Financial standards - the unfair albatross - new accounting rule for post-retirement benefits - Column

USA Today (Society for the Advancement of Education), Nov, 1994 by Jeff A. Schnepper

THE FINANCIAL Accounting Standards Board (FASB) has the authority and responsibility to issue or create required standards for financial accounting and reporting. In December, 1990, it issued FASB 106, "Employer's Accounting for Post-Retirement Benefits Other Than Pensions."

Before then, most employers used cash basis (or pay as you go) accounting for "other" post-employment benefits. Typically, these were health care plans and life insurance premiums. Historically, these amounts were minor and, while it was conceptually wrong to account for such payments on a cash basis (because financial accounting attempts to match expenses and revenues to the period in which they are incurred or earned), it was not worth the cost in time and money to report them on an accrual basis. The only major requirement was that these cash basis amounts be disclosed in the annual report's footnotes.

FASB 106, however, requires companies to account for such post-retirement benefits currently--as they are "earned," rather than when they are paid. It thus allows investors today to see where a company's future cash flows will be directed.

Companies now have the option of two approaches--immediate or deferred recognition. Immediate recognition gets the pain over all at once. It shocks the balance sheet with a liability that represents the accumulated post-retirement benefits obligation. It also reduces equity because it is counted against current earnings. Moreover, it produces higher continuing expenses than cash reporting and therefore cuts net earnings.

Under delayed recognition, the accumulated liability does not get recorded at all. Rather, it is amortized against earnings over as much as 20 years. Rather than producing an initial balance sheet shock, delayed recognition gradually works its way onto the balance sheet. That amortization means the recurring expense hit under this method is even higher.

In simplest terms, FASB 106 requires employers who are providing health and welfare benefits to their retired employees (outside a tax-qualified pension plan) to create a new financial accounting liability account. The net liability represented by this account is determined by the present value of the health and welfare benefits to be provided to the retiree group less the current value of the assets of the enterprise set aside to fund them.

While the long-term effect remains subject to conjecture, the short-term impact is apparent. Adoption of FASB 106 has resulted in diminished corporate earnings, a reduction in collateral performance-based management compensation, and lower shareholder dividends. Most significantly, FASB 106 has caused corporate America to revise the way it provides post-retirement benefits. In some cases, it has eliminated them altogether.

While some businesses are taking strong steps to reduce the costs of retirement health benefits, others have been pushed by FASB 106 to adopt new funding methods or exploit complex tax loopholes that are buried in annual report footnotes. The new funding methods almost always leave retired employees with more risk from future health spending increases. For example, Procter & Gamble Co. and Gillette Co. have started employee stock ownership plans that will give workers convertible preferred shares to pay for their health benefits when they retire. However, if the stock's price stagnates or declines, the retiree's fund for medical costs could dry up. The IRS approved the P&G plan in 1990, but later said it would not approve similar plans because of the revenue drain. For this reason, the Gillette medical funding program requires employees to pay income taxes on stock they receive through the plan.

Other firms are contributing to post-retirement health and medical plans only if employees chip in first--long before they retire. For example, all American Airlines' U.S.-based employees except pilots and flight attendants must make monthly contributions to a medical care account for at least a decade before they retire in order to qualify for retiree medical benefits from the company.

In September, 1993, William J. Falk, director of the health and welfare actuarial practice for the benefits consulting firm of Towers Perrin, reported that FASB 106 would reduce many of the biggest U.S. corporations' total reported profits by a higher-than-expected 33% in 1993 and as much as 45% for 1994. Lower interest rates forced companies to set aside higher reserves because the smaller return created lower earnings and therefore will not contribute as much to offset future retirees' medical expenses. "The greater reductions to be seen in profits as a result of this accounting change surprises us and may cause some companies to reduce the [retiree's medical] benefits even more," he forecast.

A survey of 65 of the 100 biggest U.S. companies showed that the one-time deduction to cover employees' past services has reduced the total net worth of those firms by $103,000,000,000! FASB 106 cuts into both profits and equity of American companies subject to the rule. It creates a substantial burden in the international capital markets when a U.S.-based firm is compared to a foreign corporation. The level playing field now has self-created bumps, but only for the home team.