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Pensions and OPEBs II

Pensions and OPEBs II - NBA 500 Intermediate Accounting...

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Unformatted text preview: NBA 500: Intermediate Accounting Mark W. Nelson Pensions and OPEBS II 1. Method and Consequences of Adoption of SFAS No. 106: OPEBS use the same basic disclosure format as pensions, but OPEB expense is not tax-deductible until paid, and increases in assets are taxed, so there has never been much incentive for firms to fund. Lack of funding meant firms had to recognize huge losses and liabilities upon adoption of SFAS 106, and net OPEB liabilities tend to be relatively large because there is relatively less plan assets to offset the APBO. Shifting to SFAS No. 158 brought those liabilities on balance sheet. 2. Pensions under SFAS No. 158: Pitney Bowes: Learning to navigate a pension footnote and infer pension entries. Note: as shown on the PB case, we will make journal entries affecting the PEG or the plan assets to the net “pension liability” (as discussed in the “additional consideration” box on p. 959), and we will make entries to other comprehensive income net of deferred taxes (as indicated in the note at bottom of Illustration 17-5 of your book). For most of chapter 17, your book makes entries to PEG and to plan assets and then nets those two accounts later, and your book ignores tax effects. 3. Pension Headwinds, Pension Gaps Loom Larger: a. c. Errors in expected return assumptions have predictable effects: Firms assuming high expected return will have lower pension expense (or higher pension income) in the current year, but may have higher pension expense (or lower pension income) in future years if actual returns aren’t as high as expected (because they have to amortize the accumulated difference between expected and actual if it gets large enough). Firms assuming low expected return will have higher pension expense (or lower pension income) in the current year, but may have lower pension expense (or higher pension income) in future years if actual returns exceed expected returns (because they have to amortize the accumulated difference between expected and actual if it gets large enough). Key difference: governmental plans use expected rate of return as their discount rate — another reason to assume a high rate of return! A firm with a severely underfunded pension plan could: o wait and hope that interest rates rise (such that they could justify using a higher discount rate to calculate their PBO, and therefore calculate a lower PBO) and/or that the stock market rebounds (such that the fair value of their plan assets increases). 0 fund the plan with cash, other assets, or their own stock. This can improve future earnings, since contributed amounts will increase the fair-value of plan assets and therefore reduce future pension expense (or increase future earnings) at the expected rate of return. 0 change their pension plan to a cheaper alternative, including termination or renegotiation of plan or switch to cash balance plan. Underfunding can justify changes that couldn’t be made otherwise. d. A governmental entity with a severely underfunded pension plan could: 0 Pass the buck to retirees by curtailing benefits 0 Raise taxes to fund 0 Sell bonds to fund (note: replacing a flexible OPEB liability for an inflexible bond). 0 Raise revenue in other ways (selling assets, privatizing toll roads, lottery systems, etc.) 0 Increase risk of portfolio to boost expected return (added attraction: GASB 45 pegs the discount rate for the liability to the expected return on investments. If invest in equity, have higher discount rate, so lower present value of liability, as well as higher expected return on assets). Note: have to get the cash from somewhere to buy the equity, so probably also raising taxes and/or selling bonds. If selling bonds to buy equity, risky arbitrage strategy. 0 Close their eyes, cover their ears, and ignore the standard (e.g., Texas — just for fun, see “Window on State Government” and “Accounting, Texas-Style” attached.) House Bill 2365 Protects Texans From F ar-Reaching Consequences of Government Acco... Page 1 of 3 . Window on State Government Susan Combs Texas Comptroller of Public ACWu nu. Web Site Survey House Bi112365 Protects Texans From Far- Reaching Consequences of Government Accounting Rule By Texas Comptroller Susan Combs State Senator Robert Duncan State Representative Vicki Truitt In 2004, the Governmental Accounting Standards Board (GASB) issued Statement No. 45 (GASB 45), creating accounting standards for governmental entities’ "other post employment benefits" (OPEB). We are concerned that an arbitrary accounting rule, handed down by a board with no checks or balances, will adversely impact health care benefits for our state retirees. GASB 45 requires Texas state and local governments to recognize and record retiree health insurance benefit costs as a financial obligation, even if there is no such legal obligation. On the surface this appears to be a fairly innocuous and ministerial requirement. However, because the rule requires these costs to be measured and reported for a period up to 50 years in the future, the requirement has a far- reaching and potentially damaging affect. Consider your own individual health care costs and those of your family for this year alone. Now try to predict how your health may change during the next 50 years and project the associated cost. It’s an impossible figure to determine or to guess. Despite this fact, now contemplate opening a trust account and depositing that total amount today. For most people, attempting to do this would be financially impossible or would at least cause serious fiscal hardship. GASB 45 has put state and local governments around the country in this untenable position. Retirement health benefits for the state of Texas and most Texas governmental entities are not constitutionally mandated or contracted programs. Instead, the programs are reviewed and renewed during the regular budgeting process. Accounting experts tell us GASB 45 — this nationally developed, voluntary accounting stande — conflicts with Texas law. We explored this issue fully during the recently concluded legislative session. There was healthy debate in both the House and the Senate. We learned the American Academy of Actuaries believes the rule would damage the credibility of a balance sheet and add unwarranted volatility. Many actuaries recommend predicting 11ab111t1es for no more than five to ten years into the future. http://www.window. state.tx.us/newsinfo/colurnns/ 07061 1gasb.html 3/4/201 1 House Bill 2365 Protects Texans From Far-Reaching Consequences of Government Acco... Page 2 of The rule didn’t pass the GASB board unanimously. One dissenter, Paul Riley Wood, indicated it would mean governments should pre-fund or book items that do not require pre-funding or booking. This is precisely the concern we have in Texas. We appreciated the appearance of Carl Johnson, a main author of the GASB 45 statement, during our legislative discussions. We asked how this principle was developed and requested an explanation of the rule’s underlying theory. His response was that it’s what the board concluded based on “all of the facts and communications.” Ipse dixit, the Latin phrase for “because I say so.” Contrary to the GASB board’s out-of-state hearing process, our facts and communications are laid out in full view. Texas retiree health benefits are budget - not contract - based, and that process is clearly visible every budget cycle, when the Legislature and other local governmental entities draft their budgets. Texas budgets within available revenue; however, what we can afford as a state changes each biennium. For example, in 2003 the Legislature faced a $10 billion shortfall. Consequently, benefits were reduced. Texas is a pay-as-you—go state, and there is no way to accurately report that changing figure on a balance sheet. Susan Spataro, an accounting expert and Travis County, Texas, auditor for the past 18 years, investigated what GASB 45 would mean for her county. She obtained two opinions from professional accounting firms on the cost of pre-funding retirees’ health insurance benefits based on the requirement of projecting the cost of the program. One firm suggested a price tag of $89 million; the other projection was $320 million. This disparate range illustrates the flaw in GASB 45's measurement of the cost of the benefits. It’s true. GASB doesn’t specifically say these amounts must be paid immediately. Instead, they require calculation and reporting of an “Annual Required Contribution.” Travis County would be required to front an annual required contribution of $46 million. To obtain those extra millions, property taxes would have to increase 16 percent, the proceeds of which would be devoted exclusively to the GASB contribution. If that price went unpaid, it would compound, eventually showing these fictional liabilities as exceeding assets. The county would be insolvent on paper. The county would be in the same unenviable position as the state — register a huge, so-called liability and take the ensuing lumps, or cut retiree health benefits. Ms. Spataro concluded GASB 45 does not meet the two-prong test necessary for an accounting transaction to be booked: it does not meet the accounting definition of an obligation, nor is it measurable. Some suggest that the county or the state could simply book this as a liability without pre-funding. But accounting rules should not require a governmental entity to measure its solvency by liabilities it does not legally bear. Those who want Texas to comply with this mandate also ignore the human and social cost of complying with the rule. To pre-pay retiree benefits as though we had no control over them would http://www.window.state.tx.us/newsinfo/columns/07061 1 gasb.htm1 3/4/201 1 House Bill 2365 Protects Texans From Far-Reaching Consequences of Government Acco... Page 3 of 3 cost the state of Texas billions of dollars or unnecessarily force significant adjustments to retiree benefits. Even worse, other important areas of appropriation such as public education, transportation, criminal justice and Medicaid could also be adversely affected. This is a problem. Consider what happened when the private sector equivalent of GASB, the Financial Accounting Standards Board (FASB), imposed a similar rule on private companies. No fewer than 70 percent of Fortune 500 companies cut or eliminated retiree health insurance benefits. Texas is not alone in questioning GASB 45. State Sen. Leticia Van de Putte of San Antonio, the president of the National Conference of State Legislatures, points out that other states are consulting their attorneys and accountants and working through the math. Still others are even looking at ways to eliminate the GASB board altogether. Texas has decided instead to be a leader of reason in the effort to counteract the potential for adverse consequences to our retirees. Texas’ Attorney General has clarified there is no legal obligation. House Bill 2365 simply creates an “other comprehensive basis of accounting (OCBOA)” that allows government retiree health plans to continue to be accounted for as they have been for years — on an annual, pay-as-you-go basis. In addition, the bill calls for long-term retiree health cost data to be made available for informational purposes, as part of the supplemental information submitted with a financial statement. This is a fair and balanced approach. Texas funds OPEB obligations for two-year periods because the state Constitution generally prohibits the Legislature from creating a debt or obligation beyond two years. As elected officials, we have an obligation to uphold the Constitution and take into account the implications of implementing GASB 45 for those who have devoted their professional lives to the state of Texas. And that is exactly what we are doing. __30-_ Susan Combs is Texas Comptroller of Public Accounts. Texas State Senator Robert Duncan of Lubbock represents Senate District 28. Texas State Representative Vicki Truitt of Keller represents House District 98. (1,129 words) http://www.window.state.tx.us/newsinfo/columns/ 07061 1gasb.html 3/4/201 1 Article | Accounting, Texas-Style Page 1 of 2 Hit ;'vfr,\‘.\:ori (if the Mrmhunun [tin‘lflzilc’ .u m (forcing) and din-NI'HIP’IU'IL’ nu w idem that guitar git-ruler m'rulumic drum: and inrliwdum’ I tpwrirf‘riinu .‘l l titti‘tii {intellect Home About Mi Centers City Journal Experts Issues Publications Pedcasts Video MlWebsites Events Books Supporting Ml Contact Ml THE WALL STREET JOURNAL. Accounting, Texas-Style May 29, 2007 By E..l. acumen Retiree health benefits amount to an exceptionally cushy deal for America's public-sector workers. Texas, for example, not untypically pays 100% of health insurance premiums for state employees who can retire in their early 50:. Unlike pensions, - these other retiree benefits generally are financed on a pay-as—you-go basis. These benefits impose huge and growing future liabilities on taxpayers—liabilities that states and localities have long hidden from public view, deceiving citizens about the true costs. And the nation‘s second largest state is now poised to perpetuate the deceit. Last week the Texas Senate completed passage of a bill that would allow the state and its local governments to avoid funding long-term obligations for retiree health insurance and other non-pension benefits. If Gov, Rick Pen-y signs the measure, Texas will simply defy a key provision of established government accounting standards This would be stunning setback for efforts to improve transparency and accountability in government finances around the country Three years ago, the Government Accounting Standards Board (GASB) promulgated a new requirement for state and local governments to begin calculating and reporting the net present value of their retiree benefit promises GASB 45 is based on the sensible premise that future retiree benefits. like pensions, are essentially a form of deferred compensation that should be ecognized as their costs accme. The nile becomes effective in fiscal 2007-08 financial reports for the largest govemment employers. Why is this a big deal? Because the total unfunded liability for state and local retiree benefits (other than pensions) has been estimated at $2 trillion ($50 billion for Texas govemments alone). The numbers ara so daunting that opponents of funding the iabilities—especially public employee unions—have predicted governments would face a stark choice between starving basic services and entirely eliminating retiree benefits, That's baloney. While unfunded liabilities will be reported in notes to financial statements. the number of immediate concern to egislators and taxpayers will be the "annual required contribution," which amortizes the amount over 30 years. For example. a city with a total unfunded liability of $1 billion might initially have an annual required contribution of $35 million. If it pays the whole amount, there is no impact on the balance sheet. If it chooses to pay only $20 million, the result is a net liability of $15 million. The required contribution will grow rapidly it it is ignored or under-funded—so governments that choose to ignore the number will risk seeing their credit ratings suffer, Getting the jump on the GASB timetable, New York‘s Mayor Michael Bloomberg has already made what amounts to a $2 billion dawn-payment on his city's required contribution. What isn't baloney—and what opponents of the GASB 45 do understand—is that financial transparency about costs may help apply some braking mechanism to the otherwise natural tendency of governments to engage in runaway promise-making to their employees. Even 30, state and local officials do have some breathing room to explore strategies for reducing their required contributions. Options include streamlining insurance plans, eliminating overlaps with Medicare, revising eligibility standards, requiring co-pays and creating trust funds supported at least in part by employee contributions. While there are clearly many ways of skinning this cat, some government oicials would rather pretend the animal doesn‘t exist—even while they continue to feed it under the table. The pretense became official in Texas earlier this year, when Comptroller Susan Combs circulated a letter to the standards board claiming the rule simply shouldn't apply in her state. Texas doesn‘t allow its public employees to form unions; therefore, she said, retiree health benefits are not contractual obligations but bi-annual appropriations "changeable at the will of a legislative body." Yet the comptroller and her legislative allies also have made it clear that they have no intention of changing anything, because they do, In fact, view employee benefits as an obligation. If GASB 45 is implemented, Comptroller Combs mate, "the worst of all possible wonds will occur—a non-existent future liability will result in a loss of benefits now." Huh? if the liability is "non—existent," . what is being lost? The Texas bill requires disclosure of long-term retiree benefit liabilities "for information and planning purposes only." This simply . isn't good enough: Unless some of the liability hits the balance sheet under consistent niles that politicians can't manipulate, there will be no incentive to effectively manage retiree benefit costs. Ms. Combs and Texas lawmakers apparemly are gambling that the state is simply too big an issuer for credit raters to downgrade. But smaller, more vulnerable govemmenls can‘t be quite so cavalier—which perhaps explains why Houston and other cities have already indicated they won't opt out of GASB 45. lronicelly, both Comptroller Combs and Gov. Perry have been national leaders in expanding the public‘s access to detailed government expenditure data. But their stance on honest accounting only serves the interests of disclosure-averse elected officials and public-sector union bosses from coast to coast. This is truly a Texas-sized bad example. E. J. McMahon is a senior fellow at the Manhattan institute and a member of GASB's Derivatives and Hedging Task Force. ©2007 The Wall Street Journal MANIAT'I‘AN INl'l'I'l'lJTE POI POLICY IEIIAICH http://wwwmanhattan—institute.org/htm1/_wsj -accounting_texas_style.htm 3/4/ 201 1 ...
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