Update on pension accounting

In June, 2011, the International Accounting Standards Board (IASB) finalized new rules for pension accounting internationally (IAS 19). We provided, at that time, an article reviewing the new IASB rules in detail.

Since IASB’s action, the question of whether the US Financial Accounting Standards Board (FASB) would adopt new pension accounting rules, perhaps modeled on the IASB standard, has been raised by a number of persons.

In this article we briefly review the issues that have been raised with respect to current pension accounting, the new IASB standard and recent discussions of its impact on US accounting.

Current pension accounting

For the basic issues of US pension accounting, see our article Accounting for pensions: very much under construction. Current criticism of US pension accounting focuses on income statement treatment. FAS 158, adopted in 2006, is generally thought to have resolved issues with respect to balance sheet treatment.

Under current FASB (and old IASB) rules, generally, companies report with respect to a sponsored defined benefit plan: (1) service cost; (2) an interest charge on the plan’s projected benefit obligation (PBO); (3) a charge for amortization of unrecognized prior service cost; (4) a credit/charge for experience gains and losses.

Under these (FAS 87) rules, there is a lot of “buffering” of period to period results with respect to these income statement numbers:

First, the value of plan assets may be smoothed for a period of up to five years. An expected rate of return on this smoothed amount is then credited to the income statement. The expected rate of return is based on the makeup of the plan’s asset portfolio.

Second, gains and losses are netted, and net gains/losses are only recognized to the extent they exceed 10 percent of the higher of the (smoothed) value of plan assets or the plan’s PBO. If gains/losses do exceed this 10 percent “non-recognition corridor,” that excess is not charged to the current year but is amortized in future years over the “average remaining service of active plan participants.”

Third, the recognition of past service benefits (resulting, e.g., from a plan amendment) is also delayed.

Criticism of current rules

The accounting community and the “users of financial statements” (e.g., investors and analysts) have been critical of current FASB accounting treatment of DB plans. Summarizing: they believe that current rules to some extent (in the buffering provisions described above) obscure plan “performance” and make it harder than necessary for users to understand the plan’s effect on the company.

One particular feature of current FASB accounting has been singled out for special criticism — the rule that allows companies to book as income the “expected long term rate of return” on plan assets. Critics have argued that this rule encourages companies to take on more asset risk in order to improve the “expected” return, while buffering rules in many cases allow them to ignore actual poor performance.

New IAS pension accounting rules

Generally: the new IASB rule requires companies to book: (1) the plan’s current service cost (normal cost) to profit and loss; (2) a fixed rate of return (generally, the plan’s discount rate) on the net of plan assets and liabilities to profit and loss; and (3) actual (i.e., mark-to-market) returns along with actuarial gains and losses to “other comprehensive income” (OCI).

The IASB approach avoids marking plan performance to market in operating income (mark-to-market numbers are provided in OCI). And, critically, it replaces the “expected return on plan assets” concept with the plan’s discount rate.

FASB’s current position

Many have commented on recent remarks by FASB Chairman Leslie F. Seidman in a March 12, 2012 webcast “2012 Chairman’s Outlook on the FASB.” With respect to pension accounting, here is what Chairman Seidman said:

Do you believe the FASB will take on a pension project in order to try to converge with recent changes that the FASB has made to IAS 19?

… I would say that when people tell us about matters that they think the FASB should be addressing pensions tends to be at top of list. There are some concerns that have been raised about the current reporting under US GAAP for pensions and generally the concerns that people raise have to do with the use of the expected rate of return to do the discounting and also the lumping together of the elements of expense in the income statement. One possible path forward for us might be to take the IASB standard on pensions and issue that as an invitation to comment in the US to see if people think that that would be an improvement.

In terms of the timing of making that decision we are planning to discuss our agenda priorities with our charter advisory council FASAC at our meeting later this month. Pensions will definitely be among the topics that we’ll be asking for input on, and we’re going to be asking FASAC for advice about how to prioritize the various issues that people have been raising that they’d like us to take a look at.

FASAC is the Financial Accounting Standards Advisory Council. At the March 23, 2012 FASAC meeting (mentioned by Chairman Seidman), FASAC members ranked pension accounting as a low priority. Thus it seems that some regard pension accounting as a priority issue, but FASB’s advisory council does not.

FASB has put pension accounting, and “convergence” of US pension accounting rules with IASB rules, on a fast track in the past, only to decide later to take the issue off the fast track. The issue of pension accounting is fraught with controversy. It is probably fair to say that most in the securities analyst community would like to see a movement towards mark-to-market pension accounting and that most companies sponsoring DB plans would not.

SEC’s project on convergence

“Convergence” can be described as making US GAAP and international financial reporting standards fully compatible on a standard-by-standard basis. Obviously there are broad and significant accounting issues in convergence, and convergence of pension accounting is not the only priority.

The Securities and Exchange Commission has had a project on the convergence of US and international accounting rules for some time. At one point the explicit goal of that project was to require use of International Financial Reporting Standards (“IFRS”) as issued by the IASB by U.S. issuers for purposes of SEC filings by 2014. Based on remarks by Paul Beswick (SEC Deputy Chief Accountant) at the March 23, 2012 FASAC meeting, SEC thinking on convergence has become less certain. A public report (and non-public recommendations) by SEC staff with respect to convergence are expected to be released later this year.

It would appear, from the following remarks by Hans Hoogervorst, Chairman of the IASB, that the international community is anticipating some positive SEC action on the issue of convergence:

Wherever I go in the world I am asked one question more than any other. Will the US come on board with IFRSs, and if so, when and how?

I have no privileged insight regarding the SEC’s internal decision-making. However, the pace of events does appear to be picking up.

The SEC has repeatedly said that it intends to make a determination this year regarding the possible incorporation of IFRSs.


There appears to be some elevation of concern about the issue of US pension accounting. But it also appears that the SEC is more likely (than FASB) to drive this issue, as part of the larger convergence project.

We will continue to follow this issue as it develops.