Corporations now have a huge incentive to move to mark-to-market accounting for valuing their pension plans: They can bury the huge pension plan investment losses resulting from the 2008 and 2009 financial market crisis.
By moving to a market-based accounting method, companies can restate past corporate financial statements, putting the losses into them and reducing earnings as if the pension plan losses were accounted for at the time they actually occurred.
Without the change, companies would have to amortize those losses over a number of years in the future, reducing reported corporate income in those years.
The change to market-based accounting is long overdue. It better reflects the economic reality and financial management implications of the costs, risks and volatility of pension obligations. For this reason, all companies should move to the new method. Unfortunately, it might require a push from the Financial Accounting Standards Board for them to do so.
“(M)ark to market is where the accounting world is headed,” David J. Anderson, Honeywell chief financial officer and senior vice president, said in Nov. 16 teleconference, according to a transcript.
The accounting industry is moving to market-based valuation and away from amortization. However, the FASB has been slow to move to mark-to-market accounting for pension funds, having discussed the issue for at least almost a decade.
The FASB does require companies to place the funded status of the pension plans on their balance sheets. But it has delayed indefinitely a long-pending project to overhaul its pension accounting standards to require market-based pension changes be put into the corporate income statement. Instead, it deferred the issue subject to a review of changes proposed by the International Accounting Standards Board.
An IASB proposal, released last year, requires immediate recognition of pension plan gains and losses, ending the current approach of amortizing valuation changes over a number of years. The IASB proposal would place the market-based adjustment into a category called “other comprehensive income.” In comparison, the long-delayed FASB proposal would require pension plan valuation changes be reported directly into the income statement.
The IASB proposal “is getting a lot of attention” and “adds credence and momentum to that (accounting) change,” Mr. Anderson said.
It is time for the FASB to begin to give corporations and other accounting statement users a more definite timeframe for the revival of its market-based pension accounting project.
The new method adopted by the three companies aligns pension plan accounting with fair-value or market-based accounting principles. Under it, companies generally will report in the same year they incur any gains or losses in the pension funds arising from key influences: changes in the market value of their investment assets; and changes in the valuation of the pension plan liabilities from changes in actuarial assumptions. The new accounting approach enhances transparency.
The new method promotes better understanding of the cost of pension benefits, their affordability to corporate sponsors. The existing widely used accounting method shows phantom pension gain and losses.
Some fear mark-to-market accounting — and the possible volatility it will bring to reported earnings — will cause more companies to drop defined benefit plans. But amortization that smoothes losses didn't stem plan terminations.
A more accurate picture of the financial impact of the cost of a pension plan will improve the income statement, and ultimately the valuation of the corporation. And since accounting rules often influence the way companies manage their business, including pension financing decisions, mark-to-market accounting might improve corporate financial management.
The three companies adopting the new direction deserve credit for moving toward more realistic accounting, even if it might appear their timing for doing so is driven by the opportunity to bury past losses in restated financial reports.