The Financial Accounting Standards Board's ambitious project to overhaul its pension-related rules may go from underreporting liabilities to overreporting them.
That swing is not the way the FASB effort was envisioned. It was supposed to make pension accounting better reflect economic realities.
But the way the reforms are being developed could well make the reality of pension underfunding more of a nightmare than it is, and could worsen the perceived financial prospects of corporations as well as the perceived funded status of pension obligations.
The accounting change could be temporary, jerking around corporations and investors and other users of financial statements. It could cause them to value pension assets or liabilities one way in financial reports at the end of the first stage, then possibly placing a different value in the second and final phase of the overhaul.
Phase one, which the FASB plans to complete by year end, will require liabilities of underfunded plans, or assets of overfunded plans, to be shown on the corporate balance sheet. It will apply the new accounting treatment not only to pension plans, but also to other post-retirement benefits, or OPEB, such as retiree medical care.
The reform is designed to improve the transparency of these corporate liabilities by moving them onto the balance sheet.
The FASB's overhaul of pension-related accounting is long overdue, and the board deserves credit for finally undertaking it.
However, it is beginning years after problems with the current pension accounting standards became evident and led to some corporate accounting abuses.
The impact of FASB's proposed changes could be enormous. Some 82% of 337 companies in the S&P 500 with defined benefit plans had underfunded plans in 2005, according to a Wilshire Associates Inc. study. That is why the FASB ought to avoid unnecessary changes that fail in its objective to better depict the economic reality of pension plans and OPEB.
Phase one requires measuring pension liabilities on the basis of the projected benefit obligation, which reflects the projected cost of future pay increases. For OPEB, measurement would be on an accumulated benefit obligation basis, which values only benefits accrued to date.
In phase two, the FASB intends to re-evaluate how liabilities are measured, including whether ABO or PBO should be used, what discount rate should be used to value obligations, and whether pension asset and liability gains and losses should be amortized. The board has not yet released a draft proposal or a timetable for that phase.
If the first phase is adopted without revision, the overhaul would mean that companies would place pension liabilities on the balance sheet based on PBO, which makes the liabilities seem bigger than they actually are.
And then, in phase two, if the FASB changes the measurement to ABO for pensions, the balance sheet liability could abruptly shrink, rendering financial analysis of pension plans of the previous few years meaningless.
The FASB should delay implementing phase one until it finishes phase two, applying it all together. There is no need to rush a change since the information the FASB would place on the balance sheet in phase one is already in footnotes.
The FASB's effort to bring more transparency to OPEB also is misguided. OPEB doesn't belong on the balance sheet, unless it is an indisputable obligation.
Many companies can unilaterally eliminate OPEB. Because it is not afforded the same tax advantages for funding as pension benefits, corporations fund OPEB to a much smaller extent than their pension obligations. OPEB should stay in the footnotes.
To put OPEB on the balance sheet, along with the PBO measure of pension liabilities, would exaggerate corporate liabilities. Overreporting could harm corporate bond ratings by increasing the apparent debt burden and thus raise financing costs and lower stock prices. It could raise anxiety among employees about both corporate and pension security. It could cause executives to shift pension allocations much more to fixed income from equities, hurting investment returns.
Indeed, implementation of the first phase could cut shareholder equity of 1,000 of the largest companies by 10%, according to an analysis by Watson Wyatt Worldwide.
The phase one proposal needs some additional changes. The proposal would require measuring plan assets and liabilities as of the same date as the corporate financial statement. That would eliminate the up to 90-day lag companies now have in measuring plans. But it also would make it harder for companies to gather the appropriate data, especially for those with many pension plans around the world, when faced with demands resulting from efforts to speed other corporate reporting.
The FASB needs to revise the timetable for its pension accounting overhaul if it wants better to serve investors and other financial statement users.