Latest Pension Accounting Update may be HUGE…or not!

The Wikipedia definition of an “accountant” is “a professional without the charisma to become an actuary”.  You can look that up.  Well, it was there a minute ago.

Anyway, the point is that accountants rarely get the opportunity to make a public splash outside of the occasional colossal gaffe at the Academy Awards. So you can understand why the issuance of Financial Accounting Standards Board (FASB) Update No. 2017-07 was met with such little fanfare, but that doesn’t mean it isn’t potentially significant.

As foretold in a previous blog, “Pension Accounting: A Return to the Wild West”, FASB for some time has been seriously considering a proposal to change how the annual expense of a defined benefit (DB) plan is recognized on a sponsor’s income statement.

Pension Expense Today

Currently, there are four separate components that sponsors book as operating expense:

  • Service Cost: Value of benefit accruals for employees during the year (zero for frozen plans)
  • Interest Cost: Expected growth of the liability due to the loss of discounting over the next year
  • Amortization payment on accumulated gains and losses (due to interest rates, asset performance and demographic experience different from what was expected)
  • Expected return on plan assets (income offsetting other expenses)

FASB rightly recognized that only service cost, the value of pensions being earned by active employees, has the characteristics of operating expense similar to other elements of compensation. The remaining fall into net investment or re-measurement categories that are outside the scope of business operations.

And in the Future

Under the new standard, interest cost, amortizations and expected return on assets will be moved out of operating expenses. They will remain as other expenses on the income statement, but in a separate area outside of operations. (In their secret meetings, I think accountants call this “below the line”.)

DB exhibit

This change in recognition can result in a sudden increase or decrease in pension related operating expenses depending on each sponsor’s situation. Frozen plans and those that are significantly underfunded will likely see reductions.  While non-frozen, well-funded plans may actually see increases.

In addition, special “settlement charges” from paying out lump sums or purchasing annuities are also moved out of operations according to the update, which may impact decisions on offering lump sum windows. Sponsors are encouraged to contact their actuary to estimate the impact to their specific plan.

Adoption Dates

The deadline for adoption is the first fiscal year beginning after Dec. 15, 2017 for publicly traded companies, a year later for non-public plans. However, early adoption is permitted for a fiscal year as long as interim or annual statements “have not been issued or made available for issuance.”  In non-accounting speak, this means that employers with calendar fiscal years can make this change for fiscal 2017 as long as they haven’t issued a quarterly statement yet.

Varying Interest

The ability to adopt the new standard early may be a huge deal…or not…depending on the plan sponsor. Update 2017-07 does nothing to the calculation of overall pension expense.  All of the components must appear somewhere within the income statement.

The importance of the change pivots upon the perception of audiences reading the financial statements (aka “the street”) to the new disclosure. Investors and lenders are interesting folks, and there is no sure fire way to predict how they will respond to changes in the financial report.  If the operating expense of the DB plan drops from $5 million to $2 million, that could be interpreted as a positive thing even if the other $3 million is still hanging out “below the line”.

For others, particularly non-public not-for-profits, all this could be greeted with a shrug and a yawn. You know, like most accounting news.

Case by Case

Ultimately, the excitement of Update 2017-07 and the urgency to implement it will likely be determined after a meaningful conversation between the sponsor CFO and plan actuary. If you know enough about accounting that early adoption seems interesting to you, I strongly consider you schedule that meeting very soon!

While the impact of the standard will vary from case to case, moving volatile, economic entries that are beyond sponsor control out of operating expenses feels like the right move philosophically. It has the added benefit of adding greater certainty to operating expense.

Speaking of greater certainty in accounting, have you seen La La Land yet?

Mike Clark is a fellow of the Society of Actuaries (SOA) a member of the American Academy of Actuaries (AAA), which makes him kind of like a charismatic accountant.

Affiliation Disclosure

The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

Insurance products and plan administrative services are provided by Principal Life Insurance Company, a member of the Principal Financial Group® (Principal®), Des Moines, IA 50392.

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