Blogging Employee Benefits

June 28, 2006

Count on the PBO Basis

Filed under: Accounting, Pensions — Fuguerre @ 2:02 pm

When the Financial Accounting Standards Board issues a final statement this September for part 1 of its comprehensive project on employers’ accounting for pensions and other postemployment benefits, count on the balance sheet reporting for defined benefit pension plans to be based on the projected benefit obligation.

The PBO basis was the most hotly debated issue at yesterday’s FASB Roundtable Meeting on Pensions and Postretirement Benefits. For a pension plan with a salary-based benefit formula, the PBO takes future projected salaries into account for measuring the obligation for benefits attributable to service to date. Under phase 1 of the project, a plan sponsor’s balance sheet would be required to reflect the funded status of a pension plan, determined on the basis of the PBO and the market value of plan assets.

FASB acknowledges that the project’s second phase, probably to be deliberated in 2007 through 2008, will include reconsideration of whether or not the PBO is the appropriate measure of an employer’s obligation under a pension plan. Still, unrecognized amounts currently being disclosed for pensions on employers’ financial statement footnotes arise under the FAS 87 cost methodology, which would also not be reconsidered until the project’s second phase, and that cost methodology is geared to the PBO.

If FASB has not already made up its mind on the issue, it certainly at least appeared to be taking sides during the roundtable discussion. Those who supported use of the PBO – including the SEC and credit-rating agencies – were accepted rather casually, permitted an anything-is-an-improvement attitude without being pressed for justification. Those who objected to the PBO basis – mainly some employers and actuaries – were soundly challenged and criticized on all sides of the question, from consistency with FASB’s conceptual framework to proper representation of the underlying contract. Perhaps the direction of the discourse was only natural: the weight may be on opponents of the PBO basis to make the case against FASB’s own proposal. If so, they didn’t do so yesterday.

None of the sides to this debate – whether pro-PBO or anti-PBO – has focused any attention yet on the fact that the PBO basis is not actually the source of most of the pension-related reduction to shareholder equity that would come about under this first phase of FASB’s project. Rather, most of the change will arise solely because of the elimination of an artificial threshold that exists under the current ABO-based rule. Under FAS 87, if a pension plan has an underfunded accumulated benefit obligation, then a potential reduction in shareholder equity must be recognized, with that potential reduction first reversing out any prepaid pension costs being carried as an asset on the employer’s balance sheet. Eliminate the underfunded ABO – which is exactly what many employers have done via accelerated employer contributions during the past several years – and the shareholder equity charge disappears, but under the current rules the prepaid pension cost remains as a balance sheet asset. Under the proposed new rule, there would be no such artificial threshold: eliminate an underfunded ABO, and there would still be a charge to shareholder equity to reverse out any prepaid pension cost, if such an adjustment were required in order to reflect the plan’s funded status. For S&P 500 pension plan sponsors, elimination of that artificial threshold accounts for about two thirds of the estimated $175 billion additional post-tax charge to shareholder equity that will arise under the new FASB rule as of the close of fiscal year 2005. In other words, if FASB were to compromise by not stretching to the PBO basis for balance sheet reporting under phase 1, yet were to give the anything-is-an-improvement school its due by eliminating the threshold, the move would still reduce shareholder equity of S&P 500 pension plan sponsors by some $115 billion after-tax, more than two thirds of the way toward full reflection of the currently unrecognized amounts. But don’t expect that to happen. FASB is not likely to see any reason to retreat from taking it the entire way through.

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