FASB Issues Final Statement on Accounting Reform for Postretirement Benefits

On September 29, 2006, the Financial Accounting Standards Board (FASB) released Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. The two biggest changes for sponsors are the requirements to: (1) put the net financial status of their pensions and other retirement benefits on the balance sheet, and (2) measure assets and liabilities as of the end of the fiscal year. The changes are intended to make reported financial information more complete, useful and transparent.

For public organizations with a calendar fiscal year, the balance sheet changes take effect December 31, 2006, and the elimination of early measurement dates takes effect December 31, 2008. However, the FASB encourages sponsors to adopt the measurement date change earlier.

The final statement builds on the Exposure Draft released March 31, 2006. It clarifies many of the questions raised by various stakeholders during the last few months and is consistent with decisions made by the board during the re-deliberation process. This release finalizes phase one of the accounting reforms for postretirement benefit plans and amends FASB Statements No. 87, 88, 106 and 132(R).

A summary of the key accounting changes follows.

Recognition of Funded Status

Under the new rules, sponsors must:

• Recognize the financial status — overfunded or underfunded — of postretirement benefit plans on the balance sheet, as measured by the difference between the plan’s projected benefit obligation or accumulated postretirement benefit obligation and the fair value of assets.
• Aggregate the funded status of all overfunded plans and recognize the total as an asset on the balance sheet. Aggregate the funded status of all underfunded plans and recognize the total as a liability on the balance sheet.

The FASB made no changes to the rules for determining net periodic postretirement benefit cost, so SFAS 158 won’t affect the income statement. However, the new rules will affect the comprehensive income statement.

The comprehensive income statement measures the changes in net equity over a period and includes items that may not directly relate to company operations that belong in the income statement. The difference between comprehensive income and net income is generally referred to as other comprehensive income (OCI).

Under SFAS 158, net gains/losses, net prior service costs/credits and net transition obligations/assets for postretirement benefits will be recognized as components of OCI in the year they are recognized. These amounts will reside in the company’s accumulated other comprehensive income (AOCI) account. Sponsors will generally adjust this account annually to reflect changes in OCI, such as additional gains or losses, and amortization of these amounts when they are included in net periodic benefit cost.

The AOCI account will generally be adjusted for deferred taxes. If the adjustment is a deferred tax asset, the sponsor must assess the likelihood of realizing the deferred tax asset and make any necessary adjustments as required under SFAS No. 109, Accounting for Income Taxes.

If a postretirement benefit plan must recognize an additional liability on its balance sheet under SFAS 158, this will generally decrease the AOCI account (because it will be negative OCI), which will also cause an equivalent decrease in shareholders’ equity (see Watson Wyatt Insider, February 2006 and December 2005,for projections of the effect of SFAS 158 on shareholders’ equity).

The FASB eliminated the Additional Minimum Liability and Intangible Asset items and concepts from FAS 87.

Elimination of Early Measurement Dates

Sponsors must generally measure plan assets and obligations as of the organization’s financial reporting date (the last day of the fiscal year).

There are two exceptions:

• A plan sponsored by a subsidiary that uses a different fiscal period than its parent may measure plan assets as of the subsidiary’s financial reporting date.
• A plan sponsored by an investee that is accounted for using the equity method of accounting under APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, may follow the Opinion 18 rules.

Additional Disclosure Requirements

Under the new rules, sponsors must disclose:

• The amount of net actuarial gain/loss, prior service cost/credit and net transition obligation/asset in AOCI. These amounts must appear in the footnote on a pretax basis.
• The net actuarial gain/loss, prior service cost/credit and net transition obligation/asset recognized in OCI, separated into amounts initially recognized during the current year, and amounts subsequently adjusted as they are recognized as components of net periodic benefit cost during the current year. (These amounts reconcile changes during the fiscal year.) These amounts must appear in the footnote on a pretax basis.
• The estimated portion of the net actuarial gain/loss, the prior service cost/credit and the net transition asset/obligation recognized in AOCI that the organization expects to recognize as an amortization component of net periodic benefit cost during the upcoming fiscal year.
• An asset in an overfunded plan is noncurrent.
• The liability for an underfunded plan is noncurrent, unless the fair value of assets is less than the present value of benefits expected to be paid over the next 12 months. In this case, the current portion of the liability is the amount of that excess.
• The amount and timing of any plan assets expected to be returned to the organization during the upcoming fiscal year
• Changes to individual line items on the balance sheet in the fiscal year of adoption, including assets, liabilities, deferred tax assets, AOCI and shareholders’ equity. This information must be presented in a tabular format on a tax-adjusted basis.
• The change in retained earnings and AOCI attributable to a change in measurement date in the year of adoption
• An organization that presents a “classified” statement of financial position must identify the current and noncurrent portions of net assets and net liabilities. This must be done on a plan-by-plan basis and then aggregated separately for overfunded plans and underfunded plans.
  
  • An asset in an overfunded plan is noncurrent.
  • The liability for an underfunded plan is noncurrent, unless the fair value of assets is less than the present value of benefits expected to be paid over the next 12 months. In this case, the current portion of the liability is the amount of that excess.

In financial statements for fiscal years ending after December 15, 2006, but before implementation, nonpublic entities must disclose a description of the new standard, the date adoption is required and the planned adoption date. Under Staff Accounting Bulletin 74, public companies also must make similar disclosures in interim financial statements preceding the implementation of the standard.

Eliminated Disclosure Requirements

The final statement eliminates the following disclosures:

• The reconciliation of funded status
• The current requirements concerning additional minimum liability and intangible assets
• The measurement date (after the early measurement date has been eliminated)

Nonprofit Organizations

The accounting changes apply equally to nonprofit organizations that provide financial statements in accordance with FASB Statement 117, Financial Statements of Not-for-Profit Organizations. While nonprofits have different reporting requirements, presentations and terminology, the FASB adopted analogous changes for both public companies and nonprofit organizations.

Effective Dates

The balance sheet changes and the new measurement dates have different effective dates, which also vary for public and nonpublic entities. For purposes of this statement, a public entity is one that has equity securities trading in a public market.

Public entities must comply with the balance sheet changes for fiscal years ending after December 15, 2006. For nonpublic entities, the new rules take effect for the first fiscal year ending after June 15, 2007.

The measurement date change takes effect for both public and nonpublic entities for fiscal years ending after December 15, 2008. Earlier adoption is encouraged, but any FAS 88 events that occur between the measurement date and the end of the previous fiscal year must be recognized in earnings for its associated period.

Transition

Sponsors must implement the balance sheet and the measurement date changes prospectively as of their first effective reporting date. They need not restate any financial statements for prior years on account of these changes.

There are two ways to transition to a new measurement date, as shown below. In these scenarios, the organization uses a September 30 measurement date and its fiscal year ends on December 31.

1. The remeasurement method. Using this method, the sponsor calculates its 2007 disclosure using a measurement date of September 30, 2007, for the firm’s 2007 financial statements. A remeasurement is required as of December 31, 2007, using the assumptions, assets and obligations appropriate as of that date. The net periodic benefit cost for the fourth quarter of 2007 (net of any deferred tax adjustment) is a one-time adjustment to retained earnings.
   
   The amortization portion of the net items for this three-month period must be adjusted out of AOCI, and the gains and losses associated with the new assumptions, new assets and (perhaps) new census data (net of any deferred tax adjustment) must be recognized in AOCI. Then the fiscal 2008 net periodic benefit cost is calculated for the measurement period January 1, 2008, to December 31, 2008. Finally, 2008 disclosure is calculated using a December 31, 2008, measurement date. Note that any curtailment or settlement credits/charges during the fourth quarter of 2007 must be recognized in earnings for that same quarter.
   
   
   
2. The alternative method. Under this method, the sponsor calculates net periodic benefit cost for the 15-month period September 30, 2007, to December 31, 2008, based on the October 1, 2007, reconciliation of funded status. Three-fifteenths of this expense, net of tax, is the one-time adjustment to retained earnings. Twelve-fifteenths of this expense is the plan’s annual 2008 fiscal-year expense reflected in the income statement.
   
   The amortization portion of the net items for this 15-month period must be adjusted out of AOCI. The sponsor performs a single remeasurement as of December 31, 2008, which determines the disclosure information as of that date. Gains and losses resulting from the remeasurement (associated with assumption changes, asset performance and perhaps new census data) are reflected in the plan’s net gains/losses and, therefore, are reflected in AOCI (net of any deferred tax adjustments) at fiscal year-end. Any curtailment or settlement credits/charges during the fourth quarter of 2007 must be recognized in earnings for that same quarter.

What’s Next for Accounting Reform

At its October 4 meeting, the FASB rejected proposals to require employers to include five-year forecasts of either their minimum required or estimated pension contributions in their footnotes.

The FASB has not yet scheduled any meetings to discuss the second phase of its accounting reform, which will enact further changes to the accounting rules for pensions and other retiree benefits. The final reforms will have broad implications for companies, investors and participants in defined benefit plans. Meanwhile, the International Accounting Standards Board (IASB) has announced its own two-phase pension project. The first phase, which is expected to take four years, will examine accounting for cash balance plans, appropriate smoothing mechanisms and settlements and curtailments.

The FASB will begin phase two of the accounting reforms by addressing issues not being considered by the IASB. After the IASB completes the first phase of its reforms, the FASB will coordinate its projects with the international board. So it may be several years before the second phase of the FASB’s reforms is complete.

Other FASB projects likely to affect phase two of postretirement benefit accounting reform include the conceptual framework project, financial statement presentation and fair value measurement. The FASB may want to complete or at least make progress on these projects before beginning on phase two.