Will the new pension accounting standards--to be publicly available in August by the Governmental Accounting Standards Board-- spur a new round of debate as a result of the new accounting measures it introduces?
The guidance finalized June 25, after detailed redeliberations and public forums, are as follows:
Weight of Education. It is fair to observe that some entities may find it more difficult to understand what is going on in pension plans because the guidance requires two different sets of measures:
The buzz among industry practitioners however is that those states which have to report two numbers will be affected--though not in terms of substantial changes—but because of the added weight of education to explain them.
Still, for some states there may be some wailing and gnashing of teeth if the answers to the following questions are “no”: is our plan well funded? Are the contributions adequate?
Old Versus New. That said, the GASB’s changes are very significant. Under the current GASB standards Statements 25 and 27 the accounting measures essentially reflect the measures that are used to fund the plan.
These standards reflect the pension cost in the pension expense, that is, the actuarially determined contribution to the plan. So there’s a close connection to the way the benefit is funded and the way in which it’s accounted for—a very close connection.
Under the new Statements 67 and 68 that connection is broken. What the GASB is doing with the new standards is basically showing the full unfunded liability on the employer’s balance sheet, which under current standards is shown in the notes of the financial statements.
So the unfunded liability is currently disclosed, but it is disclosed in the required supplementary information section of the financial statements. The GASB has now moved up that number, put it on the balance sheet, and in addition wants to measure that unfunded liability in a substantially different way.
Discount Rate. To determine pension liabilities, a discount rate is used. Under the current GASB rules, the discount rate is the expected rate of return on the plan’s investments.
Under the new standards, if the future projected contributions, investment earnings and assets are not sufficient to pay all of the benefits of current employees and retirees over their lifetimes, then a portion of the discount rate will need to include a municipal bond rate—done through a fairly involved calculation.
The point here: under the new GASB standards, the discount rate used to discount liabilities will reflect the expected rate of return on its investments and possibly a portion of will reflect municipal bond yields, which in this environment will lower the discount rate and as a result increase in the liability. So the measure of the liability shown on the balance sheet will likely be higher than the measure of the liability that’s currently used for funding purposes.
Pension Expense Larger. With regard to pension expense, rather than using the actuarially determined contributions to the plan as is currently done, the new measure of pension expense will amortize portions the unfunded liability over a shorter period than is used in the current measure of the employer’s required contribution.
So the pension expense number will likely be larger because portions of it are being amortized over shorter periods than is done currently. That measure of pension expense goes on the employer’s income statement. There are also additional disclosures in the notes to the financial statements and in the required supplementary information. So it’s a big change.
Good News. Overall, the good news is, though the accounting statements change the way those benefits are measured, they do not change the ultimate benefits that get paid. Furthermore, for pension benefits promised to employees, the multiplication formula that is used to determine the employees benefit--typically something like 2% x year-to-service x final average salary—does not change.
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