Measuring Pension Liabilities under GASB Statement No. 68

SYNOPSIS While retired government employees clearly depend on public sector defined benefit pension funds, these plans also contribute significantly to U.S. state and national economies. Growing public concern about the funding adequacy of these plans, hard hit by the great recession, raises questions about their future viability. After several years of study, the Governmental Accounting Standards Board (GASB) approved two new standards, GASB 67 and 68, with the goal of substantially improving the accounting for and transparency of financial reporting of state/municipal public employee defined benefit pension plans. GASB 68, the focus of this paper, requires state/municipal governments to calculate and report a net pension liability based on a single discount rate that combines the rate of return on funded plan assets with a low-risk index rate on the unfunded portion of the liability. This paper illustrates the calculation of estimates for GASB 68 reportable net pension liabilities, funded ratios, and single discount rates for 48 fiscal year state employee defined benefit plans by using an innovative valuation model and readily available data. The results show statistically significant increases in reportable net pension liabilities and decreases in the estimated hypothetical GASB 68 funded ratios and single discount rates. Our sensitivity analyses examine the effect of changes in the low-risk rate and time period on these results. We find that reported discount rates of weaker plans approach the low-risk rate, resulting in higher pension liabilities and creating policy incentives to increase risky assets in pension portfolios.

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Measuring Pension Liabilities: An Examination Of The Funding Levels Of Defined Benefit Pension Plans

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v11i2.5877 ◽

2011 ◽

Vol 11 (2) ◽

pp. 73 ◽

Cited By ~ 1

Author(s):

Alan I. Blankley ◽

Rober Y. W. Tang

Keyword(s):

Interest Rate ◽

Discount Rate ◽

Pension Plan ◽

Fortune 500 ◽

Pension Plans ◽

Economic Conditions ◽

Defined Benefit ◽

Discount Rates ◽

Chi Square ◽

Pension Liabilities

We examine pension funding measures and interest rate disclosures for 223 firms from the Fortune 500. Three different liability measures are used to develop funding ratios, which indicate sample firms funding condition. We then examine firms discount rate estimates and compare these estimates with their funding levels. Using chi-square tests to examine dependence between rates and funding, we determine whether over (under) funding is simply an artifact of the choice of discount rates or the result of authentic economic conditions surrounding the pension plan.

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The Potential for Inflating Earnings through the Expected Rate of Return on Defined Benefit Pension Plan Assets

Accounting Horizons ◽

10.2308/acch-10115 ◽

2011 ◽

Vol 25 (3) ◽

pp. 443-464 ◽

Cited By ~ 15

Author(s):

Brian Adams ◽

Mary Margaret Frank ◽

Tod Perry

Keyword(s):

Financial Reporting ◽

Asset Allocation ◽

Cumulative Effect ◽

Pension Plan ◽

Pension Plans ◽

Rate Of Return ◽

Defined Benefit ◽

Operating Income ◽

Defined Benefit Pension Plan ◽

Reported Earnings

SYNOPSIS Using a sample of firms over the period of 1991 through 2005, we examine the opportunity that exists for firms to inflate earnings through the expected rate of return (ERR) assumption associated with defined benefit pension plans. The evidence suggests that, on average, the ERR is not overstated relative to several benchmarks, including contemporaneous actual returns, historical cumulative actual returns, and expected future returns based on asset allocation within the pension. We also find that actual changes in the ERR are infrequent and typically have less than a 1 percent impact on annual operating income. We also estimate that a 0.5 percent change (50 bps) in the ERR will result in a cumulative effect on operating income over a five-year period of approximately 0.5 percent or less for the majority of firms. When we examine firms with the highest ERRs or with the greatest opportunity to inflate earnings, again, we find that the ERR is not overstated relative to several benchmarks. Although we do not observe pervasive inflating of reported income through the ERR during our sample period, we do find that for some firms, small increases in ERR can have a material impact on reported earnings. Our results provide evidence related to the pervasiveness, materiality, and impact of overstated earnings through the ERR, which helps regulators assess the costs and benefits of eliminating this discretion in financial reporting.

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Predicting cash flows related to defined benefit plan contributions

Journal of Pension Economics and Finance ◽

10.1017/s1474747209990333 ◽

2010 ◽

Vol 9 (4) ◽

pp. 505-532 ◽

Cited By ~ 2

Author(s):

THOMAS D. DOWDELL ◽

BONNIE K. KLAMM ◽

ROXANNE M. SPINDLE

Keyword(s):

Cash Flow ◽

Financial Statements ◽

Cash Flows ◽

Pension Plans ◽

Defined Benefit ◽

Pension Accounting ◽

Accounting Standard ◽

Benefit Plan ◽

Accounting Rules ◽

Pension Liabilities

AbstractFuture contributions to defined benefit pension plans are a significant cash flow item that can be difficult to estimate. Funding ratios – pension assets relative to pension liabilities – have long been considered important for estimating cash flows needed for current and future pension contributions (Ballester et al., 1998). However, US GAAP or IFRS funding ratios that companies report in their financial statements may differ from funding ratios used by pension regulators. These regulatory funding ratios may be more useful for predicting future contributions.We investigate whether US regulatory and GAAP funding ratios are different and whether regulatory funding ratios provide useful information for predicting future contributions. For 3,877 firm years from 1995 through 2002, we observe that regulatory and GAAP funding ratios differ by more than 5% for 73% of our sample. We also find that predictions of future contributions are improved by using regulatory funding ratios in addition to GAAP funding ratios. Our results are relevant to accounting standard setters' ongoing review of pension accounting rules.

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Corporate bond spreads and understated pension liabilities

China Finance Review International ◽

10.1108/cfri-07-2021-0146 ◽

2021 ◽

Vol ahead-of-print (ahead-of-print) ◽

Author(s):

Huan Yang ◽

Jun Cai

Keyword(s):

Corporate Bond ◽

Fiscal Year ◽

Discount Rates ◽

Bond Yields ◽

Yield Spreads ◽

Content Type ◽

Macroeconomic Conditions ◽

Bond Yield ◽

Funded Status ◽

Pension Liabilities

PurposeThe question is whether debt market investors see through managers' attempts to hide their pension obligations. The authors establish a robust relation between understated pension liabilities and corporate bond yield spreads after controlling for factors that have been previously identified as having a significant impact on firms' cost of borrowing. The results support the idea that bond market investors are not being misled by the use of high pension liability discount rates by some companies to lower their reported pension obligations. For a small fraction of debt issuers, the reported pension liabilities are larger than the pension liabilities valued at the stipulated interest rate benchmarks. For these issuers with overstated pension liabilities, bond investors adjust their borrowing costs downward.Design/methodology/approachThe authors investigate the relation between corporate bond yield spreads and understated pension liabilities relative to long-term Treasury and high-grade corporate bond yields. They aim to answer two questions. First, what are the sizes of over or understated pension liabilities relative to guideline benchmarks? Second, do debt market investors see through the potential management manipulation of pension discount rates? The authors find that firms with large understated pension liabilities face higher marginal borrowing costs after taking into account issue-specific features, firm characteristics, macroeconomic conditions and other pension information such as funded status and mandatory contributions.FindingsThe average understated projected benefit obligations (PBOs) are understated by $394.3 and $335.6, equivalent to 3.5 and 3.0% of the beginning of the fiscal year market value, respectively. The average understated accumulated benefit obligations (ABOs) are understated by $359.3 and $305.3 million, equivalent to 3.1 and 2.6%, of the beginning of the fiscal year market value, respectively. Relative to AA-grade corporate bond yields, the average difference between firm pension discount rates and benchmark yields becomes much smaller; the percentage of firm pension discount rates higher than benchmark yields is also much smaller. As a result, understated pension liabilities become negligible. The authors establish a robust relation between corporate bond yield spreads and measures of understated pension liabilities after controlling for issue-specific features, firm characteristics, other pension information (funded status and mandatory contributions), macroeconomic conditions, calendar effects and industry effects.Originality/valueS&P Rating Services recognizes the issue that there is considerably more variability in discount rate assumptions among companies than in workforce demographics or the interest rate environment in which firms operate (Standard and Poor's, 2006). S&P also indicates that it would be desirable to normalize different discount rate assumptions but acknowledges that it is difficult to do so. In practice, S&P Rating Services conducts periodic surveys to see whether firms' assumed discount rates conform to the normal standard. The paper makes an initial attempt to quantify the size of understated pension liabilities and their impact on corporate bond yield spreads. This approach can be extended to study firms' costs of equity capital, the pricing of seasoned equity offerings and the pricing of merger and acquisition transaction deals, among other questions.

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Pension Funding and the Actuarial Assumption Concerning Investment Returns

Astin Bulletin ◽

10.2143/ast.33.2.503694 ◽

2003 ◽

Vol 33 (02) ◽

pp. 289-312 ◽

Cited By ~ 3

Author(s):

M. Iqbal Owadally

Keyword(s):

Discount Rate ◽

Asset Allocation ◽

Pension Plan ◽

Pension Plans ◽

Defined Benefit ◽

Return On Assets ◽

Investment Return ◽

Investment Returns ◽

Pension Liabilities

An assumption concerning the long-term rate of return on assets is made by actuaries when they value defined-benefit pension plans. There is a distinction between this assumption and the discount rate used to value pension liabilities, as the value placed on liabilities does not depend on asset allocation in the pension fund. The more conservative the investment return assumption is, the larger planned initial contributions are, and the faster benefits are funded. A conservative investment return assumption, however, also leads to long-term surpluses in the plan, as is shown for two practical actuarial funding methods. Long-term deficits result from an optimistic assumption. Neither outcome is desirable as, in the long term, pension plan assets should be accumulated to meet the pension liabilities valued at a suitable discount rate. A third method is devised that avoids such persistent surpluses and deficits regardless of conservatism or optimism in the assumed investment return.

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Pension Accounting: The Changing Landscape Of Corporate Pension Benefits

Journal of Business & Economics Research (JBER) ◽

10.19030/jber.v9i10.5950 ◽

2011 ◽

Vol 9 (10) ◽

pp. 27

Author(s):

Terrye A. Stinson ◽

J. David Ashby ◽

Kimberly M. Shirey

Keyword(s):

Pension Plans ◽

Defined Benefit ◽

Font Size ◽

Pension Accounting ◽

Generally Accepted Accounting Principles ◽

Fortune 100 ◽

Defined Benefit Plans ◽

Corporate Pension ◽

Pension Benefits ◽

Pension Liabilities

This paper discusses recent changes in the generally accepted accounting principles related to accounting for defined benefit pension plans. SFAS 158 imposes new rules related to calculating net pension assets or liabilities and increases the likelihood that companies may report net pension liabilities. This paper looks at a sample of Fortune 100 companies to determine the effect of implementing SFAS 158 on the reported funding status for defined benefit plans, and then tracks the reported pension status from 2005 through 2009. Contrary to expected results, the funding status did not deteriorate following implementation of SFAS 158. The ensuing economic meltdown in 2008 and 2009, however, resulted in more companies reporting pension liabilities.

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Managerial Miscalibration and Its Effects on the Auditability of Accounting Estimates: Evidence from Pension Accounting

The International Journal of Accounting ◽

10.1142/s1094406019500161 ◽

2019 ◽

Vol 54 (04) ◽

pp. 1950016

Author(s):

Ulrich Menzefricke ◽

Wally Smieliauskas

Keyword(s):

Financial Reporting ◽

Significant Risk ◽

Accounting Standards ◽

Financial Statements ◽

Pension Plans ◽

Expected Returns ◽

Defined Benefit ◽

Pension Accounting ◽

Accounting Estimates ◽

Short Run

In this archival study, we report three main findings related to how well pension accounting estimates of practice meet the stated objectives of professional accounting standards. Our evidence on estimated returns in pension accounting used in reporting on defined benefit pension plans in the financial statements indicates the following. First, the financial note disclosures of ranges of estimated returns are miscalibrated and provide low credibility of including either the actual or expected returns. Second, the estimated returns are unreliable estimates of the firms’ actual 10-year averages. Finally, the estimated returns can have significant risk of material misstatement arising from the uncertainty in the estimation process over the short run. The combination of these findings indicates that the estimated returns and related note disclosures on the ranges of the returns used in estimation processes may not be auditable, and may not meet the stated financial reporting objectives of professional accounting standards.

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Corporate Pension Plans as Takeover Deterrents

Journal of Financial and Quantitative Analysis ◽

10.1017/s0022109013000355 ◽

2013 ◽

Vol 48 (4) ◽

pp. 1119-1144 ◽

Cited By ~ 24

Author(s):

João F. Cocco ◽

Paolo F. Volpin

Keyword(s):

Pension Plan ◽

Pension Plans ◽

Defined Benefit ◽

Announcement Effects ◽

Defined Benefit Pension Plan ◽

Corporate Pension ◽

Pension Liabilities

AbstractWe use UK data to show that firms that sponsor a defined-benefit pension plan are less likely to be targeted in an acquisition and, conditional on an attempted takeover, they are less likely to be acquired. Our explanation is that the uncertainty in the value of pension liabilities is a source of risk for acquirers of the firm's shares, which works as a takeover deterrent. In support of this explanation we find that these same firms are more likely to use cash when acquiring other firms, and that the announcement of a cash acquisition is associated with positive announcement effects.

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Accounting For Defined Benefit Pension Plans: Is FASB Finally Fulfilling Its 25 Year Old Promise?

Journal of Business & Economics Research (JBER) ◽

10.19030/jber.v5i8.2573 ◽

2011 ◽

Vol 5 (8) ◽

Cited By ~ 3

Author(s):

Brian W. Carpenter ◽

Daniel P. Mahoney

Keyword(s):

Financial Reporting ◽

Balance Sheet ◽

Accounting Standards ◽

Pension Plans ◽

Main Body ◽

Defined Benefit ◽

Financial Accounting Standards Board ◽

Major Step ◽

Pension Accounting ◽

Defined Benefit Pensions

With the September 2006 release of Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” the Financial Accounting Standards Board (FASB) has completed the first phase of its ongoing pension accounting project. The new standard improves the accounting for defined benefit pensions by requiring employers to report the over(under)funded status of their plans as an asset(liability) within the main body of their balance sheet. This requirement represents a significant change from previously-existing pension accounting standards, and represents a major step forward toward the goal of increased transparency in financial reporting. This article provides a discussion of the very lengthy and controversial history of employer pension accounting, and examines the improvements that have finally resulted from Statement No. 158. Also provided is a discussion of the potential outcome of the second and final phase of the FASB’s pension accounting project

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Pension plan risk-taking: does it matter if the sponsor is publicly-traded?

Journal of Pension Economics and Finance ◽

10.1017/s1474747212000339 ◽

2012 ◽

Vol 12 (2) ◽

pp. 218-249 ◽

Cited By ~ 9

Author(s):

CHRISTINA ATANASOVA ◽

EVAN GATEV

Keyword(s):

Risk Taking ◽

Pension Plan ◽

Pension Plans ◽

Defined Benefit ◽

Publicly Traded ◽

Public And Private ◽

Publicly Traded Firms ◽

Main Determinants ◽

Funded Status ◽

Pension Liabilities

AbstractWe use a large sample of defined benefit (DB) pension plans to document economically significant differences in the risk-taking of plans sponsored by privately-held versus publicly-traded firms. The magnitude and the main determinants of pension plan risk-taking are different for public and private firms. The effect of pension liabilities’ funded status on risk-taking is two and a half times higher for plans with publicly-traded sponsors than for plans with private sponsors. In contrast, changing sponsor contributions has more than four times higher effect on risk-taking for plans with private sponsors. The results suggest that the alignment of incentives for the stakeholders in a pension contract is different for plans sponsored by private versus publicly-traded firms.

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