Accounting for Pensions and Other Post-Retirement Benefits

Accountingfor Pensions and Other Post-Retirement Benefits

Theabsence of transparency in the accounting as well as reporting forpostretirement benefits has elicited debate for more than half acentury. The Committee for Accounting Procedures (CAP) issued thefirst official announcementsin 1956 followed by the AccountingPrinciples Board (APB) ten years later (Zeff, 1984). The APB Opinion8 and the Accounting Research Bulletin 47 were both titled Accountingfor the Cost of Pension Plans.They however addressed pension as well as other postretirementobligations (Scholey, 1969). These accounting standards didn’t needbalance sheet disclosure for any asset or liability connected toretirement benefits, except under unusual instances.

In1980, FASB (the Financial Accounting Standards Board) tried toenhance disclosures by pension monies as well as their sponsorsthrough the issuance of standard SFAS (Statement of FinancialAccounting Standard) 35 and SFAS 36 respectively (Barth,Beaver&ampLandsman, 2001). These standards were both titledDisclosureof Pension Information.The FASB later issued SFAS 81 in 1984, titled Disclosureof Postretirement Health Care and Life Insurance Benefits.This standard required the disclosure of postretirement benefitsapart from pensions. It was followed in 1985 by SFAS 87, entitledEmployers’Accounting for Pensions,as well as SFAS 88, entitled Employers’Accounting for Settlements and Curtailments of Defined BenefitPension Plans and for Termination of Benefit. Thesetwo were hitherto the most inclusive standards for accounting as wellas reporting for pensions together with their settlement andcurtailment. In 1990, SFAS 106 entitled Employers’Accounting for Postretirement Benefits Other Than Pensionswas issued and it superseded SFAS 81. SFAS 106 was later in 1998revised by SFAS 132 titled Employers’Disclosures About Pensions and Other Postretirement Benefits,which was consequently amended in 2003 by SFAS 132R without changingthe title. Lastly, SFAS 158 titled Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans followed in2006 and modified all preceding standards that were still inexistence (Edwards, 2013).

TheEarly Historical Accounting Vs. Today

AlthoughSFAS 158 amends SFAS 87, SFAS 88, SFAS 106 and SFAS 132R reportingmeasures, it doesn’t alter the measurement and recognition rulesstipulated in these standards(Edwards, 2013). Instead, SFAS 158abolishes off the books practice as well as footnote reporting ofpostretirement benefit plan liabilities and asset allowed inpreceding standards by requiring the reporting of these items inbalance sheet.

SFAS158 was meant to make postretirement obligations apart from pensionsas well as defined benefit pension information, the funded planstatuses – net asset or liability position – and their manydisclosures and parts more transparent. The FASB targeted atprovision of transparency to users. Preceding standards didn’tcommunicate openly the funded position of postretirement plansbenefits and amounts of long term and short term plan obligations.Users now have more information that helps them make informeddecisions (Beaudoin, Chandar&amp Werner, 2011). Ultimately, SFAS 158has enhanced transparency and financial reporting by requiringorganizations with defined benefits as well as other postretirementplans.

Standard45 has changed how government agencies report postretirement benefitsapart from pensions. These benefits comprise health, life insurance,hearing, vision, dental, long term disability and long term care, butare generally lumped together and referred to as postretirementhealth benefits. Prior to 2006, most agencies used the pay-as-you-goaccounting procedure – meaning that they only show the actual moneypaid out for the accrued benefits in a financial-year-end (Beaudoinet al, 2011). Yet the exact cost of already-earned staff benefits canbe significantly higher. In order to correctly account forpostretirement benefit costs, GASB has required public agencies touse an actuarial estimate that assigns an annual budget expense toaccount for the projected and actual benefits connected with thatfinancial year’s activities.

Changesto the guidance / rules

Althoughthe SFAS 158 has greatly improved the financial accounting andreporting of postretirement benefit accounting, lots of room forimprovement is still available. SFAS 158 didn’t alter anymeasurement rules in SFAS 87, 88 and 106. As such, company managementhas the discretion on the discount rate to be used. In addition, onlythe net plan liabilities and net plan assets amounts are reported,which avails scant information about the wellness of the plan.Moreover, the disclosures and notes to should be expanded in a bid tocomprise a detailed cash outflows schedule so that the company’sliquidity needs are identified. These changes would ensure fair andaccurate accounting of postretirement benefits.

Currently,accounting standards require little accountability in regard to thediscount rate and rate of return chosen, with some organizationssimply using the rates being used by other organizations and onlyciting the approval of the auditor as the reason for using that rate.The discount rate should be fixed and set at a uniform rate and acompany’s actual performance be used to calculate postretirementbenefit expenses rather than being recorded in Other ComprehensiveIncome (OCI). This would result into a more representationallyaccurate depiction of the financial position of the postretirementbenefit plans.

TheFuture of Accounting and Changes

Thefuture of accounting for postretirement health care and lifeinsurance benefits is likely to change significantly in the followingtwo ways basing on foreseeable potential changes in the business andpolitical climate. Firstly, the smoothing mechanisms in the currentaccounting rules that companies generally adopt are likely to beeliminated (Ball, 2006). Smoothing enables companies to reduce thedisparity between the expected and actual performance ofpostretirement benefits fund assets as well as estimates of theplans. The smoothing practice points to the earlier day accountingculture before Sarbanes-Oxley helped usher in a new practice focusingon transparency and at the likely expense of predictability. A moretransparent practice will possibly emerge and will offer a faithfulrepresentation of the economic and financial realities of apostretirement plan.

Secondly,defined benefits pension plans will continue to lose ground whiledefined contribution plans increase. Most companies, includingindustry leaders and household names, have declined defined benefitplans to all fresh workers and in some cases replaced those planswith an increased employer match as well as decreased vesting period(Munnell, 2006). These plan changes are efforts to lower expenses andincrease earnings in the increasingly competitive global marketplace.

Twotypes of Changes and the Impact

Postretirementhealth care and life insurance benefits include coverage for visioncare, dental care. The retiree health plans generally provide a widescope of high quality health care services with little or noco-payments and deductibles. Significant changes happening in thehealth care realm can result to dramatic consequences not only in thefinancial accounting and reporting practices of postretirement healthcare and life insurance benefits, but also in the larger corporateAmerica (Kaplan, Powers&ampZucker, 2009). The overall health carecosts continue to skyrocket while health care costs eat more than 17percent of the GDP (Feldstein, 2011). With the snowballinguncertainty around prospective health care obligations, FASB respondby enforcing radical changes in the accounting of retiree healthcarecosts.

Fewcommentators have focused on the gargantuan underfunding ofpostretirement health benefits. The huge unfunded deficit will forcefrequent revision of postretirement health care and life insuranceplans, which is thankfully easier than the revision of pension plans.Public unions and local governments will have to strike deals on therange covered by such retiree healthcare plans. The agreements willlikely need to comprise of some cost deductions seeing that healthcare plans in most local governments can attract the 40 per cent“Cadillac” tax of the Affordable Care Act starting in 2018(Gruber, 2011).

Supportfor the Impact of the Changes

About77% of America’s local governments pay a larger amount of theirretirees’ health care premiums beginning when they retire (mostlybefore age 55) up to when they’re eligible for Medicare when theyhit 65. Most of these local administrations proceed to pay Medicarepremiums and even supplemental health insurance premiums such asMedigap for their retirees. Such postretirement health plans areoverly costly for the local governments.

Additionally,prior to 2006, there was no requirement by the GASB (GovernmentAccounting Standards Board) for local governments to publicly makeknown their Other Post-Employment Benefits (OPEBs) – compromisingnearly exclusively of healthcare benefits (Beaudoin et al, 2011).Thus, it was simple for legislators to approve lavish healthcareplans with financial impacts not being felt until decades later whenthose legislators are not in office anymore.

Dueto the skyrocketing costs of postretirement health care plans, GASBhas continuously sought to tighten OPEB rules by for instanceproposing a uniformed discount rate for computing unfunded healthcarecommitments at a level markedly lower than most local governments’rates. In order to lower long term liabilities, an amount of discountis applied considering the comparatively certain investment profitson assets’ plans, which help fund future benefit payments.Consequently, a lower rate of discount results to higher unfundedliabilities for postretirement health care and life insurancebenefits.

References

Ball,R. (2006). International Financial Reporting Standards (IFRS): prosand cons for investors. Accountingand business research,36(sup1),5-27.

Barth,M. E., Beaver, W. H., &amp Landsman, W. R. (2001). The relevance ofthe value relevance literature for financial accounting standardsetting: another view. Journalof accounting and economics,31(1),77-104.

Beaudoin,C., Chandar, N., &amp Werner, E. M. (2011). Good disclosure doesn`tcure bad accounting—or does it?: Evaluating the case for SFAS 158.Advancesin Accounting,27(1),99-110.

Edwards,J. R. (2013). AHistory of Financial Accounting (RLE Accounting)(Vol. 29). London: Routledge.

Feldstein,P. (2011). Healthcare economics.New York: Cengage Learning.

Gruber,J. (2011). TheImpacts of the Affordable Care Act: How Reasonable Are theProjections?(No.w17168).National Bureau of Economic Research.

Kaplan,R. L., Powers, N. J., &ampZucker, J. (2009). Retirees at Risk: ThePrecarious Promise of Post-Employment Health Benefits. Yalejournal of health policy, law, and ethics,9(2),09-04.

Munnell,A. H. (2006). Employer-sponsored plans: The shift from definedbenefit to defined. TheOxford handbook of pensions and retirement income,359.

Scholey,J. K. (1969). Accounting for the cost of pension plans. Journalof the Institute of Actuaries,393-443.

Zeff,S. A. (1984). Some Junctures in the Evolution of the Process ofEstablishing Accounting Principles in the USA: 1917-1972. AccountingReview,447-468.