Accounting for benefits the global way.
Early in 1998, the International Accounting Standards Committee is expected to issue an international accounting standard (IAS) on employee benefits that will mean major changes in recognizing and measuring employee benefit costs and obligations for the companies affected by the standard. Even though U.S. firms do not report under international accounting standards, you should understand the IAS to compare your firm to the many multinational competitors that follow these rules. You also should monitor any implications on the future direction of U.S. accounting standards, since some experts warn that companies will face changes in U.S. accounting requirements under FASB Statements 87, 88, 106 and 112 on pension, postretirement and postemployment benefits - to conform to international standards.
The new IAS rules have many similarities to the rules under Statements 87, 88 and 106, yet are different in certain respects. The IASC has gone beyond the FASB, moving toward faster or immediate recognition of certain actuarial gains and losses and plan amendments something once proposed by the FASB but not adopted in its "evolution" of benefits accounting standards. So, recognizing the growing importance of international accounting, we conducted a study, completed in June of 1997, to assess the impact of these proposed rules, using actual data from eight large international companies.
WHERE IT HURTS
Under the principles set forth in the new IAS, the financial statements of companies sponsoring defined benefit pension and postretirement benefit plans face the following:
Major changes in annual expense For six of the eight study companies, expense on average during the study period (1993 to 1996) was 23 percent to 178 percent higher than under Statements 87, 88 and 106, while the other two companies reported reduced expense of 84 percent and 227 percent. In general, amortization of unrecognized amounts that would typically reduce expense or generate income under Statements 87, 88 and 106 (for example, transition assets, other actuarial gains and negative plan amendments in the postretirement plans) were reflected as part of the cumulative catch-up adjustment required to be recorded upon initial application of the new standard. As a result, reductions to expense that normally would be reflected in future operating earnings under existing rules will instead be recharacterized "below the line" as a cumulative effect of adopting the new standard.
More year-to-year expense volatility - Annual changes in pension or postretirement benefit expense may be significantly greater under the new IAS, due to the proposed requirement that actuarial gains and losses outside of a 10-percent corridor and the effects of plan amendments for former employees be immediately recognized. Also, there would be no option to use a market-related value of the plan assets. In limited cases, however, the new IAS may also produce smaller year-to-year expense changes than current accounting when actuarial gains and losses stay within the 10-percent corridor or when companies anticipate future benefit increases in measuring the benefit obligation.
A significant catch-up adjustment at transition - For the eight companies in the study, the average change in net income and stockholders' equity due to the one-time catch-up adjustment in the assumed year of adopting the new accounting principle (1993) was 24.8 percent and 2.5 percent, respectively.
Widely differing impact on net income - For five of the eight study companies, their net income under the IAS changed by more than 10 percent in at least one year. However, under certain conditions, the new rules can produce even larger changes in net income that generally do not occur under Statements 87 and 106. For example, in certain years for several study participants, modeling under one set of alternate interest rates and asset returns resulted in an annual change in pension and postretirement benefit expense in excess of 500 percent and a change in net income in excess of 50 percent over the results under Statements 87 and 106.
Fourth-quarter expense adjustment The IASC would require a company to remeasure its defined-benefit obligations and plan assets at the end of the fiscal year, with the resulting actuarial gains and losses reflected in the current year's expense. As a result, if gains or losses fall outside the 10-percent corridor, the adjustment to the current year's expense may be substantial, making the accurate budgeting of pension and postretirement benefit expense virtually impossible and causing significant fourth-quarter earnings adjustments. Under Statements 87 and 106, gains and losses from year-end measurements are not reflected in expense until the subsequent year.
WHAT DRIVES THE NUMBERS
Some key factors that will affect benefit obligations and expense under the new standard include:
* The funded status of your plan especially at the transition date and the extent of overfunding or underfunding.
* The extent and direction (gain or loss) of unrecognized amounts under current accounting that would be included in the cumulative catch-up adjustment at transition.
* The extent of actuarial gains or losses subsequent to transition and whether such gains or losses are outside the 10-percent gain/loss corridor.
* The nature, extent, timing and direction (positive or negative) of plan amendments subsequent to transition and the population affected (active employees or retirees) - in conjunction with the extent to which you anticipate future benefit increases when measuring the benefit obligation and expense.
* The assumptions you use to measure the obligation and expense, and the company's practice of moving other economic assumptions in tandem with annual changes in the discount rate.
Obviously, the new international accounting rules - and possible conforming changes to U.S. rules could affect your financial management. For instance, many companies have deferred actuarial gains that, absent a cumulative catch-up adjustment to adopt a new standard, would flow through operating income. To avoid losing operating income, these firms should assess the ways they could accelerate the recognition of gains deferred under current accounting or consider assumption changes that would reduce the potential for additional gains over the next few years.
The new rules may also change the timing of actuarial valuations and require you to assemble data more quickly, particularly for non-U.S. and multiemployer plans.
Finally, because accounting considerations often affect plan design decisions, the new rules may cause some companies to take a closer look at the benefits they offer and may [TABULAR DATA OMITTED] specifically affect the timing of plan changes and the extent of amendments for employees.
We expect the standard to be approved as it now reads at the IASC's November 1997 meeting. However, because this article is based on our understanding of the standard as Financial Executive goes to press, readers should monitor whether any final changes are made. If approved, the new rules are expected to be effective in 1999.
Copies of the study are available by contacting Murray Akresh via telephone at (212) 259-2362, via fax at (212) 259-5700 or via e-mail at Murray.Akresh@us.coopers.com.
Mr. Murray S. Akresh, Ms. Barbara S. Bald and Mr. Lawrence J. Sher are with Coopers & Lybrand L.L.P., the Kwasha Lipton Group/Human Resource Advisory. Akresh and Bald are based in New York City, N.Y., and can be reached at (212) 259-1000.
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|Author:||Sher, Lawrence J.|
|Date:||Nov 1, 1997|
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