Summary of Statement No. 87
Employers' Accounting for Pensions (Issued 12/85)
Summary
This Statement supersedes previous standards for employers'
accounting for pensions. The most significant changes to past
practice affect an employer's accounting for a single-employer
defined benefit pension plan, although some provisions also apply
to an employer that participates in a multiemployer plan or
sponsors a defined contribution plan.
Measuring cost and reporting liabilities resulting
from defined benefit pension plans have been sources of accounting
controversy for many years. Both the Committee on Accounting
Procedure, in 1956, and the Accounting Principles Board (APB), in
1966, concluded that improvements in pension accounting were
necessary beyond what was considered practical at those times.
After 1966, the importance of information about
pensions grew with increases in the number of plans and amounts of
pension assets and obligations. There were significant changes in
both the legal environment (for example, the enactment of ERISA)
and the economic environment (for example, higher inflation and
interest rates). Critics of prior accounting requirements,
including users of financial statements, became aware that reported
pension cost was not comparable from one company to another and
often was not consistent from period to period for the same
company. They also became aware that significant pension-related
obligations and assets were not recognized in financial
statements.
Funding and Accrual Accounting
This Statement reaffirms the usefulness of
information based on accrual accounting. Accrual accounting goes
beyond cash transactions to provide information about assets,
liabilities, and earnings. The Board has concluded, as did the APB
in 1966, that net pension cost for a period is not necessarily
determined by the amount the employer decides to contribute to the
plan for that period. Many factors (including tax considerations
and availability of both cash and alternative investment
opportunities) that affect funding decisions should not be allowed
to dictate accounting results if the accounting is to provide the
most useful information.
The conclusion that accounting information on an
accrual basis is needed does not mean that accounting information
and funding decisions are unrelated. In pensions, as in other
areas, managers may use accounting information along with other
factors in making financial decisions. Some employers may decide to
change their pension funding policies based in part on the new
accounting information. Financial statements should provide
information that is useful to those who make economic decisions,
and the decision to fund a pension plan to a greater or lesser
extent is an economic decision. The Board, however, does not have
as an objective either an increase or a decrease in the funding
level of any particular plan or plans. Neither does the Board
believe that the information required by this Statement is the only
information needed to make a funding decision or that net periodic
pension cost, as defined, is necessarily the appropriate amount for
any particular employer's periodic contribution.
Fundamentals of Pension Accounting
In applying accrual accounting to pensions, this
Statement retains three fundamental aspects of past pension
accounting: delaying recognition of certain events,
reporting net cost, and offsetting liabilities and
assets. Those three features of practice have shaped financial
reporting for pensions for many years, although they have been
neither explicitly addressed nor widely understood, and they
conflict in some respects with accounting principles applied
elsewhere.
The delayed recognition feature means that
changes in the pension obligation (including those resulting from
plan amendments) and changes in the value of assets set aside to
meet those obligations are not recognized as they occur but are
recognized systematically and gradually over subsequent periods.
All changes are ultimately recognized except to the extent they may
be offset by subsequent changes, but at any point changes that have
been identified and quantified await subsequent accounting
recognition as net cost components and as liabilities or
assets.
The net cost feature means that the recognized
consequences of events and transactions affecting a pension plan
are reported as a single net amoÿÿÿÿ the
employer's financial statements. That approach aggregates at least
three items that might be reported separately for any other part of
an employer's operations: the compensation cost of benefits
promised, interest cost resulting from deferred payment of those
benefits, and the results of investing what are often significant
amounts of assets.
The offsetting feature means that recognized
values of assets contributed to a plan and liabilities for pensions
recognized as net pension cost of past periods are shown net in the
employer's statement of financial position, even though the
liability has not been settled, the assets may be still largely
controlled, and substantial risks and rewards associated with both
of those amounts are clearly borne by the employer.
Within those three features of practice that are
retained by this Statement, the Board has sought to achieve more
useful financial reporting through three changes:
- This Statement requires a standardized method for measuring net
periodic pension cost that is intended to improve comparability and
understandability by recognizing the compensation cost of an
employee's pension over that employee's approximate service period
and by relating that cost more directly to the terms of the
plan.
- This Statement requires immediate recognition of a liability
(the minimum liability) when the accumulated benefit obligation
exceeds the fair value of plan assets, although it continues to
delay recognition of the offsetting amount as an increase in net
periodic pension cost.
- This Statement requires expanded disclosures intended to
provide more complete and more current information than can be
practically incorporated in financial statements at the present
time.
Cost Recognition and Measurement
A fundamental objective of this Statement is to
recognize the compensation cost of an employee's pension benefits
(including prior service cost) over that employee's approximate
service period. Many respondents to Preliminary Views and
the Exposure Draft on employers' accounting for pensions agreed
with that objective, which conflicts with some aspects of past
practice under APB Opinion No. 8, Accounting for the Cost of
Pension Plans.
The Board believes that the understandability,
comparability, and usefulness of pension information will be
improved by narrowing the past range of methods for allocating or
attributing the cost of an employee's pension to individual periods
of service. The Board was unable to identify differences in
circumstances that would make it appropriate for different
employers to use fundamentally different accounting methods or for
a single employer to use different methods for different plans.
The Board believes that the terms of the plan that
define the benefits an employee will receive (the plan's benefit
formula) provide the most relevant and reliable indication of how
pension cost and pension obligations are incurred. In the absence
of convincing evidence that the substance of an exchange is
different from that indicated by the agreement between the parties,
accounting has traditionally looked to the terms of the agreement
as a basis for recording the exchange. Unlike some other methods
previously used for pension accounting, the method required by this
Statement focuses more directly on the plan's benefit formula as
the basis for determining the benefit earned, and therefore the
cost incurred, in each individual period.
Statement of Financial Position
The Board believes that this Statement represents an
improvement in past practices for the reporting of financial
position in two ways. First, recognition of the cost of pensions
over employees' service periods will result in earlier (but still
gradual) recognition of significant liabilities that were reflected
more slowly in the past financial statements of some employers.
Second, the requirement to recognize a minimum liability limits the
extent to which the delayed recognition of plan amendments and
losses in net periodic pension cost can result in omission of
certain liabilities from statements of financial position.
Recognition of a measure of at least the minimum
pension obligation as a liability is not a new idea. Accounting
Research Bulletin No. 47, Accounting for Costs of Pension
Plans, published in 1956, stated that "as a minimum, the
accounts and financial statements should reflect accruals which
equal the present worth, actuarially calculated, of pension
commitments to employees to the extent that pension rights have
vested in the employees, reduced, in the case of the balance sheet,
by any accumulated trusteed funds or annuity contracts purchased."
Opinion 8 required that "if the company has a legal obligation for
pension cost in excess of amounts paid or accrued, the excess
should be shown in the balance sheet as both a liability and a
deferred charge."
The Board believes that an employer with an unfunded
pension obligation has a liability and an employer with an
overfunded pension obligation has an asset. The most relevant and
reliable information available about that liability or asset is
based on the fair value of plan assets and a measure of the present
value of the obligation using current, explicit assumptions. The
Board concluded, however, that recognition in financial statements
of those amounts in their entirety would be too great a change from
past practice. Some Board members were also influenced by concerns
about the reliability of measures of the obligation.
The delayed recognition included in this Statement
results in excluding the most current and most relevant information
from the statement of financial position. That information,
however, is included in the required disclosures.
Information Needed
The Board believes that users of financial reports
need information beyond that previously disclosed to be able to
assess the status of an employer's pension arrangements and their
effects on the employer's financial position and results of
operations. Most respondents agreed, and this Statement requires
certain disclosures not previously required.
This Statement requires disclosure of the components
of net pension cost and of the projected benefit obligation. One of
the factors that has made pension information difficult to
understand is that past practice and terminology combined elements
that are different in substance and effect into net amounts.
Although the Board agreed to retain from past pension accounting
practice the basic features of reporting net cost and offsetting
liabilities and assets, the Board believes that disclosure of the
components will significantly assist users in understanding the
economic events that have occurred. Those disclosures also make it
easier to understand why reported amounts change from period to
period, especially when a large cost or asset is offset by a large
revenue or liability to produce a relatively small net reported
amount.
* * * * *
After considering the range of comments on
Preliminary Views and the Exposure Draft, the Board
concluded that this Statement represents a worthwhile improvement
in financial reporting. Opinion 8 noted in 1966 that "accounting
for pension cost is in a transitional stage." The Board believes
that is still true in 1985. FASB Concepts Statement No. 5,
Recognition and Measurement in Financial Statements of Business
Enterprises, paragraph 2, indicates that "the Board intends
future change [in practice] to occur in the gradual, evolutionary
way that has characterized past change."
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