CCA Strategies Offers Compelling Compromise for FASB Consideration
Jun 19, 2006
In this article, we offer an approach that balances FASB's short-term objective with the primary concerns raised about its two-step approach to comprehensive reform.
As the Financial Accounting Standards Board (FASB) begins to analyze the comments it received regarding its first step towards overhauling postretirement benefit accounting, CCA Strategies offers an approach that balances FASB?s short-term objective with the primary concerns raised about its two-step approach to comprehensive reform.
In Phase II, the existing rules for employer accounting for pension and retiree welfare plans will undergo a thorough, multi-year review, and will likely culminate in a move to fair value or ?mark-to-market? measures and a convergence with international accounting standards. Phase I, in contrast, leverages existing accounting mechanisms to effect immediate balance sheet improvement in the interim.
The FASB has posted on its website well over 200 comment letters regarding its Phase I exposure draft. Many respondents request that Phase I be deferred and incorporated into Phase II. A common concern is that the exposure draft ties balance sheet reporting for a pension plan to the funded status on a Pension Benefit Obligation (PBO) basis. Concerned respondents contend the Accumulated Benefit Obligation (ABO) is a better measure of an employer?s current obligation, and hope that ABO will be recognized as such under Phase II?s comprehensive review. To the extent ABO ultimately prevails, respondents reason, interim use of PBO will create significant balance sheet disruptions. Deferring Phase I, however, would fail to satisfy the FASB?s strong desire for immediately improved balance sheet reporting.
Balancing these concerns, CCA Strategies advocates leveraging FAS 87?s two-prong approach for liability recognition. Currently, expense calculations are driven by PBO, with a minimum liability concept that ties the balance sheet to at least the unfunded ABO. The exposure draft simply relies on PBO, and would require the balance sheet to report the PBO funded position.
Knowing that Phase II will tackle the fundamental definition of the fair value of benefit obligations and the outcome is likely to fall on the ABO/PBO continuum, we propose no Phase I adjustment should be required to the extent an employer?s balance sheet currently reflects an accrual between the ABO and PBO funded positions. Phase I merely needs to ensure that those that fall outside these parameters adjust their balance sheets to move within the range of likely Phase II outcomes.
To illustrate, assume we have a plan with a $100 PBO and a $90 ABO. The graph below displays the funded status for a range of asset levels: $80, $95 and $110. The exposure draft would require the balance sheet accrual be adjusted to the bottom, blue line. Our suggestion is that the balance sheet accrual only needs to be brought within the range shown by red and blue lines.
| Example A Under-Funded; Under-Accrued | Example B Under-Funded; Reasonably-Accrued | Example C Reasonably-Funded; Under-Accrued | Example D Over-Funded; Over-Accrued |
Example E Over- Funded; Reasonably- Accrued |
|
| PBO | ($100) | ($100) | ($100) | ($100) | ($100) |
| ABO | (90) | (90) | (90) | (90) | (90) |
| Assets | 80 | 80 | 95 | 110 | 110 |
| (Accrued)/ Prepaid | (5) | (15) | 15 | 5 | 15 |
| Adjustment -- Current Rules | (5) | 0 | 0 | 0 | 0 |
| Adjustment -- Exposure Draft | (15) | (5) | (20) | 5 | (5) |
| Adjustment -- Alternative | (5) | 0 | (10) | 5 | 0 |
Under-Funded, Under-Accrued: In this example, the employer?s unfunded obligation lies between $10 and $20, depending on how the Phase II debate of PBO versus ABO plays out. The current balance sheet shows a $10 liability, reflecting a $5 accrued liability with an additional $5 liability under the current mark-to-market provision that applies to plans under-funded on an ABO basis. The exposure draft would push the liability up another $10 to move it to the unfunded PBO level at $20. As with the current rule, we propose that a $5 adjustment to the unfunded ABO level is appropriate for this Phase I interim.
Under-Funded, Reasonably-Accrued: The current accounting in this case has already yielded a $15 result that is between the $10 unfunded ABO and the $20 unfunded PBO. Rather than accruing to $20, we suggest this plan is reasonably accrued for Phase I purposes.
Reasonably-Funded, Under-Accrued: This is perhaps the most prevalent scenario among employers today. This plan has been funded enough to avoid the mark-to-market treatment that currently applies to under-funded plans, but the employer carries a balance sheet asset larger than the plan?s surplus. Our recommendation would force a write-down of this $15 asset to the actual $5 surplus based on ABO.
Over-Funded, Over-Accrued: Shifting to an over-funded situation, this plan?s assets exceed obligations by $10 to $20, based on PBO and ABO, respectively. To the extent the balance sheet only reports an asset of $5, that asset should be increased to $10.
Over-Funded, Reasonably-Accrued: To the extent the balance sheet asset at $15 already fits between the $10 over-funded PBO and $20 over-funded ABO, we suggest further adjustment during this interim period is unnecessary.
Summarizing in the pension context, we propose that Phase I should target the unfunded ABO to unfunded PBO range, and not try to aim for a single point within that range.
A similar interim approach for retiree welfare obligations is not only available, but even more necessary. Under FAS 106, expense migrates to the Accumulated Postretirement Benefit Obligation (APBO). Unlike with pension benefits, however, most employers have reserved the right to unilaterally reduce or revoke retiree welfare benefits. So APBO, while perhaps reasonable as a means for pacing expense accruals, is questionable as a statement of an employer?s existing obligation.
On the other hand, we disagree with the comments that advocate reporting only ?vested? APBO, netting, in effect, a zero liability on the balance sheet. CCA Strategies encourages the FASB to reintroduce from the FAS 106 exposure draft the concept of the APBO associated with retirees and actives that are fully eligible to retire. Consistent with our suggestion for pension accounting, if the existing FAS 106 accounting has produced a balance sheet accrual between this ?fully eligible? APBO and the total APBO, the result should be considered sufficient until the appropriate target can be determined under Phase II. An adjustment under Phase I should only be required to move the accrual within this range.
| Under-Funded; Reasonably-Accrued |
Under-Funded; Under-Accrued |
|
| APBO | ($100) | ($100) |
| Fully Eligible APBO | (70) | (70) |
| Assets | 0 | 0 |
| (Accrued)/Prepaid | (80) | (50) |
|
Adjustment -- Exposure Draft |
(20) | (50) |
| Adjustment -- Alternative | 0 | (20) |
Consider the under-funded, reasonably-accrued employer illustrated above. With $100 in total APBO, it has been accruing towards $100, but sits at $80 due to the various amortizations for plan amendments, etc. This APBO-based approach has produced a reasonable means of accruing expense. However, the reality is the employer is not strictly liable for the full $100, and forcing an additional $20 onto the balance sheet during Phase I would not be representative of the employer?s true obligation. If the employer in this example had a balance sheet liability between $70 and $100, no adjustment during this Phase I interim period should be needed. In contrast, it would be reasonable to require the employer in the under-funded, under-accrued example to increase the $50 balance sheet liability $20 to reach the $70 minimum.
CCA Strategies encourages the FASB to consider this balanced approach. Phase II outcomes are uncertain. Use Phase I to bring balance sheets into the likely range of outcomes. Doing so will ensure immediate, reasonable balance sheet reporting. And targeting the range and not an uncertain point within that range will avoid the disruptive effects of overshooting the target.
Our full comments may be found on the FASB website, comment letter #192, at http://www.fasb.org/ocl/fasb-getletters.php?project=1025-300, or click here to view them in their original format.
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