Pensions as important financial instruments - Essay Example

Pensions are important financial instruments because they provide people with money for their retirement. The economic outlook for retirees 30 yearsfrom now include the realization that the 7.65% social security deduction everyone in the United States is paying will be worthless since the long probable outcome for this governmental pension fund is bankruptcy. It is the duty of the FASB to protect the best interest of retirees and to ensure that investors make decisions considering the effect pension funds have on the financial performance of a company.

Pension funds are backed up by financial assets. These assets are supposed to be equal or superior that the pension liabilities of the fund. Unfortunately there are times in which the portfolio managers of pension funds make bad investment decisions which cause the pension fund to be under funded. An under funded pension fund is a pension fund that has accumulated pension obligation that exceed its assets. In accounting the term to describe this situation is called pension minimum liability. FASB Statement No.

87 covers the topic of minimum pension liability. “This Statement requires immediate recognition of a liability (the minimum liability) when the accumulated benefit obligation exceeds the fair value of plan assets, although it continues to delay recognition of the offsetting amount as an increase in net periodic pension cost” (Fasb). Statement No. 87 was issued on December 1985. Many accountants and scholars believed that the treatment of minimum liability under Statement No. 87 was not totally logical, complete or conceptually sound (Katagiri).

On September 2006 there was a reform to the treatment of minimum pension liabilities. The changes came when the FASB created SFAS No. 158 Employers “Accounting for Defined Benefit Pension and Other Postretirement Plans. This statement amends FAS-87. The effective date of implementation of SFAS No. 158 was December 15, 2006. All public companies were mandated to comply with SFAS 158. One of the major changes associated with the statement is that companies are now required to report the funded status of the pension in the financial statements of the company specifically in the balance sheet.

One of the contributions of the statement to the accounting profession is that it increases overall transparency. In the past investors and users of financial information received information regarding minimum liability in the notes of the financial statements of a company. The financial disclosures provided by the statement have made it easier for investors to understand the effect pension plans have on the financial performance of a corporation. “This Statement improves financial reporting because the information reported by a sponsoring employer in its financial statements is more complete, timely, and, therefore, more representationally faithful” (Fasb).

Pension accounting has always been a complex accounting topic. Due to the importance of pension to the employees companies must ensure that the plans of the employees are properly funded. Back in 2001 Enron committed one of the biggest frauds in the history of the United States. Their fraudulent activities included mishandle of the pension fund of its employees. Instead of using a diversified portfolio strategy the firm filled the pension fund with its own stock fully knowing that the stocks were not worth the market value since the firm had no real intrinsic value.

The arrival of SFAS No. 158 serves as an audit mechanism that ensures proper disclosure is made to all shareholders in regard to the existence of a minimum liability. Once a company recognizes in the balance sheet that a minimum pension liability exist the employees of the company can put pressure on the firm to make sure that the company puts more money in the pension fund to properly fund it. Prior to the inception of SFAS No. 158 many financial analysts believed that including a pension minimum liability in the balance sheet was going to distort the financial ratio analysis of a company.

To me this opinion was not justified since pension plans once created constitute an obligation that must be paid since businesses are legally bound to pay that money once the employee reaches retirement age. From an international perspective the recognition of the equivalence of a minimum pension liability which forces companies to recognize the existence of a pension liability in the financial statement varies a lot by country. The table below shows a list of seven countries to illustrate in which countries pension liabilities is recognized.

Country Recognition of Pension Liability United States Yes France No Germany Yes Netherlands Yes Spain Yes United Kingdom Yes Switzerland No References Fasb.org. Summary Statement No. 87. Retrieved September 9, 2011 from http://www.fasb.org/summary/stsum87.shtml Fasb.org. Summary Statement No. 158. Retrieved September 9, 2011 from http://www.fasb.org/summary/stsum158.shtml Katherine, K. The College of Saint Rose. Retrieved September 9, 2011 from ftp://12.161.242.12/public/college/accounting/kieso/slide21.ppt