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. |