Of Black Holes and Smoothing: Pension Accounting Baggage Goes Over the Limit?

It is probably not a good sign about the shape that pension accounting is in when two standard setters mention the terms “black hole” and “smoothing” within 30 seconds of each other during a meeting.

Members of the Financial Accounting Standards Board did just that Nov. 2. [see below for details.]

The use of baggage-laden accountingese-meets-astronomy-and-rock-tumbling occurred about an hour before the panel voted to advance some final rules.

The planned accounting standards update, expected in the first quarter of 2017, promises substantial improvements in employers’ reporting on certain costs when providing defined pension and other postemployment benefits to their employees, six of seven FASB members have concluded.

The talk about smoothing led this writer to explore: 1) how FASB, in considering taking on a major project on pensions and “OPEBs,” would be poised – maybe – to consider eliminating the time-honored option of being able to defer, or smooth out, gains and losses sustained by benefit plans – if it decides to tackle rulemaking on that general topic of pensions, etc.; and 2) the views of writers of comment letters responding to the board’s “invitation to comment” on what FASB’s next big-topic agenda should be.

Could it be that there is now a critical mass of support for getting rid of the controversial smoothing of pension/OPEBs gains and losses? It is interesting that Deloitte & Touche and KPMG, in their comment letters to FASB’s “agenda consultation,” state their support – very directly -- for having smoothing go the way of the dodo.

Such a course that FASB laid out as one possible path (“Alternative B”) in a pensions and other postretirement benefits project “would improve the utility of financial information provided to users and be operable,” according to Deloitte.

Ernst & Young LLP, to name another Big Four firm, spoke more positively about an alternative to getting rid of smoothing dubbed “Alternative A” by FASB. That would basically align U.S. generally accepted accounting principles with international financial reporting standards (IAS 19, Employee Benefits) by having actuarial gains and losses recorded in “other comprehensive income.”

OCI has become a holding pond for various items on income-like stuff that companies would rather not see go into net income.

KPMG also would support the IFRS-aligned route, particularly if that Alternative A is more compatible with FASB’s effort on performance reporting, “including work on whether OCI is intended to be a performance measure,” according to the firm’s Oct. 21 letter.

Who Might Decide What: The Scene in ’17.

To cut to the chase here, it may be that other standards revamps besides or along with pensions/OPEBS would be chosen in 2017 for new rounds of important, years-long standard-setting. Some of these could be difficult slogs, prospects of which FASB members clearly are aware and don’t relish. (e.g., play back board members’ comments in a Nov. 4 meeting with FASB’s Academic Resource Group, when they spoke about a conference set for June at which liabilities/equity accounting will be explored by weighing 45 – count ‘em, 45 – different scenarios of financial instrument transactions. Just for fun. One Nov. 4 meeting participant held up a figurative index-finger-and-thumb gun to his temple to signify what’s in store for the June gathering.)

And there is the dynamic of impending changes of FASB’s membership. Daryl Buck leaves the board on New Year’s Eve. His colleague Larry Smith is set to step down June 30 because of term limits.

Who will be deciding what topics should be tackled will be seen in early ’17.

The other likely-candidate subjects for hammering out improved accounting rules would be:

  • distinguishing financial instruments that have traits of liabilities and equity, one of the peskiest topics that FASB has had on both on front and back burners; and

  • reworking various parts of the collective financial statements, including the income and cash flows statements, plus dealing with comprehensive income – all to better present information for investors on enterprises’ performance and activities.

Back to the Nov. 2 Discussions.

The Nov. 2 discussion marked by FASB Chairman Russell Golden speaking about “the black hole,” as he sought to sort out a point made by board Vice Chairman Jim Kroeker, was followed by colleague Marc Siegel spotlighting a “smoothing mechanism.”

The dialogue went like this:

Kroeker: “So today, a change in actuarial assumption associated with life expectancy goes into the corridor.* So do asset changes, and so do discount rate changes.  They all get put in a lump.”

[* According to Investopedia, “the corridor rule is a materiality rule that requires disclosure of a pension actuarial gain or loss, if the gain or loss exceeds 10% of the greater of the pension benefit obligation (PBO) or the fair value of plan assets.”]

Golden: “Alright.”

Kroeker: “So if you amortize them later--”

Golden: “I got it. I got it. I got it. So, in other words, the black hole, if you will, is not solely--.”

Siegel: “So that conversation highlights just why this project is so important. If we have to remember, going around the table, how the smoothing mechanism actually works, and the fact that some people do the smoothing mechanism; some people don’t. Some people, when they do the smoothing mechanism, change the amortization period over which times they smoothed, depending on whether they were in a gain position or a loss position. I’ve seen that happen. They amortize gains quickly. They amortize losses slowly.”

Seigel repeated his stated view on the importance of FASB’s effort on splitting out and spotlighting net periodic costs stemming from defined pension benefits and defined retiree health care.  He pointed to big support for the reporting changes among investors and other users of financial statements.

“I’ve never seen user outreach yield an over 90 acceptance ratio to a proposal in the eight years that I’ve been here,” said Siegel, a former equity analyst and specialist in forensic accounting.

He also said that big companies such as IBM, FedEx, Xerox and Bristol-Myers Squibb have given positive readings about the planned rules on presenting periodic costs.

Gospel According to Kohler’s.

Kohler’s Dictionary for Accountants (Sixth Edition) defines smoothing as “any treatment designed to remove irregularities in data, such as unusual peaks or valleys in a curve, that may be the result of nonrecurring operating conditions.”

It seems, however, that smoothing, as it’s been used in pensions accounting, reflects conditions that are not atypical and repeat, and repeat again, over the years. 

Continue the discussion on pension accounting at  Bloomberg BNA Accounting LinkedIn.