Discount Rate Adjustment by Not-for-Profits in Response to SFAS 158

• In Event: Breakfast Rountable Session

Abstract

In the United States, the not-for-profit sector occupies an important and growing role in the production and provision of public goods. Despite the significant incentives within the sector to report favorable financial information, the scarcity of strong oversight systems, and the relative flexibility within generally accepted accounting principles for managerial discretion, surprisingly little research examines bias in not-for-profit accounting.

This paper aims to test whether not-for-profits manage the discount rates of their defined-benefit (DB) pension plans to report favorable financial information. Our research is situated in the context of Statement of Financial Accounting Standards (SFAS) 158, issued by FASB in September 2006. The new standard became effective from June 15, 2007 for not-for-profit organizations. The most significant change introduced by SFAS 158 is the recognition of the funded status of a defined-benefit plan on the firm’s balance sheet. Under the new standard, the funded level is defined as the difference between Pension Benefit Obligation (PBO) and plan assets. This is a substantial revision of SFAS 87 which required firms to recognize only the accrued pension cost, calculated as the difference between cumulative net period pension cost and cumulative employer contributions. SFAS 87 also required organizations to record an additional minimum liability if the unfunded accumulated benefit obligation (ABO) exceeded the accrued pension cost.

For most DB plans, SFAS 158 instituted a shift from recognizing unfunded ABO to recognizing unfunded PBO on the balance sheet. Depending on the difference between a plan’s ABO and PBO, the effect of SFAS 158 on a firm’s debt-to-equity ratio could have been anywhere between extremely negative to somewhat positive. This situation created strong incentives for firms with unfunded plans to increase their discount rates in order to shrink their PBOs. We hypothesize that firms responded to the incentives created by SFAS 158 and increased their discount rates after adopting the new standard.

We draw on a hand-collected panel dataset of 75 unique not-for-profits and a matched sample of for-profits obtained from Compustat to test our hypothesis. Our key findings suggest that the not-for-profit organizations that were most vulnerable to the effect of SFAS 158 increased their discount rates post-SFAS 158. However, we find that comparable for-profit firms did not alter their discount rates discernably. These findings have implications for accounting choice and the recognition versus disclosure difference in the not-for-profit sector.

Authors

• Anubhav Gupta, National University of Singapore

• David Matkin, Brigham Young University