by Glenn Cheney
Norwalk, Conn. - The Financial Accounting Standards Board goes into its second semester with a heavy agenda of issues that are as tough as they are pressing.
Against predictable resistance from the corporate sector, FASB is considering adjusting its standard on employee stock option compensation, and under dire warnings of pension fund troubles coming from Washington, the board is tweaking its standard on pension fund reporting.
In late July, the U.S. comptroller general, David M. Walker, warned that the Pension Fund Guaranty Corporation was on a list of “high risk” government operations, and the secretary of labor, Elaine L. Chao, warned that the federal system that guarantees pensions is “at risk.”
The federal government insures the pension plans of some 34 million Americans. Under the Bush administration, however, the program’s $9.7 billion surplus has become a $3.6 billion deficit.
Accounting and disclosures are neither the cause of - nor the solution to - America’s pension problems, but when things get shaky, corporations, employees, investors and the government like to know how pension plans are affecting corporate finances. Nationwide, pension plans fall short of their obligations by an estimated $350 billion.
“The main thing we are trying to do is make sure investors and other users of financial statements have more information about pension plan assets that are subject to market and interest rate risks, and to provide a clearer picture of what the future cash requirements are,” said FASB project manager Peter Proestakes. “The sources of cash requirements - contributions made by the plan’s sponsor, and payments made directly to retirees - are the essence of what we are talking about.”
The project is essentially an amendment of Statement 132, Employers’ Disclosures about Pensions and Other Post-retirement Benefits. If passed, the new statement would probably require disclosure of the types and amounts of assets that are owned - measured at fair value - for each period of a balance sheet that is presented in an annual report.
Companies would also have to report target allocation based on investment strategies. The expected long-term rates of return on assets would be required for each asset.
The board has tentatively decided that it would be a good idea to require quarterly, rather than annual, disclosures on the impact of pension plans on earnings in each quarter. The impact would be visible on various income statement line items.
If the board proceeds in its current direction, companies may also be required to make annual disclosures about how much they expect to contribute to pension funds. If those forecasts change substantively, companies would be required to make quarterly disclosures of the changes.
The board does not seem inclined to require new breakdowns of asset categories, though additional breakdowns would be encouraged when a company feels that the information would be useful. The board has tentatively decided not to require duration information, but to require projected benefit payment disclosures instead.
Reducing smoothing
The board may decide to expand the project a bit to include requirements that would reduce the “smoothing” effect that was an objective of FASB Statements 87, Employers’ Accounting for Pensions.
That standard minimized the bumps and volatility caused by short-term reporting on long-term investments. With a looming pension crisis, however, FASB may opt for more frequent reporting to help companies and investors react to changes in market conditions and shifts in corporate financial situations.
Financial Executives International has been tracking the project and contributing to the process. FEI senior vice president for public affairs Grace Hinchman said that her organization’s members are less than eager to expand disclosures about pension plans. The problem isn’t the burden of producing the information, but the confusion brought on by excess information.
“Our letter to FASB raised the specter of, ‘Is this really necessary?,’” Hinchman said. “Our membership is concerned that there is already a lot of information on pension plans available. Is additional information of any value? A lot of our members said their people don’t pay any attention to it now. In our opinion, it’s overkill.”
The board has made most of the big decisions on this project, but the decisions are still tentative and need to be re-affirmed before a proposed standard is issued. The board had hoped to issue an exposure draft in August and a final statement by the end of the year. Now it looks like an ED won’t come out until September, followed by a relatively quick 45-day comment period. If the project is held up any longer than that, a final statement by year’s end is not likely.
“I am expecting a limited amount of re-deliberation, because we’re really only talking about a handful of additional disclosures,” Proestakes said. “But if we don’t get a draft out by the middle of September, I doubt we’ll be able to have a final statement in December.”
The project was nudged back a bit after the board decided to dedicate most of August to an even thornier issue: employee stock option compensation.
Studying its options
The board has pretty much decided, albeit tentatively, to adopt a stance that it had taken in the mid-1990s, but that was shot down by corporate objections and even a non-binding resolution from the U.S. Senate. The board had proposed that employee stock option compensation be expensed at fair value on income statements rather than amortized. After reconsidering that proposal, the board backed down to requiring that the effects of expensing only be disclosed in footnotes.
Since then, many companies, such as Coca-Cola, have opted to voluntarily expense stock option compensation. Microsoft, most famously, avoided the problem by ceasing to use stock options as compensation, issuing restricted stock instead.
The International Accounting Standards Board has moved toward an international standard that would require expensing. In its continuing effort to converge with international standards, FASB has taken up the issue again and is leaning hard toward expensing. Corporations, especially in the high-tech sector, are again resisting, their main concern being the inevitable inaccuracy of predicting the fair value of stock options that may not be exercised for many years.
The board has, therefore, decided to dedicate most of its August meetings, held weekly at headquarters here, to discussion of the measurement issue. Corporations are warning that measurement is inaccurate and, therefore, produces inconsistent results that should be left out of income statements. Investors say that any number is more accurate than zero. The board has formed a panel of experts to discuss valuation.
Hinchman said that the FEI is pleased to see so much attention being given to valuation. The organization has been advocating a shift to expensing, but only if an adequate means of valuation has been established. The FEI has determined that the widely used Black-Scholes method is inadequate, but that other methods may prove more useful.
