In January 2016, the Financial Accounting Standards Board issued two proposed updates on the Codification sections that guide employers’ accounting for defined-benefit pensions. That’s the good news.

Now, here’s the bad news. The proposed minor changes don’t deal with the two most significant issues of how to measure the annual pension cost and whether to report the pension fund assets and benefit obligation on employers’ balance sheets without offsetting. It’s been just over 30 years since the board issued SFAS 87 that deliberately hid the truth and nearly 10 years since it issued SFAS 158 that helped but nonetheless retained most of the obscurity.

Our bottom line is that fundamental reform is badly needed and the way is clear for putting it into place.

This column is mostly an encore of our June 2010 column that called for those reforms based on a straightforward economic analysis of pensions. We’re reprinting it because FASB disregarded our suggestions (except for one) and what we said six years ago is still pertinent to the fresh, all-encompassing reconsideration of pension accounting that is so desperately needed.

According to the ancient legend of the Gordian Knot, whoever could untangle its complicated strands would rule the world. Tradition says a bold sword stroke by Alexander the Great sliced open the vexing knot, followed by his conquest of everything between Greece and India. We think this fable provides a fine metaphor for defined-benefit pension accounting and makes us wonder whether any standard-setters have the courage to dismantle this mess by wielding useful truth as their sword.

When FASB issued SFAS 158 in 2006, it seemed to be laying a sharp edge on the knot, but its rush to complete its overly ambitious efforts to converge GAAP and IFRS figuratively put the pension sword back in the scabbard without a date for bringing it back out.



To explain just how bad pension accounting really is, one of our earlier columns, “Pensions and OPEB: Bass-O-Matic Accounting” (Dec. 19, 2005), described the impenetrable practices foisted on the capital markets.

One flaw is blending together the three totally distinct annual factors into one lump-sum labor-based pension cost, which is then capitalized or expensed, depending on what the covered employees work on. These disparate factors include:

  • Service cost, the only true labor cost for pensions;
  • Interest, a financing cost that has nothing to do with labor and everything to do with being in debt; and,
  • Asset return, the product of investing that also has nothing whatsoever to do with labor and everything to do with risk exposure.

Another flaw is concealing the employers’ risks by artificially stabilizing reported annual cost and earnings per share, instead of revealing the volatility that would clearly signal the existence and extent of those risks. To placate apprehensive managers (while stifling the flow of useful information to capital markets), FASB endorsed five smoothing techniques in 1985:

  • Expected asset returns are used to compute the blended annual cost instead of actual observed results;
  • Unexpected asset returns/losses are deferred and offset against past and future unexpected amounts;
  • Unexpected changes in the pension obligation’s value are also deferred;
  • A very small portion of the combined deferred amount is recognized under only the most extreme circumstances; and,
  • Changes in the obligation created by amending the plan (both up and down) are deferred and amortized as prior service costs or credits.

We note that this Rube Goldberg scheme for suppressing volatility deferred more than $22 billion of losses for AT&T in 2009, thus protecting its reported earnings of only $12.5 billion from being turned into a net loss. The resulting ugly mess defies rational explanation and produces useless information. (Note: Deferring AT&T’s pension-related losses boosted its 2015 reported pretax earnings by 17.5 percent.)
SFAS 158 created a third flaw despite correcting an even worse one. The balance sheet now reports market-based amounts for pension obligations and plan assets but their amounts are offset before going onto balance sheets. This net number can be extremely misleading and distortive. For example, consider AT&T’s situation as of the end of 2009: Its pretax ROA was apparently 7.1 percent but fell by 230 basis points to only 5.8 percent after undoing the effects of offsetting. Using the reported balance sheet figures, its debt/equity ratio appeared to be 1.27 but undoing the offset increased it by 45 percent to 1.84. (For 2015, AT&T’s corrected ROA falls to 3.9 percent, 25 percent less than the nominal return and the corrected debt ratio is 2.65, 18 percent higher than the nominal ratio.)



All in all, terrible standards that intentionally deviate from telling the whole truth have produced this totally baffling nonsense. Briefly, this knotty problem arose in the 1980s when FASB lacked strong support from the Securities and Exchange Commision, and was still dependent on corporate contributions. Being afraid to resist intense bullying served up by statement preparers, the board kowtowed and created a mess. The International Accounting Standards Committee went along later and incorporated essentially the same unprincipled rules in its standards. As a result, the truth was suppressed and otherwise withheld from capital markets all over the world.



As we mentioned, FASB gave a half-hearted whack at the knot when it issued SFAS 158. However, the main change it accomplished was recognizing the net difference between the assets and obligation on the employer’s balance sheet. Ironically, the original board said in 1985 that it wished it could have required this treatment. In other words, the only progress achieved by this feeble swipe was implementing a 20-year-old preference without eliminating income statement smoothing. FASB promised that “Phase 2” of the project would tackle and truly fix that part of the knot. However, in the ensuing years since 2006, the board hasn’t done anything about it.

Bottom line, FASB’s blade barely made a dent and left fiction, myth and legend in financial statements, not cold, hard economic truth.



Nothing will fix the Gordian knot more completely and quickly than a commitment by FASB to produce standards that require employers to tell the truth, the whole truth, and nothing but the truth in a straightforward and understandable manner. This approach will obviously help statement users comprehend risks produced by pensions. Importantly, it will also hold management far more accountable. Finally, it will help regulators of all kinds get a handle on the health of the private pension system.

Here’s the sword of truth we would apply:

  • Plan assets should be reported (at market value) among investments on employers’ balance sheets.
  • Benefit liabilities should be reported (at market value) among other short- and long-term debts.
  • Service cost is compensation and should be capitalized or expensed as appropriate.
  • Interest is a financing cost and belongs with all other interest charges on the income statement.
  • Return on plan assets is investment income and the full actual amount (whether realized or unrealized) should flow through income statements.
  • Prior service costs from increases in obligations or prior service credits from decreases in obligations should be reported in full as additional compensation or savings when the amendment occurs.
  • Changes in obligation values should be reported in full as gains or losses on income statements in the year they occur.
  • Pension footnotes should be clear and unambiguous (see below).

Once this fundamental simplicity of pension arrangements is reflected in financial statements, all sorts of behaviors will change. There is not now, never has been, and never will be any legitimate justification for the complex obscurity that characterizes existing GAAP.


Just how hard could it be to pull this change off? It simply requires candid truth-telling, which means ignoring the persistent obstacle found in managers’ persistent fallacy that accounting creates volatility. If it’s done right, better accounting would only reveal volatility that has been concealed for three decades.

In contrast, looking at this challenge with the simple goal of truth-telling with forthrightness will reveal the Gordian knot is nothing but a simple slip knot. All a responsible board would have to do is just tug on one of the loose ends with a truthful standard, and it would disappear forever.



In February 2016, we collaborated on a comment letter to FASB that proposes four new supporting disclosures that would help analysts understand how these benefit plans affected the employer. We’ve presented two of them that use FASB’s example data. (See “Periodic income and cost.”)

Figure 1 shows how pensions and other benefits impacted the period’s comprehensive income by listing all its components and then shows how much is considered to be periodic cost and how much is hidden on the balance sheet.

Figure 2 presents a revised schedule about the periodic cost. The upper half enhances users’ access to the relevant information by itemizing the three primary cost elements and labeling their sum as the “unmodified net cost.” The lower half clearly discloses the distortive effects created by the volatility-reducing modifications.

Of course, the letter also encourages the board to dismantle the complex compromises created 30 years ago when the board was politically besieged.

With FASB’s independence now firmly established, there’s no reason to continue strangling the flow of useful information about pensions to financial statement users.

Paul B. W. Miller is an emeritus 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 or Accounting Today. Reach them at

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