Over the first half of the decade, pension plans and other post-retirement benefit plans were hit hard by a perfect storm of economic forces. Investment returns were irregular and often less than expected. Falling interest rates caused employers’ obligations to soar. And many old-line industries experienced a cash crunch that encouraged management to offer increased pension benefits in lieu of higher wages. A shift in demographics has resulted in far fewer younger workers and many more who have retired or are about to do so.

These factors combined to create severely under-funded pension and other benefit plans with growing expenses and losses. The then-applicable accounting standards kept these effects off financial statements, possibly diverting public attention. Only when large bankruptcies aroused concerns that the Pension Benefit Guaranty Corp. would not have the wherewithal to bail out the troubled plans did the crisis draw widespread interest.

This confluence of events heightened awareness that accounting standards needed substantial repair, if not outright replacement. In response, FASB created a two-phase project. The goal of the first phase, now complete in the form of FASB Statement no. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, was to move off-balance-sheet items onto the financial statements. The second phase, in cooperation with the International Accounting Standards Board (IASB), will take a more careful look at the issues including assumptions used in measuring benefit obligations and whether postretirement benefit trusts should be consolidated with sponsors’ financial statements.

Statement no. 158 was released in September 2006, with an effective date that requires public companies to implement it for fiscal years ending after Dec. 15, 2006. Private companies are required to implement the new standard for fiscal years ending after June 15, 2007.

FASB 158 in a Nutshell

FASB’s action established new practices in several areas without changing the basic measurements under Statement no. 87, Employers’ Accounting for Pensions, and Statement no. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions. Basically, Statement no. 158 requires companies to take information out of the footnotes and put it into the body of the financial statements as follows:

• The balance sheet reports a net asset or net liability equal to the difference between the estimated values of the projected benefit obligation and fund assets as of the balance sheet date.
• The balance sheet also presents a positive or negative component of accumulated comprehensive income equal to the sum of the previously off-the-books memo accounts for deferred effects of plan amendments and accumulated deferred gains and losses.
• The statement or schedule of comprehensive income presents changes in the prior service costs and accumulated actuarial gains caused by new events and amortization.

The minimum liability reporting requirements have been eliminated. The standard changes employers’ balance sheets but doesn’t alter the annual cost calculation. The required footnote disclosures now include an estimate of the coming year’s amortization of prior service cost and any corridor amortization (an expense adjustment that occurs when accumulated unrecognized gains or losses exceed 10% of the greater of the plan assets or projected benefit obligation).

A New Worksheet

The changed status of the formerly off-the-books amounts means employers must complete a different set of calculations. This section describes a worksheet CPAs can use to produce the required results, including the annual cost, as well as reconciliations of the beginning and ending balances of the asset, obligation and components of other comprehensive income. The worksheet also supports the journal entry needed to record the year’s events (for simplicity, the entry does not include deferred tax effects).

The Recommended Footnote

Among other items, FASB’s required footnote disclosures include:

• The nature and amount of changes in plan assets and benefit obligations recognized in net income and in other comprehensive income for each reported period.
• The changes in plan assets and benefit obligations that have been deferred and recognized in other comprehensive income.

After reviewing the standard, we believe the disclosures can be made even more complete and transparent.

Additional Points

FASB addressed three other key issues. First, the board decided it would not require managers to apply the new standard retrospectively to the beginning of the earliest year on the comparative income statement in their financial reports. However FASB recommends the restatement be accomplished; doing so will improve the comparability and usefulness of the financial statements.

To get the accounts into their needed condition as of that earlier date, the employer will record an adjustment that debits a new pension assets account for its market value and credits a new pension obligation account for its estimated value. Then, the adjusting entry will create accounts as needed for accumulated other comprehensive income items describing deferred prior service costs and actuarial gains and losses. In addition, the employer will close the Statement no. 87 prepaid/accrued pension cost account. The employer will then debit or credit any remaining difference to retained earnings as needed. This last amount will equal the balance, if any, of the deferred transition gain or loss left over from the initial application of Statement no. 87.

FASB also amended accounting practices for settlements and terminations as governed by Statement no. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, which used to require that the financial statements recognize changes in various on- and off-the-books accounts. With suitable modifications, the basic worksheet and footnote schedule can deal with these events.

The new standard applies to other postretirement benefits as well as pensions. Once the calculations are complete for all plans, the employer must aggregate the net balances of all overfunded pension and other benefit plans into a single asset on the balance sheet. Then, the employer will aggregate the net balances of all underfunded plans into a single liability.

An Interim Fix

Despite its significant changes, Statement no. 158 is only FASB’s interim solution for improving users’ access to pension-related information. The new standard should reduce uncertainty and lower users’ risks while decreasing their processing costs, with the ultimate result of higher stock prices. Some managers objected to the proposal, perhaps out of fear the new presentation would reduce the market values of their securities. This reduction could happen only if moving information from the footnotes to the balance sheet would cause users to lower their estimates of the employer’s future cash inflows or to perceive greater risk. In either event, the managers’ premise seems to be that their companies’ shares were previously overpriced because the market was misinformed. We don’t expect such downward adjustments to occur. Even if they were to happen, the new standard would be working for the best because the goal of sound financial reporting is to boost capital market efficiency by increasing the quality of information.

What’s Next?

While Statement no.158 will provide more transparent information about companies’ postretirement benefit obligations, influential bodies including the SEC, the CFA Institute, and the Financial Accounting Standards Advisory Council have called for a more complete reformation of GAAP, even to the point of calling for consolidating the financial statements of the parent and the pension plan. FASB, together with the IASB, has pledged to consider these issues in the second phase of its project on pension accounting. Specific areas to be addressed include comprehensively considering how the elements that affect the cost of postretirement benefits are best recognized and displayed in the statement of earnings and comprehensive income, how to measure an entity’s benefit obligations and whether postretirement benefit trusts should be consolidated by the plan sponsor.

View full article with helpful exhibits and resources.

Paul B.W. Miller, CPA, Ph.D., is professor of accounting at the University of Colorado at Colorado Springs. Paul R. Bahnson, CPA, Ph.D., is professor of accounting at Boise State University in Boise, Idaho. Their views as expressed in this article do not necessarily reflect the views of the AICPA or the Journal of Accountancy.