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FAS 132 update

Dec 11, 2008

In June 2008 we posted an article on the financial reporting of DB plan assets, reviewing Financial Accounting Standards Board deliberations on a proposed FASB Staff Position (FSP). In this article, we begin with a summary of the proposed FSP and then discuss changes that, since our last article, have been tentatively approved by FASB.

A word of caution: FASB's process is remarkably open, but it is something of a moving target. There is no final guidance on this issue yet. FASB meeting minutes come with the disclaimer that:

All of the conclusions reported are tentative and may be changed at future Board meetings. Decisions become final only after a formal written ballot to issue a final Statement, Interpretation, or FASB Staff Position.

The FSP on FAS 132 project – Financial reporting of DB plan assets

As a preliminary matter, let's be clear what we are talking about. FAS 132(R) provides rules for the disclosure of information about assets held in a DB plan in the financial statements of the employer sponsoring that plan. The proposed FASB Staff Position, FSP FAS 132(R)-a, has two pieces to it. The first piece generally applies FAS 157, Fair Value Measurements, to DB plans. The second piece provides rules for additional disclosures about asset categories and concentration of risk. Let's begin with FAS 157.

FAS 157 and DB plans

FAS 157 "defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements." It applies wherever, in the FASB accounting  regime, a fair value measurement is required or permitted.

FAS 157 creates a "fair value hierarchy" of assets, based on the reliability of the valuation measurement "inputs." There are three asset level inputs:

Level 1 inputs are "quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date." In other words, market prices from reliable markets.

Level 2 inputs are "inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly." Examples of Level 2 inputs are quoted prices for similar assets in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable (for example, interest rates and yield curves); inputs that are derived principally from or corroborated by observable market data by correlation or other means (market-corroborated inputs).

Level 3 inputs are “unobservable inputs for the asset or liability.”

FAS 157 requires that a reporting entity categorize assets as Level 1, 2 or 3. Special disclosures (including a reconciliation of the beginning and ending balances) are required with respect to Level 3 assets. Valuation techniques must generally be disclosed; this disclosure is particularly important for Level 3 assets.

Application of FAS 157 to corporate DB plan reporting

The FSP on FAS 132(R) project was initiated in response to a controversy over whether FAS 157 required an employer to provide any information about assets held in a DB plan. After all, the DB plan is a separate entity (subject to its own financial reporting requirements) from the employer. While FASB determined FAS 157 did not directly apply to DB plan disclosure on the employer’s financial statements (note that FAS 157 likely does apply to the plan’s financial statements), they decided to extend FAS 157 principles to DB plan disclosure via this FSP.

That is the first piece of proposed FSP FAS 132(R)-a. The second piece requires additional disclosures concerning categories of assets and concentration of risk.

FSP FAS 132(R)-a – disclosure of categories of plan assets and concentrations of risk in plan assets

Under the proposed FSP, a DB plan sponsor must disclose separately the fair value of each major category of plan assets. Major categories include:

In addition the sponsor must disclose the nature and amount of a "concentration of risk arising within or across categories of plan assets." An example of cross-category risk: investments in real estate made directly by the plan, through a real estate investment trust, and through a hedge fund that holds a significant position in real estate.

Proposed effective date

As originally proposed, the FSP was to apply to fiscal years ending after December 15, 2008. So, for calendar year reporting entities, the changes would have been effective for 2008.

Criticism of the proposal

A number of commenters on the proposal criticized it as imposing administrative burdens that outweighed the benefits additional disclosure might provide.

Changes to the original proposal

Since the FSP was first proposed, early in 2008, the Board has held three meetings reviewing comments on the proposal, the most recent on October 29, 2008. The tentative conclusions that the Board has reached (subject to the disclaimer above) are:

1. Effective date. The Board agreed to delay the effective date so that the FSP will apply to fiscal years ending after December 15, 2009.

2. Overall objectives. The Board agreed to include in the FSP a statement of "overall objectives" as follows:

The overall objectives of the disclosures about plan assets are to provide users of financial statements with an understanding of the following:

a. Major categories of assets held in an employer’s plan(s)

b. Investment allocation decisions made by management, including the factors that are pertinent to an understanding of the employer's investment policies or strategies

c. Significant concentrations of risk within plan assets

d. Inputs and valuation techniques used to measure the fair value of plan assets.

As we'll see (below), the Board backed off providing detailed requirements for disclosures about concentration of risk, and in other areas where the Board believed more disclosure was appropriate, it declined to provide detailed rules. Instead, it appears that the purpose of this statement of "overall objectives" is to inform management decisions about how much more detailed information to disclose with respect to different assets, asset categories and investment decisions. So, in effect, the Board is opting for general principle over detailed rules.

3. Clarification of asset categories. The Board expressed concern that some asset categories were too broad and should be disaggregated further. For example, the category of common stocks could be further disaggregated between large-cap-, mid-cap-, and small-cap-common stocks. To address this issue, the Board agreed that further disaggregation should be based on management's investment allocation policies and strategies and that employers should consider the "overall objectives" for further guidance on disaggregating categories of plan assets. There will be examples (including examples of asset categories) illustrating how this very general rule is to be applied.

4. Investment funds and asset categories. A number of commenters had questions about how to treat investment funds and whether employers would have to "look through" some investment funds to report on the underlying assets held by the fund. The Board agreed to the inclusion of a category of "investment funds" segregated by type of fund (e.g., hedge fund or mutual fund) and that employers would not be required to "look through" investments in funds. Significant investment strategies for investment funds would have to be disclosed as "categories of plan assets." Presumably, this means that an international equity fund or a real estate fund would have to be so identified.

5. Concentration of risk. The original FSP would have required employers to disclose concentrations of risk across asset categories. The Board, based on a number of comments, concluded that this requirement was too burdensome and agreed to eliminate it. The Board did find, however, that "providing information to users of financial statements about concentrations of risk in plan assets should be retained as an overall objective in the final FSP, and that this objective should be considered in providing the specific disclosures …." [emphasis added]. So, there will be no detailed rules about concentration of risk, but management may conclude it must disclose certain concentrations. Quoting the minutes of the September 24, 2008 Board meeting, "The Board agreed that one of the objectives of the final FSP would be to provide users of financial statements with an understanding of significant concentrations of risk in plan assets, and that this objective should be considered in providing the detailed disclosures required by the final FSP."

What's going on here?

There is pressure from a number of constituencies for DB plan sponsors to provide detailed information about assets held in the DB plan. Additional information about bond duration was an element of the recent revision of Form 5500. Securities analysts, rating agencies and the PBGC have supported FASB efforts to require more information, on corporate books, about DB plan assets. And President-elect Obama had, as one of his four pension reform proposals, a requirement of "Full Disclosure of Company Pension Investments."

Why this pressure? If, as is reasonable, you view the funded status of a DB plan as a (positive and negative) risk to corporate financials, then not just the size of under (or over) funding (now a required balance sheet disclosure under FAS 158), but also its volatility and the overall reliability of the numbers are relevant. It matters – to, e.g., investors, creditors and the PBGC – whether the plan's $100 million in assets are invested in Aaa bonds valued based on daily prices from a highly liquid exchange or in a limited partnership holding emerging market real estate valued using a number provided by the general partner. The stakeholders' risk with respect to those two different types of assets is considerably different.

Thus, FASB clearly believes that there is a need for the kind of information that will be required by FSP FAS 132(R)-a. The question, which FASB is presently trying to resolve, is how much information is necessary, and at what point does the cost of developing information outweigh its utility.

Conclusion

Given the scope of this material, it's easy to lose the forest in the trees. Bottom line, here's FASB's current position:

1. Beginning in 2009, employers will be required to provide detailed information about the assets held in DB plans they sponsor (including a breakdown by the Level of assets, and a reconciliation of the change in Level 3 assets during the year).

2. Required disclosures will include information about:

A. Valuation inputs, with detailed disclosure required about valuations of hard to value (Level 3) assets

B. Asset categories, broken down to relevant detail

C. Concentration of risk, based on a flexible rule that focuses on "risks that matter" to the reporting entity rather than a detailed disaggregation/cross-matching regime

3. On tough issues of how to trade off disclosure burden vs. transparency, a set of general overall objectives is to guide management decisions about the detail of disclosure.

We will continue to cover FASB deliberations on these issues.