The Financial Accounting Standards Board's project to overhaul accounting rules for pension and other post-retirement benefits is part of a new attempt by the board to have accounting standards better reflect economic reality.
It joins the expensing of employee options in the FASB's attempt to provide a better picture of financial value of an uncertain cost, and thus improves the income statement and ultimately the valuation of the corporation.
Such efforts by the FASB have been long overdue. They should do much to cleanse an environment that led to the accounting manipulation that artificially swelled corporate earnings and contributed to corporate excesses, which harmed shareholder value.
The FASB is stepping up to challenges it hadn't previously been willing to face. Investors and honest corporate finance executives should welcome the effort. Investors should welcome the changes because, with more realistic earnings, stock valuations should be more reliable. Finance executives should welcome the effort because they will have a more accurate picture of the cost of pension promises, and they will not be competing with others who are exploiting loopholes in the rules to inflate their companies' earnings and, hence, stock values.
New standards for valuing pensions and employee benefit costs are urgently needed. Current rules allow too much flexibility in the calculation of their costs, and this can distort the representation of the financial condition of a company.
For example, current accounting rules allow companies using unreasonable assumptions to generate pension income that dropped to the bottom line and helped boost corporate earnings, which in turn boosted executive bonuses.
In many cases this pension income was phantom income.
Some argue the type of accounting doesn't matter because the market will see through financial statements to determine economic value. But a survey has shown analysts and portfolio managers have generally done a poor job looking at pension accounting and the risks to corporations.
But even for the investor doing thorough due diligence, more detailed information typically wasn't available from corporations.
Academic research suggests there is a relationship between financial accounting information and the economic performance of companies. Standards matter.
Accounting rules have a profound impact on the way companies manage their business, including capital investment decisions, dividend policies and management compensation. Option expensing already has influenced the way companies compensate executives at some companies. Standard & Poor's "inclusion of option expense will result in a 4.2% decrease in earnings for the S&P 500 in 2005," the research company noted. It will affect the information technology sector the most, with an 18% earnings reduction.
The pension rule changes that come out of the FASB pension project could have a bigger impact than the current congressional effort to overhaul funding requirements and Pension Benefit Guaranty Corp. premiums.
By the time FASB finishes its new project to overhaul Financial Accounting Statements 87 and 106, there will be fewer defined benefit plans to value because of continuing terminations for cost. But that doesn't make the project any less worthwhile; many major companies will continue to have at least legacy defined benefit plans for many years.
The FASB understands time is of the essence. As a result, it is dividing the project into two phases, promising to adopt a new standard for the first phase by the end of next year, although it forecast no completion date for the more complex second phase.
The accounting reform's impact on corporate financial statements will be a watershed. It could move accounting to a mark-to-market approach, increasing volatility of pension effects on corporate financial statements and causing corporate sponsors to lessen that impact by adopting more conservative asset allocations.
More realistic accounting serves companies and employees alike. Great benefit promises and expectations that in the end wind up with the PBGC — and slashed by that agency's maximum benefit ceiling — serve no one's long-term interest.