132(R) and New Pension Disclosures
OCTOBER 2005 - Financial
reporting for defined-benefit pension plans requires extensive
footnote disclosures under SFAS 87, Employer’s Accounting
for Pensions, and SFAS 132, Employers’ Disclosures About
Pensions and Other Postretirement Benefits. While voluminous,
current disclosures lack information that is vital to understanding
how defined-benefit plans impact firms’ financial position
and performance. To fill this void, FASB released a revised
version of SFAS 132 in December 2003.
Are Additional Disclosures Necessary?
theme of pension accounting under SFAS 87 is the smoothing
of effects of events that differ from expectations. For
example, entities use expected, rather than actual, returns
on pension plan assets in computing net income. As a result,
understanding the determinants of companies’ expected
returns is important in assessing the quality of reported
earnings. Research indicates that the expected return on
pension assets cannot reliably predict future pension plan
returns. The percentage of plan assets invested in equity
securities, which is typically not disclosed in financial
statements, can be useful in explaining future pension returns.
Other research and anecdotal evidence links expected pension
asset returns to earnings manipulation.
developments have led to increased scrutiny of the funding
status of defined-benefit pension plans. The original issuance
of SFAS 132 in 1997 followed a period of strong market returns
that left many pension plans well funded. As a result, SFAS
132 no longer required the disclosure of the accumulated
benefit obligation (a measure of pension liability that
ignores future salary increases). More recently, low interest
rates, which increase firms’ pension liabilities,
combined with weak asset returns, have combined to severely
reduce overall funding levels and have resulted in more
companies booking additional pension liabilities.
SFAS 132(R) disclosures are designed to address financial
statement users’ concerns with the following:
Evaluating plan assets and the expected long-term rate
of asset returns;
an employer’s funded status and its expected future
obligations (cash flows) under its plans; and
the impact of pension cost on net income.
each major category of plan assets, SFAS 132 requires the
percentage of the fair value of plan assets held. Exhibit
1, an excerpt from General Motors’ 2004 Form 10-K,
provides an example of such a disclosure.
132(R) also requires narrative descriptions of companies’
investment policies and strategies, including a target allocation
percentage or range of percentages (if applicable), as well
as the basis used to determine the expected long-term rate-of-return-on-assets
assumption, which includes the extent to which this rate
was based on historical asset returns and otherwise adjusted.
its 2004 Form 10-K, General Motors (GM) provided an extensive
discussion of how it determined its expected long-term rate
of return. Interestingly, the discussion revealed that effective
January 1, 2003, GM lowered its expected long-term rate
of return from 10% to 9%. GM also disclosed target asset
allocations that, when combined with current asset allocations
and expected and actual returns on plan assets, would yield
a better understanding of how pension cost impacts net income.
132(R) also requires companies to disclose interim financial
reports for each period an income statement is presented,
and the amount of net periodic pension cost recognized,
along with the individual components of periodic pension
cost. Because the “integral view” of financial
reporting in APB 28, Interim Financial Reporting,
requires companies to make estimates in interim reports
based on conditions expected for that annual period, timely
interim pension disclosures can also yield insights in predicting
better understand pension plans’ funded status, SFAS
132(R) again requires the disclosure of the accumulated
benefit obligation. This disclosure helps users estimate
how likely it is that a company will need to record a “minimum
liability” under SFAS 87 and, thus, potentially approach
constraints of restrictive debt covenants. SFAS 132(R) also
requires extensive disclosures of contributions expected
to be paid to the plan during the next fiscal year, along
with expected future benefit payments, which includes the
benefits expected to be paid in each of the next five fiscal
years, and in the aggregate for the five fiscal years thereafter.
The format of these disclosures, presented in Exhibit
2, follows that of operating leases, which has been
shown to be useful in assessing both equity and debt risk.
most disclosures, SFAS 132(R) is effective for fiscal years
ending after December 15, 2003. Disclosures of estimated
future benefit payments and for certain foreign plans are
effective after June 15, 2004. With these disclosures and
an understanding of pension accounting, users can better
comprehend the impact defined-benefit pension plans have
on a company’s financial performance, financial position,
and earnings quality.
Shaw, PhD, CPA, is a Joseph A. Silvoso Faculty Fellow
and an associate professor of accountancy at the University
of Missouri, Columbia, Mo.