Monday, January 24, 2011

Pension and OPEB Accounting - Immediate Gain and Loss Recognition

I read this morning that Verizon is changing its accounting methods for recognition of actuarial gains and losses. Rather than amortizing gains and losses outside of a corridor over an extended period of time (I could get really technical here, but suffice it to say that since roughly 1985-1987, virtually every American company with a defined benefit pension plan has been using an amortization method similar to the one I described here), they will be expensing all of these gains and losses in the year they occur. Presumably, this is to prepare for global accounting convergence.

To me, this is part of mark-to-market hysteria, and it is just wrong. Let's make the assumption that Verizon's current intention is to keep these plans going (if they intend to terminate, that's a whole different discussion). What happens then is that changes in a hypothetical bond portfolio that Verizon doesn't even own will have a direct effect on the company's annual earnings. And, to make it worse, this earnings effect will be based on the yield on that hypothetical portfolio on a specific day. So, if the yields on that bond portfolio increase on December 31 after a decrease on December 30, and then followed by a big decrease on January 2, then Verizon gets to book extra income (or less expense). Similarly, if the assets that the plan holds rise on December 31, that rise will be reflected in that year's income.

This makes no sense to me. The obligations under the plan are long-term obligations. Short-term deviations in the valuation of those liabilities should be irrelevant for most companies. Similarly, short-term deviations in the valuation of plan assets should be irrelevant. If the plan has a short remaining life span, or if the company is in a very bad financial position, these deviations become far more relevant, but for a solid company with ongoing plans, this is, IMHO, just foolhardy.

I don't know how many people, if any, will comment on this, but I feel certain that at least some readers will disagree with me. That's ok. You are entitled to your opinion. And, you know, I wouldn't be so adamant about this if, for example, companies got to pick a discount rate for valuation of these obligations based on some sort of moving average of bond yields (even a weighted moving average), but people shouldn't have to hang on tenterhooks waiting to see what is happening with bond rates on December 31, not in my world anyway.

I guess I think it's time for the JLASB (if you can't figure it out, I just might not tell you).

1 comment:

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