How will full adoption of statement 87 affect your liability disclosure?

How will full adoption of Statement 87 affect your liability disclosure?

Has your company fully complied with the FASB's Statement 87, on accounting for pensions? The deadline allowed by the standard's transition provisions comes this year, and two accounting experts advise that you take one more look at your minimum liability disclosure. This year's reporting process will culminate at least two years of corporate adjustment to the income statement provisions of FASB Statement 87, Employers' Accounting for Pensions. While the transition to adopt this complex standard has been difficult for some companies, continued challenges lie ahead--since the transition provisions for recognizing a minimum liability and the application of all provisions to certain plans become effective in the first quarter of 1989.

Although most of the requirements of Statement 87 were effective for fiscal years beginning after December 15, 1986 (and many companies adopted early), the statement's transition provisions permitted a minimum two-year delay in the effective date for the following reasons: * Recognition by employers of additional pension liabilities on the balance sheet in situations where pension plans are not fully funded. * Application of the statement to non-U.S. plans (i.e., foreign plans) and nonpublic companies with defined benefit plans that have no more than 100 participants. Beginning in 1989, however, the transition window closes for calendar year-end companies. As a result, all companies will be required to apply all provisions of Statement 87, regardless of the number of participants in the plan or the plan's geographical location.

Notwithstanding Statement 87's requirements to obtain annual actuarial measurements at or near year-end, the FASB has stated that, consistent with the original transition provisions of the statement, the delayed transition provisions must be applied in the first interim period in the year they become effective. Thus, for public companies with calendar year-ends, the requirements to record a minimum pension liability for underfunded plans and to apply all the provisions of Statement 87 to foreign plans become effective in the first quarter of 1989. And meeting the minimum liability requirement could be trickier for many companies than they think.

What's your minimum liability?

Because of the passage of time since the initial adoption of Statement 87, its requirement to record a minimum liability has not received much recent publicity. One reason may be that the minimum liability provisions will not affect all companies. The requirements apply only to single-employer defined benefit pension plans, so they do not affect accounting for multiemployer or defined contribution plans.

Also, the requirement to recognize a minimum liability applies only to underfunded plans, i.e., those plans where the accumulated benefit obligation--the present value of benefits earned assuming current (as opposed to projected) salary levels--exceeds the fair value of the plan's assets. In this regard, however, it is important to keep in mind that the minimum liability requirements generally must be applied on a plan-by-plan basis. As a result, a company could have an excess of plan assets over pension obligations in the aggregate, but still be required to recognize a minimum liability for individual plans that are underfunded.

If a plan has an unfunded accumulated benefit obligation as of the most recent measurement date, say December 31, 1988, calculating that amount is the first step in computing the pension liability that must be recognized on the employer's balance sheet at March 31, 1989. To determine whether an additional minimum liability must be recognized, the amount determined at December 31, 1988, is compared to any prepaid or accrued pension amount recorded on that December 31 balance sheet as a result of differences between net periodic pension cost recorded under Statement 87 and contributions to the plan.

For example, assume that the fair value of the assets of a defined benefit plan totaled $4 million and the accumulated benefit obligation totaled $6.8 million. Also assume that the sponsoring company had recorded accrued pension liabilities of $800,000. The minimum liability for the unfunded accumulated benefit obligation of $2.8 million would be compared to the amount already recorded of $800,000, and an additional liability of $2 million would be necessary. If, instead of accruing the $800,000, the company had recorded a prepaid pension asset of $200,000, the liability would be $3 million.

These are the liability amounts that would have been recorded on the December 31, 1988, balance sheet if the minimum liability requirement had been effective then. The last step in arriving at the liability to be recorded at March 31, 1989, is to add to the December 31 amount an excess of first quarter pension cost over contributions, or subtract an excess of contributions over cost.

Fortunately for those companies sponsoring an underfunded plan, the corresponding offset to recording the minimum liability creates an intangible asset rather than a charge against income. However, the amount that can be recognized as an intangible asset is limited to the sum of certain "delayed recognition" items under Statement 87, specifically the unrecognized prior service costs and any unamortized transition obligation. Any excess, net of related income tax benefits that can be recognized, would be recorded as a direct reduction of shareholders' equity. The intangible asset and separate component of equity will, in almost all cases, remain unchanged until December 31, 1989, when new obligation and asset measurements are obtained.

Because the measurement of the minimum liability is performed each year, volatility will occur. An increase in the accumulated benefit obligation (e.g., resulting from a change in the discount rate assumption) or decrease in the fair value of plan assets could trigger recognition of an additional pension liability. It is also possible for a minimum liability to appear in the balance sheet one year and not appear the next year, because of changes in the discount rate and the fair value of plan assets. Managing this liability position will require a matching of plan asset investment performance with fluctuations in the accumulated benefit obligation.

1988 disclosure considerations

Companies should not only be prepared for the impact of these transition provisions on their financial statements for 1989, but also evaluate the need for disclosures about the impact of the new requirements in their 1988 annual shareholders' report.

It is important for SEC registrants to consider Staff Accounting Bulletin 74, Disclosure of the Impact that Recently Issued Accounting Standards Will Have on the Financial Statements of the Registrant When Adopted in a Future Period. SAB 74 reflects the SEC staff's view that disclosure of impending accounting changes is necessary in order to keep the reader informed about expected impacts on financial information to be reported in the future.

The following are some items to consider in evaluating the need for and extent of disclosures: * The likelihood of a material minimum liability adjustment being required in subsequent interim financial statements--In most cases, this can be determined based upon the year-end measurement of pension obligations and assets that are included in the pension footnote disclosures required by Statement 87. * Whether the minimum liability adjustment will result in a material direct reduction of shareholders' equity--The components of the maximum amount that can be classified as an intangible asset (i.e., the unrecognized prior service cost and the unamortized transition obligation) also will generally be disclosed in the footnote required by Statement 87. * The potential impact of a minimum liability adjustment on loan covenants or other restrictive agreements based on financial ratios or tangible net worth requirements. * The anticipated financial statement impact of applying the provisions of Statement 87 to foreign plans for the first time.

Sharing with shareholders

Companies that must recognize significant additional pension liabilities should carefully weigh the financial statement impact. Even though the offsetting adjustment will not result in a charge against income, it is likely that many financial statement readers will be concerned with balance sheets that reflect significant pension liabilities, particularly if the recognition of those liabilities, in part, results in a direct reduction of shareholders' equity. As a result, affected companies will have to carefully explain the long-term nature of the amounts recorded on the balance sheet because of these requirements, as well as note that their inclusion on the balance sheet does not impact the cash flows for pensions that the company would otherwise incur.

The possibility of additional pension liabilities causing a violation of loan covenants or other restrictive contract provisions also should be evaluated. In some cases, it might be possible to modify the restrictive clauses of such agreements rather than to reduce the liability by increased funding. In any event, it is important to consider all the implications of the minimum liability requirements to determine an appropriate course of action.

The authors are partners in the national office of Ernst & Whinney. They thank colleagues Alex T. Arcady and Jan J. Meder for their assistance.