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Q. WHAT IS COMPREHENSIVE INCOME?
A. This question comes from the controller of a company that sponsors an underfunded defined benefit pension plan.
She has heard of the new Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income. She is uncertain what this new standard has to do with her employer's underfunded plan.
In order to understand the new rules recently adopted by the Financial Accounting Standards Board, we need to first review the current rules for accounting for underfunded pension plans.
At the end of the fiscal year, the current rules require a comparison of the liability on the company's balance sheet for pensions-called the accrued pension cost-to the unfunded accumulated benefit obligation. The unfunded accumulated benefit obligation is the accumulated obligation less pension assets. The accumulated benefit obligation is the value of benefits that have been earned to date by current pension plan participants.
If the accrued pension cost is less than the unfunded accumulated benefit obligation-in other words, if the unfunded pension liabilities are more than the liability on the company's books for pensions-then the accrued pension cost must be increased to make it equal to the unfunded accumulated benefit obligation. This increased pension liability is called the additional minimum pension liability.
Current accounting rules allow the increase in accrued pension cost to be offset on the company's balance sheet by an intangible asset.
However, the amount of the intangible asset that can be placed on the balance sheet is limited. If the increase in accrued pension cost is greater than the intangible asset, the difference reduces shareholder equity in the business.
The new accounting rules change how this equity reduction is reported on financial statements. A shareholder equity reduction is still shown on the balance sheet, but it now also is included in calculating "comprehensive income."
Under Statement of Financial Accounting Standards No. 130, businesses must, in addition to net income reported, report a new comprehensive income figure. Comprehensive income is net income plus all changes to the business's shareholder equity. These changes in shareholder equity can be caused by year-to-year changes, such as foreign currency translation adjustments, or unrealized gains or losses from holding debt securities.
The year-to-year changes in the equity account attributable to the change in the additional minimum pension liability can be drastic. For example, once a pension plan has an equity adjustment due to the pension plan, market decreases during the year in pension assets serve to reduce that year's comprehensive income dollar for dollar.
So what does this new standard mean for the controller?
First, Statement of Financial Accounting Standards No. 130 has created a second and more volatile earnings measure that security analysts and shareholders must study. Companies with stable, predictable net income growth tend to be rewarded by the securities markets with higher stock prices when compared with companies that have less stable and less predictable net income. To the extent that a company has less predictable comprehensive income, the company's stock price may suffer.
Second, this new requirement also offers the controller a planning opportunity in terms of the timing of compliance.
Statement of Financial Accounting Standards No. 130 is effective for fiscal years beginning after Dec. 15, but early compliance is permitted. For a company with a calendar fiscal year, that means a choice between complying for 1997 or 1998. This might be a good year to comply.
Pension assets in many defined benefit plans have risen dramatically due to the rising stock market, and this may create income to be shown in comprehensive income. However, the timing decision needs to be made by looking not only at the pension impact on comprehensive income, but as a result of considering all items reflected in comprehensive income.
Would you like advice from an experienced colleague on a risk management, benefits management or actuarial problem? Four quarterly features in the Perspective section of Business Insurance can give you some answers.
Ask A Casualty Actuary, Ask A Benefit Actuary, Ask A Benefit Manager and Ask A Risk Manager answer written questions from readers on risk and benefits management issues and actuarial problems.
This month's column on actuarial issues in the benefits field is written by William J. Miner, an actuary with Watson Wyatt Worldwide in Chicago.
Richard E. Sherman, president of Richard E. Sherman & Associates Inc. in Ashland, Ore., answers actuarial questions in the casualty field. Christopher E. Mandel, director-risk management at PepsiCo Restaurant Services in Louisville, Ky., answers questions on risk management. Dennis J. Nirtaut, managing director of compensation and benefits for Andersen Worldwide S.C. in Chicago, answers questions on employee benefit plans.
Address your questions to ASK, Business Insurance, 740 N. Rush St., Chicago, Ill. 60611. Please give us your name, title and employer; however, Business Insurance will consider unsigned letters.