Company-sponsored pension plans: accounting and management issues Despite their technical nature, the international rules on accounting for pension costs arouse strong feelings. Here’s a sample of some of the criticisms.

(A) Reviewing the financial statements of companies with DB pension plans that have adopted IAS, an analyst remarks: ‘The balance sheet figure for pension liabilities these companies report is meaningless. The smoothing techniques allowed under international rules mean that most of the actuarial gains and losses are off-balance-sheet. And there’s no accounting or economic justification for this. After all, if a company has bank debt and the debt is increasing each year, it can’t remove the increase from the balance sheet. Why should it be able to do this with pension liabilities?’

(B) A UK actuary queries the decision to value pension fund assets and liabilities at fair value at each balance sheet date. ‘This doesn’t give a true picture of the state of the pension fund since it only represents a snapshot of a fund’s assets and liabilities on one day. People look at a pension fund deficit and assume that the company must inject cash of this amount into the fund to eliminate the deficit. But this isn’t necessarily the case. The liabilities are long-term and the assets already invested in the fund may well be sufficient to cover them. For example, the aggregate deficit on UK corporate pension funds during the 2001 bear market was around £70 billion. However, if you assume fund assets earn a conservative stock market return – dividends and capital gains combined

– of 6% a year, this deficit will be wiped out in a decade. It would be more sensible to value fund assets on a long-term actuarial basis, based on the present value of expected returns.’

(C) A director of a German company that has an unfunded pension plan complains that international standards are forcing German companies to introduce funded plans. ‘Analysts say German unfunded plans aren’t transparent. But where’s the lack of transparency? We disclose a breakdown of our pension expense in the accounts. We also show the movement in the pension fund’s liabilities over the year. Funding would be costly for us. We would have to hand over company cash to the fund each year. This would deprive us of flexibility – at the moment, we can choose to invest the cash destined for future pension payments either in financial investments or in our operations. As a result, we can finance our business more cheaply. And our employees are protected since, under German law, we have to insure against the risk of default on our pension liabilities.’

Required Consider the above criticisms separately. According to accounting regulators, there are errors or misunderstandings in each of them. Identify them.

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