This column presents most of our comment letter to the Financial Accounting Standards Board concerning its exposure draft on accounting for pensions and other post-retirement benefit plans. The draft was published on March 31 of this year, with a target release date of September and an anticipated effective date that will alter 2006 annual reports. It constitutes Phase 1 of FASB's plan that shores up the balance sheet, while deferring repairs to the income statement until Phase 2.Although we applaud the progress in the FASB draft, it is just the first of several necessary steps to converge generally accepted accounting principles representations with economic reality.

Dear FASB members and staff:

We are writing to strongly support your efforts to create more useful financial reporting as proposed in your March exposure draft, Employers' Accounting for Defined-Benefit Pension and Other Post-Retirement Plans.

That progress will occur by moving relevant information out of the footnotes and onto the balance sheet. By improving the usefulness of financial statements, this move will diminish (but not erase) the blot on the integrity of the standard-setting process reflected in this quote from SFAS 87: "The delayed recognition included in this statement results in excluding the most current and most relevant information from the employer's statement of financial position."

As you know, this move does not change the politically shaped and deeply flawed Rube Goldberg calculation of annual costs. Because you are deferring a more complete fix, we encourage you to create new disclosure requirements that will help statement users bridge the gulf between reality and the reported amounts.

In particular, we believe the footnote should encourage them to substitute good information for bad. This disclosure should be designed to allow users to identify the economic effects of all events affecting fund assets and the liability, to easily generate unsmoothed measures, to understand the year's comprehensive income and to determine how much of the reported annual cost was capitalized and expensed.

As we see it, current and proposed standards for pensions and other post-retirement employment benefits don't produce useful information and are literally not in compliance with other fundamental acceptable principles.

This Gordian knot deserves to be slashed, although we understand your desire to unravel it. In any case, your decision to leave the income measure alone makes it essential that new disclosures help users bear with the situation.


Among the otherwise unacceptable practices in pension (and OPEB) generally accepted accounting principles, or "P-GAAP," is the offsetting of fund assets against the liability. This practice is patently rejected everywhere else. For example, mortgage debt is not subtracted from the book value of mortgaged property, and accounts payable are not offset against cash, because doing so obscures relationships between assets, debt, equity and returns.


Frankly, we don't mind a whit that the new standard threatens existing debt covenants by revealing that violations of the old limits were hidden by poor accounting.

If debtors are to receive any grace, it can rightfully come only by direct and specific action by their creditors, not from you and certainly not by your allowing inferior financial reporting to continue for even one day, much less another year. Your responsibility is to get truth into the statements as soon as you can, and then it's up to debtors and creditors to renegotiate in light of that truth.

Aggregation and smoothing

As you know, the amount of annual cost under P-GAAP is an unfathomable aggregate. Because you won't be changing the calculation, we offer the following observations and recommendations:

* Service cost: Service cost is a labor cost, exactly the same as current accruals for payroll, except that the cash flow is postponed and its amount is actuarially reduced. Service cost disclosures should clearly reveal whether it was assigned to production; research and development; selling, general and administrative expenses; or something else.

* Interest cost: Elsewhere, interest is reported separately as a financing expense to help users assess the impact of debt. Although interest may be capitalized, SFAS 34 specifically prohibits adding it to inventory cost; thus, P-GAAP doesn't comply with GAAP. As a result, new disclosures should show how much interest was incurred and where it ended up in the statements.

* Prior service cost: According to P-GAAP, granting retroactive benefits creates employee "goodwill," a fiction that leads to deferring and amortizing the cost over the projected work lives of affected employees. This flimsy rationale is even less credible now that SFAS 142 has done away with amortizing goodwill.

Indeed, it has never been acceptable to recognize internally generated goodwill. The nature of, and useful accounting for, this spurious intangible needs rethinking.

Moreover, we're especially puzzled by the accounting that causes savings from reduced employee benefits to be amortized over the future. Apparently, savings achieved by creating "badwill" are being offset against higher future costs produced by disgruntled employees. Obviously, this practice and its justification are irrational. A plan amendment produces a one-time cost or saving that affects only the current year's income.

We recommend that the footnote reconcile the beginning and ending balances of unrecognized prior service cost to enable users to easily isolate the damage done to the statements by deferring and amortizing.

In addition, the note should reveal how much cost or benefit ended up in inventory and various expenses.

* Actuarial gains/losses: The current crisis was exacerbated in large part by the losses caused by falling interest rates. These losses are called "actuarial," even though they are caused by being indebted for unknown amounts due at unknown dates. Of course, other adjustments are caused by real actuarial factors. For example, more employees are retiring early and living longer. Although these latter gains and losses are nominally different from interest-driven gains and losses, the ill-conceived policy of financing current operations with open-ended and risky debt generates real volatility.

To help users comprehend what happened, these gains and losses should be fully disclosed. As with prior service cost, we recommend that the footnote reconcile the beginning and ending balances of the deferred actuarial gain/loss.

* Investment returns: We have always been chafed by the P-GAAP practice of reporting expected returns instead of actual results. Imagine what damage would be done to the credibility of GAAP statements if all revenues and expenses were to be reported at management's expected amounts!

This contrivance is transparently indefensible, because it obscures truth. The best way to get volatility out of the statements is to eliminate real volatility, and we think managers will get rid of it only if they have to report it.

Because you aren't repairing the expense, you are obliged to require full disclosure of actual and expected returns in the same table, unlike SFAS 132, which puts actual returns in the asset reconciliation and the expected return in the annual cost tabulation. We recommend a new format that clearly reveals the real and P-GAAP amounts. (We have attached a prototype schedule, showing the 2005 numbers for General Electric's principal pension and OPEB plans.) (See box at right.)

* Corridor amortization: There is no better proof of the absurdity of P-GAAP than corridor amortization of accumulated gains and losses. Although this practice is clearly arbitrary and irrational, present footnotes present it as a legitimate component of annual cost. The resulting amount has no connection with anything real and cannot be useful under any circumstance.

Again, your decision to defer Phase 2 makes it incumbent on you to enable users' rational analyses by reconciling the beginning and ending balances of the deferred gain/loss account. This disclosure would also clearly reveal the results of terminations, settlements and curtailments that will surely be triggered by the new standard.


Please know that we praise your resolute willingness to enter into the P-GAAP minefield. You have responded promptly and taken a good first step. Because your predecessors deferred reporting the truth, the whole truth and nothing but the truth, it falls to you to serve the capital markets by requiring complete and comprehensible disclosures.

Despite the superficial, even fatuous, arguments that you will find in other letters that focus only on preparers' needs, you must address financial statement users' needs by providing more information in a format that facilitates analysis and accountability.

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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