Pension accounting: new solution for an old dilemma?

• Author: Akresh, Murray S.
• Position: FINANCIAL REPORTING

Potential changes are under examination by U.S. and global accounting regulators for accounting changes to the approximately 30,000 qualified defined benefit plans in the U.S.

While some employers have moved over the past decade to freeze, reduce or eliminate employee retirement benefits, there are still roughly 30,000 qualified defined benefit pension plans in the United States--not to mention many additional plans that get similar accounting treatment, such as non-U.S. plans, non-qualified pension plans and retiree health plans.

And it's usually not easy to fully eliminate a defined benefit plan, given stringent Employee Retirement Income Security Act of 1974 (ERISA) rules, often extensive cash requirements and, in a number of cases, the complication of union negotiations. As a result, defined benefit retirement plans are likely to be a part of corporate accounting for decades to come.

The accounting standards-setters understand this. They also recognize that retirement benefits promises are often a significant economic issue for employers and that current financial reporting rules are complex and hard to understand. In response, both the U.S. and international accounting standards-setters are again revisiting pension accounting.

The U.S. Financial Accounting Standards Board was first to respond. In 2005, it published rules requiring companies to report, for the first time, the current value of the net benefit obligation (or funded status) on their balance sheets. What FASB didn't do, however, was require changes in the values of benefit obligations and plan assets to be immediately reflected in determining net income.

Criticism of Today's Accounting Rules

The accounting rules for employers' retirement benefit obligations have many vocal critics. The main criticism is that the primary financial statements do not portray the economic reality of an employer's benefit arrangement. This results largely from the delayed recognition (the "smoothing") features of the U.S. and international accounting rules.

For example, gains and losses due to changes in assumptions used to measure the obligation, changes in the value of plan investments and adjustments resulting from plan amendments are deferred and recognized in income over many future years. The concerns arising from this treatment are heightened by the significant losses that most employers have not yet reflected in net income--losses that arose from volatility in the securities markets during the past few years and the low level of interest rates used in measuring the benefit obligation.

A recent study by PwC of 50 large U.S. companies showed that the median company had unamortized losses equalling 34 percent of total plan obligations, representing billions of dollars not yet reflected in the income statement. In addition, the accounting rules are so complex that many financial analysts and other financial statement users don't understand them or the information that results from their application.

These issues have not changed very much over the past 30 years. Each time FASB or the International Accounting Standards Board reviewed pension accounting, they agreed on compromises that continue the deferral mechanisms and contribute to generally smooth reported benefit expense in the income statement from period to period.

Taking...