and how companies arrive at the various assumptions that form the basis for pension accounting, among others.
FASB said it will coordinate efforts with the U.S. Department of Labor and the Pension Benefit Guaranty Corporation—both of which are looking at pension rule changes of their own—as well as international standard setters in an effort to align U.S. rules with those abroad.
A Ticking Time Bomb
Problems with underfunded and failing pension plans got policymakers’ serious attention earlier this year when United Airlines sought relief from its pension obligations from the PGBC, the federal insurance system that backs private pension offerings. Subsequent failures and reports of underfunded pensions have seemed to snowball, with Credit Suisse First Boston estimating recently that the S&P 500 could end the year some $218 billion short of its current pension obligations.
The U.S. Government Accountability Office released a study this summer on underfunded pensions, blaming the problem on governance weaknesses, including rules that allow companies to sink deep into underfunded status before they’re required to make additional contributions; rules that allow companies to “smooth” assets and liabilities to decrease volatility in reporting were also blamed. The Securities and Exchange Commission report on off-balance-sheet accounting issued in June devotes several pages to describing how the practice of smoothing has enabled pensions to become significantly underfunded.
The SEC has been investigating pension accounting at such corporate giants as General Motors, Boeing, Ford and Northwest Airlines to see if managers have propped up their pension figures by pushing the limits of financial assumptions about interest rates, mortality and numerous other factors that impact pension assets and liabilities.
Turner
Lynn E. Turner, former chief accountant with the Securities and Exchange Commission and director of research for Glass Lewis, characterizes the situation as “a ticking time bomb, it seems, waiting to go off, helped along by poor transparency that has permitted policy makers, management and employees to ignore a huge and growing problem.”
Pension plans are governed largely by the Employee Income Retirement Security Act of 1974, a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry. But the accounting rules associated with pension plans are contained largely in FAS No. 87, Employers’ Accounting for Pensions, dated December 1985 (see box above, right). Congress earlier this year began buzzing with pension reform proposals while FASB now examines the accounting rules.
“Until about five years ago, pensions were fully funded so accounting wasn’t seen as a problem,” said Paul Miller, accounting professor at the University of Colorado at Colorado Springs. “When the light shines on pensions, it shows the accounting is not up to snuff.”
A Grim Future
Miller
Miller, a former FASB member, said the provisions that allow companies to reduce volatility are at least in part to blame for the current underfunding crisis. “Volatility is a way of life,” he said. “Interest rates go up and down.”
Miller said he and another former FASB member, Paul Bahnson, analyzed the pension accounting of the four largest U.S. companies—ExxonMobil, General Motors, Ford and General Electric—and found they have a combined liability of pensions and medical benefits of $140 billion, yet their balance sheets report a combined net liability of only $1.5 billion. “The accounting standard in this area has never been good,” he said. “With the events of the last five years, it has become immensely bad because of the misleading information that it produces.”
Miller said the accounting standards presume that minor variations will offset one another over time, but it’s not happening, resulting in a growing pension funding deficit. “The Big Four have basically deferred recognizing $138 billion of expenses and losses,” he said. “They’ve done nothing technically wrong; indeed, they’ve probably complied with GAAP scrupulously. Nonetheless, the consequence is financial statements that don’t tell the truth, at all. They don’t just hide the truth, they present information that is simply not true at all, in terms of describing the real economics.”
According to Miller, FASB conceived the current rules in a different environment, when it was dependent on corporate contributions for its funding and under greater corporate pressure to minimize volatility. “There was a great deal of frustration with what they had to produce,” he said.
Beresford
Dennis Beresford, FASB chairman from 1987 to 1997, says the rules that smooth volatility were written with a long-range view in mind. “This is a long-term cost of doing business,” he said. “The defined benefit is a promise to pay at retirement, so the accounting is intended to spread the cost out over the life of the employee.”
He says the future of defined benefit pension plans is grim, given current funding problems and prospective rule changes. “To the extent there is more focus on this issue, it will encourage companies to do away with their pension plans,” he said. “The trend is already occurring and this will certainly accelerate it.”
McEnally
Rebecca McEnally, director of capital markets for the CFA Institute, an organization for financial analysts, said even analysts have a difficult time comprehending current pension accounting. “Many times they don’t know how to analyze pensions and other off balance sheet arrangements,” she said.
According to McEnally, analysts will welcome financial statements that they can analyze without rewriting them to glean the pertinent pension information. They’ll stump for fair value measurement of pension assets and obligations reported in the balance sheets, McEnally said, as well as changes in fair value charged to earnings each period and disclosures about how the fair values are calculated.
Related coverage, documents and resources are available from the box above, right.
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