Journal of FSP: Accounting Reform and Pension Fallout

January 15, 2007

NEWTOWN SQUARE, PA — “New defined-benefit pension accounting rules are likely to negatively impact financial statements, debt covenants and stock prices, and give plan sponsors the incentive to seek less volatile pension asset allocations. These new accounting rules will only provide additional incentives for managers to freeze, reduce, or terminate defined-benefit plans,” according to Scott E. Stickel, PhD, CPA and James J. Tucker, III, PhD, CPA.

This statement introduces their article “New Accounting Rules for Defined-Benefit Pension Plans: Impact and Fallout,” which appears in the January 2007 issue of the Journal of Financial Service Professionals.  In the article, Stickel and Tucker dissect the likely effects of Statement of Financial Accounting Standards (SFAS) No. 158, issued by the Financial Accounting Standards Board (FASB), on benefit plans and investment portfolios.

Publication of SFAS No.158 marks the completion of phase one of a planned two-phase project by FASB to review and revise long-standing accounting rules for pensions and other postemployment benefits.  This phase focuses primarily on moving the funded status of defined-benefit plans from the footnotes to the balance sheet.

The authors note that the new accounting rules will require financial advisers to more closely scrutinize the financial health and funded status of pensions, as they are likely to significantly reduce stockholder equity for many companies and increase the volatility of stockholder equity in the future.  Since under the new rules, pension plans have an increased and negative impact on stockholder equity, they posit that companies will continue to downsize defined-benefit plans.  They note that advisers also need to consider whether their clients are likely to receive promised pension benefits.

The authors discuss how SFAS No. 158 eliminates from the balance sheet the “income smoothing” effects of overly optimistic pension assumptions, including treating deferred costs and losses as assets.  The impact of transferring such deferred items from net pension assets to stockholder equity is presented in a table.

In a section entitled “Impact on Financial Statements,” the authors point to two industry studies that estimated an 8%-9% reduction in stockholder equity for large public companies if the new accounting rules had been in force during previous years.  The impact of the new pension accounting rule for 10 large US companies, calculated in another industry study, is presented in tabular form.

The authors also consider the impact of the new rules on debt covenants, stock prices, and credit ratings.  Only credit ratings, which are given by agencies that already include footnote disclosures in their analyses, are unlikely to be significantly affected by the new rules.  On the other hand, the new rules could put many companies in danger of violating their debt covenants.  And on the stock pricing front, implementation of the new rules – which go into effect for fiscals reported after December 15, 2006 – is likely to create negative market reaction and provide strong incentives for corporate managers to freeze or terminate defined-benefit plans.

The authors briefly touch upon phase two of FASB’s accounting reform project, which they characterize as “a massive overhaul of the entire pension accounting framework [which]...promises to spark considerable controversy.”  They also note that the rules for accounting for pensions will also apply to other postemployment benefits, such as promised health care insurance, which are generally even less funded than pension plans.

Scott E. Stickel, PhD, is the Markmann Professor of Accounting at La Salle University.
A former member of the audit staff of the international accounting firm of Deloitte & Touche, he also served on the faculty of the Wharton School at the University of Pennsylvania. He can be reached at [email protected].

James J. Tucker III, PhD, CPA, is associate professor of accounting, taxation, and law at Widener University. He previously served on the faculty of the Graduate School of Management, Rutgers University. He may be reached at [email protected].

Published by the Society of Financial Service Professionals, the Journal of Financial Service Professionals is one of the oldest and most prestigious journals in the financial planning field.  From its roots in insurance, pensions and estate planning, the Journal has evolved into a vehicle for groundbreaking applied research in all areas of financial planning, including retirement planning, investments, tax, health care, economics, ethics and other topics of concern to insurance and financial advisers. 

Founded in 1928, the Society of Financial Service Professionals is the standard bearer for excellence in professionalism, advanced continuing education, and ethical guidance for the nation's top financial advisers. The Society has approximately 19,000 members, each of whom holds one or more of the following recognized financial service credentials: CLU®, ChFC®, CFP®, CPA, JD (licensed), RHU®, REBC®, CEBS® , CLF®, CFA©, CTFA®, CPC, EA and graduate degrees in financial services.  Active in nearly 200 Chapters nationwide, Society members assist the public in their efforts to achieve personal and business-related financial goals. Consumers can obtain free financial information or find a Society member in their community by calling the Society's toll-free National Consumer Referral Service at 1-888-243-2258 or visiting www.financialpro.org.

NOTE TO EDITORS:  A sample copy of the Journal of Financial Service Professionals is available upon request to Lisa Wetherby by phone: 610-526-2513, or email: [email protected].

Contact: 

Lisa Wetherby
(610) 526-2513
[email protected]