AT&T does it, so does Verizon and Honeywell. Better still, investors love it. So what’s not to love about mark-to-market accounting?
More and more high-profile companies are moving to the controversial valuation of their pension plans and, in the process, will avoid reporting billions of dollars in losses, the vast majority of which came during the financial crisis of the last three years.
The accounting change allows companies to revise their past financial statements retroactively and recognize the losses as if they occurred in the prior years. AT&T, for instance, took on losses of $17 billion, while Verizon was hit with a loss of $22 billion which would otherwise have been spread over years through standard accounting methods, such as amortizing or smoothing pension plan losses and gains.
So while it hurt Honeywell to condense $7.5 million in losses into one year, the technology manufacturer took all its medicine at once and will ultimately help its corporate income earnings down the road.
In many ways, mark-to-market accounting is a preemptive response to what the Financial Accounting Standards Board and the International Accounting Standards Board promoted last year in a bid toward converging global accounting standards.
Smoothing pension plan losses was already fading within companies such as AT&T, Verizon, and Honeywell, which have long stock traded on international exchanges.
“Effective implementation of some of their investment and hedging strategies would work better without the smoothing mechanisms,” says Jonathan Waite, director of investment management advice and chief actuary for consultancy group SEI International.
Even more importantly, according to Verizon CFO Fran Shammo, the new accounting policy will make financial reporting easier to understand and more transparent.
“Expense recognition will be more tied to current market returns, interest rates, and health care cost experience,” said Shammo in a transcript from a Jan. 21 teleconference. “This is actually a preferable accounting method and one that aligns with the fair value accounting concepts and current IFRS proposals. Given what AT&T, Honeywell, and some other large-cap companies have recently announced relative to benefit accounting and reporting, we accelerated our action and adopted this change now instead of waiting until the end of 2011.”
Mark-to-market accounting might be an option for some, but not all. SEI’s Waite points out that companies with defined benefits plans that took enormous pension plan losses in 2007 and 2008 could be paying for those for as long as 10 years, all of which eats at corporate income. But not many companies can afford to take on $22 billion in losses in one year, like Verizon.
Then there’s the risk factor.
“It brings a lot of volatility to corporate earnings,” says SEI’s Waite. “What if we go through another year like we had in 2008 when revenue was down and expenses were up? Now a lot of these companies will also be taking on a big loss for their pension that has to be recognized. That would have been really tough for a lot of organizations to swallow. They’re opening themselves up to some additional scrutiny.”
But for many companies, the bigger picture is having the opportunity to have clean books going forward. Most pensions today have large deferred losses on their balance sheet. Mark-to-market valuation allows companies to get rid of that.
“It also makes it cleaner and anyone looking at a company’s financials will have a better picture of how their organization is doing financially,” says SEI’s Waite.