The impact of pension accounting on companies' financial statements.

Author:George, Nashwa
Position:Pension fund analysis
 
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ABSTRACT

The Financial Accounting Standards Statement No. 87 "Employers" Accounting For Pension" gives companies chance to choose the expected rate of return on pension assets as well as the discount rate that is used to calculate the present value of pension liabilities. Companies tend to choose these rates in such a way to reduce pension expense and pension liabilities. With the declining in stock market, actual return on pension assets is very low compared to the expected return that is used to calculate pension expense and pension liabilities. If companies used the actual return, their pension expenses are much higher and net incomes would be much lower. In addition, pension liabilities would be much higher. By using expected return and high discount rate, companies' financial statements do not reflect the economic condition of companies' pension expense or pension liabilities. The Financial Accounting Standards Board should clarify the assumptions as well as the rates that should be used by companies in calculating their pension expenses and pension liabilities.

  1. INTRODUCTION

    Corporate management has been accused of managing earnings to produce the target earnings that are so essential in maintaining market share. Following the collapse of Enron Corporation, World Com, and others and the down draft in the stock market for two consecutive years, the Securities and Exchange Commission and the Financial Accounting Standards Board (FASB) is taking steps to examine corporate accounting practices. One of these practices is pension accounting.

    Under Generally Accepted Accounting Principles, public companies include in their operating earnings gains from pension funds because companies are allowed to use expected return on pension plan assets and expected interest on pension obligations as elements of pension expense or income.

  2. TYPES OF PENSION PLANS

    Company might adopt one or more of the following pension plans:

  3. Defined benefits plan. In which, a company promises to pay an employee a specific retirement benefits. The benefits that employee received at retirement are calculated using some formulas. Employer's contributions to pension fund are placed in a trust and invested. Benefits are paid to retirees from the trust's accumulated assets. The employer's annual contribution is actuarially determined based on employees' ages, salary histories, mortality rates, and other factors.

    Employer bears the financial risk if the pension plan assets are not adequate to meet the promised benefits that should be paid to retirees. Employees gained most of their benefits in the last few years before retirement. Retirees receive a monthly payment for a life when they retired.

  4. Defined contributions plan. In which, the amount of cash that the employer puts into the plan for the benefits of the employee is known. However, employees are not guaranteed a specific benefit on retirement. An individual account is maintained for each participant. The account balance is based on contribution made by employer and/or employee and the return on investment of this money. Participant bears financial risk of investment.

  5. PURPOSE OF THE STUDY

    The purpose of this study is to examine the impact of pension accounting practice related to calculation of pension cost on companies' net incomes, assets, liabilities, and cash flows.

  6. COMPONENT OF COMPANY'S PENSION COST

    The Financial Accounting Standards Board Statement No. 87, "Employers' Accounting for Pension Plans," clarifies many of the accounting issues related to pension. However, the statement gives companies the...

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