The Association of U S West Retirees



Pension Reporting Sparks Debate
Accounting Board, Firms Spar Over Proposed Rule And How It Reflects Worth
By David Reilly
The Wall Street Journal
Wednesday, July 5, 2006

PepsiCo Inc.'s pension plans showed an $850 million deficit last September.

Or did they?

The answer depends on how you measure the beverage company's obligation to employees.  The deficit is based on PepsiCo's projected-benefit obligation, a measure of what the company will have to pay employees that takes into account expected future salary growth, among other factors.

But basing the plans' financial health solely on benefits employees have already built up paints a different picture.  Using that measure, PepsiCo's plans showed a surplus of $355 million.

The $1.2 billion difference is at the heart of a debate between companies and the Financial Accounting Standards Board over the accounting rule-making body's first stab at overhauling the complex -- and many people on either side of that debate would say flawed -- rules for pension accounting.

This is more than just wonks crossing slide rulers over accounting minutiae.  One hundred of the country's largest public companies had a combined pension deficit of about $10 billion at the end of 2005 using the earned-benefits measure, according to a study earlier this year by actuarial consultants Milliman.  But that combined deficit swells to about $90 billion using the projected-benefit obligation, the study showed.

Pension plans at aerospace company Boeing Co., for example, showed a $1.7 billion deficit at the end of last September using the projected-benefit obligation.  Based on earned benefits, the company's pension plans registered a nearly $2.5 billion surplus.  At Hewlett-Packard Co., the projected-obligation measure resulted in a $935 million deficit, compared with a nearly $700 million surplus based on the earned-benefit measure.

Which obligation measure to use is an issue because FASB is considering a rule that, starting next year, would require companies to report the funding status of pension plans on their balance sheets rather than relegating them to footnotes of financial statements.  In doing so, the board has proposed that the surplus or deficit in a pension plan should be based on the difference between the projected-benefit obligation and the value of the plan's assets.  That's how the funded status is currently presented in financial-statement footnotes.  The board is hoping to finalize the new rule this September.

Moving a deficit or surplus figure onto the balance sheet based on the projected-benefit or earned-benefit obligation won't change the amount companies must pay to service their pension plans.  But it could affect their net worth and, if that figure turns negative, force some companies to renegotiate the agreements they have with lenders known as debt covenants.

That, in turn, could prompt more companies to freeze pension plans, said Tonya Manning, chief actuary for U.S. retirement benefits at Aon Consulting.  Indeed, many companies in recent months, most notably International Business Machines Corp., have decided to freeze plans because of their growing cost.  Given that backdrop, Ms. Manning urged the FASB not to rush to make a decision about a standard "that has such a dramatic impact on employers."

The FASB's proposal to elevate plans' funding status to the balance sheet is part of a two-stage approach to overhauling pension-accounting rules.  The second phase, expected to last a number of years, will tackle issues such as how to deal with mechanisms that "smooth" pension expenses over a number of years.

Companies generally don't oppose having to report the funding status of pensions and other postretirement benefit plans on their balance sheets, reasoning that information is already available to investors.  But many, including PepsiCo, are calling on accounting rule makers to use the earned-benefit measure, because they believe it better reflects the actual liability facing a company.

In a comment letter to the FASB in May, Robert B. Cavanaugh, chief financial officer at J.C. Penney Co., noted: "An employer is not obligated to provide future pay increases to employees, nor is an employer obligated to provide a pension plan in the future."

Peter Bridgman, PepsiCo's controller, agrees.  "At this point, [the projected obligation] is not a liability to the company, so it seems kind of odd to include it," he said.

So far, the FASB is sticking to the projected-obligation measure.  George Batavick, an FASB member, said in a recent interview that switching the measurement of the obligation would open up a debate that is probably best left for the next stage of pension-accounting overhaul.  Although he added that "it's kind of unrealistic [for companies] to say you're never going to give people salary increases ever again."

Many accounting-practice observers favor the projected obligation, saying it is a more conservative measure that better reflects what companies expect to pay in the future.  In that sense, they argue, it is a more useful measure to investors.

In addition, the projected-benefit obligation has been the preferred measure in pension accounting for nearly 20 years and is what appears in footnote disclosure related to pensions.  Supporters and some FASB members believe using it in this first phase of the revamp of pension accounting is pragmatic and proper.

Write to David Reilly at