March 31, 2006

Outside Audit

FASB to Move Pension Accounting

From Footnotes to Balance Sheets

By DAVID REILLY

March 31, 2006; Page C3

Accounting rule-makers are about to take the first real step toward overhauling the way U.S. companies account for pensions and other post-retirement benefits such as health care.

The Financial Accounting Standards Board is expected to propose today that public and private companies move onto their balance sheets the deficits or surpluses in their pension and other postretirement plans. Currently, those amounts are only shown in footnotes to financial statements, while plan assets and liabilities that do appear on the balance sheet often bear little resemblance to a plan's actual funded position. In the language of retirement-plan management, plans that have more than enough assets to match future liabilities for retirees are referred to as fully funded or overfunded; those that face shortfalls are said to be underfunded. (Read the proposal)

Although the proposal won't affect companies' earnings, the changes to the balance sheet will allow investors "to see the full impact of the obligations that the plan sponsors have to their employees," said George Batavick, a FASB member. "This will make the balance sheet more complete, more transparent."

At the end of 2004, for example, companies in the Standard & Poor's 500-stock index reported a $99 billion net pension asset -- even though footnotes showed the plans faced a total shortfall of $165 billion, according to research from Credit Suisse.

While somewhat cosmetic, lifting a plan's funded status from the footnotes onto the balance sheet could boost a company's liabilities and cause real pain. In some cases, companies might find that their debt-to-equity ratios or other key financial measures would change, requiring them to renegotiate lending agreements. That could add stress to already financially strapped companies, such as auto makers, and may prompt more companies to no longer enroll new employees in their traditional, defined-benefit pension plans, as recently has happened at International Business Machines Corp. and Verizon Communications Inc.

As a result, even this first phase of FASB's pension project could come under fire from companies and labor unions. And opposition could grow as the Norwalk, Conn., board moves to the second phase of its project, in which it could change the underlying accounting for calculating pension costs, plan returns and future obligations. Combined, these changes could prove to be "even more controversial" than the overhaul of stock-option accounting, according to a report late last year from Bear Stearns.

Still, investors, accountants, academics and regulators have long clamored for change, saying current accounting rules for pensions and other post-retirement benefits don't reflect reality. In many cases, companies are able to "smooth" out over a period of years the impact on earnings from changes in their pension plans. In addition, key assumptions underpinning future obligations and returns are often subjectively decided by management, while plan assets and liabilities are kept off the balance sheet.

"The application of pension accounting today results in balance sheets that are misleading and in amounts on the balance sheet that are in many cases meaningless," Credit Suisse said in a report.

Although today's first FASB proposal on pensions won't dig into the thorniest accounting issues, it is a temporary fix that can be quickly put in place. The proposal will be subject to a 60-day comment period. FASB hopes to issue a final standard related to the proposal sometime in the third quarter, Mr. Batavick said, and companies would begin using it for fiscal years ending after Dec. 15.

In moving a plan's funded status onto the balance sheet, a company will compare the market value of its assets to its projected benefit obligation, which includes assumptions about employee longevity and wage inflation. The difference between these two -- either a surplus or deficit -- will then be recorded as an asset or liability.

Companies won't, however, actually move plan assets and obligations onto the balance sheet. But in lifting the plan's funded position from the footnotes, companies will be required to "cleanse" some existing pension-plan items -- such as prepaid pension assets and accrued pension liabilities -- from their balance sheet.

The FASB proposal would also require companies to record the funded status at the end of their fiscal year. Currently companies can record this measure within three months of the close of the fiscal year.

Write to David Reilly at david.reilly@wsj.com2

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