Accounting

New Pension Accounting: Volatility City?

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To that end, Mulford, along with graduate student associates Erin Quinn and Ryan Swanson, produced a study issued this month that seeks illustrate the impact of running changes in pension-plan value through the income statement. In a nutshell, the accounting change would spur a big rise in volatility stemming from the percentage changes in pension expense and in income from continuing operations. (The latter refers to net income before such one-time events as extraordinary items and discontinued operations.)

The study looked at 24 of the 30 companies represented in the Dow Jones Industrial Average. Six companies were eliminated from the report because they either didn't have pension plans or pension data wasn't clear or available. The researchers applied the full fair value treatment to changes in asset values for each company for a five-year stretch (2002 to 2006). The study compared actual returns on pension plan assets to expected returns, reflecting the market swings of bull and bear markets.

In 2002, for example, all 24 companies — including 3M, Boeing, Caterpillar, Citigroup, Dupont, JP Morgan Chase, and Merck — predicted positive returns. But weak markets led to actual losses on plan assets for all two-dozen companies.

Thus, the pension expense for median companies that year climbed by 887 percent. Run through the income statement, and evaluated by an untrained eye, that increase in pension expense could make the median company look quite a bit less profitable. Further, company profits would look extremely volatile compared to 2006, when the median company adjusted pension expense dropped by 109 percent.

To see the effects the change in accounting treatment might have on a single company, consider Dupont's pension expense over the five years (see chart). The chemical company's adjusted expense figure swung from a 2,077 percent deviation between expected and actual results in 2002 to a negative deviation of 374 percent in 2006.

The study's results for percentage change to income from continuing operations was similarly "all over the map," said Mulford. Using the revised accounting treatment, the median company would have reported a 51 percent drop in income from continuing operations in 2002, while income would have risen by 9.8 percent in 2006.

When it comes to the volatility of individual companies, Boeing stands out as being especially affected by fair-value pension accounting (see chart). The aircraft manufacturer would have recorded a 177 percent dip in income in 2002, but a 168 percent rise in 2006. Alcoa would have suffered from a big swing in volatility as well, going from a 306 percent drop in income in 2002 to a 9.8 percent rise in 2006. Caterpillar's fair-value adjustments would have been recognized as a 171 percent decrease in income in 2002 and an 11 percent jump in 2006.

Comment on this article

Readers' Comments

My point about liabilities

Posted by Daniel Moore | March 27, 2008 11:04am

Fair Value of Pension Obligations Included

Posted by Charles Mulford | March 27, 2008 08:36am

Mulford study half-baked

Posted by Daniel Moore | March 27, 2008 07:39am