April 26, 2006
On March 31, 2006, the FASB issued an Exposure Draft of a proposed Statement, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R), in connection with the first phase of its project to reconsider the current accounting guidance for defined benefit postretirement plans. The provisions of the proposed Statement would apply to entities (including not-for-profit organizations) that sponsor one or more defined benefit postretirement plans.
Background
Existing accounting standards for defined benefit postretirement plans do not require that an employer recognize the economic events that affect the cost of providing postretirement benefits – the changes in plan assets and liabilities – as those events occur. Transition items and prior service costs/credits are deferred and amortized into income in future periods. Other gains and losses, including investment gains and losses, also may be deferred in the expectation that the amounts may reverse in future periods. Consequently, the statement of financial position of an employer does not reflect the funded status of the defined benefit postretirement plans it sponsors. Instead, information about the funded status is relegated to the notes to the financial statements. Phase one of the FASB’s pension project addresses this accounting.
FASB proposal
The proposed Statement would require an employer to recognize the current funded status of the defined benefit postretirement plans it sponsors in the statement of financial position. Unrecognized components of the pension obligation (actuarial gains and losses and prior service costs and credits), other than remaining transition amounts, would be recognized immediately as other comprehensive income (OCI), net of tax. Any remaining transition items related to the original application of Statement 87, Employers’ Accounting for Pensions, or Statement 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions, would be written off, net of tax, as an adjustment to the opening balance of retained earnings and previously reported income. Although the FASB’s proposed approach for recognizing the funded status will not otherwise affect reported net income, it will decrease or increase the reported equity of the entity. The existing rules for measuring plan assets, benefit obligations, and annual net periodic benefit cost do not change. Phase two of the FASB’s pension project will address these items and other issues.
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All future changes in the funded status would be recognized as OCI, net of tax, in the period in which they occur. Amounts previously recognized in other comprehensive income would be reclassified to net income through periodic pension cost or would reverse through other comprehensive income as future gains and losses occur. Not-for-profit organizations and other entities that do not report OCI would report future changes in a separate line in the statement of activities.
The proposed Statement also eliminates
• the option to use a plan measurement date that is up to ninety days prior to the date of the statement of financial position,
• recognition of the minimum pension liability, and
• certain disclosures related to the unrecognized components.
Implementation
The proposed effective date for all entities to recognize the funded status is fiscal years ending after December 15, 2006 (December 31, 2006 for a company with a calendar year-end). Public entities that have elected to use a measurement date other than the date of the statement of financial position will have an additional year to change their measurement date (fiscal years beginning after December 15, 2006). Nonpublic entities will have still another year after that to change their measurement date (fiscal years beginning after December 15, 2007).
The proposed standard is to be applied retrospectively unless impracticable. Determination of whether retrospective application is impracticable is limited to consideration of the effects of assessing the realizability of incremental deferred tax assets and the need for additional valuation allowances.
Take note!
Equity can either increase or decrease as a result of the proposed recognition rules. Recognition of prior service credits and other gains will increase equity. Equity will decrease when the plan has unrecognized prior service costs and other losses, even when the plan is overfunded. The incremental effect on equity for underfunded pension plans is limited to the amount that has not already been recognized as a minimum liability under existing rules. Entities with debt covenants or other contractual considerations can estimate the likely effects using existing information in the notes to the financial statements.