As government and a non-profit organization. The first
As early as 1636, pension plans were initially introduced by the Plymouth colony to entice people to join the military and was offered to those who became disabled as a result of defending the colony from the Native Americans. During the Revolutionary War, the offering was solidified with the first pension law. By 1789, the United States federal government passed legislation to make pension plans available to all disabled veterans, and in 1818 pension benefits were made available to all veterans, whether or not they were disabled (History of Pensions: Why Were They Started, n.
d.). Additionally, a pension plan had been established in 1759 for the benefit of widows and children of Presbyterian ministers (Employee Benefit Research Institute, 1995). Up to this point in time, pension plans had only been offered by the government and a non-profit organization.
The first private-sector plan was established by the American Express Company as an employer-sponsored retirement plan in 1875 (Employee Benefit Research Institute, 1995). “During the next century, some 400 plans were established, primarily in the railroad, banking, and public utility industries. The most significant growth has occurred since the mid-1940s, and in 1992, private pension plans numbered more than 708,000 and covered more than 45 million active participants” (Employee Benefit Research Institute, 1995). Over the years pension benefits have grown to include other postretirement benefits (OPRBs) as well as ongoing compensation for individuals after retirement. These other benefits include tuition assistance, legal services, housing subsidiaries, as well as health care and life insurance.
Just as pension plans have evolved and changed over the years, so have the tax implications, legal requirements and accounting standards. Pension plans have created two financial issues that have very different rules and calculations. Pension funding, which is related to the cash contributions made to the plan, is one of the financial issues but will not be discussed in detail in this paper. The other financial issue created by pension plans, pension accounting, is the main focus of this paper. “Pension accounting is the annual pension expense calculation and the disclosure of a pension plan’s assets and liabilities in the company’s financial statement.
The Financial Accounting Standards Board (FASB) governs pension accounting under generally accepted accounting principles (GAAP) in the United States” (Pension Committee, 2004, p. 2). Accounting for pension plans and the calculations underlying the pension obligation are complex and accounting professionals depend on FASB for guidance. Currently, pension assets and obligations are a significant cost for many companies and those costs are rising. “Pension accounting principles require pension costs to be recognized in a specific pattern to attribute the value of the benefits over a work life and require clear and consistent disclosure of pension costs, along with the plan’s assets and obligations in a company’s financial statements” (Pension Committee, 2004, p. 9).
Annual pension costs are made up of three components: service cost represents the increase in benefits due to the employee working another year; interest cost is the interest accrued for the year on the pension liability; and expected return on assets is the increase in the plan assets due to investment returns. The pension expense reported on the income statement is related to how much the pension liability increased during the year as compared to return on the plan’s assets. Since pension benefits are generally related to the years of service, pension liability increases as employees continue to work and get closer to retirement. In addition pension liability will increase if the company should change its promised benefits to an increased amount.
No matter the reason for the increase in liability, this will also cause an increase to pension expense on the income statement. Pension assets will increase with the earnings that the company realizes on its investments. These earnings will reduce pension expense reported on the income statement. Prior to the Financial Accounting Standard Board’s (FASB) most recently issued guidance, “all components of net benefit cost, including current period employee service cost, interest cost on the obligation, expected return on plan assets, and amortization of various amounts deferred from previous periods, must be aggregated and reported as a single net employee compensation cost, which was either reported within the operating section of the income statement or capitalized into assets, when appropriate” (Horn & Schmid, n.d.
). However, under the most recently issued regulations, companies that sponsor defined benefit plans have new presentation expectations.In March, 2017, FASB issued ASU No. 2017-07 on the presentation of net periodic pension and postretirement benefit cost, or net benefit cost. Effective 2018, calendar-year public companies that sponsor defined benefit plans must present net benefits costs according to the new rules.
“Service cost will be included with other employee compensation costs within operations, if such a subtotal is presented; the other components of net benefit cost will be presented separately (in one or more line items) outside of income from operations, if such a subtotal is presented; and only the service cost component will be capitalized, when applicable. In addition, if a separate line item is used to present the other components of net benefit cost, it should have an appropriate description. If a separate line item is not used, the line item in the income statement where the other components of net benefit cost are included must be disclosed” (Horn & Schmid, n.
d.). With this recent issuance it was the objection of the Board to “develop rules that are more transparent and to take steps toward improved consistency between rules applicable in the United States and those applicable elsewhere in the world” (Burrows, 2006). In addition, it was “the Boards desire to comprehensively reconsider accounting for postretirement benefits such as those described by FAS 87, single employer defined benefit pension plans, and FAS 106, postretirement benefits other than pensions” (Burrows, 2006).
The Statement of Financial Accounting Standards (SFAS) No. 106 “Employers’ Accounting for Postretirement Benefits Other than Pensions” addresses the accounting for all benefits other than pension benefits (Schroeder et al., 2017). Although this statement applies to all postretirement benefits, it focuses mainly on health care and life insurance. SFAS No. 106 would change the current practice of accounting for postretirement benefits on a pay-as-go basis by requiring accrual of the expected cost of providing the benefits to an employee.
Employers would now have to accrue this cost during the years that service is rendered by the employee (“Summary of Statement No. 106”, n.d.). The Board’s reasoning for this change is due to seeing the defined postretirement benefit as setting terms for an exchange between the employee and employer. The employer is promising to provide health and other welfare benefits after the employer retires in exchange for the current services being provided. Since OPRBs are part of an employee’s compensation and payment is deferred, these types of benefits are considered deferred compensation (“Summary of Statement No.
106″, n.d.). The change from pay-as-go basis to requiring accrual of the expected cost would improve the financial reporting for postretirement benefits in several ways. One improvement would be enhancing the relevance and representational faithfulness of the employer’s reported results of operations by recognizing the net periodic benefit cost (“Summary of Statement No.
106″, n.d.). Another improvement is to enhance the ability of users of the statements to understand the extent and effects the employers undertake to provide the postretirement benefits through disclosures. This also allows for easy comparability and understandability of amounts reported by employers who use similar plans by requiring employers to use the same method (“Summary of Statement No. 106”, n.d.
). Another change in the current guidance is that net benefit costs will no longer be reportedly in aggregate. Currently net benefit costs were reported in aggregate even though the benefits are made up of various components such as service costs and interest cost (“FASB Proposes Changes to Several Aspects of Pension Accounting”, n.d). The new ASU change would not change any of the current measurement, it would change the presentation of the net benefit costs on financial reports. Employers would be required to split out the service cost from the total benefit cost and include it with employee compensation costs.
This goes back to the opinion that OPRBs are considered part of an employee’s compensation. This would improve the transparency and usefulness of the financial information (“FASB Proposes Changes to Several Aspects of Pension Accounting”, n.d). Many changes have been made to postretirement benefits when it comes to the financial accounting and reporting. One recommendation to improve financial accounting and reporting for benefits is to provide a separate statement that provides details just related to postretirement benefits.
As stated above one change made by FASB to the reporting of benefits is to split out the service cost from the net cost to make the reports more transparent. If a separate statement is created employers can go more in detail on what makes up the net benefit costs. This will allow each component such as service costs, interest costs, and amortization to be broken out. FASB ASC 715 requires “the disclosure of plan details, including the funding policy and amounts and types of funded assets, the components of net periodic cost, and a reconciliation of the funded status of the plan with amounts reported in the statement of financial position” (Schroeder et al., 2017). This disclosure could be turned into the statement so that work doesn’t have to be completed twice.
This will be similar to the income statement, statement of cash flows, and statement of changes in equity. Another recommendation would be to use a standardized method for measuring other postretirement benefits. This would provide consistency among companies when it comes to their reporting. Users of financial statements will be able to easily compare the postretirement benefits of other companies.
Even though OPRBs are reported at estimates having a standardized method to measure them will allow companies and regulators to know these benefits are being measured the same way.