By the time this column is printed, many will be trying to comply, audit or otherwise cope with the Financial Accounting Standards Board's new standard on pensions.While there is no doubt that SFAS 158 is a huge improvement, no one should complacently think that it takes care of accounting issues related to pensions and other post-retirement employee benefits. Much remains to be done to make financial reports more realistic and useful because, in fact, generally acceptable accounting principles for pensions and OPEBs are almost totally unacceptable, not only when they are compared with reality, but also when they are contrasted with GAAP in other areas.

In case you missed it, Phase 1 of the project was completed last fall with the issuance of SFAS 158. The changes are limited to the balance sheet, specifically with recognition of a net pension item and additional components of accumulated comprehensive income. Don't get us wrong - this is a quantum improvement in quality. However, don't overlook the fact that Phase 2 is both needed and coming.


SFAS 158 focuses on only the funded status (the difference between the plan assets and the benefit obligation) by requiring employers to report that amount on the balance sheet as either an asset or liability depending on the circumstances. We've looked around, but haven't found a counterpart to that offsetting practice anywhere else.

If a company secures debt with collateral, the asset and liability are never offset against each other, so why do it here? Besides, we think offsetting obscures the simple truth about the company - it really is in debt for the full amount of the obligation. The good news is that it has assets earmarked for paying it off, but assets belong on the other side of the sheet. We're hoping the board will reconsider this treatment and get rid of it.


Nowhere else in GAAP beside pensions are so many disparate income items aggregated into a single undecipherable amount. Specifically, the annual cost includes the effects of ongoing labor costs, interest on the liability, investment income, unrealized gains and losses, deferred gains and losses, goodwill amortization, market adjustments to debt, and some bizarre smoothing adjustments.

All that is wrapped up with a bow and called "pension cost," but it doesn't stop there, because some of it is capitalized into inventory cost and some flows to the bottom line.

An obvious avenue for improvement is disaggregation and reclassification of each of these components into its rightful place. In some cases, that place is nowhere, because it doesn't belong on any income statement, as we explain below.


Even transporting ourselves back 20 years, we cannot grasp how the board endorsed reporting the expected return on the plan assets as if it actually happened, while ignoring the actual return as if it didn't.

Can you imagine the confusion that would ensue if mutual funds reported expected, instead of actual, results? Chaos would reign, because no one would be able to assess performance or the value of their holdings. Well, it turns out that a lot of pension funds are nothing but closed-end mutual funds. So, if mutuals can mark their portfolios to market and include unexpected gains and losses in their income statements, then employers can do the same with their pension funds.

Near as we can tell, there was no good excuse back then for using the expected return, and there certainly is none now. This tomfoolery just has to go during Phase 2.


The board rationalized deferring and amortizing retroactive benefit increases (prior service cost) on the slippery proposition that employees would feel goodwill toward their employer because of the new, higher benefits.

This intangible asset was then to be amortized over a projected work life. But nowhere else is self-generated goodwill recognizable as an asset; furthermore, even if it were, SFAS 142 would not permit its cost to be amortized. Impairment testing would be done and, if done honestly, would certainly show a zero value shortly after it was created, thus leading to a full write-off.

The rationale for the goodwill treatment becomes even more absurd when it's applied to situations in which management negotiates reduced future benefits (primarily for OPEBs). Specifically, if benefits are reduced, the savings are deferred and spread over the future, instead of reducing the cost in the year of the gain. How bizarre is it to offset the savings against higher costs produced by disgruntled employees who now refuse to work hard?

Here is the really strange part: By deferring prior service results, GAAP encourages managers to grant even outrageously high new benefits, because they won't hit the bottom line right away. On the other hand, they also discourage negotiations that lead to savings for the same reason. This charade has to go in Phase 2 - just report the results in the year they occur.


Under pension GAAP, the employer's obligation is essentially marked to market, but the income statement is buffered against that real volatility by deferring the value changes indefinitely. The consequence is income that appears as placid as if the employer faces no risk for having promised to pay an unknown amount to unknown recipients for an unknown period of time. If that is not an irrational and risky debt, we have never seen one.

By their nature, volatility and risk are intertwined, and the only transparent way to reveal the risk is to let the volatility flow through the income statement. If management wants to alter the financial arrangement to eliminate real volatility, more power to them, but they should not report patently false, nonvolatile numbers that nobody believes, except perhaps themselves. Therefore, actuarial changes should be reported as ongoing gains and losses for the year in which they occur.


Perhaps the most abominable creature in all accounting is "corridor amortization." This gizmo was invented as a fail-safe mechanism to protect against over-deferral of asset and actuarial gains and losses. In case the deferred balance exceeds 10 percent of the larger of the pension asset or liability, a tiny fraction of the excess is brought back into annual cost. What nonsense - but you'll find it in virtually every footnote describing pension and OPEB plans.

Of course, if deferrals are eliminated in Phase 2 of FASB's project, there will be no need for corridor anything.


Standing head and shoulders above the current twists and turns of pension accounting is a very simple answer: Consolidate the pension fund assets and liability, because they are part of the employer's financial structure.

Look, who is going to pay the benefits if the fund can't? The employer. So, the pension obligation is a direct liability and belongs on the employer's balance sheet at market value. On the other side are those fund investments. Who do they belong to? The employer. They are committed to being used to satisfy the employer's debts; therefore, they are its assets. Thus, consolidation is justifiable because the employer clearly controls the assets and owes the liability. This is not rocket science.

Without a doubt, FASB has much to accomplish in Phase 2. We urge them to pursue unvarnished and unfiltered truth in financial statements, mainly by keeping it simple. If they take their eyes off this goal, everyone will suffer, because opaque reporting fosters capital market inefficiency, and haven't we had enough of that?

Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at

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