Accounting Rules Smooth Over Pension's Potholes

The nine companies turned the 2002 pension plan losses into gains on their annual report by computing 2002 pension earnings based on average expected rates of return of 9.2%.   However,the pension funds actually suffered losses averaging 9.3% in 2002 and 7.97% in 2001, according to an analysis by Bloomberg .  While the firms have reduced their 2003 expected returns to an average of 8.58%, as a result of the accounting standards under FAS 87, the corporations legally transformed $30.61 billion of pension losses into pretax earnings of $7.9 billion, according to the report.

That financial alchemy was done using “smoothing” provisions in the accounting rule, which  allows companies to take certain assets and obligations off balance sheets and amortize them as income or expenses over time.  Additionally, companies are allowed to report the expected return on assets, instead of actual losses and gains (See  Smooth Move ).

None of the nine companies with billion-dollar pension losses were required to disclose the actual amount of losses in the management discussion and analysis section of their annual reports. Rather, the losses were included in footnotes to financial statements in the reports, the Bloomberg analysis found.

The Financial Accounting Standards Board (FASB), the United States’ accounting rulemaking body, is well aware of the concerns surrounding FAS 87, recently voting to add pension accounting to its formal review agenda (See  FASB Agrees To Look At Pension Accounting ).   The move comes in response to a plethora of complaints about current pension accounting standards, and will focus specifically on how to enhance companies’ disclosure of their pension finances.

Can You Hear Me Now?

Verizon was the biggest beneficiary among the nine that Bloomberg analyzed. In fact, its pension fund accounted for 40% of its 2002 pretax earnings of $6.2 billion.   The company reported a $2.5 billion gain from the pension fund, under FAS 87, even though the fund actually lost $4.68 billion on its investments. The expected rate of return was positive 9.25%, while the actual return was negative 9.63%.

Joining the telecommunications company on the list is:

• IBM – actual pension losses of $6.94 billion; reported a gain of $520 million
• General Electric Co – actual pension losses of $5.25 billion; reported a gain of   $1.56 billion
• SBC Communications Inc – actual pension losses of $3.40 billion; reported a gain of $1.14 billion
• Boeing Co – actual pension losses of $3.27 billion; reported a gain of $400 million
• Lucent Technologies Inc – actual pension losses of $2.47 billion; reported a gain of $580 million
• Lockheed Martin Corp – actual pension losses of $1.40 billion; reported a gain of $160 million
• BellSouth Corp – actual pension losses of $1.28 billion; reported a gain of $830 million
• DuPont – actual pension losses of $1.92 billion; reported a gain of $220 million

However, change may be in the air.   In December, Verizon announced 2003’s earnings estimates will be lower, hit by a decision to expense stock options and a reduction in earnings derived from pension investments (See  Options, Pensions To Clip Verizon 2003 Earnings ).

Additionally, the telecommunications company, in response to shareholder requests, agreed to take pension income out of formulas used to determine executive compensation (See  Verizon Tossing Out Pension Income in Exec Compensation ).   The situation is very similar to another large company that is sharing space on Bloomberg’s list: General Electric (See  GE Reworks Executive Compensation Structure ).   General Electric also explained the change was brought on by advocacy groups, concerned that pension income is not actual income on the pension investments.