Pensions Go on the Balance Sheet: FASB

In a unanimous vote, the accounting standards board decided last week to look into an overhaul of the retiree-benefit accounting system.

Employers would be facing a bumpy road ahead if they’re no longer permitted to smooth results over a number of years when they account for the pensions and retiree health benefits they provide.

That possibility became much more immediate last Thursday, when the Financial Accounting Standards Board voted to add a project to its agenda studying pension accounting. Specifically, FASB will take a fresh look at its guidance in Statements 87, “Employers’ Accounting for Pensions,” and 106, “Employers’ Accounting for Postretirement Benefits Other than Pensions.”

The first part of the two-phase project is expected to be completed by the end of 2006. That phase would require companies to show on their balance sheets any assets or liabilities from overfunded or underfunded pensions. The currently prevailing practice is to show those figures in footnotes.

The next phase will be much more complex. Probably as a joint project with the International Accounting Standards Board, FASB will look at overhauling the entire system for accounting for and reporting on postretirement benefits.

The overhaul could include the elimination of smoothing, the practice of spreading out the estimated value of pensions over a period of time as a way to counter rate volatility. Critics have said that the practice inaccurately shows a pension’s financial condition by papering over losses with previous gains.

Companies that smooth may be safe for now, since FASB’s initial plans don’t include any such changes. Under the plans announced Thursday, any changes in amounts by which a pension is underfunded or overfunded as a result volatility may continue to be left out of net income. (Such losses would instead be recorded in a separate statement of comprehensive income.)

The first phase could leave many financing executives sweating over the implications of implementing the first phase. To be sure, its impact on earnings would depend on how the pension fund performs. But companies with significantly underfunded pensions will take a hit on earnings and shareholder equity. At the meeting Thursday, FASB members reckoned that the total impact of first-phase implementation on corporate earnings would be in the hundreds of billions of dollars.

The move could cause companies that are overwhelmed by pension burdens to file for bankruptcy and saddle the already overburdened Pension Benefit Guaranty Corp. with new pension responsibilities. According to a Government Accountability Office report, the PBGC, which steps in when companies can’t make good on their pension obligations, had a shortfall of more than $23 billion for fiscal year 2004.

Still, the idea of recording assets and liabilities from pension funds on the balance sheet has been seconded by the securities industry and the Securities and Exchange Commission. In a recent study on off-balance-sheet reporting, the SEC wrote that “under the current standards, the balance sheet is often not transparent as to the true funded status of pension plans and…additional clarity is necessary.”

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