SFAS 132(R) and New Pension Disclosures

By Ken Shaw

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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.

Why Are Additional Disclosures Necessary?

One 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.

Market 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.

The New Disclosures

The 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;
  • Evaluating an employer’s funded status and its expected future obligations (cash flows) under its plans; and
  • Estimating the impact of pension cost on net income.

For 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.

SFAS 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.

In 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.

SFAS 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 future earnings.

To 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.

Effective Date

For 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.

Ken Shaw, PhD, CPA, is a Joseph A. Silvoso Faculty Fellow and an associate professor of accountancy at the University of Missouri, Columbia, Mo.




















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