Ready For Line-Item Pension Disclosures?

Pensions assets and liabilities will begin appearing on the face of 2006 corporate balance sheets beginning with calendar-year-end companies, following the Financial Accounting Standards Board’s action to finalize its latest statement of accounting standards.

In the first of two phases to overhaul how companies account for pensions and other retirement benefits, FASB is requiring companies to promote the funding status of such benefits from a footnote disclosure to a line item on the balance sheet. The goal is to give more prominence to any liability companies may be carrying related to promised—but underfunded— benefits, which increasingly has become the norm for public companies.

The statement requires companies to recognize changes in their funded status—meaning whether they have too little or more than enough to meet future pension and benefit obligations—in the year the changes occur. That eliminates the “smoothing” allowances companies have long used to minimize the peaks and valleys in their pension funds created by market fluctuations.

The statement also requires companies to coordinate the timing of the pension-liability measurements with the closing of their financial statements, so the figures in the financial statements are more timely when issued. Under existing rules, companies have a longer window of time from the measurement date to the reporting date.

Batavick

The standard represents “a significant improvement in financial reporting as it provides employees, retirees, investors and other financial statement users with access to more complete information,” said FASB member George Batavick in a written statement. “This information will help users make more informed assessments about a company’s financial position and its ability to carry out the benefit promises made through these plans.”

The standard is effective for companies whose fiscal year ends after Dec. 15, 2006, so companies operating on the calendar-year schedule will begin reporting under the new rules with their 2006 year-end statements.

The new rule, Financial Accounting Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, is an amendment of the provisions that relate to pensions and retirement benefits in FASB Statements 87, 88, 106, and 132(R). FAS 158 represents the first of two phases to overhaul how companies account for pensions and other post-employment benefits. FASB promises in the second, longer-term phase to consider additional issues, including the yardstick by which companies measure their pension obligations.

What FAS 158 Will Do

FAS 158 retains the measurement approach that has existed in prior rules, in which companies focus on the projected-benefit obligation, taking into account future salary projections for covered employees. Companies and actuaries have asserted that the rule should focus on the accumulated-benefit obligation because a projected figure takes in prospective benefits for which the company does not have a present liability.

FASB promised that it would entertain the debate over using the PBO instead of the ABO as the accepted measurement approach in its second-phase look at pension accounting rules. That promises to be a lively exchange, says Tom Selling, a financial reporting consultant and adviser to the Association of Audit Committee Members.

FAS 158

The excerpt below is from FASB's Summary of Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R):

This Statement improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. This Statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions.

This Statement requires an employer that is a business entity and sponsors one or more single-employer defined benefit plans to:

Recognize the funded status of a benefit plan—measured as the difference between plan assets at fair value (with limited exceptions) and the benefit obligation—in its statement of financial position. For a pension plan, the benefit obligation is the projected benefit obligation; for any other postretirement benefit plan, such as a retiree health care plan, the benefit obligation is the accumulated postretirement benefit obligation.

Recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to FASB Statement No. 87, Employers’ Accounting for Pensions, or No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions. Amounts recognized in accumulated other comprehensive income, including the gains or losses, prior service costs or credits, and the transition asset or obligation remaining from the initial application of Statements 87 and 106, are adjusted as they are subsequently recognized as components of net periodic benefit cost pursuant to the recognition and amortization provisions of those Statements.

Measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position (with limited exceptions).

Disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation...

Source:

Summary of Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)

Selling

“That argument is still ahead,” he says. “The fact that the FASB is requiring, with everything they’ve already heard, that companies put on the balance sheet a projected benefit obligation, you’ve got to believe that’s the measurement basis that’s currently in the lead.”

In addition to FASB’s statement requiring companies to give the funding status more prominent display, Congress recently enacted the Pension Protection Act of 2006, requiring companies to beef up contributions to underfunded plans to minimize the risk of default.

Other FAS 158 Considerations

Miller

“There isn’t much that people can do to make things look better unless they speed up their funding to produce a lower net liability,” says Paul B.W. Miller, accounting professor at the University of Colorado.

“But that will make their cash look worse. If they borrow money to do the funding, then they are just turning the net pension liability into a note payable.”

The new rules also remove opportunities for companies to work pension assumptions in a way that improves earnings figures. “In an environment where the daily pressure to make numbers can be powerful, removing the temptation to ‘manage’ numbers is a win-win outcome,” says Jonathan Turner, managing director for investigative consulting firm Wilson & Turner. “Where previous financial statements may have been impacted by creative interpretation, going forward statements put all companies on an even playing field.”

Companies increasingly have been turning away from defined-benefit plans, freezing or terminating plans as the enormity of the underfunding problem became more apparent and as lawmakers closed in on the new rules and requirements. Standard & Poors issued a report last year that put a price tag of nearly $300 billion and $150 billion, respectively, on the cost to bring underfunded post-retirement benefits and defined-benefit pension plans to full funding status.

Corporate giants like IBM, Northwest Airlines, Delta, Hewlett Packard, Sears, Motorola, Verizon, and others already have thrown in the towel on their defined-benefit plans and are turning attention toward defined-contribution plans, like 401(k)s, where employees hold more responsibility for the ultimate account balance.

Extensive details on the new FASB statement—including the full text of the statement, an overview, related commentary, and related coverage—can be found in the box above, right.