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Improving the Disclosure Basis of Pension Accounting

Fri, April 26, 1:40 to 3:20pm, Hyatt Fisherman's Wharf, TBA

Abstract

The footnote-oriented U.S. pension accounting standards have been criticized for a variety of practices including inducing off-balance liabilities and deferring the recognition of pension costs. In response to these criticisms, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 158 (SFAS 158) in 2006 to require firms sponsoring defined-benefit (DB) pension plans to report the funded status of DB plans on their balance sheets. Although this is an improvement, SFAS 158 continues the smoothing mechanism allowing both prior service costs (PSC) and actuarial gains/losses (AGL) to be deferred. Additionally, under SFAS 158, DB firms report only a fraction of pension liabilities on the balance sheet, leaving a majority of pension liabilities available only in footnotes. Prior studies have documented evidence that investors cannot fully assimilate pension disclosures in assessing firm values (Picconi, 2006, Hann, 2007, etc.). With a major portion of pension information still available only in footnotes, the current pension accounting is likely to lead to a mispricing of firm values. Given that correct firm pricing is a foundation for an effective capital market, we question the effectiveness of the extant footnote-oriented pension accounting and propose a fair value pension accounting in which the gross pension assets and liabilities are reported and PSC and AGL are recognized as they incur. For Comparison purposes, key financial variables and ratios are derived for Dow Jones 30 companies based on three alternative pension reporting methods; namely, current U.S. pension accounting, international pension accounting (i.e., IAS 19 (R)) and our proposed fair value pension accounting. Results indicate that the proposed fair value pension reporting portrays significantly different financial profiles of firms than either the current U.S. pension standards or the IAS 19 (R).

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