FASB’s Herz Opposes Pension Smoothing

The chairman's position is important because FASB has voted to consider an overhaul of postretirement benefit accounting.

Financial executives worried about the prospect of losing the ability to report pension values that are averaged out over a number of years have reason to worry. Financial Accounting Standards Board Chairman Robert Herz is no fan of smoothing results in pension accounting, he told CFO.com last Thursday at a conference on current financial reporting issues hosted by Financial Executives International at the New York Hilton.

Last week, FASB voted to insert a project to study pension accounting into its agenda. As part of the project, the standards board will consider overhauling the entire system for accounting for and reporting on postretirement benefits—an overhaul that could include the elimination of smoothing.

Rather than to report pension results as an average, “I think it is better to portray things as they happen,” Herz explained. “We will look at [smoothing in pension accounting] carefully and consider whether to eliminate it or simplify it.”

His opinion could be significant for companies that smooth fluctuations in pension values on their financial statements. Although Herz is just one of seven members on the board, he is the chairman—and could exert powerful influence on the outcome of the project.

Some critics have argued that smoothing can disguise a pension plan’s true economic condition by showing market gains even when the plan has been hit with losses in a given bear market. If FASB were to eliminate smoothing, the volatility of pension values would also appear on paper.

As part of FASB’s push toward convergence with international accounting standards, the board is undertaking a two-phase project to rethink how companies account for pensions and other benefits as laid out in Statements 87, “Employers’ Accounting for Pensions,” and 106, “Employers’ Accounting for Postretirement Benefits Other than Pensions.”

The first part of the project, which is expected to be finished by late 2006, would entail requiring companies to shift the funded status of pensions from the footnotes to the balance sheet. In the more complex second phase of the project—the one that could include the rejection of smoothing—FASB will consider how to change the entire system of accounting for pensions and other postretirement benefits

The project is in line with the wishes of the Securities and Exchange Commission, which in June 2005 recommended a joint FASB and International Accounting Standards Board project on pension accounting. The SEC contends that the accounting for defined-benefit plans isn’t consistent with accounting for other assets and liabilities. Further, the commission says that the balance sheet isn’t transparent about the true state of pension plans and other benefit obligations.

At the conference, Herz also said that FASB’s most important project is the one concerning how corporations reporting on their financial performance. The project, which the board is working on with IASB, is focused on how to better align the income statement and the cash-flow statement. For example, FASB is mulling whether there should be a section in the income statement that shows how much income comes from financing or investment rather than operations, he noted.

“Providing a better display could help us get past some bugaboos that have plagued us,” Herz commented. “I think we can dramatically improve the look and feel of the income statement.”

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