Accounting rules can turn pension losses into 'gains'

Many firms legally inflate earnings by using upbeat retirement fund estimates

April 06, 2003|By BLOOMBERG NEWS

NEW YORK — The Financial Accounting Standards Board, the private-sector panel that sets accounting rules, is calling for reforms in how businesses account for their retirement plans.

The reforms are being sought at a time when Lockheed Martin Corp., International Business Machines Corp. and seven other major companies lost more than $1 billion in pension-fund investments last year, while reporting pension gains in their income statements in annual reports to shareholders.

Verizon Communications Inc., which said in a footnote that it lost $4.68 billion, reported a $2.5 billion pension gain. That accounted for 40 percent of its 2002 pretax earnings.

U.S. accounting rules allow companies to include estimated pension gains, rather than actual returns, in their income statements.

As a result of the rule, called FAS 87, the nine companies legally transformed $30.61 billion in pension losses into pretax earnings of $7.9 billion, annual reports show.

"I don't like the FAS 87 model," said Robert H. Herz, chairman of the Financial Accounting Standards Board, which promulgated the rule in 1985. "I believe you're better off showing what actually happened."

As a first step, pension disclosure to investors should be improved, he said. The board decided this month to develop a new pension-accounting proposal, with a draft expected by year-end.

None of the nine companies with billion-dollar pension losses disclosed the amount of losses in the management discussion and analysis section of their annual reports to the Securities and Exchange Commission, most of which were filed last month. The losses were included in footnotes to financial statements in those reports.

In February, SEC officials said companies aren't providing investors with clear disclosure about pension accounting.

Carol A. Stacey, chief accountant of the SEC's division of corporation finance, said in an interview that there was a "general lack of informative transparent disclosure" in more than 500 annual reports covering 2001.

The rule requires companies to use estimated pension investment gains, rather than actual gains or losses, to "smooth" away stock-market volatility, according to its primary author, Timothy S. Lucas, then director of research at the Financial Accounting Standards Board.

The nine companies computed their 2002 pension earnings based on average expected rates of return of 9.2 percent.

Their pension funds actually suffered losses averaging 9.3 percent in 2002 and 7.97 percent in 2001, and have reduced their 2003 expected returns to an average of 8.58 percent.

"I certainly don't have those kind of expectations for my portfolio," said Herz, an accountant who became the accounting board's chairman last summer after retiring as a partner at PricewaterhouseCoopers LLP.

The rule distorts earnings during bull markets, too, company filings show. In 1999, pension earnings for the nine companies exceeded expected rates of return. Their pension funds actually gained $55.19 billion, while pretax earnings were only boosted by $5.34 billion.

Verizon, the largest U.S. regional telephone company, got the biggest boost of the nine companies. The company relied on its pension fund for 40 percent of its 2002 pretax earnings of $6.2 billion.

The rule allowed the company to report a $2.5 billion gain from the pension fund at a time when the fund actually lost $4.68 billion on its investments. The expected rate of return was a positive 9.25 percent, while the actual return was a negative 9.63 percent.

The management discussion and analysis section of Verizon's annual report filed March 14 didn't mention the pension plan's actual loss, which was found in a footnote.

"Investors aren't investing in Verizon's pension plan, they're investing in Verizon," said company spokesman Robert Varettoni. "We follow all SEC rules. We think we're providing all the necessary disclosure."

Lockheed Martin, the largest U.S. defense contractor, added $160 million to its 2002 profit with estimated pension earnings, though its pension fund actually lost $1.4 billion. The company used an expected rate of return for the fund of 9.5 percent; the fund actually lost 6.9 percent. Lockheed Martin didn't mention the pension loss in its discussion section of its annual report.

"The $160 million that is listed as income, according to FASB, is just that, a list of numbers on paper and not cash income, and no indication of the fund's performance on the market," said Lockheed spokeswoman Meghan Mariman.

SBC Communications, the second-largest U.S. regional telephone company, boosted pretax earnings in 2002 with $1.14 billion of estimated pension earnings, based on an expected rate of return of 9.5 percent. The pension fund actually lost $3.4 billion, or 10.5 percent. The loss wasn't mentioned in the annual report's management discussion and analysis.

"We feel like it's good disclosure," said SBC spokesman Russell Johnson. He said the management discussion is 12 pages more than in the 2001 annual report. "It's a lot more than it was last year."

IBM, the world's largest provider of computer services, boosted pretax earnings by $520 million from estimated returns, as its pension fund actually lost $6.94 billion. Its expected rate of return was 9.5 percent, and its actual return was a loss of 11.35 percent.

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