Magazine article The CPA Journal

How the New Pension Accounting Rules Affect the Dow 30's Financial Statements

Magazine article The CPA Journal

How the New Pension Accounting Rules Affect the Dow 30's Financial Statements

Article excerpt

Potential Implications for Policymakers and Equity Research Analysts

The Sarbanes-Oxley Act of 2002 (SOX) charged the sec with studying off-balance sheet financing, special purpose entities (SPE), and reporting transparency. The sec completed its study on June 15, 2005, and pension accounting was a primary target of the report's standards-setting recommendations. Noting that pension plan trusts are conceptually similar to SPEs, the sec pointed out that large amounts of pension liabilities are not recognized on the balance sheet The sec further observed that the current demographic and political environment made the accounting for these benefits of critical interest at the highest levels of both the public and private sectors.

The SEC report focused on the incompleteness of balance-sheet recognition of pension assets and liabilities, noted the lack of transparency and clarity, and concluded that pension accounting should be reconsidered. It identified three issues of concern: 1) consolidation; 2) deferral of actuarial gains and losses; and 3) asset valuation. The report also criticized the complex smoothing mechanisms inherent in SFAS 87, Employers' Accounting for Pensions (1985). The report also cited remarks that then-SEC Chief Accountant Michael H. Sutton made at the December 19% AICPA National Conference-"good disclosure doesn't cure bad accounting"-suggesting that the revised and expanded disclosures relating to pensions and other postemployment benefits (OPEB) promulgated in SFAS 132(R), Employers' Disclosures About Pensions (December 2003), left the essence of the secs concerns unaddressed.

At its November 10, 2005, meeting, FASB added to its agenda a comprehensive two-phase project on accounting for defined-benefit pension plans and OPEB. The first phase resulted in an exposure draft (ED) issued on March 31, 2006. In September 2006, it was adopted with slight modifications as SFAS 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, an Amendment of FASB Statements Nos. 87, 88, 106, and 132(R). The new standard requires balance-sheet recognition of the funded (or unfunded) status of pension and OPEB plans. Notably, companies are required to use the projected benefit obligation (PBO), the more comprehensive measure of the pension liability. Furthermore, SFAS 158 allows net asset or liability recognition rather than the separate asset and liability recognition that the SEC preferred. SFAS 158 still maintains the smoothing mechanisms currently in force, protecting the income statement from the full effects of actuarial gains and losses. Those amounts, however, would be included in other comprehensive income. The second phase of the project will further consider how these deferred amounts should be recognized and reported, as well as other liability measurement issues.

The authors studied a sample of high-profile companies-the Dow 30-to illustrate SFAS 158's potential effects on the balance sheet and on select ratios commonly used by the analyst community. The authors also illustrate how the new standard has affected the social policy debate and how analysts will need to reconsider their measurements of certain classes of ratios, especially in longitudinal comparisons.

How SFAS 158 Addresses the Accounting Issues

The SEC and FASB focus in the first phase of the project has been on balancesheet deficiencies in pension accounting. SFAS 158 continues the income-smoothing mechanisms of SFAS 87. Changes in liabilities recognized under the new standard will be offset in accumulated other comprehensive income (AOCI) with only gradual income statement recognition. The reasoning behind smoothing is that, over time, experiential gains and losses should reverse themselves. Accumulated net income would be correctly reported and undue volatility resulting from mark-tomarket measurement would be avoided.

Unrecognized gains and losses may arise on both the asset and the liability side of the pension plan. …

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