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Get in Step With FASB's New Standard

The new pension accounting rules affect independent institutions’ financial statements. Here’s what you need to know.

By Teresa P. Gordon and Cornelia L. Sawatzky

The FASB issued its Statement of Financial Accounting Standards No. 158 in September 2006 in response to increasing concerns about off-balance-sheet arrangements that make it difficult to understand an entity’s true financial position. For the most part, the new rules do not require new information to be generated; all the details already exist in notes to the financial statements. However, under the new rules, the funded status of benefit plans will be recognized as a noncurrent asset for over-funded plans and as a liability for under-funded plans. For plans that provide a retiree health-care benefit, there will probably be a current as well as a noncurrent liability.

Figure 1

Estimating the Impact

To estimate the impact on NACUBO members, we examined the 2005 financial statements that member institutions had voluntarily posted on the NACUBO Web site.  Many institutions provide only defined contribution plans through TIAA-CREF and other programs and will not be affected by the new standard. However, more than one third (represented by 33 of 91 documents posted) reported either a defined-benefit pension plan or some other retiree-benefit obligation (see Figure 1). The larger colleges and universities tended to have the type of retiree-benefit plans that will require recognition on the balance sheet. The average enrollment for all institutions was 4,203 students, while the institutions with affected plans had 7,434 students enrolled. However, institutions of any size may be affected.

We used data from the pension and post-retirement benefit notes to estimate the impact of the new standard on liabilities, unrestricted net assets, total net assets, and a leverage ratio. Not every report provided sufficient information in the notes for our analysis; hence, Tables 1-4 are based on 20 annual reports with the necessary data.

Table 1
Percentage Change Caused by Adoption of SFAS No. 158

  Liabilities Unrestricted Net Assets Total Net Assets Debt to Unrestricted Net Assets Ratio

Average

5.1%

-3.6%

-1.9%

9.3%

Median

3.4%

-2.7%

-1.3%

6.3%

Minimum

-2.8%

-14.7%

-6.2%

-1.8%

Maximum

19.1%

1.8%

0.7%

33.8%

For the 15 colleges and universities at which liabilities rose, the average increase was more than 7 percent, with a nearly 5 percent decrease in unrestricted net assets. The new standard will have a double-whammy impact on any debt-to-equity ratios, because liabilities generally increase but net assets decrease. If your organization has post-retirement benefit plans or severely under-funded defined-benefit pension plans, your current ratio will also be affected. Under the new rules, the anticipated costs for the next year are reported as current liabilities unless sufficient plan assets are set aside to cover the amount. The six colleges and universities with more than 10,000 students were harder hit by the new standard as compared to the smaller institutions, as shown in Table 2.

Table 2
Median Change by Enrollment

  Liabilities Unrestricted Net Assets Total Net Assets Debt to Unrestricted Net Assets Ratio

5,000 or fewer students

3.3%

-1.4%

-0.6%

4.8%

More than 5,000 but fewer than 10,000 students

3.2%

-2.9%

-1.9%

6.3%

More than 10,000 students

4.8%

-3.6%

-2.2%

8.2%

Under the earlier rules, defined-benefit pension plans were subject to a minimum-liability requirement. This may explain why the impact for the three institutions that reported a defined-benefit pension plan but no other post-retirement plans seemed to be affected the least by the new standard. In contrast, the four institutions with both types of affected plans were the hardest hit by the new rules. In both cases, the sample size is too small to be predictive, but our findings (see Table 3) do suggest that planning ahead could be important.

Table 3
Median Change by Types of Affected Retirement Plans

  Liabilities Unrestricted Net Assets Total Net Assets Debt to Unrestricted Net Assets Ratio

Other post-retirement benefit plans only

3.6%

-2.9%

-1.3%

6.3%

Pension only

-0.6%

-1.0%

-0.5%

2.4%

Both types of plans

9.5%

-3.2%

-1.5%

13.2%

We also estimated the impact on the change in unrestricted net assets if the new rules had been in effect for fiscal years 2004 and 2005 (see Table 4). The effect on the statement of activities proved to be interesting. Seventy percent of the colleges and universities experienced a positive impact on the change in unrestricted net assets in 2005 and a negative impact in 2004. The volatility introduced by the new standard will probably differ in direction from year to year as discount rates and expected rates of return on any plan assets vary with economic conditions.

Table 4
Impact of SFAS No. 158 on the Change in Unrestricted Net Assets

  Negative Impact (increase in deficit or decrease in surplus) Positive Impact (decrease in deficit or increase in surplus)
 

# institutions

Average

Median

# institutions

Average

Median

2004

14

-23.4%

-8.8%

6

29.6%

4.8%

2005

3

-17.7%

-12.3%

17

111.3%

11.5%

The impact of actuarial gains and losses arising during the year as well as amortization of prior period and transition gains and losses must be presented separately on the statement of activities and not added in with other expenses. Given the volatility that the new standard introduces, more colleges and universities may opt to report an intermediate operating measure on the statement of activities. The example provided in SFAS No. 158 paragraph A40 will probably be less confusing for financial statement users as compared to the example in paragraph A41. (To access the complete statement, go to www.fasb.org/pdf/fas158.pdf.) The abbreviated statement of activities shown in Table 5 provides the general idea of what is meant by the term “intermediate operating measure.” NACUBO’s Accounting Principles Council is currently working on an advisory report that will identify other items that would typically be considered nonoperating.

Table 5
Abbreviated Statement of Activities With Intermediate Operating Measure

Statement of Activities  
 

Unrestricted

Operating revenues and gains:

 

        Tuition and fees

$  XXX

        Contributions, grants, and contracts

XXX

        Investment income

XXX

        Auxiliary services

XXX

        Net assets released from restrictions

XXX

                Total unrestricted revenues, gains, and other support

XXX

   

Expenses:

 

        Instruction

XXX

        Research

XXX

        Institutional support

XXX

        Auxiliary enterprises

XXX

                Total expenses

XXX

                        Increase (decrease) in unrestricted net assets from operating activities

XXX

        Nonoperating items:

 

                Investment income and gains in excess of spending policy

XXX

                Net assets released from restrictions--long-lived assets

XXX

                Pension-related changes other than net periodic pension cost

XXX

   

Increase (decrease) in unrestricted net assets

$ XXX

Readying Your Accounts

To determine the impact for your institution, consult the financial statement notes that describe your pension or other retiree-benefit plan. The difference between the projected benefit obligation and any plan assets is referred to as the “funded status.” This will be your new liability account, although a few institutions may have plan assets greater than the obligation and will be able to recognize the difference as a noncurrent asset.

The impact on unrestricted net assets is a bit trickier to estimate. It will be the difference between the amounts currently recognized and the funded status. This includes previously unrecognized actuarial gain or loss plus unamortized prior service costs and any remaining unamortized transition gain or loss that existed when SFAS No. 87 or SFAS No. 106 were initially adopted. Since the minimum liability rules no longer apply, any intangible asset related to pension plans will also be eliminated against the additional liability with a possible increase to unrestricted net assets.

On the statement of activities, total expense will not be affected at all. For the year of initial adoption, a separate line item on the statement of activities will report the net change in unrestricted net assets as of the end of the fiscal year. There is no effect on reported expenses and no other separate line for the impact on the current year. See the example in SFAS No. 158, paragraph 37. (To access the complete statement, go to www.fasb.org/pdf/fas158.pdf.)

In subsequent years, a separate line not included in total expense will report the change in the funded status of the retirement plans that is not already reported in net-periodic-pension and other post-retirement benefit costs. This line comprises several items. First, the amortization of prior service cost included in expense is reversed.  Second, the amortization of any transition amount included in expense is reversed. The third and most volatile component is the gain or loss. Actuarial gains and losses are fully recognized in the retirement obligations on the balance sheet as they occur, but they are only taken into net-periodic-pension cost if they are material in amount. Accordingly, this third component is the actuarial gain or loss for the year net of any amount amortized using the corridor approach described in SFAS No. 87, paragraph 32. (To access the statement, go to www.fasb.org/pdf/fas87.pdf.) Actuarial gains will increase unrestricted net assets, and actuarial losses will decrease unrestricted net assets. Such gains and losses are largely outside the control of management. This is one reason we recommend reporting the new line (“pension-related changes other than net periodic pension cost”) as a nonoperating item (see Table 5).

If all of this sounds complicated, we should at least be thankful that the final standard is much simpler to implement than the exposure draft. The comment letters from NACUBO and others had a positive impact on the FASB’s deliberations.

Still Time to Plan

The FASB opted for a very quick implementation of the recognition and disclosure portion of the new standard. Consequently, NACUBO members with fiscal years ending June 30, 2007, or later will be making the changes during the fiscal year ending in 2007. If your fiscal year ends in May 2007, you may implement early or make the change during the fiscal year ending May 2008.

SFAS No. 158 also requires that the measurement date for plan assets and liabilities coincide with the fiscal year-end. This portion of the standard is effective for fiscal years ending after December 15, 2008. Accordingly, you will have ample time to make arrangements with your actuary.

Despite the quick implementation, you have time to plan changes in the presentation of your financial statements (for example, adding an intermediate operating measure). If you anticipate a substantial impact on ratios or other amounts, changes in debt covenants and other contracts can still be negotiated.

Unfortunately, this is not the final word on accounting for retiree-benefit plans.  The FASB will be reconsidering a number of aspects of the current standard, including the measure of both expenses and obligations. For example, it could change the measurement of the pension obligation such that future salary increases are not considered.  As of this date, FASB has not announced when documents related to this second phase will be released.

TERESA P. GORDON is professor of accounting and CORNELIA L. SAWATZKY is a technical writer for the University of Idaho, Moscow.