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Not Your Daddy’s Pension Cost

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* * * aftermath exclusive * * *

Here’s another graph you won’t see anywhere else. There’s no lack of chatter about what this chart points at; but as far as I know, nobody else has run the figures.

For fiscal years 2003 through 2007, we’re showing the net periodic pension cost (red triangles) for S&P 500 companies that sponsor defined benefit pension plans, as determined under GAAP as prescribed by SFAS 87. In constrast, we then show what the “immediate” pension cost (orange circles) would have been for those same companies.

SFAS 87 prescribes a matching methodology that essentially spreads pension costs over employees’ periods of service. The result is relatively smooth, producing gentle waves above and below the long-term average pension cost. The SFAS 87 methodology and its results have been very poorly understood and quite widely criticized in recent years, such criticism in part leading to a current major FASB project that will reconsider pension cost methodology in the context of a broader GAAP overhaul of corporate income reporting.

Many of the critics who least understand pension accounting seem to think SFAS 87’s cost smoothing techniques to be illogical and misleading. OK then, here’s what their S&P 500 would have been reporting as pension cost during the past 5 years. The two most recent years being the most intriguing of that period: during 2006, the S&P 500 companies would have reported more than $100 billion of additional corporate income for the year, then would have followed that party up by reporting about $90 billion of additonal corporate income for 2007. Pray tell, how might those WSJ critics have screamed if corporate executive bonuses those two years would have reaped the benefits of that windfall, particularly since those amounts don’t technically flow into the corporate coffers the way actual income does?

Under SFAS 87, we can virtually guarantee that 2008 pension cost will continue to drop from the 2007 levels, at about the same pace as the decline from the 2006 peak. If SFAS 87 deferral and smoothing techniques were to be elimated, however, we’d not be able to accurately predict 2008 pension cost levels until final discount rates and market values are known in the future, at the close of the year; but so far, preliminary calculations would bring the “immediate” cost back up above the SFAS 87 cost, similar to case in 2004 and 2005.

All of these calculations of course treating everything else as remaining intact. Which in reality would quite likely not be the case. Reporting a long-term arrangement where gains and losses do not actually flow directly to the company’s own income with the same extreme volatilty as if the pension plan were simply any normal investment of the firm? CFOs would have about as little taste (as in, zero) for that as they’d have for building a nuclear power plant if not permitted to capitalize the costs but rather had to recognize all costs up front without matching up those costs against the future income produced by the plant. In other words, give us GAAP that would produce a chart like we’ve produced here, and you can expect to see significantly more pension plan terminations. And for the few that do hang on to their pension plans, watch for the development of internal accounting methodologies very very reminiscent of SFAS 87 to reflect pension plan experience in a corporate income figure adjusted for purposes such as executive bonuses and other such realities. After all, SFAS 87 is not nearly as illogical as some would have us believe.

(Remember, as I’ve previously observed, posts such as this represent efforts of my favorite pastime. My formal work does not involve any of this, and none of it represents any position or comment that should in any way be attributed to my employer. Likewise, as always, it represents general personal impressions and should not be treated or used as formal professional advice.)

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Written by macheide

29 August 2008 at 8:20 pm

Posted in άctuary

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