Financial accounting and NQDC

• Author: Marla J. Aspinwall - Michael G. Goldstein
• Pages: 327-354

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CHAPTER XIV

FINANCIAL ACCOUNTING AND NQDC

R. Lee Nunn

Senior Vice President, Aon Hewitt

I. INTRODUCTION

This chapter discusses the accounting for nonqualified benefits, the financing related to

these benefits and corporate taxes related to both the benefits and the financing.

A.

Why Is Accounting Important? Accounting rules attempt to standardize the

process of measuring financial performance, which affects both stock prices and the terms under

which companies borrow money. Stock prices affect investors, potential investors, and

employees whose compensation is tied to employer stock price. Credit ratings affect a

company’s ability to borrow or to borrow at favorable rates. The Sarbanes-Oxley Act raised the

stakes for publicly traded companies by imposing criminal and civil penalties on principal

executive officers and principal financial officers who knowingly certify fraudulent financial

statements.1

When a company considers adopting or changing a nonqualified deferred compensation

plan (or related financing), cash flow analysis and accounting are key components of financial

analysis. Accounting issues relating to nonqualified deferred compensation plans and related

financing can be highly specialized and financial decision makers want to avoid surprises —

especially when plan results vary from assumptions.

B.

Who Decides What the Accounting Rules Are? The Financial Accounting

Standards Board (FASB) is the private sector organization responsible for maintaining financial

standards for nongovernmental organizations in the US. These financial standards are known as

US Generally Accepted Accounting Principles (US GAAP). Both the Securities and Exchange

Commission2 and the American Institute of Certified Public Accountants3 officially recognize

FASB standards. For publicly held companies, Congress gave the SEC the authority to establish

financial accounting and reporting standards under the Securities Exchange Act of 1934.

Although the SEC relies heavily on FASB to establish and maintain accounting standards, the

SEC does have its own rules that apply in addition to FASB’s standards. FASB’s Accounting

Standards Codification now includes some non-authoritative SEC guidance on accounting and

reporting issues. The Governmental Accounting Standards Board (GASB) sets the financial

accounting standards for state and local governments. These governmental accounting standards

are beyond the scope of this book.

1 17 CFR, part 240, Securities Exchange Act of 1934, §§ 240.13a-14(a) and 240.15d-14(a), reflecting

changes made by the Sarbanes-Oxley Act of 2002.

2 SEC Financial Reporting Release No. 1, Section 101, and reaffirmed in the SEC’s April 2003 Policy

Statement.

3 AICPA Rule 203, Rules of Professional Conduct, as amended May 1973 and May 1979.

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The International Accounting Standards Board (IASB) is responsible for developing and

publishing International Financial Reporting Standards (IFRS). All major economies across the

globe now plan either to adopt IFRS or to merge their standards (local GAAP) with IFRS. FASB

and IASB have been working toward convergence of US GAAP and IFRS since 2002 and

reaffirmed their mutual commitment to converge the standards in October 2009. The current

strategy is to work jointly to issue new standards that reflect best practices, not necessarily

current US GAAP or IFRS. The application of IFRS to nonqualified deferred compensation is

beyond the scope of this book.

C.

Codification. FASB has reorganized US GAAP into a single source: FASB

Accounting Standards Codification (Codification), which supersedes all previous US GAAP.

The old hierarchy that included Statements (e.g., SFAS 87) down to Technical Bulletins (e.g.,

Technical Bulletin 85-4) is now a unified single source, searchable by topic and cross-referenced

with pre-Codification Standards. FASB intended to codify, not change, US GAAP but

acknowledges that unintentional changes may have occurred. Codification allows constituent

feedback on content in order to identify unintentional changes and to alert FASB on the need for

intentional changes as part of the ongoing standard setting process. The starting point was US

GAAP as of July 1, 2009, but FASB issues Accounting Standards Updates regularly.

FASB has organized Codification by topic in order to simplify its use. For example,

Corporate Owned Life Insurance (COLI) is categorized as an asset under Codification Topic

325 — Investments Other. Investments in Insurance Contracts is Subtopic 325-30. Initial

Measurement of COLI is Section 325-30-30. General guidance on such initial measurement is

paragraph 325-30-30-1. Under the Codification reference system, one number indicates a Topic;

two numbers indicate a Subtopic; three numbers indicate a Section; and four numbers (e.g., 325-

30-30-1) indicate a paragraph. If you know the pre-Codification standard, but can’t find it in

Codification, the FASB website offers an easy cross-referencing tool. This chapter will

reference GAAP according to Codification, not pre-Codification standards.

D.

Financial Statements. The financial statements that reflect accounting results

include not just the Balance Sheet4 and Income Statement.5 Much of the information important

to understanding nonqualified plans and related financing appears only in the Notes to Financial

Statements.6 Likewise, certain changes in benefit obligations and financing appear only in

Comprehensive Income7 rather than the Income Statement. Other elements of the financial

statements, which sometimes reflect nonqualified plans and related financing, are the Statement

of Shareholder Equity8 and the Statement of Cash Flows.9

4 Codification Topic 210.

5 Codification Topic 225.

6 Codification Topic 235.

7 Codification Topic 220.

8 Codification Topic 215.

9 Codification Topic 230.