The Financial Accounting Standards Board (FASB) sent shudders through many retirement-plan sponsors in November when it voted to reconsider its statements on accounting for pensions and other postretirement benefits. The announcement of the new project came less than a year after the board issued its much-debated standard on accounting for share-based payments. Companies are just starting to assess the potential effects of the changes that the FASB wants to see. New research paints a gloomy picture of the likely impact on the bottom line.
The FASB sees the initiative as part of its ongoing drive "to ensure that standards for pensions and other postretirement benefits provide credible, comparable, conceptually sound and usable information to the public." The board will reconsider its guidance in FAS 87, which governs accounting for pensions, and in FAS 106, which covers accounting for other postretirement benefits. The effort will unfold in two stages. In the first, which it expects to be finalized by the end of this year, the standard setter will seek to require companies to pull key financial information about their plan's funding status out of the footnotes of financial statements and place it squarely on the balance sheet. The second, more long-term phase will address a broad range of issues including methods for measuring companies' postretirement obligations and for recognizing the various elements of that cost.
A study by professional services firm Towers Perrin looked at how the planned rule changes would have affected the financial results of the 78 Fortune 100 companies that sponsor defined-benefit retirement plans if they had been in effect in 2004. These organizations would have been required to recognize an additional liability of $331 billion on their balance sheets at year-end 2004, compared with the $62 billion that they actually recognized. After tax adjustments, the planned changes would have wiped out $180 billion in shareholder equity, 9.3 percent of the group's total.
An analysis by Watson Wyatt Worldwide found similar results. The consulting firm studied the effect the new rules would have had on the U.S. pension finances of Fortune 1000 sponsors for fiscal year-end 2004. The total decrease in shareholder equity for this group was 9.5 percent. But the study noted that some companies would have reported an increase in shareholder equity.
The Towers Perrin study also looked at the potential for increased balance-sheet volatility. An additional 10 percent return or loss on assets, if recognized on the income statement, would have changed the Fortune 100 companies' pretax income by 19 percent.
"As our analysis shows, these accounting changes are certain to have a dramatic impact on many companies' financial statements in the years ahead," notes Bill Gulliver, principal and chief actuary for Towers Perrin's HR Services business, based in Hartford, Conn. "Phase one is likely to result in significant reductions in shareholders' equity, and phase two seems certain to introduce added earnings volatility. However, it is uncertain exactly how the market will react, because most of the information expected to find its way onto the balance sheet is already disclosed in financial statement footnotes. Consequently, many analysts are already using that information to adjust the balance sheet today."
Whatever its effect on the markets, the FASB's move may influence companies' pension-plan strategies. Will the planned rules add to the impetus that's driving companies to freeze their pensions? Gerard O'Callaghan, partner with Florham Park, N.J.-based PricewaterhouseCoopers LLP, thinks that "more transparency around companies' obligations to their current and future retirees might be seen by some companies as another reason to continue down this path." But he emphasizes the benefits of the FASB initiative: "The bottom line is that the accounting model needs to be improved, and it's way beyond its time. Today's financial statements need to better reflect companies' obligations in a way that provides the transparency users are demanding."
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