Running_Man
Thinks s/he gets paid by the post
- Joined
- Sep 25, 2006
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In erisa, Congress allowed companies to treat their own estimates of how much their pension investments would earn as if they had actually earned that much, even when the true returns were much smaller. Thus, a company can estimate that it will earn 8 percent, actually make 3 percent, yet still value its pension plan as if it had made the higher amount. In theory, this process, known as "smoothing," is supposed to account for fluctuations in asset valuations over time. In practice, it means that pension plans can become filled with phantom assets. At one point in 2004, the New York Times reported, the entire net worth of General Motors was accounted for by these imaginary investment gains in its pension plans. (The fanciful accounting practice has since been limited somewhat.)
In erisa, Congress allowed companies to treat their own estimates of how much their pension investments would earn as if they had actually earned that much, even when the true returns were much smaller. Thus, a company can estimate that it will earn 8 percent, actually make 3 percent, yet still value its pension plan as if it had made the higher amount. In theory, this process, known as "smoothing," is supposed to account for fluctuations in asset valuations over time. In practice, it means that pension plans can become filled with phantom assets. At one point in 2004, the New York Times reported, the entire net worth of General Motors was accounted for by these imaginary investment gains in its pension plans. (The fanciful accounting practice has since been limited somewhat.)
This is not an "accounting trick". This process is part of GAAP. A company is required to recognize an additional pension expense if their expected return fall to far behind actual return though.
Could you point me to the GAAP ruling that requires an adjustment in the company's estimate of expected return due to under performance of invested assets?[/QUOTE
Disclaimer: I am currently an accounting senior (graduate this week...yay) so with finals this week I didn't have time to research the exact treatment of pension accounting so I'm going basically off memory.
Companies are not required to adjust their expected rate of return, but their pension expense, which is the expense that shows up on the income statement. When calculating the pension expense, the company will used their expected rate of return. However if the expected return is significantly lower than the actual return, the company's pension expense would be increased. On the other hand, if actual returns were significantly higher than expected returns then pension expense would be reduced.
I believe that all public companies are required to disclose the funded status of their plans (Present value of obligations vs. Fair value of plan assets)
In the short time I spent researching this topic, here's what I found.
FAS 87:
http://72.3.243.42/pdf/aop_FAS87.pdf
Financial Statements: Pension Plans
Could you point me to the GAAP ruling that requires an adjustment in the company's estimate of expected return due to under performance of invested assets?[/QUOTE
Disclaimer: I am currently an accounting senior (graduate this week...yay) so with finals this week I didn't have time to research the exact treatment of pension accounting so I'm going basically off memory.
Companies are not required to adjust their expected rate of return, but their pension expense, which is the expense that shows up on the income statement. When calculating the pension expense, the company will used their expected rate of return. However if the expected return is significantly lower than the actual return, the company's pension expense would be increased. On the other hand, if actual returns were significantly higher than expected returns then pension expense would be reduced.
I believe that all public companies are required to disclose the funded status of their plans (Present value of obligations vs. Fair value of plan assets)
In the short time I spent researching this topic, here's what I found.
FAS 87:
http://72.3.243.42/pdf/aop_FAS87.pdf
Financial Statements: Pension Plans
The expected rate of return never has to be adjusted if the company can bakc up if they feel it is reasonable. However if they do not earn that rate the basis on which the future value of the pension will be lower than expected so that future years will have greater expense, but that is do to lower earnings, not a change in assumptions.
Good luck on your finals, when you get out in the real world you'll be surprised how many corners can be cut out of one FASB prounouncement.
This is, I suspect, why some of the pension plans managed by unions are more sound than those managed by external advisors. It's easy to take outsized risks with leverage and hedge funds when it's someone else's retirement you're playing with.The best reason for individual control(particularly when it involves a corporation) is because no one(that isn't subject to your control) will have a more vested interest in the outcome of how your money is invested(as well as spent) than the person whos money is on the line or the beneficiary of that money. That is actually a major tenant of modern economics(and is largely obvious).