The path to where we are today regarding generally accepted accounting principles for public pension plans, with the advent of the Governmental Accounting Standards Board in between, is probably worth tracing if for no other reason than to be sure the history is not lost.
To get to the starting point, it is necessary to go back to Labor Day 1974 – that was the day President Ford signed the Employee Retirement Income Security Act into law. One seemingly innocuous provision in that voluminous document called ERISA reads as follows:
"… the administrator of an employee benefit plan shall engage, on behalf of all plan participants, an independent qualified public accountant … to form an opinion as to whether the financial statements and schedules required to be included in the annual reports . . . are presented fairly in conformity with generally accepted accounting principles . . . .”
So, what's the problem? On the public plan side, ERISA generally did not apply but, even if it had, governmental plans had been preparing GAAP-based financial statements for years following the pronouncements of the now-defunct National Council on Governmental Accounting. The problem was on the private sector plan side. Surprisingly enough, there was no document that could be referenced to determine what constituted GAAP for a private sector employee benefit plan.
Naturally, that void generated a flurry of activity in Stamford, Conn. (then the home of the Financial Accounting Standards Board) to position private sector plan administrators to prepare plan financial statements in accordance with GAAP. Of course, this was of no concern to those on the public plan side since FASB statements did not apply to governments. The absence of concern on the public plan side vanished quickly when the FASB issued the exposure draft for what eventually became Statement of Financial Accounting Standards No. 35, Accounting and Reporting by Defined Benefit Pension Plans. The exposure draft and final statement, issued in March 1980, included the following provision in the introduction:
“This Statement applies to an ongoing plan that provides pension benefits for the employees of one or more employers, including state and local governments . . . .”
The turf issue notwithstanding, this standard was viewed as being seriously flawed for assessing an “ongoing plan” regardless of whether it was in the public sector or private sector. The most critical shortcoming was the stipulation that future salary increases were not to be considered in determining what most people would think of as the liability side of the equation. (As an aside, the FASB standard also required that assets be reported at “fair value” which was generally market value.)
By the time this standard was issued, the public plans covering most governmental employees were being funded on an actuarial basis that gave recognition to the future salaries on which benefits would be based rather than the salaries at the valuation date and they had accumulated assets accordingly. While there were certain fine point distinctions, the FASB standard effectively called for presentation of a plan termination obligation for a plan that was being called “ongoing.” As you can imagine, plans that had been reporting unfunded liabilities were suddenly going to have the erroneous appearance of being overfunded. At the time it was believed that this erroneous appearance would lead to unwarranted reductions in contributions or increases in benefits or a combination of the two.
This confusion was well documented by a publication of the Government Finance Officers Association, which at the time was called the Municipal Finance Officers Association. In their May 1980 “Guidelines for the Preparation of a Public Employee Retirement System Comprehensive Annual Financial Report,” two sets of illustrative financial statements were included – one based on the long standing NCGA standard and another based on the new FASB standard.
The FASB encroachment on NCGA turf led to a flurry of activity in Chicago (the home of the NCGA and the MFOA). While GAAP for governmental plans had been established by application of NCGA standards and practices, there was no single document that could be referenced for public-sector defined benefit pension plans. In December 1981, the NCGA issued Interpretation 4, Accounting and Financial Reporting for Public Employee Retirement Systems and Pension Trust Funds. Interpretation 4 called for including salary projections in determining the pension benefit obligation. In addition, under Interpretation 4, equity securities were to be reported at the lower of cost or market and debt securities were to be reported at amortized cost. Now we had conflicting standards. There is an interesting footnote to the “lower of cost or market” standard. It resulted in a cottage industry of brokers who, for a modest fee per transaction, would sell and instantly repurchase equity securities that had market values above cost as a means of marking them up to market on the last day of a plan's fiscal year – if equity markets were generally up, it was possible to achieve a specific return target by selling and repurchasing just what was needed to generate the gains needed to hit the return objective. (You can't make up stuff like this.)
The pension activity at the NCGA continued at a rapid pace. For example, in November 1982 an exposure draft was issued and five months later was finalized as Statement No. 6, “Pension Accounting and Financial Reporting: Public Employee Retirement Systems and State and Local Government Employers.” (The FASB had yet to address employer accounting but the NCGA now had both the plan and employer bases covered.)
It's also worth mentioning that those arguing for a different standard for governments had what they thought of as support from an unlikely source – specifically, the three board members of the seven-member FASB who dissented to Statement 35. FASB commentary included the following regarding their dissent to the statement:
“ … it improperly includes what they consider to be actuarial statements within the financial statements rather than as supplementary information outside the financial statements and provides detailed reporting beyond usefulness to plan participants. They share an overriding concern that, taken as a whole, these provisions invite comparison of items that do not possess enough common properties to be directly comparable and lend an unjustified aura of reliability to estimates of the future.”
The two and one-half page dissent statement from those three people was not exactly a raging endorsement of the work of the seven-member FASB.
The conflicting standards led to considerable back-and-forth negotiations between representatives of FASB and NCGA, with the end result being that early in 1982 both bodies suspended application of their statements to governmental pension plans. This action took governments from the unenviable position of having too much GAAP to the untenable position of having no GAAP for their pension plans.
While there had been discussions of the possible establishment of a full-time standard setting body to replace the part-time work of NCGA, the conflicts related to pension accounting resulted in a much greater sense of urgency. The Financial Accounting Foundation established GASB to serve that purpose. The GASB website includes the following in the description of the organization:
“Established in 1984 by agreement of the Financial Accounting Foundation and 10 national associations of state and local government officials, GASB is recognized by governments, the accounting industry, and the capital markets as the official source of generally accepted accounting principles (GAAP) for state and local governments.”
As you might guess, GASB's initial agenda included a pension project which resulted in the November 1986 release of GASB Statement No. 5, “Disclosure of Pension Information by Public Employee Retirement Systems and State and Local Government Employers.”
GASB Statement No. 5 could basically have been called “NCGA Statement No. 6 Redux.” To keep from deviating too much from FASB Statement No. 35, GASB added salary projections to the unit credit actuarial cost method called for by FASB, resulting in the projected unit credit actuarial cost method being used in determining public plan benefit obligations for financial statement disclosure purposes. On the plus side, this kept public plans from grossly understating their going-concern benefit obligations. On the negative side, most plans still had to deal with two sets of obligation numbers since most were determining required contributions using the entry age actuarial cost method. (A number of plans actually switched from the entry age to the projected unit credit actuarial cost method for funding purposes just to eliminate the confusion that ensued from concurrently having alternative benefit obligation numbers.)
Important in GASB Statement No. 5 is the title's reference to “disclosure of” rather than “accounting and financial reporting for” pension activity, meaning that there was still a lack of comprehensive GAAP guidance. Consequently, the issue remained on GASB's agenda.
The next key step on the path came in November 1994 when GASB released Statement No. 25, “Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans” and Statement No. 27, “Accounting for Pensions by State and Local Governmental Employers.” Those statements have established GAAP for public plans and governmental employers since that time, except as modified by GASB Statement No. 50 that will be addressed later. Noteworthy points from Statements 25 and 27 include:
- The employer's expense for pensions was equal to the annual required contribution as determined by the actuary using the actuarial funding method and assumptions in use for funding purposes.
- If the employer's actual contributions were different than the ARC, the accumulated difference plus interest was reported as the Net Pension Obligation in the employer's financial statements.
- Actuarial trend information was reported as Required Supplementary Information to the financial statements, including note disclosures to the RSI. This permitted auditors to opine on employer and plan financial statements without having to express an opinion on the work of the actuary that was presented as RSI.
- Confusion that had existed because of differences between actuarial information used for funding versus financial reporting was eliminated.
Statements 25 and 27 were amended in a material way in May 2007, with the release of GASB Statement No. 50, which:
- Required that the most recent year's actuarial information from the RSI be included in the notes to the basic financial statements, meaning auditors had to enlist the services of actuaries for assistance in opining on the financial statements. (Ca-Ching.)
- Required that plans using the aggregate actuarial funding method develop financial disclosures using the entry age actuarial funding method. The reason for this was that under the aggregate method the accrued liability is equal to the plan's assets resulting in a plan always appearing to be 100% funded regardless of the size of the assets held. Interestingly enough, they still permitted the use of the entry age method with frozen initial liability without additional disclosures, even though, as a practical matter, that method would ultimately produce the same result as the aggregate method. (To be generous, one might assume this was an oversight but, if skeptical, one might look at which, among a small number of plans, were using the frozen initial liability method.)
Further activity related to a perceived need for changes to the GASB pension statements came to fruition on June 25, 2012, when GASB announced adoption of Statement No. 67, “Financial Reporting for Pension Plans” and Statement No. 68, “Accounting and Financial Reporting for Pensions.” The announcement indicated that the statements would first be available in August 2012, which has caused some people to wonder if they were adopted before actually having been written.
Those desiring information regarding what these statements do will find that there is no shortage of information available on the internet. Simply Google “GASB Pension” and more references will be found than most would be interested in attempting to read. The protracted exercise leading up to the final vote by GASB on these new statements had the trappings of due process but many interested outsiders involved in the effort wondered if it was simply an exercise in providing the illusion of due process for decisions that had already been made.
While it will take quite some time to sort out all the nuances, there seems to be general agreement that the most significant impact of these new statements will come from the segregation of methods and assumptions used in determining actuarial accrued liabilities and required contributions from the methods and assumptions used in determining liabilities and expenses reported in the employer's financial statements.
As was learned many years ago, distinctions of that type are problematic. Adding to the anticipated confusion will be the fact that the method developed for financial reporting is sufficiently arcane, including newly introduced terminology, that very few people will understand the substance of the distinctions between the funding and reporting numbers. However, what is almost a certainty is that those who have various agendas regarding public sector defined benefit pension plans will selectively use the information that will be most likely to further their cause, whatever that cause may happen to be.
It would not be accurate to suggest that there was no agreement among the various interests in the final product of GASB pension project. Regardless of what they thought should be done, all seem to be disappointed to some degree or other.
Perhaps this can all be best summarized with a couple of Yogiisms:
"It's deja vu all over again."
"It ain't over till it's over.”
While not a Yogiism, there is a question that may merit consideration. If generally accepted accounting principles are not generally accepted why are they called generally accepted?
Stay tuned for some very interesting Management Discussion & Analysis in public retirement system financial disclosures. (Don't be surprised if you are strongly encouraged to disregard all information in financial statements regarding public sector defined benefit plans if you are truly interested in gaining an understanding of the financial condition and financial position of said plans.)
Gary Findlay is executive director of the Missouri State Employees' Retirement System, Jefferson City.
