The Association of U S West Retirees



Putting Pensions on Balance Sheets
Plans' Deficits, Surpluses Are Taken Out of Footnotes In First of Coming Changes
By David Reilly
The Wall Street Journal
Friday, September 29, 2006

Forget the fine print.  Accounting standard setters plan today to issue a final rule requiring companies to include on their balance sheets the overall deficit or surplus for their retirement plans, lifting the figure from often overlooked and complex footnotes.

Bringing deficits for pension and other retiree benefit plans onto the books could cause some companies' net worth -- or shareholders equity -- to fall or even turn negative.  That in turn could force some companies to renegotiate covenants in debt agreements, or in some cases hamper companies' ability to pay dividends.  Lenders and ratings firms typically factor the deficits into their calculations, so the change isn't expected to cause upheaval at many companies even if it takes some investors by surprise.

But it is the first step in what could be a contentious and widely watched battle in the world of pension accounting rules.  The Financial Accounting Standards Board next plans to rework all the accounting rules related to pension and other retiree benefit plans.  The course the board eventually charts will have broad implications for companies, investors and employees who participate in defined-benefit pension plans.

That is because FASB is likely to consider changes that could curtail, in part or altogether, companies' ability to smooth out over a period of years the impact on profits from changes in the surplus or deficit of a pension plan.  By smoothing results, companies don't immediately recognize gains or losses related to plans in the period in which they occur.  Rather they take them over time.  At the moment, smoothing means pension-related figures appearing in corporate financial statements bear little resemblance to the reality of what is happening in pension and other retiree benefit plans.

A move to eliminate smoothing could add volatility to corporate earnings as changes in the value of pension plans are reflected in profit.  That isn't likely to sit well with executives and some investors who believe pension movements aren't core to a company's operations and will obscure what is actually happening in a company's underlying business.  Employees could also suffer if, as some observers worry, such changes hasten moves by companies to close or eliminate defined-benefit pension plans.

"The battle on this will be for mom and pop losing their pension plan because the company can't deal with the volatility or doesn't think investors can deal with it," said Janet Pegg, an accounting analyst at Bear Stearns Cos.  But she believes problems facing defined-benefit pensions don't lie with any rule changes brought about by FASB.  Rather, the board is bringing more transparency to the issue.

Bear Stearns has predicted that the fight over pension accounting will be even more bruising than the political slugfest that erupted when FASB moved to require expensing of stock options.

So what is up for grabs as FASB reconsiders pension accounting?  Everything, it seems.  For a start, the board will have to consider how to measure the pension obligation companies have to employees.  Under the rule being issued today, companies will base this obligation on a measure that includes expected future salary increases for employees.  FASB stuck with this measure despite opposition from many companies that wanted pension deficits to be based on benefits that employees had already earned.

Now, FASB is likely to return to this debate and will extend it to determining the retiree health-care obligation companies face.  Besides considering the merits of projected or accumulated benefits, the board could also consider basing a company's obligation on the termination value of a plan or could even look to a measure of a plan's market value.

Jack Ciesielski, editor of the Analyst's Accounting Observer, added that the board will also have to grapple with another big-picture issue:  whether a pension plan should be treated as part of a company's assets and liabilities.  "A company doesn't have unilateral control over a pension trust, it can put assets in but would have a hard time getting them out," he said.  Still, Mr. Ciesielski doesn't think the board will ultimately de-consolidate pension plans from the books of companies that sponsor them.

FASB will also have to consider the thorny question of "smoothed versus volatility" as it applies to the way pension costs flow through to a company's income statement, Bear Stearns's Ms. Pegg said.  Underlining the complexity of these issues, FASB expects that it could take two to three years before new pension-accounting rules emerge.

Write to David Reilly at