The Consulting Actuary

Session 703 - FAS 158 Basics
Presenters: Michael D. Schachet, Craig D. Hodges
Recorder: Gregory A. Reardon

One of the main criticisms investors, analysts, and credit agencies had with standards prior to Financial Accounting Standard (FAS) 158 was the potential for an employer to record an asset or liability inconsistent with a plan’s funded status. In response to this criticism as well as acknowledging some other issues with the Pre-FAS 158 standards, the Financial Accounting Standards Board (FASB) started a two-phase reform in an attempt to improve the informative value of an employer’s financial disclosure as well as to better reflect financial effects of current period events.

The birth of FAS 158 and its ramifications

Phase 1 of the FASB reform began in September 2006 with the creation of FAS 158, which affects plans accounted for under FAS 87, 88, 106, and 132(R). While FAS 158 made no changes to income statement entries (i.e., methods used to calculate net periodic benefit cost remain unchanged), FAS 158 has changed the way accounting entries are reflected on the balance sheet.

FAS 158 requires a plan’s net funded status on a projected liability basis to be recorded as an asset or liability on the balance sheet. There is no longer a need to record intangible assets for pension plans or additional minimum liabilities for plans experiencing an unfunded accrued benefit obligation (ABO). As such, pension liabilities are expected to increase as FAS 158 creates more focus on a plan’s unfunded projected benefit obligation (PBO) position and puts less emphasis on the unfunded ABO position.

FAS 158 requires the sum of a plan’s unrecognized losses/gains, prior service costs/credits, and transition obligations/assets to be charged/credited as accumulated other comprehensive income (AOCI). In general, stockholder’s equity will be reduced due to this new treatment of AOCI.

FAS 158 also changed the way in which other comprehensive income (OCI) is maintained. In addition to the annual AOCI amortizations as of the beginning of the fiscal year, OCI is further adjusted to reflect changes in PBO due to gains or losses, or the adoption of new plan amendments. This adjustment is immediately and fully recognized in OCI.

FAS 158 also eliminated the option to have a measurement date up to three months prior to the fiscal year-end. Under this revision, FAS 158 provides two approaches to transition the shift in measurement date to the end of the fiscal year. One approach is to re-measure the obligation at both the old and new measurement dates and calculate expense for the period between based on the earlier measurement date. Gains and losses that occur during this short period will also need to be calculated. The partial year expense and gains or losses are then reflected on the balance sheet. Curtailment or settlement gains or losses in the short period must be recognized.

The second approach is to calculate expense from the prior year’s measurement date to the current year’s fiscal year-end date (i.e., up to a 15-month period). This expense is then prorated to reflect the short period adjustment in addition to the 12-month period within the current fiscal year. Similar to the first approach, balance sheet items must reflect the short period expense and curtailment or settlement accounting; however under the second approach there is no need to calculate gains or losses between the old and new measurement dates.

For publicly traded companies, FAS 158 is effective for fiscal years ending after Dec. 15, 2006. All other companies subject to FAS accounting are required to conform to the new standard effective for fiscal years ending after June 15, 2007. However, the requirement to measure plan assets and liabilities as of the financial statement date is effective for fiscal years ending after Dec. 15, 2008.

In the initial year in which FAS 158 is adopted, certain transition entries must be recorded to properly account for how the balance sheet adjusts for the new methodology. Typically the intangible asset account is reversed and the plan’s pre-FAS 158 accrued (prepaid) account is increased (decreased) by an amount sufficient to result in the plan’s funded status. The AOCI is then adjusted to reflect the closing out of the intangible asset account as well as the increase in the plan’s liability.

FAS 158 also established additional disclosure requirements such as classifying liabilities as current or noncurrent. Current liability is the excess, if any, of the present value of amounts expected to be paid in the upcoming fiscal year over plan assets. Noncurrent liability is a plan’s liability (i.e., funded status) reduced by current liability.

Some additional disclosure requirements under FAS 158 are reporting each component of AOCI and OCI separately, as well as reporting expected amortizations related to gains or losses, prior service costs or credits, and the transition obligation or asset for the upcoming fiscal year.

Although FAS 158 created numerous additional requirements related to financial disclosures, FASB did remove the reconciliation of the funded status and the requirement to disclose the measurement date.

What’s after FAS 158?

It is expected that the second phase of the FASB reform will focus on the balance sheet and the income statement. These reforms, which could take several years to complete, are expected to address additional issues such as asset smoothing methods, liability measurement (accumulated vs. projected basis), additional disclosure requirements, and the inconsistencies between FASB and the International Accounting Standard Board (IASB).