Pension Accounting: Catalyst for Change?

I have long wondered when people would really start to pay attention to what some describe as the "pension perfect storm". Could new accounting rules be the catalyst for change? Just recently, the Financial Accounting Standards Board unveiled the first of several changes in how companies will have to portray pension fund finances. Arguably long overdue, a company will need to recognize "the overfunded or underfunded status of defined benefit postretirement plans as an asset or a liability in the statement of financial position". A second phase of this multi-year project will impact reported earnings.

What lies ahead?

If past is prologue, a change in the way financial statements are assembled will have a material influence on corporate behavior. Consider FAS 133, the mammoth rule book for derivative instrument accounting. Not long after it took effect, more than a few companies cut back on the use of derivatives, citing FAS 133 compliance as overly complex and time-consuming. Reducing speculative positions is one thing. Abstaining from the use of derivatives to mitigate interest rate, commodity, currency or equity risk is another thing altogether. Following the promulgation of FRS 17 in the UK several years ago, the National Association of Pension Funds "found that more than three quarters of companies offering final salary pension schemes were less likely to do so because of the new accounting standard".

In both cases, the law of unintended consequences prevailed. Instead of promoting transparency, new accounting rules encouraged outcomes that were contrary to the original intent. Does this mean that additional companies will shed their defined benefit plans rather than report "bad" numbers? (Note that freezing or terminating a plan has both an accounting and economic impact so the choice is not as straightforward as it may seem.)

Am I saying that accounting reform is bad? Not all all. I think the marketplace is desperate for more and better information. Will that ensue with FASB initiatives? It's too soon to say. Final rules are months away. (Subsequent postings will dive deep into the issue of pension information and the lack thereof. Suffice it to say, there is so much about pension assets and liabilities that remains a mystery.)

Will the new accounting requirements improve pension economics? Will shareholders have a better understanding of the true cost of providing post-retirement benefits and the related impact on dividends, earnings and flexibility? Will employees and retirees feel more or less comfortable that defined benefit plan promises will be kept? Will taxpayers worry that a federal bailout looms large as post-implementation numbers surface? Will reported figures square with actuarial or statutory assessments?

Notwithstanding a plethora of unanswered questions, I'm betting on FASB to mix things up. After all, the pension issue impacts the lives of nearly every adult in the U.S. (and abroad), either as investor, employee and/or taxpayer. When accounting rules change, so too do people's actions. posted by Susan Mangiero at 3/31/2006 12:01:00 AM