Among the many disasters lurking behind the scenes of the U.S. economy is that of pensions and other post-retirement benefits. It has been estimated that in 2005 there were $472 billion of unrecorded obligations for pension and other post-retirement benefit plans, and that the after-tax effect of these obligations would reduce shareholders' equity by $248 billion or more.Perhaps to give the Senate Committee on Banking, Housing and Urban Affairs an inkling of hope, Financial Accounting Standards Board Chairman Robert Herz and International Accounting Standards Board Chairman Sir David Tweedie presented their plans to require the underlying economic effects of post-retirement plans to be more faithfully and transparently reported through better accounting practices.

Committee chairman Richard C. Shelby, R-Ala., expressed clear support for the project and the independent judgment of both boards. "Sound and transparent accounting standards are the lifeblood of the capital markets," Shelby said in his introductory remarks. "Financial reporting must reflect economic reality. If it does not, investors will lose confidence in the integrity of our markets. It is that simple."

FASB is farther along on its project, having issued an exposure draft of the first of the project's two phases. The proposal would require employers to recognize the overfunded or underfunded status of their single-employer defined-benefit pension plans and other post-retirement benefits.

"We have undertaken the project because current accounting standards do not provide complete and transparent information about employers' obligations and costs relating to these benefits," Herz told lawmakers.

Tweedie concurred, warning the committee that "existing accounting practices [are] deficient, distort behavior, have inter-generational consequences and could lead to great loss to taxpayers."

Herz explained that current accounting standards allow an employer to delay recognition of the economic events that affect the cost and obligation of post-retirement benefits. Current requirements also relegate important information to the notes to the financial statements. Current reporting rules also bury an employer's reported results of operations by combining the effects of compensation, investing and financing activities.

FASB's proposed standard would also require that employers measure the plan assets and obligations as of the date of their financial statements. In contrast, current accounting standards permit them to be measured at dates up to three months earlier, giving companies an opportunity to "smooth" the effects of plan investments, distributing ups and downs over a longer period of time.

Comments and concerns

FASB received over 200 comment letters on the exposure draft. Comments ranged from highly critical to strongly supportive. Herz told the committee that comments were showing the most concern over measurement of the underfunded or overfunded status, the proposed effective dates, and the proposed requirement to measure plan assets and liabilities as of the employer's fiscal year-end.

The Accounting Executive Committee of the American Institute of CPAs generally supported the proposal, and urged the board to expedite Phase 2, which is expected to deal with recognition of the various benefit cost elements in earnings or other comprehensive income, measurement of obligations, whether different guidance should be provided for measurement assumptions, and whether post-retirement benefit trusts should be consolidated.

AcSEC also suggested postponing the change in measurement date until the completion of Phase 2. That phase will address a wider and more complex range of financial accounting and reporting issues in the area of post-retirement benefits. The board will consider how best to recognize and display in earnings or other comprehensive income the various elements that affect the cost of providing post-retirement benefits; how best to measure the obligation, in particular the obligations under plans with lump-sum settlement benefits, cash-balance plans and multi-employer plans; whether more or different guidance should be provided regarding measurement assumptions; and whether post-retirement benefit trusts should be consolidated by the plan sponsor.

The CFA Institute, which advocates for investors and other users of financial reports, reiterated the urgency of the issue, the importance of resisting changes to the proposal, the inadvisability of delaying implementation and the need to quickly move on to Phase 2.

In a letter, the CFA Institute pointed out that in 1976, it had advised the board to take on a project on pensions, arguing that "pension plan accounting must be substantially directed toward future results," and that the users of plan information are concerned with "the potential loss of financial flexibility and future earning power that would result were it necessary in future periods to divert a disproportionate percentage of the sponsor's available resources to fund a shortfall in the pension plan."

The letter went on to say that, "These statements predicted with chilling accuracy the current, severely underfunded state of many companies' large defined-benefit plans."

A comment letter from FedEx Corp. was in diametric and vehement contrast to that of the CFA Institute. The company did not see the proposal as an improvement, and recommended that it be considered only as part of a long-term project to review all aspects of accounting for post-retirement benefit plans.

"Radical reform to these accounting standards without practical transition could result in unintended consequences and jeopardize the entire system of employee-sponsored defined-benefit plans," the FedEx letter stated.

A lesson from the U.K.

Tweedie suggested that FASB and the IASB might follow in the footsteps of the U.K. Accounting Standards Board, which issued a standard on pensions a few years ago. It eliminates the smoothing mechanism by requiring companies to value the assets and liabilities of their pension funds at year-end. Surpluses and deficits are shown on the balance sheet, and changes are shown, not in net income, but in a display similar to what in the United States is termed "other comprehensive income."

When the standard was first proposed, it met resistance in the U.K., but the board devised a mechanism for keeping companies and investors happy.

"When the ASB published its proposals for FRS 17, some criticized the standard as providing a snapshot that was inappropriate, considering assets and liabilities in pension funds are long-term," Tweedie said. "For that reason, FRS 17 requires disclosure of the position of the pension fund at balance-sheet date over a five-year period, so investors and pensioners can see the trends and determine whether a deterioration of the pension fund's position is an anomaly or an indication that attention is needed."

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