Monday, December 20, 2010

Comparability in Financials, What Comparability?

A news release from SEI said that in its study of FAS 87 (now ASC 715) discount rates for 2009 fiscal years, 90% of them fell within the 161 basis point range from 5.27% to 6.88%. I wonder, where were the other 10% and how were they justified?

In the early days of FAS 87, in my experience, most companies were fairly cavalier in their choice of discount rates. Many used the same rate as they used for funding under Code Section 412. Others used their current liability interest rate. Still others seemed to use a dart board or a Ouija board.

Then the SEC intervened. They interpreted the FAS 87 guidance that companies look to the rate on high-quality fixed income instruments to mean that the rate should approximate that found on Moody's Aa bonds. A fairly typical approach was to look at Moody's Aa's a month or two before the measurement date, round up, usually to the next higher quarter of a point (but sometimes more than that) and use that rate unless there was significant change before the measurement date.

Accounting firms gradually gave this more and more scrutiny and then came Sarbanes-Oxley. Suddenly, the Big 4 (and other accounting firms generally followed) were asking companies to justify their discount rates. Discount rates became more and more tied to bonds of similar duration to the plan's obligations. Rounding up became taboo.And, all the while, the underlying discount rates on high-quality bonds were falling. Pension cost went up at the worst possible times.

So, what happened? Consulting firms came to the rescue. Since the accountants asked that discount rates be tied to specific bonds of similar duration to the obligations, actuaries developed tools to assist defined benefit plan sponsors in selecting and perhaps optimizing discount rates. As methods became more and more sophisticated, some plan sponsors went discount rate shopping. Think about it: if you were required to book the costs for a $billion pension plan and for a fee of, say, $10,000, you could buy yourself and additional 30 basis points in discount rate, would you do it?

So, while FAS 87 was supposed to improve the comparability of accounting for pension plans (and it probably did for a while), it appears that we have returned to days of less comparability. Come up with a rule and give smart people enough time and they will find the angle and find a way to optimize results.

It'snot as bad as it could  be, but comparability, we don't have no stinkin' comparability.

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