http://www.nysscpa.org/cpajournal/2004/1004/essentials/p24.htm
CPA Journal
Pension Accounting: The Continuing Evolution
New Disclosure Standards
By Brian W. Carpenter and Daniel P. Mahoney
Efforts to enhance the relevance and understandability of reported pension information date back to the earliest standards setters, and the many pension-related standards have been met with mixed reviews. A recent FASB pronouncement provides new pension disclosure requirements intended to address previous shortcomings. The new disclosure standard, SFAS 132 (Revised), Employers’ Disclosures About Pensions and Other Postretirement Benefits, replaces a previous statement of the same title and number issued in 1998. SFAS 132R, the “new” SFAS 132, retains essentially all of the disclosure requirements of the original but includes new disclosures intended to better meet the expressed needs of financial statement users. Because of the carryover of the previously required disclosures, FASB decided against assigning “Statement 151” to the revised disclosure standard and opted to reassign the existing number in order to preclude an unnecessary proliferation of statement numbers. This could initially prove to be a source of potential confusion for those unaware of FASB’s decision. Because disclosures for defined contribution plans are relatively uncontroversial, the primary focus of SFAS 132R is on defined benefit pension plans. Certain issues have, over time, consistently made defined benefit pension accounting and disclosure a controversial topic. Issues that are controversial today were also controversial 50 years ago. In fact, one can question how much progress the profession has made in this area of accounting and financial reporting. For example, measurement issues related to defined benefit plans have been unchanged since 1985, when FASB issued SFAS 87, Employers’ Accounting for Pensions. Even those changes were, at the time, intended to be stopgap measures that represented, in FASB’s own words, “a step in the evolution of pension standards.”
Progress in pension reporting since SFAS 87 has been limited to matters of disclosure as opposed to more fundamental measurement issues. SFASs 106, 132, and 132R have not addressed the lingering measurement issues from SFAS 87 in spite of the fact that SFAS 87, paragraph 116, included the following comment:
[F]ootnote disclosure is not an adequate substitute for recognition. The argument that the information is equally useful regardless of how it is presented could be applied to any financial statement element, but the usefulness and integrity of financial statements are impaired by each omission of an element that qualifies for recognition. Further, although the “equal usefulness” argument may be valid for some sophisticated users, the Board does not believe it holds for all or even most other users.
While SFAS 132R does not address issues of measurement, it can be lauded for its fine-tuning of important disclosure matters. The long-standing and pervasive nature of pension reporting issues, together with the constancy of certain of those issues, makes it clear that an understanding of progress in this area is not fully possible without at least a limited exposure to the history of pension accounting and reporting.
The “New” SFAS 132
The new SFAS 132R addresses issues of disclosure only. Matters of measurement and recognition are not addressed. It incorporates all of the disclosure requirements of the original SFAS 132, but also includes new provisions intended to enhance standardization of pension disclosure and better satisfy user needs.
In developing the revised standard, FASB gave significant attention to the cost and difficulty of obtaining the data needed for those new disclosures and concluded that additional data collection should be required only when the benefits clearly exceed potential additional costs. In assessing the perceived importance of various disclosures, FASB gave significant consideration to feedback it had received on the exposure draft (issued September 12, 2003). One of the most frequently expressed needs was for additional information concerning assets set aside for honoring future pension obligations.
Disclosures pertaining to types of plan assets. To enhance the usefulness of asset-related disclosures, FASB chose to target information that would provide users with an improved understanding of the nature of plan assets. Preparers are now required to provide information concerning the percentage of plan assets invested in the following broad classifications: debt securities; equity securities; and real estate investments. FASB had initially contemplated the requirement of additional, more detailed groupings, but SFAS 132R requires such additional groupings only if the preparer believes that such detail significantly enhances user understanding. Similarly, FASB had contemplated requiring companies to disclose their target compositions, but decided otherwise because not all companies establish such targets. Instead, SFAS 132R simply encourages companies that do establish target compositions to disclose such information.
Part of the reason for disclosure of the composition of plan assets is to provide users with information that will help them better assess the assets’ investment risk and potential returns. For example, a pension plan composed largely of debt securities would be sensitive to interest rate fluctuations. Additionally, such information helps users assess the reasonableness of the preparer’s expected rates of return for plan assets. FASB initially contemplated requiring the disclosure of expected rates of return for each individual asset grouping. It instead opted for a narrative description of the company’s method of calculating its overall long-term expected rate of return on plan assets. This narrative, along with the required disclosure of the composition of plan assets, should aid users in assessing the reasonableness of the company’s estimated rate of return on plan assets.
Narrative disclosures pertaining to investment policy and estimated rates of return. To further assist financial statement users in their assessment of plan assets, SFAS 132R requires a narrative discussion pertaining to the company’s investment policy. This required narrative should include discussion of such matters as the company’s investment goals, risk management practices, and acceptable and prohibited investments. It might also include information such as the basis for the expected rate of return, the extent to which this rate is based on historical returns, as well as the extent to which historical rates are used to adjust expected future rates of return. The discussion helps users assess whether the company’s investment policy is aligned with their expectations. The combination of information will likely provide users with a better understanding of the company’s investment goals and a means of assessing the reasonableness of various key assumptions.
Disclosure pertaining to measurement dates. SFASs 87 and 106 permitted the measurement of plan assets and obligations as of either the date of the financial statements or a date up to three months preceding the date of the financial statements, as long as the date was used consistently. This option presented a potential omission of critical information. For example, a significant change in interest rates between the measurement date and the date of the financial statements could affect the value of the plan assets. FASB recognized that this issue needed to be addressed, and thus contemplated requiring the disclosure of the measurement date whenever economic events subsequent to the measurement date but prior to the financial reporting date resulted in significant changes in pension-related valuations. Most respondents said that disclosing measurement dates could potentially penalize companies with earlier measurement dates. FASB ultimately adopted an alternative proposal, and thus the new SFAS 132R requires the disclosure of the measurement dates in all circumstances.
Disclosures of plan obligations and cash flows. SFAS 132R requires an explanation of any significant change in benefit obligations or plan assets that is not otherwise apparent in the statement’s other disclosures. This captures the true spirit of full disclosure, because any substantive issues or events related to a significant change in the asset or liability valuation must be disclosed, irrespective of a stipulated requirement.
SFAS 132R requires that the accumulated benefit obligation (ABO) always be disclosed. Prior to this statement, the ABO was required only when the provisions of the minimum pension liability requirement applied. The ABO was reported only when it was less than the fair market value of the pension plan assets. The new standard requires that it be reported under all circumstances.
SFAS 132R requires the disclosure of expected benefit payments for each of the next five years and the aggregate payment amount for the subsequent five-year period. A related new disclosure is that of the company’s expected contribution to the plan for the forthcoming year. These disclosures should help users assess whether expected benefit payments are adequately funded, and may represent the most important new provisions of the statement.
Miscellaneous disclosure requirements. The new statement retains the requirement that current-year benefit costs be disclosed, together with information pertaining to the components of these costs, such as interest costs, expected return on plan assets, the amortization of transition gains or losses, current gains or losses, the amortization of prior service cost, and the gains or losses recognized due to a settlement or curtailment. Additionally, companies must disclose any amount reported as part of comprehensive income for the period resulting from a change in any additional minimum pension liability. The purpose for this requirement is to alert users to changes in owners’ equity that may result from SFAS 87’s minimum pension liability provision. Frequently, changes in additional minimum pension liabilities are accompanied by changes in reported pension-related intangible assets, but sometimes the corresponding entry accompanying a debit or credit to additional minimum pension liabilities is made directly to an owners’ equity account, which would not otherwise be reported in net income. This provision helps to ensure that these changes that might not otherwise be noticed are brought to the user’s attention.
In an attempt to improve the usefulness of disclosed information, SFAS 132 requires that assumptions used in the accounting for these plans be presented in a more standardized format. The following assumptions must be disclosed: assumed discount rates; rates of compensation increase; and expected long-term rates of return on plan assets.
Important disclosure provisions that were likewise retained from the “old” SFAS 132 include a reconciliation of the beginning and ending balances of the benefit obligation, and a reconciliation of the beginning and ending balances of the fair value of plan assets. Another carryover provision is the requirement for information concerning the funded status of the plans. This information includes the following:
- Any unamortized prior service cost;
- Any unrecognized net gain or loss;
- Net prepayment or accrual;
- Any intangible asset; and
- Any accumulated other comprehensive income recognized pursuant to the minimum pension liability provisions of SFAS 87. This accumulated amount of comprehensive income would be reported as a component of owners’ equity.
Disclosures pertaining to nonpension postretirement obligations. SFAS 132R, like its predecessor, applies to both pension and other postretirement benefits. The new statement offers no new disclosure requirements that pertain solely to health-care benefits. Some significant disclosure provisions that pertain only to postretirement benefits other than pensions are carried over from the old standard:
- The assumed health-care cost trend rates for the following year used to measure the expected cost of benefits covered by the plan, and a general description of the direction and pattern of change in the assumed trend rates thereafter.
- A form of sensitivity analysis showing the effect of a 1% increase or decrease in the assumed health-care cost trend rates on the aggregate of the service and interest cost components of net periodic postretirement health-care benefit costs and the accumulated postretirement benefit obligation for health-care benefits.
Disclosures in interim financial statements. SFAS 132R emphasizes that interim disclosures are required only for publicly traded companies whose interim financial statements include a statement of income. For interim reports that meet these criteria, SFAS 132R requires the following disclosures:
- The net periodic benefit cost recognized, with separate identification of—
- service-cost and interest-cost components;
- expected return on plan assets for the period;
- amortization of the unrecognized transition obligation or transition asset;
- recognized gains or losses;
- recognized prior service cost; and
- gain or loss recognized due to any settlement or curtailment.
- The total amount of the employer’s contributions paid, and expected to be paid, during the current fiscal year, if the amount is significantly different from the previously disclosed expected contribution.
Special requirements for nonpublic entities. As FASB noted, nonpublic entities have reduced disclosure requirements. For example, nonpublic entities are not required to provide the detailed reconciliations of beginning and ending assets and obligations. The rationale for this reduced disclosure was based primarily on respondents’ observations that their analysis of nonpublic companies does not require as much detail about benefit costs and net income as is provided by public companies.
Effective Dates
SFAS 132R is effective for fiscal years ending after December 15, 2003. Information concerning estimated future benefit payments, however, is not required until fiscal years after June 15, 2004. The Exhibit 1 and Exhibit 2 provide a summary of the new and previously existing disclosure requirements of SFAS 132R.
Implementation Concerns
As noted, FASB has stated that it sought to enhance the usefulness of pension disclosures without imposing undue costs on financial statement preparers and auditors. It would appear that the disclosures that SFAS 132R requires were indeed affected by implementation concerns. For example, FASB had contemplated a requirement for a form of sensitivity analysis that would have been based on hypothetical changes in certain assumptions used in measuring pension-related assets and obligations. FASB ultimately decided not to require disclosure of these items on the grounds that it might be misunderstood by financial statement users. Had FASB adhered to this requirement, implementation would likely have proved more onerous.
With respect to a “measurement date,” FASB had contemplated requiring disclosure only in those cases in which the measurement date was different from the fiscal year-end and subsequent economic events occurred that would have significantly changed the reported valuations. Such a requirement would have required preparers to assess the significance of economic events that occurred between the measurement date and fiscal year-end—a requirement to which the exposure draft respondents took exception. In the final standard, FASB changed its position in response to this criticism.
FASB had sought to provide users with information that would help them assess near-term demands on the company, with respect to its pension obligations. FASB initially regarded information about anticipated changes in the company’s pension benefit obligations as theoretically superior to any alternative required disclosure concerning near-term future obligations. Respondents to the exposure draft, however, indicated that such information is not readily obtainable and suggested the alternative of “expected benefit payments.” FASB capitulated, and chose to require what respondents to the exposure
draft viewed as the easiest and least costly information.
Other disclosure requirements impose little or no implementation difficulty. The new requirement that the ABO always be disclosed is one example, because this valuation should always be known to the preparer. Similarly, the required disclosure of asset composition would seemingly present little imposition.
The required narrative discussions might require preparers to address the extent to which previously disclosed expected rates of return on plan assets have either exceeded or fallen short of actual rates of return. There is the additional likely requirement of an explanation as to whether the preparer has made adjustments to expected rates of return based on actual experiences, and if not, why not. The required narrative might therefore place the preparer in a position of justifying disclosures that had not previously been required; still, the actual cost of implementing this requirement is not an issue.
Mission Accomplished?
In a FASB “Project Update” dated shortly before the release of SFAS 132R, FASB offered the following comment regarding the soon-to-be-released standard:
Current reporting requirements for pensions do not always provide users with a clear picture of the status and health of a company’s defined benefit pension plans; therefore, this project aims to select the disclosures that will provide users with the most useful information, without imposing undue costs on auditors and preparers.
SFAS 132R retains the disclosure provisions of its predecessor and provides new requirements as well. FASB has clearly sought to provide a clear picture of companies’ defined-benefit pension plans, and has also striven to do so in a way that minimizes implementation costs. The new statement’s various provisions will likely be seen by some as enhancing the clarity and usefulness of pension information, but the adequacy of this improvement, and the extent to which the new provisions are cost-effective, are matters of opinion that will be revealed as the provisions are implemented over time.
Brian W. Carpenter, PhD, is a professor of accounting, and Daniel P. Mahoney, PhD, CFE, is a professor of accounting, both at the University of Scranton, Penn.
