Financial Accounting Standards Board Statement of Financial Accounting Standard No. 87 (FAS 87) became effective for non-U.S. plans for fiscal years beginning after December 15, 1988. Earlier application was encouraged. Later application was not discussed.
Many subsidiaries of U.S. companies required to comply with FAS 87 in Japan made no substantive changes to their consolidations. No actuarial valuation, the center-point of FAS 87, was ever provided. What now?
Ask two actuaries and two accountants and you will get three answers. Fortunately for the accountants, they control the answer!
The simple answer derives from the above paragraph. If your retirement plan was in existence prior to the FAS effective date for your plan, then your plan has already complied with FAS 87.
"What?" you say. "We never did any valuations, we never hired an actuary. The auditor just carried our premiums forward in consolidation leaving us with no residual accrued pension cost. They said the difference was not material. How can you call that compliance?"
The key to the dilemma is materiality. As always, the accountants are right. It's their show! They determine what is material and what is not.
The reality of what transpired is that your accountant determined, in a non-actuarial manner, that consolidated earnings were not materially affected by the difference between a proper calculation of Net Periodic Pension Cost (NPPC) and the premiums paid to your carrier. Perhaps he went further and had you give him a calculation of 100% of the (in-)voluntary severance benefits, compared that to the level of assets reported by the carrier and determined that there was no material impact of a possible "additional liability" on the balance sheet.
If your plan had been a "Book Reserve System" plan, a similar analysis would have been required using the level of the book reserve rather than plan assets held by someone else.
So, while the results were, by definition, "right," it left you, the plan sponsor, in a difficult position; what did they do about the reconciliation of funded status? Did they make estimates of the components of Net Periodic Pension Cost?
The reconciliation of funded status examines the difference between the Projected Benefit Obligation (PBO) on the one side and the assets and Accrued Pension Cost (APC) on the other. The difference is composed of Net Transition Obligation (NTO), Unamortized Past Service Cost (PSC) and Unrecognized Net Gain & Loss (UNGL). These pieces are not so important for estimating NPPC. They are critical for determining the Intangible Asset.
The intangible asset arises only when there is an additional liability. It recognizes the sponsor's promise to make up the "unprovided" PBO through a series of pre-determined amortization payments. The NTO and the PSC fulfill the requirements and can be used to make up an Intangible asset. The UNGL cannot be used.
In any event, odds are, the accountant didn't calculate the pieces. The only number you are sure of is the (additional) accrued pension cost of zero.
Now your actuary has just completed his valuation. He is ready to set up the reconciliation of funded status and asks you for the assets and the Net Transition Obligation and any Prior Service Costs hanging around. You give him a blank stare, recall that his hourly rate is the same for blank stares as it is for doing your work and you tell him "I don't know, do whatever is right."
Now the bad news. As we already said, you complied with FAS 87 with your first fiscal year following December 15, 1988. Your auditor let you "estimate" NPPC as being equal to your premium, saying that the estimate was within material limits and he was right. Was there a component of the NPPC for the amortization of the NTO?
We originally took a very hard line approach. No NTO had been calculated and the act of doing a precise calculation is not a plan amendment. We required the entire unprovided discovered at the first legitimate valuation to be Unrecognized Net Gain & Loss. This resulted in some very large UNGL since the non-actuarial methods previously used were not very good estimates. It also, put the sponsor painfully close to having to reduce owners' equity for an additional liability. Now, as discount rates are being reduced, equity is being charged.
An alternative is to go back to the first compliance year, collect data, determine the, then, correct NTO and its proper amortization schedule. Determine correct NPPC for each year and precisely determine the balances of NTO and UNGL. This would be expensive.
The SEC has permitted a shortcut approach to the alternative. Do the preceding year-end actuarial valuation, determine the unprovided, then split it up theoretically. The NTO will be the amount of this unprovided that would still be unamortized if the current situation exactly applied to the original situation and the NTO had been properly amortized. As before, with reducing discount rates, a charge against equity is likely.
An interesting situation arises when a company was not required to apply FAS 87 previously (really, not just a materiality issue) and, for whatever, reason, they must now comply. We feel that a full NTO is appropriately calculated here. Equivalently, a PSC as if the plan were new.
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