Pension plans invest some cash into the stock market, and the stock market collapse of 2001 and 2002 hurt them just as badly as it hurt individual investors. But if an interested party examines corporate reports, one will not find much evidence of this decline in value. Corporate reports pretend that none of the wallops and whacks by the market has affected them. On the other hand, when General Motors issues $10 billion of bonds and states that it plans to use the cash to shore up its pension fund, then one understands that the market crash really and truly blitzed corporate pension plans.

 

The confusion results because of FASB's Statement 87, which ought to be amended as soon as possible. In today’s world, investors yearn for a more accurate picture of what's going on, and so we should end the fictions created under present-day pension accounting.

 

To begin, pension plans are in essence subsidiaries of their parent corporations, so they should be consolidated. The immediate impact of consolidation will be the inclusion of pension assets and pension liabilities on corporate balance sheets; for most business enterprises, this inclusion will reveal higher financial risk. Today's accounting not only understates pension liabilities, but also it allows firms to net the pension assets against the pension debts. The result is to make the company look better than it really is.

 

Next, we should eliminate the artificial smoothing involving prior service costs and related items. Whenever a firm changes a pension plan, it should record the expense immediately. The FASB, instead, allows business entities to hide the obligations imbedded in these pension activities and amortize the expense over an extended period of time. Such a capricious amortization process merely serves to minimize the true economic effects of these items. It isn't much different from AOL's suppression of its marketing costs.

 

For some weird reason, the FASB allows firms to employ an expected return from its pension investments instead of the actual returns. This rule has allowed some organizations to show positive returns on the pension plan even while it lost millions. For example, Sprint added to its income statement expected returns on its pension assets of $336 million in 2000 and $353 million in 2001 when in fact Sprint lost $157 million in 2000 and $236 million in 2001. This alone implies that the rules allowed Sprint to misstate earnings by one billion dollars over the two years. Shame on the accounting profession!

 

Without getting involved in the messy details, Statement 87 does provide some relief when actual returns differ markedly from expected returns. This so-called corridor method is ridiculously complex because it reports only those differences that pass a certain threshold, and even then it allows firms to amortize these gains or losses over a long period of time. Let's eliminate this nonsense.

 

Finally, the pension interest expense depends on the interest rate, but corporations may soon have the latitude to play games with this rate. Companies now should choose the 30 year-Treasury bond rate, which entails a low rate in today's climate. This low interest rate produces a low interest expense but shows relatively higher pension liabilities. The Bush administration proposes to allow businesses to apply corporate bond rates instead, which allows higher rates and produces small pension liabilities (though they must show higher interest costs). After a transition, business enterprises would have to match the age of its workers with the maturity of the bonds, i.e., firms with older workers would use the interest rates associated with corporate bonds that mature in a short period, while those with younger workers can employ the interest rate of corporate bonds with longer maturities. Some gaming will still occur, of course.

 

If the FASB would correct these problems in pension accounting, reported pension liabilities would increase by billions and perhaps trillions of dollars. Corporate managers might use these numbers to pressure employees to accept lower pensions. Members of Congress will not like the consequent political pressures, but workers should know the truth now and prepare for their hoped for retirement years -- or at least realize that they might not be able to retire.

 

It will be interesting to report the truth about pensions and also report the truth about stock options. American workers might realize that they are getting shafted, while managers receive huge benefits from their stock options. The FASB should follow their policy of economic neutrality and not worry about these effects. Let's disclose this chasm, and let the chips fall where they may.