Over the last few years, accounting standards for employee benefits around the world have begun to look similar. In the long term, convergence of accounting standards may be a positive step for employers, as there will be fewer sets of accounting rules to follow in the short term, local rules will change.
Accounting for employee benefits in the U.S. in the future will likely contribute much more volatility to corporate books. This added volatility will be another disincentive for employers offering defined benefit pension plans and post-retirement medical programs.
In many ways, the U.S. Statement of Financial Accounting Standards 87 (SFAS 87) and its related statements (numbers 88, 106, 112, 132) are no longer the trendsetters for employers’ accounting for employee benefits.
Newer standards outside the United States resemble the SFAS family but attempt to address SFAS shortcomings. Governing bodies for accounting standards in several countries have a review of benefits accounting high on their agendas. All these factors may be leading to one approach, or standard, for employee benefits accounting, regardless of where in the world an organization is headquartered or operates.
Historically, organizations took a simplified approach to benefits accounting, with no liabilities disclosed on the balance sheet or in related footnotes. The charge, or expense, to profits for a period was generally equal to the cash contributions to a fund or insurance policies, the amount directly paid to participants, or the amount set aside as an internal reserve if benefits were unfunded.
Accounting bodies concluded that there was a need to disclose liabilities on the organization’s balance sheet (or in financial statement footnotes), since they could be quite significant in some cases. Also, actuarial methods and assumptions for determining cash contributions to a benefits fund could vary considerably from one organization to another. Under certain circumstances, a country’s tax regime may allow no contributions in some years, even though benefits continue to accrue. As a result, expense amounts were not always comparable and could be subject to manipulation.
In December 1985, the Financial Accounting Standards Board (FASB) in the U.S. issued SFAS 87. At the same time, it issued SFAS 88, covering employers’ accounting for settlements and curtailments in defined benefit pension plans, as well as termination benefits.
A few years later, SFAS 106 and 112 were released, covering employers’ accounting for post-employment benefits other than pensions. For most U.S. employers, this primarily means retiree medical and retiree life insurance coverage.
The disclosure and expense requirements under these standards set the trend for most ensuing accounting statements for employee benefits around the world. The basic principles of disclosing the market value of assets and a current interest rate measure of liabilities in the footnotes to the balance sheet, and a prescribed method for calculating expense for the period have withstood the test of time.
The FASB approach to accounting for employee benefits spread quickly around the world because overseas subsidiaries of U.S. companies as well as non-U.S. companies wishing to do business or raise capital in the U.S. were required to report on that basis. Over the years, other countries adopted their own accounting standards for employee benefits that looked similar to the SFAS statements. In particular, Canada, Mexico and Japan followed the lead of the U.S.
Some observers felt that SFAS 87 as originally written allowed too much smoothing of changes in asset and liability values due to economic market fluctuations. Under the standard, employers are allowed to systematically recognize asset gains or losses over a period of up to five years when determining the market-related value of assets used for determining the return on assets component of the net periodic benefits cost.
Smoothing is also employed for gains or losses from both assets and liabilities, which must be recognized only to the extent that the net value exceeds 10 percent of the greater of assets and the projected benefit obligation, or PBO. In addition, the net value outside this corridor is further smoothed by gradually recognizing it in pension expense over the average expected working period of the covered employees assumed to benefit under the plan.
Primarily due to the extended bull markets of the 1990s, another criticism of SFAS 87 has surfaced over the last few years. When pension plans become well funded, an employer may actually have net periodic pension income and build up a prepaid pension cost as an asset on the balance sheet.
In the last few years, this created front-page headlines in the U.S. about large companies “inflating” their earnings by using pension income. This increased the pressure for more transparent accounting for benefits in the U.S.
In 1985, the predecessor to the International Accounting Standards Board introduced its version of an accounting standard for employee benefits (IAS 19). Some employers in countries with no formal accounting standards now use IAS 19. The standard was modified over the years, most significantly in 1998, so that the current version closely resembles the FASB approach, while attempting to address some of the perceived shortcomings of the FASB statements.
In particular, the standard places a limit on the buildup of a net pension asset on an organization’s balance sheet. Also, prior service costs are recognized over the period until benefits covered by a plan amendment are vested (in many cases, this may mean immediate recognition). Table 1 compares the primary provisions of the different standards.
The types of benefits covered by IAS 19 are quite broad. In general, post-employment benefits are included in the standard, as well as such benefits as vacations and sick leave. Because IAS 19 is intended to apply internationally, the IASB did a better job of anticipating the variety of benefits typically encountered outside North America.
In Regulation 1606/2002, the European Union has prescribed that International Accounting Standards will be required for the accounts of publicly traded employers in member countries starting in 2005, or 2007 in some cases. Other non-publicly traded employers may report under national accounting standards if such standards exist.