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New accounting rules may affect balance sheet

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Q: As a controller of a large, publicly traded manufacturing organization that sponsors both defined benefit pension plans and retiree medical plans, I'm seeking to understand the implications of the Financial Accounting Standards Board-issued Statement No. 158. What does the SFAS 158 mean for us?

A: On Sept. 29, 2006, the Financial Accounting Standards Board issued Statement No. 158. The goal of SFAS 158 is to address immediate concerns by financial-statement users regarding transparency and understandability of the accounting for pension and retiree medical plans. This statement makes significant changes to the financial accounting for these plans, and these changes have significant implications for the company's balance sheet.

Before SFAS 158, the funded status of an employer's defined benefit or retiree medical plan (i.e., the difference between the plan assets and obligations) was not always completely reported in the balance sheet. Employers reported an asset or liability that almost always differed from the plan's funded status because previous accounting standards allowed employers to delay recognition of certain changes in plan assets and obligations that affected the expense reported on the income statement for providing such benefits. Past standards required only that an employer disclose the complete funded status of its plans in the notes to the financial statements.

SFAS 158 has changed that by replacing the pension asset or liability on the balance sheet by the actual funded/unfunded position of the pension plans as measured by the projected benefit obligation. This measurement replaces a measurement based on the accumulated benefit obligation.

Under the previous rules, a plan sponsor was required to adjust its balance sheet to include a pension liability at least as great as the unfunded accumulated benefit obligation. This requirement was triggered only when pension assets were less than the ABO. If assets exceeded the ABO, no adjustment to the balance sheet was required.

Financial adjustments

Under SFAS 158, the unfunded projected benefit obligation must be shown on the balance sheet as a liability and the excess of pension assets over the PBO must be shown as an asset. In order to have the balance sheet reflect the plan's funded status, current pension assets and/or liabilities must be increased or decreased. If these changes result in an increase in the pension liability or a decrease in the pension asset, this change increases accumulated other comprehensive income and decreases shareholder's equity. Conversely, any increase in a pension asset or decrease in pension liability decreases AOCI and increases shareholder's equity.

These adjustments generally are made annually at the end of the fiscal year. This means that investment gains or losses on pension assets, changes in pension liabilities due to changes in the discount rate or other changes that flow through to a pension plan's funded status will result in an annual increase or decrease in shareholder equity.

In addition, the actual funded/unfunded position of retiree medical and other post-retirement benefits--as measured by the accumulated post-retirement benefit obligation--also will be placed on the balance sheet. The principles to adjust the balance sheet for a retiree medical or other post-employment benefit plan's funded status are analogous to the principles described above for pension plans.

A Watson Wyatt Worldwide study released in April 2006 found that these post-retirement benefit plan changes are expected to decrease stockholders' equity of the Fortune 1000 companies by 10%. Troubled industries, such as motor vehicle manufacturers and airlines, are expected to be hit particularly hard. But most will argue that there will be minimal impact on stock prices, citing the belief that most stock analysts already adjust the balance sheet for the funded status information currently available in the financial statement footnotes.

However, there may be other concerns for companies. Loan covenants specifying balance sheet metrics related to liabilities or shareholder equity should be reviewed to ensure this likely change to shareholder equity does not send the company inadvertently into default.

A second change is not expected to have a significant financial impact, but it may cause some headaches. Currently, plan sponsors are allowed to measure benefit obligations and assets up to three months prior to their fiscal year-end. This early measurement date has been attractive to employers because it helps ensure that these liabilities will not hold up the fiscal year-end financials. This has been of particular importance to multinational companies because of the amount of time required of headquarters staff to coordinate with multiple overseas local actuaries.

Preparation deadlines

Under SFAS 158, plan sponsors will be required to prepare pension, retiree medical and other post-employment benefit plan financial reporting information as of the last day of the fiscal year. For many organizations currently using an early measurement date, this change will shift the employee benefit accounting work to an already busy time.

SFAS 158 applies to plan sponsors that are public companies, private companies and nongovernmental not-for-profit organizations. The requirement to recognize the funded status of a benefit plan is effective with the completion of a fiscal year ending after Dec. 15, 2006, for entities with publicly traded equity securities; for all other entities, it is effective with the completion of a fiscal year ending after June 15, 2007. The requirement to measure plan assets and benefit obligations as of the date of the employer's fiscal year-end statement is effective for fiscal years ending after Dec. 15, 2008.

SFAS 158 brings to a close the first phase of a two-phase project to overhaul the accounting of pension and other post-employment benefit plans. The second phase will attempt to provide a reporting standard that will apply globally, and is expected to take several years.

This month's column on actuarial questions in the benefits field is written by William J. Miner, an actuary with Watson Wyatt Worldwide in Chicago. Mr. Miner was assisted in the preparation of this column by Christy Meehleis, a consultant in Watson Wyatt's Chicago office.