Displaying the Funding Status of Postretirement Plans
The Impact of SFAS 158 Disclosure

By David N. Hurtt, Jerry G. Kreuze, and Sheldon A. Langsam

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JULY 2007 - FASB issued Statement of Financial Accounting Standards (SFAS) 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, in September 2006. SFAS 158 represents the initial phase of a comprehensive project on employers’ accounting for postretirement plans. FASB began the project in November 2005 in response to requests by users of financial statements, the SEC staff, members of FASB’s Financial Accounting Standards Advisory Council and User Advisory Council, and representatives of the Pension Benefit Guaranty Corporation. Its goal is to improve transparency and understandability regarding the costs and obligations of providing postretirement benefits and the ability of an entity to fulfill its obligations under its pension plans. FASB believes this project is important due to the magnitude and long-term nature of existing arrangements, in spite of the declining trend of companies sponsoring defined benefit postretirement plans.

Specifically, SFAS 158 requires employers to fully recognize their obligations associated with their defined pension, retiree healthcare, and other postretirement plans in their financial statements. A company must recognize in its statement of financial position the overfunded or underfunded status of a defined benefit postretirement plan, measured as the difference between the fair value of plan assets and the benefit obligation. The measurement date for determining funding status must coincide with the date of the employer’s statement of financial position. The impact on the statement of financial position may be significant, but because most changes will be recognized as a component of other comprehensive income, net of tax, the income statement should not change much. All public, nonpublic, and not-for-profit organizations are affected by SFAS 158.

Reasons for Plan Accounting Changes

FASB cited numerous reasons for mandating changes in pension and other postretirement plan accounting. FASB believes that SFAS 158 will provide financial statements that are more complete and easier to understand. Existing standards on pension and postretirement plans, according to FASB, fail to produce representationally faithful and understandable financial statements, by allowing employers to recognize an asset on the statement of financial position for plans that are significantly underfunded. Although SFAS 87 mandates minimum liability recognition, that measurement is based on the accumulated benefit obligation. Furthermore, under certain circumstances SFAS 106 does not require the recognition of a minimum liability.

FASB believes that disclosure of the underfunded status of defined benefit postretirement plans in the footnotes, as currently presented, is not a substitute for proper recognition of this funding status in the statement of financial position, causing users difficulty in assessing an employer’s financial position and its ability to satisfy plan obligations. Moreover, the actuarial gains and losses and the prior service costs and credits that arise during the period, according to FASB, should be recognized as a component of other comprehensive income, net of tax. Deficiencies in present reporting, according to FASB, could result in an inefficient allocation of resources in the capital markets.

FASB also maintains that financial reporting will be improved by measuring plan assets and benefit obligations as of the same date as the employer’s other assets and liabilities. Present alternative measurement dates add complexity and reduce understandability. They allow potentially significant changes in plan assets and benefit obligations that occur after the measurement date but before the fiscal year-end to go unrecognized until the following period.

Specifics of SFAS 158

The basic approach to measuring plan assets, benefit obligations, or net periodic benefit cost is not changed by SFAS 158. It does, however, require entities to report the overfunded or underfunded status of defined benefit postretirement plans in their statement of financial position. The funding status is measured as the difference between the fair value of plan assets and the benefit obligation. The benefit obligation for pension plans is calculated as the projected benefit obligation, while for other postretirement benefit plans, such as a retiree healthcare plan, it is calculated as the accumulated postretirement benefit obligation. When computing the (present value of the) benefit obligation, employers should consider rates of return on high-quality fixed-income investments. These assumed discount rates should be reevaluated at each measurement date.

For presentation on the statement of financial position, the aggregate statuses of all overfunded plans are recognized as an asset, while the aggregate statuses of all underfunded plans are recognized as a liability. Employers presenting a classified statement of financial position should separately report the current and noncurrent portions of the asset or liability in accordance with existing standards. SFAS 158 does not allow entities to aggregate all plans and report the net amount as a single net asset or net liability. The netting of all plans, according to FASB, is inconsistent with other standards that preclude offsetting assets and liabilities unless a right of offset exists.

The funding-status determination must coincide with the date of the employer’s statement of financial position for fiscal years ending after December 15, 2008. Previously, under SFAS 87, the measurement date for the pension plan could be up to three months earlier than the date of the employer’s statement of financial position. The measurement date conformity should not be applied retrospectively. An exception to this rule applies if the plan is sponsored by a subsidiary that is consolidated using a different fiscal period than the parent, pursuant to ARB 51, Consolidated Financial Statements. In that case, the date used to consolidate the subsidiary’s statement of financial position should be used for the postretirement benefit plan assets and benefit obligations.

Actuarial gains and losses and the prior service costs and credits that arise during the period that are not recognized as components of net periodic benefit cost (pursuant to SFAS 87 and 106) will be recognized as a component of comprehensive income, net of tax. As these gains, losses, costs, and credits are subsequently recognized as components of net periodic benefit cost, accumulated other comprehensive income will be adjusted accordingly. In determining the applicable income tax effects, the provisions of SFAS 109 shall be followed.

Any transition asset or obligation remaining from the initial application of SFAS 87 or 106 shall be recognized as an adjustment to the opening balance of retained earnings, net of tax. These amounts would not be subsequently amortized as a component of net periodic benefit cost.

In addition to recognizing the funding status of a plan in the statement of financial position, employers must disclose the following:

  • For each period a statement of income is presented, the net actuarial gain or loss and the prior service cost or credit must be recognized in other comprehensive income, separated into amounts initially recognized in other comprehensive income and amounts subsequently recognized as adjustments to other comprehensive income, as those amounts are included as components of net periodic benefit cost.
  • For each period a statement of financial position is presented, the amount of net actuarial gain or loss and the prior service cost and credit must be included in accumulated other comprehensive income.
  • An estimate of the net actuarial gain/loss and the prior service cost/credit included in accumulated other comprehensive income that will be recognized as a component of net periodic benefit cost over the next fiscal year must be presented.

By reporting the funding status of the defined benefit postretirement plan in the statement of financial position, certain existing disclosures are eliminated. Current disclosures to reconcile the funded status of the plan to amounts recognized in the employer’s statement of financial position are eliminated, as are disclosures that reference the additional minimum pension liability. Because the measurement date of the plan conforms with the financial statements, there is no need to report the measurement date of the plan.

SFAS 158 applies to public, nonpublic, and not-for-profit organizations, with an effective date for fiscal years ending after December 15, 2006, for public companies, and for fiscal years ending after December 15, 2007, for all other entities. Earlier application is encouraged. All requirements of SFAS 158 should be applied retrospectively for all financial statements presented, unless it is impracticable to do so. A single transition method must be applied consistently for all of an employer’s defined benefit plans. Plan assets and benefit obligations do not have to be remeasured for interim-period reporting.

Implementation Issues

Based on input from constituents, FASB maintains that the costs of implementation will not be significant. All the information needed to recognize a plan’s funded status is already determined and included in annual footnote disclosures. Minimal costs should be incurred in reorganizing the information from the footnotes to the financial statements.

Costs will be incurred, however, by companies that previously used an earlier measurement date for determining plan assets and benefit obligations, and thus must now align the plan measurement date with the date of the employer’s statement of financial position. These costs may include fees paid to external consultants to measure benefit obligations, value plan assets, and change systems and processes for accumulated information, as well as fees paid to external auditors to audit the results of a second measurement of plan assets, benefit obligations, and related effects of net periodic benefit cost.

Reporting the results of the funded statuses of postretirement plans may have some economic consequences. Companies with significantly underfunded plans could have their cost of capital increased due to changes in behavior of lenders and investors. Employees may see future benefits decrease as companies try to reduce, eliminate, or otherwise revise their plans. FASB contends, however, that the economic nature of plans determines decisions by lenders, investors, donors, and others, not their financial accounting treatment. Only time will tell if the reporting of the funding status of plans will impact employees and the cost of capital, especially for those companies whose plans are significantly underfunded.

Case Studies: Financial Statement Impact

SFAS 158 will not impact all companies uniformly. Old industrial companies with heavily unionized workforces will be most affected. These companies typically have defined benefit pension and postretirement plans that are also often underfunded. A recent report by Bear Stearns found that companies with the biggest balance sheet changes probably include the likes of General Motors, Verizon, BellSouth, and General Electric. These four companies were selected to determine the impact of SFAS 158 on their financial statements.

The 2005 financial statement results for these four companies were modified to include SFAS 158 implementation as of January 1, 2004. The impact of the restatements is summarized in Exhibit 1 and then detailed for each company. The changes to their income statements and statements of comprehensive income are readily observable from their restated statements of financial position. The impact on net income is insignificant, as most adjustments flow through comprehensive income.

Of the four companies examined, General Electric’s statement of financial position would be least affected by the provisions of SFAS 158 (Exhibit 2). The funding status of its postretirement plans, under SFAS 158 treatment, would be overstated on its statement of financial position by $9.1 billion. Its total assets would be $9.1 billion less, deferred income taxes would decrease by $1.6 billion, and stockholders’ equity (specifically, other comprehensive income) would decrease by $7.5 billion. General Electric’s debt-to-equity ratio would increase from 508% to 544%, an increase of 36%, while its debt-to-asset ratio would increase by only 0.9%.

BellSouth’s postretirement plan funding status would be reduced by $5.3 billion (Exhibit 3). Its total assets would be $4.5 billion less, liabilities would fall by $1.1 billion, and stockholders’ equity (retained earnings of $94 million and other comprehensive income of $3.3 billion) would be $3.4 billion less. BellSouth’s debt- to-equity ratio would increase by 19%, and its debt-to-asset ratio would increase by 2.9%.

Verizon’s financial results would be more significantly impacted (Exhibit 4). Specifically, Verizon’s postretirement plan funding status on its statement of financial position would be reduced by $16 billion. Its total assets would be $13 billion fewer, liabilities would be reduced by $1.9 billion, and shareholders’ equity (retained earnings of $12 million and other comprehensive income by $11.2 billion) would be reduced by $11.2 billion. Verizon’s shareholders’ equity would decrease from $39.7 billion to $28.4 billion, a 28% decline. The debt-to-equity ratio would increase significantly, from 256% to 351%. Even before SFAS 158 was issued, Verizon had frozen its pension benefits for management employees and announced that new management employees hired after December 31, 2005, were not eligible for pension benefits (instead they receive an increased company match on their savings plan contributions).

The impact of SFAS 158 on General Motors far surpasses the impact on the other companies examined (Exhibit 5). General Motors’ shareholders’ equity would go from $14.6 billion to negative $38.2 billion—total assets would be less than total liabilities. The funding status of its postretirement plans would decrease by $64.4 billion, total assets would decrease by $16 billion, liabilities would increase by $22.2 billion, and shareholders’ equity would decrease by $38.3 billion (retained earnings by $21 million and other comprehensive income by $38.2 billion). From a GAAP standpoint, General Motors has negative equity. Equity may be positive on a fair value basis, however, as many of General Motors plant assets may be undervalued. Nevertheless, SFAS 158 requirements do portray General Motors in a significantly different perspective and add greater transparency to its underfunded postretirement plan obligations. The magnitude of General Motors’ promises to its existing employees and the costs of those present commitments are presented in a more transparent manner. Whether General Motors can satisfy those future obligations remains to be seen, however, especially given the competition in the automobile industry. General Motors will also incur additional costs to comply with SFAS 158, as its September 30 plan measurement date does not coincide with its December 31 year-end.

A Significant Step

SFAS 158 mandates recognition of the overfunded or underfunded status of defined benefit postretirement plans. The plans’ measurement date must coincide with the date of the statement of financial position for fiscal years ending after December 15, 2008. Without a doubt, SFAS 158 will adversely impact the reported financial results of numerous companies. Industrial companies with many unionized workers will be the most significantly impacted. These impacts may cause companies to eliminate, reduce, or modify benefits to employees. Lenders, investors, donors, and others may view these postretirement benefit arrangements differently in the wake of this enhanced transparency.

SFAS 158 will reignite discussions similar to those after the issuance of SFAS 106. Shareholders will pressure companies to more effectively manage the postretirement plan commitments. Nonetheless, FASB believes that SFAS 158 will result in a more complete, comparable, and representationally faithful presentation of postretirement benefit plans. The cost of implementation should be minimal, but the impact on future postretirement plan policies and practices, cost of capital computations, and labor negotiations may be significant. What is certain is that, just like SFAS 106, SFAS 158 will be a significant item of discussion in corporate boardrooms.


David N. Hurtt, PhD, CPA, CMA, is an associate professor in the department of accounting and business law, Baylor University, Waco, Texas.
Jerry G. Kreuze, PhD, CPA, and Sheldon A. Langsam, PhD, CPA, are both professors in the department of accountancy, Haworth College of Business, Western Michigan University, Kalamazoo, Mich.


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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