Accounting for Pensions and other Post-Retirement Benefits

For pensions and post-retirement accounting methods to recognize the benefits costs, estimates and assumptions on future events ascertaining the timing and amount of benefits payments must be sought first. This paper seeks to compare and contrast the early historical accounting for pensions and post-retirement healthcare and life insurance benefits with the rules and guidance applied today in addition to the changes to such guidance and rules that would improve the accounting and reporting of such benefits depending on the business and political changes and as such, predict the effect of such changes on financial reporting and accounting practices.

The Early Historical Accounting for Postretirement Health Care and Life Insurance Benefits and the Guidance or Rules in Place Today

The employers offering pension plans were to disclosure the plans as well as the general features that were contained in the document in addition to the current year and pension expense incurred. This would equal the postretirement health care and life insurance benefits. As such, the components of the pension expense, net funding status, pension asset and obligation accounts, and pension expense components needed disclosure. Since then the net pension liability or asset have to be booked while the changes in pensions liabilities and assets not included in the income being added into other comprehensive income. According to the SFAS No.87 Employers’ Accounting for Pensions, the disclosure of the pension plan market values of assets, as well as the projected benefits obligations of plans, is done although they are not recognized on their balance sheets.

Further, the SFAS 87 emphasizes on offsetting of plan assets and liabilities, unlike earlier where it allowed for the value of the plan assets to be reduced by the liabilities of the plan. Therefore, as the FASB recognized that to not include a common practice, it allowed reporting only the over or under funded status of all pension plans since firms are seen as responsible only for both the unfunded and funded status of the plan as opposed to the plan assets or liabilities. Additionally, some firms have been found to have more than one post-retirement plan with different funding levels.

However, in 1990, the SFAS 106 was issued and applied accrual accounting to postretirement benefits as opposed to pensions with the specific focus on health care benefits. Entities have in the past been recording and reporting the benefits on a pay-as-you-go basis using cash basis accounting. This has since changed to include the accrual of the future medical costs of the employee and covered beneficiaries at the time of the employee’s service. The SFAS 106 allows an entity to estimate the growth rate of healthcare costs since any reduction in this estimated growth rate would mean a reduction in the obligation, thereby underfunding the plan.

The SFAS 82, APB Opinion 8, and the ARB 47 assumed that the postretirement assets and obligation belonged to the pension fund and were to be accorded by the entities although it was only in rare circumstances that an entity reported an asset or liability on the balance sheet. Additionally, the expense reported in the income statement was thus equal to the amount funded. Other post-retirement benefits were accounted for on a pay-as-you-go basis. However, this way of accounting for postretirement benefits changed in 1985 when the FASB issued SFAS 87 and 88.

As such, the measurement and recognition, as well as reporting rules for the defined benefit pension plans required in these standards applied accrual basis of accounting when recognizing and measuring the expenses, assets, and liabilities of pension plans and remained has thus unchanged since. The SFAS 87 required entities to recognize pension expense in the income statement, and the information underlying be disclosed in the footnotes rather than being reported in the financial statements thereby allowing more useful information to the users of the financial statement. The SFAS 158 does not include footnote and off the books reporting of postretirement benefits plan asset and liabilities and requires such items to be reported on the balance sheet. The SFAS now requires the recognition of the funded status of a defined benefit and plans as well as changes to amounts recognized in other comprehensive income. The entity is also supposed to measure the defined benefit plan of the assets and obligations as of the date of the fiscal year-end statement of financial position.

Recommended Changes to the Guidance and Rules That Would Improve the Financial Accounting and Reporting of the Benefits

An amending to the postretirement benefits accounting model accompanying the development the new accounting for share-based payment should be done. This follows the premise that many companies offer defined-benefit pension as well as retiree medical benefits to their employees and retirees. This method of accounting ties up huge amounts of capital for many employees. Additionally, by changing the stock-based compensation to employees, the FASB’s postretirement benefits project’s outcome may lead to companies freezing or reducing the postretirement benefits. Therefore, it would be more apt for entities to recognize that the FASB tries to set the accounting principles right.

Secondly, entities and the FASB should try to eliminate the smoothing mechanisms used in the current accounting guidance, which companies can adopt. This would thus allow entities to minimize the differences between the actual and expected performance of postretirement. It is better to have a transparent method that reflects on the financial status of the said plan thereby deterring the assumptions that favorably impact operating income. The good faith applied in the smoothing mechanisms would reflect the long-term nature of postretirement benefits plans. By adopting such a proposal, the capital markets and companies’ reported financial results would be positively impacted. Reporting of the actual pension asset returns would introduce a new and noticeable source of volatility into corporate earnings and thus, directly impact the corporate earnings due to the performance of pension fund assets.

The Significant Manner in Which the Future of Accounting for the Benefits Could Change

The FASB seeks to improve the postretirement benefits arrangements reporting in an employer’s financial statements through the identification of information that stakeholders find suitably useful and transparent. As such, an entity’s postretirement benefits obligation should be put on the balance sheet in net of plan assets. This would work to eliminate the off-balance sheet item. An entity’s balance sheet should fully reflect the funded status of the defined benefits plans. The difference between the funded status and the amount currently recognized in the balance sheet ought to be reported as an equity adjustment and thus provide substantial amounts of liabilities onto the balance sheet.

Moreover, entities would look into the mitigation of the effect of such changes on the balance sheets. The underlying effect would be some companies facing a substantial reduction in their reported equity. Companies would also need to communicate the rationale for their decisions to investors and analysts. Therefore, significant adjustments to valuations upon implementation of the FASB’s proposal would not be anticipatory. It would be important for entities to ensure that the unrecognized cost of benefits earned in the past, as well as the unamortized experience losses, be recognized in the balance sheet with a corresponding charge to equity. This would eliminate any chances of having prepaid postretirement benefits assets in the cases of unfunded off-balance sheet liabilities for such benefits.

Changes in Postretirement Health Care and Life Insurance Benefits

This would include a funded status of a plan for reporting on the balance sheet, and thus move towards International Financial Reporting Standards, IFRS on pension as well as other postretirement benefits. IFRS, thus presently provides entities with an option of recording their plans’ funded status. However, there is an option for the differences included in different expense recognition treatments of experience gains and losses to be changed. This would also entail the cost of benefits earned in the past financial years and the method of arriving at the amount of expected earnings on plan assets.

The liabilities included in the estimate for future salaries should be included in the plans with benefits that are based on salary levels. This would provide entities with present liability based in part on future salaries but have not been earned yet. This would be essential in the delivery of a substantial improvement in the understandability, usefulness, and transparency of the balance sheet. The board can also work to eliminate the smoothing mechanism of income statement which requires companies to report directly in the income statement actual asset returns in addition to the gains and losses. However, this may provide room for an inadequate sound conceptual basis for smoothing reported earnings and to addressing the volatility in corporate earnings from non-operating activities that would emanate if the smoothing were eliminated. Moreover, for partially and fully-funded plans, an entity should consolidate the pension or postretirement benefits trust in its financial statements. This would work to present the pension liability and consolidate the concepts and report the pension assets separately on the balance sheet rather than after net liability or asset presentation.

Argument and Correspondence

The accounting for pension and other postretirement benefits obligations should entail the use of various assumptions, for instance, the disability rate, the average length of service, retirement age, the employee turnover rate, and the salary and wage increase rate. As a result, health care cost trend rate, the rate of return on plan assets, the discount rate, and mortality, should be included in the financial statement disclosure as well as the MD&A disclosure requirements for the health care cost trend rate, rate of return on plan assets, and discount rate. The chief financial officer should, when selecting assumptions, focus on the consistency and appropriateness of the underlying approach in addition to the adequacy of supportive accounting documentation that provides the amount of disclosure required by the FASB standards.

The entities should set a sufficient amount of time to gather the necessary information and thus perform actuarial calculations to meet the deadlines for the year-end reporting. This would be important in allowing the companies to measure plan assets and benefits obligations as of the date of the financial statements instead of proceeding with the existing practice of permitting an alternative measurement date of three months before the date of the financial statements. It would also be important for the management to ensure an increased accountability through accurate measurement, recording and reporting of postretirement benefits to boost the commitments to employees and to allow the benefits of economic sense for the company.

Leave a Reply