FASB may tighten rule for pension fund accounting

The Financial Accounting Standards Board is considering revamping how companies report pension fund gains and losses to give investors a clearer earnings picture.

The board’s review comes at a time of heightened scrutiny of corporate accounting practices, following the collapse of Enron Corp., and tighter policing by securities regulators.

It also comes at a time when the downdraft in the stock market for two consecutive years has shrunk pension surpluses at many of the nation’s largest corporations, highlighting the desperate moves by some companies to preserve their pension assets.

As part of a new project on the manner in which companies report performance, the Norwalk, Conn.-based rule-making body is thinking about barring companies from including pension-fund investment gains in their earnings. The project is expected to take at least three years.

Corporations might be overestimating their earnings by as much as $50 billion a year because of the way they disclose pension liabilities, according to an analysis by Robert D. Arnott, managing partner at First Quadrant LP in Pasadena, Calif.

“It’s conceivable [that the board] might disaggregate the pension numbers” and let companies include only the cost of pension benefits earned in the current year as an operating expense, says Timothy S. Lucas, the standards board’s director of research and technical activities.

Some investment and accounting experts have been suggesting just that for years.

Under the current accounting rule, Financial Accounting Standard 87, companies are allowed to include assumed returns on pension fund investments and the interest expense on the deferred benefits as elements of pension cost – or pension income.

Investment experts believe that the inclusion of the assumed returns and interest expense distort the true cost to corporations of providing pension benefits, and lets them turn a cost center into a profit center by artificially reducing their pension liabilities and increasing their net incomes.

The standards board’s project on financial performance measures has borne out that concern in preliminary research.

Securities analysts and institutional investors have expressed frustration about companies managing earnings through manipulating pension costs and other elements of periodic financial statements.

Some investors and investment experts also accuse companies of deliberately using artificially high assumed returns on pension assets to bolster their profits, generally a factor in calculating incentive compensation for top executives.

Lynn Turner, former chief accountant at the Securities and Exchange Commission, agrees that the time has come to change the way companies disclose their pension obligations on financial statements.

“I would say it is time to make revisions to FAS 87 to make it more transparent,” says Mr. Turner, now director of the Center for Quality Financial Reporting at Colorado State University.