Things change. Even assumptions. When assumptions change - assumptions about interest rates, discount rates, actuarial projections, and the like - other things change as a result.It was the war in Iraq that indirectly brought the issue to light. To the surprise of the U.S. Treasury, the extent of the U.S. military's costs for pensions, other post-employment benefits, and health care costs associated with the Veterans Administration appeared to be lower in 2006 than in 2005, despite an ongoing war.
"Everyone was saying, 'No, that's not what we expect,'" said Tom Allen, chairman of the Federal Accounting Standards Advisory Board. "We had the war, a lot more people injured, a lot more troops and everything else. It didn't make sense."
The mirage of a drop in costs turned out to have been caused by changes in certain assumptions on which long-term obligations are routinely based. Pension and post-employment health care costs are two big ones, especially in an organization as large as the Department of Defense. A minor adjustment to assumptions can result in a gain or loss of several billion dollars.
Suggesting that it's time to change the way such changes in assumption are reported, FASAB has issued a proposal, titled Reporting Gains and Losses from Changes in Assumptions and Selecting Discount Rates and Valuation Dates. If adopted, the standard would require gains and losses from changes in assumptions to be displayed in the statement of net cost.
The readers of financial statements would then be able to see costs as they would change in the absence of changes in assumptions, and the actual changes in costs caused by changes in assumptions. Under the current federal accounting standards, nothing in a financial statement would explain the cause of the gain or loss.
The problem involved more than just the lack of disclosure about assumptions. The U.S. Treasury was also concerned about a lack of consistency among various federal agencies when they selected U.S. Treasury discount rates and valuation dates for present-value measurements of expense and liability reports. The proposed standard specifies the use of a long-term discount rate, rather than a spot rate, because the former would fluctuate less.
An example of the lack of consistency became apparent in a financial report from the Veterans Administration, which had used a discount rate on the last day of the fiscal year, rather than a long-term rate. The existing standard was not clear on which to use.
The proposed standard also stipulates that if actuarial calculations are set at a point other than at the end of the year, the results may be used, but any subsequent changes would have to be accounted for.
"We are not telling you that you have to go out and get a new actuarial calculation at the end of every fiscal year," Allen said. "A lot of governments don't even have annual actuarial calculations ... so we are saying that you can use the last calculation you have, but consider any factors that may require you to adjust it."
Cato Institute senior fellow Jagadeesh Gokhale praised the proposal, saying that it improves financial reporting by making obligations and liabilities clearer.
"A change in the discount rate assumption reflects a re-evaluation of the future return on federal assets," Gokhale explained. "For example, if the discount rate is revised upward, it implies that expected returns on assets that government entities are required to sequester for funding long-term future obligations should be larger, and the funding cost would therefore be smaller. Separately displaying how much the cost of funding obligations that are coming due in the future would help to clarify policy trade-offs to lawmakers and enable better private expectations about policy decisions."
FASAB standards apply only to the federal government, but they can sometimes presage a direction that the Governmental Accounting Standards Board, which writes standards for state and local governments, may take.
David Bean, GASB director of research and technical activities, said that the GASB standard on pensions requires disclosure of significant changes in assumption, but does not require display of specific comparisons. The topic is, however, part of a GASB research project on pensions, and may eventually make its way onto the board's agenda.
FASAB requested comments on the proposal by Nov. 30, 2007.
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