Pension Accounting Changes and the ‘Oh Good Grief Standard’

By Tom Schryer

E-mail Story
Print Story
JULY 2007 - Even when we all try to do the best we can, sometimes that just makes things worse. Right now, the world’s accounting commissions are trying to make standards more uniform by using the best practices available. Sir David Tweedie, chairman of the International Accounting Standards Committee (IASC), is one of the key players in trying to minimize accounting differences around the world. He is in favor of two rules for defined benefit (traditional) pension plans that do not seem to be best practices: 1) using only the market value of assets (instead of something more stable) when estimating the pension plan’s expected investment income, and 2) booking a significant special income or loss entry that fully recognizes changes in a pension plan’s balance between assets and liabilities. How sound are these two ideas?

Enterprises in the United States can calculate a “market-related value” of a pension plan’s investments, which might take up to five years to fully reflect deviations from expected returns. That smoothed asset value is then used to calculate the year’s expected investment return, thus smoothing out one component of net pension expense by avoiding a lot of the extremes (upside and down) inherent in snapshot market values. This was not by accident. Otherwise, according to SFAS 87, Employers’ Accounting for Pensions (paragraphs 120 and 121), short-term changes in asset values “would produce unacceptable volatility and would be inconsistent with the present accounting model.” International Accounting Standard (IAS) 19, Retirement Benefit Costs, lacks a similar mechanism. In short, the U.S. standard allows enterprises to smooth secondary expenses (e.g., for pensions) so attention is better-focused on fluctuations in performance due to the core enterprise, just the sort of better practice that should be embraced when standards are made more uniform.

In the United States the two changes in the rules for pension plans (disallowing smoothing expected investment returns and focusing more attention on simple assets and liabilities) would have the following effect:

  • Increase the apparent volatility of the business. One potential standard for gains and losses relating to pensions would recognize them immediately, probably in a special category. For example, the balance sheet and part of the bottom line at General Motors would irrationally swing between incredibly good and incredibly bad.
  • Probably be disruptive. Similar changes in the United Kingdom have been partially responsible for roughly 65% of their traditional pension plans now being closed (not covering new employees).
  • Obscure the focus on the current and future profitability of the core business.
  • Do a reasonable job for failing companies but probably overstate the underfunding risk for most companies by not assigning a reasonable likelihood of an immediate plan termination and settlement.
  • Affect macro-level stock prices, because declining stock values would significantly reduce the expected investment income from pension plan assets and reduce reported earnings. This in turn reduces stock values further. The world’s accounting rules should not be designed to destabilize capital markets.
  • Make it more difficult to continue providing a traditional pension plan.

It might actually be best to expand the smoothing techniques available in SFAS 87 to allow the market-related (smoothed) value of assets to follow the liability’s changes due to interest rate fluctuations too. Such a technique can smooth out funding requirements for pension plans facing severe volatility in contribution levels due to fluctuations in liabilities, and it can dramatically smooth the results. The IRS has approved it, so FASB might want to consider it.

The proposed instant recognition of all gains and losses in pension plans seems more like assuming all possible warranty claims will be made now (a similarly gloomy assumption). A pension plan’s investments in the stock market can significantly affect the stability of the sponsor’s earnings, which in turn affects the plan’s price/earnings ratio. Some people want to make sure volatility is not masked. Rather than trying to recognize every last dollar/euro/yen of the annual fluctuations in the market value of a pension plan’s assets, it would probably be more worthwhile to investors to know how pension investments affect an appropriate “risk reserve” that would factor in the likelihood that the plan will be terminated and settled in the future—which would require an additional charge to the books at such time. Stochastic actuarial models are available that could probably set suitable reserves. Such a concept is similar to carrying a reserve for warranty claims.

Alternatively, smoothing could be allowed under international standards, and a measurement of pension costs calculated without smoothing could be reported in a footnote. Because there are disagreements on the smoothing issue, this could be the sort of well-balanced compromise that is going to be needed.

The ‘Oh Good Grief Standard’

Commentators who believe that asset-smoothing has no place in solid accounting practices seem to be getting caught up in narrow objectives without seeing the bigger picture. People who are good with numbers sometimes have to work harder at making well-balanced decisions, but two things can help: 1) cultivating a good relationship with someone with numerical abilities and a strong “right brain” (for making balanced, holistic judgments), and 2) the “Oh Good Grief Standard.”

These comments are from an actuary, whose profession requires a mastery of math, strategies, and following rules. Fortunately for me, I can “borrow” a more balanced perspective from an associate. She explained the “Oh Good Grief Standard” to me as follows: When something feels out of whack, try saying “Oh Good Grief” and judge how reasonable it feels. Often, this lets you recognize that there are fundamental questions about what you are trying to accomplish.

Potential changes to IAS 19 do not seem to pass the “Oh Good Grief Standard,” especially with regard to the immediate recognition of the full annual change in the balance between pension assets and liabilities in a special income or loss entry. SFAS 158 has already been changed to make this information available, but only on the balance sheet and not on the bottom line. The liabilities used are future pension payouts discounted using bond yields, whereas these plans will typically operate for many more years using investments in equities and bonds, making the proposed liabilities, including those under SFAS 158, close to “liquidation” liabilities. Such “liquidation” liabilities can be 50% higher than they would be from an “ongoing plan” perspective using the trust’s expected rate of return.

Reporting liquidation values seems potentially worthwhile, especially for enterprises nearing bankruptcy. However, the reporting needs to be comprehensive and to reflect changes in liquidation values for assets such as factories, equipment, real estate, stock options, and patents, and for insuring warranty claims. Still, such values are poor guides to how well a reasonably healthy enterprise is doing, so either they should not be used in that context or an alternative should also be presented. Whenever liquidation values are presented, the reader should be made aware of the perspective being used.

In any event, the proposed values have almost no relevance for a healthy plan sponsor. How would reporting them in a major way for all enterprises (without a more rational measurement, at least in a footnote) clarify pension costs for the readers of financial statements?

Instead of focusing on liquidation values, the reader of the typical financial statement would probably be much better served by seeing an estimate of the price-per-share value of the sponsor as if it were offered for sale as a continuing enterprise. This seems much closer to the objectives espoused by the mark-to-market advocates.

Numerous Rules and Other Sources of Irritation

The numerous extra rules that traditional pension plans have to follow make it harder and harder to justify keeping these plans, even when the plans are truly cost-effective. Pension accounting issues are already a significant source of irritation in the board room. Ideally, effective accounting standards should present the important financial aspects of the enterprise to the public in a way that keeps each part of the financial picture in perspective.

An enterprise can, I believe, comment on alternative measurements of performance, so the concepts above might be adaptable to other situations. For example, if the price of a major raw commodity is erratic but its long-term trend is reasonably well understood, a hypothetical “smoothed” bottom line calculated assuming that a mainstream price had been paid might help the company’s board or the broader public better understand the future by eliminating the “noise” due to price fluctuations.

One final tidbit: Many pension plan sponsors use asset-smoothing to set contribution levels so they will be more stable from one year to the next. That might cost the sponsor nearly 20 basis points in average return over the long haul. Why? When the raw market value is used to set contribution levels, you “buy low” (contribute more when the market is low) and “sell high” (keep paying out benefits but contribute less when the market is high). It is ironic that smoothing is under attack for setting the accounting charges, where it clarifies results, and is probably much more common when setting contribution levels, where it is inefficient for strong companies.

Comments on proposed changes can be sent to FASB at and to the IASB at These comments were shared with FASB and the IAS.

Tom Schryer, ASA, is a consulting actuary with the Cleveland, Ohio, office of the human resources consulting firm Findley Davies (




















The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

©2009 The New York State Society of CPAs. Legal Notices