Financial Reporting Considerations Related to Pension and Other Postretirement Benefits
Introduction
This publication highlights some of the important accounting
considerations related to the calculations and disclosures entities provide under
U.S. GAAP1 in connection with their defined benefit pension and other postretirement
benefit plans. Many of these considerations have been included in prior Financial
Reporting Alert newsletters and are summarized below. In the current year,
relevant issues and disclosure items include (1) inflation and rising interest
rates, (2) the Inflation Reduction Act (IRA), and (3) the ongoing effects of the
COVID-19 pandemic.
Background
Inflation and Rising Interest Rates
The global economy has experienced volatility over the past several months,
together with pressures such as the lingering effects of the COVID-19 pandemic,
supply-chain disruptions, and geopolitical tensions. Faced with an
extraordinarily high rate of inflation, global central banks have been raising
interest rates in an effort to temper it.
Given the inflationary environment and the high level of uncertainty, entities
with pension and other postretirement benefit plans may find it challenging to
consider all relevant factors and develop assumptions for those plans. Entities
are advised to consult with their actuaries to evaluate the approaches they
should take to establish assumptions. We expect that entities would reflect the
known and actual impact of inflation and other macroeconomic factors in the
relevant short- and long-term assumptions. Even if some of the factors have
offsetting effects and the assumptions do not fluctuate year over year, entities
should document the considerations and provide related disclosures in their
periodic filings.
Connecting the Dots
ASC 715-20-50-12 requires enhanced disclosures about (1) the funded status of
defined benefit plans and (2) the key considerations of events during
the annual period that affect plan assets (particularly when Level 3
investments or derivatives instrument are held by the plans).
Accordingly, in issuing comments to SEC registrants, the SEC staff has
asked questions related to significant concentrations of risk within
plan assets and has required enhanced disclosure in accordance with ASC
715-20-50-1(d)(5) related to significant concentrations of risk within
plan assets. Entities should consider whether they have properly
assessed and disclosed the risks related to their plan assets,
particularly if their plans hold Level 3 investments.
Rollforward Method
Many entities use census data prepared before their fiscal year-end and
project forward any changes to measure their benefit obligation, as
allowable under ASC 715. Entities that elect to do so should use judgment in
determining whether any adjustments are necessary as a result of inflation
and rising interest rates when rolling forward their benefit obligation and
should document the judgments they made, as applicable. For example, if the
actual compensation paid for the fiscal year is higher than that assumed in
the calculation as of the beginning of the year because of inflation, the
actual benefit obligation at the end of the fiscal year should reflect such
change if significant. In addition, entities should consider disclosing
material changes made in the rollforward. See the Presentation and
Disclosure section for more information.
Risk-Mitigating Activities
In response to inflation and macroeconomic uncertainties,
entities with pension plans may consider purchasing insurance contracts to
cover plan benefits. Purchasing a nonparticipating annuity involves the
transfer of significant risk from the employer to the insurance entity
(commonly referred to as “buyout”) and will typically trigger plan
settlement.3 Entities with pension plans may also purchase insurance contracts that
do not transfer the benefit obligation to the insurer (commonly referred to
as “buy-in”), under which the pension plans receive periodic payments from
the insurer to cover the pension obligation. A buy-in contract typically
does not trigger settlement accounting since the employer retains the
primary responsibility for the pension obligation. Further, insurance
contracts in a buy-in arrangement typically qualify as plan assets. Entities
that are considering risk-mitigating activities should evaluate the nature
of the insurance contracts and determine the appropriate accounting
treatment.
Lump-Sum Settlements
In response to current macroeconomic uncertainties, some
entities may consider the use of restructuring programs involving a
reduction in workforce that may include early retirements. Such entities may
have pension plans that permit employees to elect to receive their pension
benefit in a lump sum, which could result in multiple lump-sum payments over
the course of the year. Further, rising interest rates may trigger more
pension participants to elect to receive lump sum payment sooner before the
interest rates go higher. Entities should consider whether the cost of all
settlements in a year exceeds the service-and-interest-cost threshold and,
if so, recognize a settlement gain or loss in accordance with ASC
715-30-35-79.
Connecting the Dots
The ASC master glossary defines a settlement of a pension or other
postemployment benefit obligation as a “transaction that is an
irrevocable action, relieves the employer (or the plan) of primary
responsibility for a pension or postretirement benefit obligation,
and eliminates significant risks related to the obligation and the
assets used to effect the settlement.”
Under ASC 715-30-35-82, any gain or loss from a settlement must be
recognized in earnings “if the cost of all settlements during a year
is greater than the sum of the service cost and interest cost
components of net periodic pension cost for the pension plan for the
year.” An entity that adopts an accounting policy of applying
settlement accounting to one or more settlements that are below the
service-and-interest-cost threshold must apply this policy to all
settlements.
When settlements occur in an interim period during a
year in which it is probable that the cumulative settlements for the
year will exceed the service-and-interest-cost threshold, an entity
should assess, on at least a quarterly basis, whether it is probable
that the criteria for settlement accounting will be met (e.g.,
whether the total settlements will exceed the threshold). If the
entity concludes that it is probable that the threshold will be
exceeded during the year, the entity should apply settlement
accounting on at least a quarterly basis rather than wait for the
threshold to be exceeded on a year-to-date basis. Accordingly, as
the settlements occur, and at least quarterly, the entity should
complete a full remeasurement of its pension obligations and plan
assets in accordance with ASC 715-30-35. Recognizing settlement
accounting at quarter-end would be an acceptable practical
accommodation unless, under the circumstances, the assumptions and
resulting calculations indicate that use of the exact date within
the quarter would result in a materially different outcome.
Inflation Reduction Act
On August 16, 2022, the IRA was signed into law. The IRA contains a tax and
spending package of roughly $740 billion that includes provisions related to
climate, clean energy, and health care affordability. The following key
provisions of the IRA may affect entities’ other postretirement benefit plans:
- Drug price negotiation — Selected drugs covered by Medicare Parts B and D will be subject to mandatory price negotiations with Medicare beginning in 2026, with negotiated prices subject to a cap. The number of drugs selected for negotiation will increase from 10 in 2026 to 20 in 2029 and subsequent years.
- Inflation rebate — Certain drugs covered by Medicare Parts B and D for which prices are rising at a higher rate than that of inflation will become subject to rebates. Under Medicare Part B, the rebate will first be due with respect to the first quarter of 2023. Under Medicare Part D, the rebate will first be due with respect to the period from October 1, 2022, to September 30, 2023. In addition, the government is permitted to delay rebate invoices until 2025 for initial periods, which could defer the timing of the first rebate payment by the manufacturers.
- Medicare Part D benefit redesign — The coverage gap under Medicare Part D will be eliminated, and as of January 1, 2025, manufacturers will be subject to mandatory discounts on brand drugs in the initial coverage and catastrophic coverage phases. In effect, the change will cap the out-of-pocket spending for Medicare Part D costs at $2,000 per year starting in 2025. The change will be phased in starting in 2024 by capping the out-of-pocket costs at approximately $3,250 in that year.
Since the above changes will be implemented in phases over the next several
years, estimating the potential impact of these provisions on other
postretirement benefit plan prescription drug benefits may be challenging.
Although the changes are designed to lower costs overall, entities should
continue to monitor their impact and consider all relevant facts. In addition,
for other postretirement benefit plans that apply for the Retiree Drug Subsidy
(RDS), qualifying for the RDS has become more difficult since the plans cannot
qualify unless the prescription drug benefits they offer are at least
actuarially equivalent to the now improved Medicare Part D benefits. It may be
that some plans no longer qualify for the RDS or are expected to still qualify
but for fewer years of subsidy payments.
COVID-19
The COVID-19 pandemic continues to affect major economic and financial markets,
and entities are facing challenges associated with the economic disruptions of
adjusting to what appears to be an uncertain “new normal.” Since the outbreak of
the pandemic, many entities have considered (1) the impact of their own actions
on defined benefit plans (e.g., plan amendments) and (2) the potential impact of
COVID-19 on certain significant actuarial assumptions that affect the
measurement of defined benefit obligations. Nevertheless, the potential
long-term economic effects associated with the COVID-19 pandemic can vary
depending on a reporting entity’s particular facts and circumstances, thereby
introducing additional uncertainty to ongoing estimates related to pension and
other postretirement benefits. However, the requirement in ASC 715 that entities
use the “best estimate” for each assumption as of the current measurement date
remains unchanged. Therefore, entities should consider whether COVID-19 may have
an impact on actuarial assumptions and document what factors they considered
(including any recommendation by their actuaries) in selecting this year’s
assumptions for their pension and other postretirement benefits, as
applicable.
Entities that elect to use the rollforward method to measure the benefit
obligation should use judgment in determining whether any experience adjustments
related to COVID-19 are necessary when rolling forward their benefit obligation
and should document the judgments they made, as applicable.
Further, entities may hold significant amounts of assets that do not have an
active market, such as investments in hedge funds, structured products, and real
estate assets that may have become more illiquid, making their valuation more
complex. Appropriately determining the fair value of such assets is important in
the determination of the funded status of a defined benefit plan.
Discount Rate
Over the past few years, we have provided insights into approaches
used to support discount rates for defined benefit plans (e.g., hypothetical bond
portfolio, yield curve, index-based discount rate), considerations related to the
application of discount rates when an entity measures its benefit obligation, and
considerations related to the use of a more granular approach to measure components
of benefit cost. Entities should discuss with their employee benefits specialists
whether certain refinements to hypothetical bond portfolio and yield curve
construction methods occurred in the current period. Considerations related to an
entity’s discount rate selection method, its use of a hypothetical bond portfolio,
and its use of a yield curve are addressed below.
Discount Rate Selection Method
ASC 715-30-35-43 requires the discount rate to reflect rates at which the defined
benefit obligation could be effectively settled. In the estimation of those
rates, it would be appropriate for an entity to use information about rates
implicit in current prices of annuity contracts that could be used to settle the
obligation. Alternatively, employers may look to rates of return on high-quality
fixed-income investments that are currently available and expected to be
available during the benefits’ period to maturity.
One acceptable method of deriving the discount rate would be to use a model that
reflects rates of zero-coupon, high-quality corporate bonds with maturity dates
and amounts that match the timing and amount of the expected future benefit
payments. Since there are a limited number of zero-coupon corporate bonds in the
market, models are constructed with coupon-paying bonds whose yields are
adjusted to approximate results that would have been obtained through the use of
the zero-coupon bonds. Constructing a hypothetical portfolio of high-quality
instruments with maturities that mirror the benefit obligation (also referred to
as bond matching) is one method that can be used to achieve this objective.
Other methods that can be expected to produce results that are not materially
different would also be acceptable — for example, use of a yield curve
constructed by a third party such as an actuarial firm. The use of indexes may
be acceptable as well.
Connecting the Dots
In determining the appropriate discount rate, entities should consider
the following SEC staff guidance (codified in ASC 715-20-S99-1):
At
each measurement date, the SEC staff expects registrants to use
discount rates to measure obligations for pension benefits and
postretirement benefits other than pensions that reflect the then
current level of interest rates. The staff suggests that
fixed-income debt securities that receive one of the two highest
ratings given by a recognized ratings agency be considered high
quality (for example, a fixed-income security that receives a rating
of Aa or higher from Moody’s Investors Service, Inc.).
Entity’s Use of a Hypothetical Bond Portfolio
To support its discount rate, an entity may elect to use a hypothetical bond
portfolio developed with the assistance of an actuarial firm or other third
party. Many hypothetical bond portfolios developed by actuarial firms or other
third parties are supported by a white paper or other documentation that
discusses how the hypothetical bond portfolios are constructed. It is advisable
for management to understand how the hypothetical bond portfolio it has used to
develop its discount rate was constructed, including the universe of bonds used
in the analysis. In particular, management should consider evaluating how bonds
included in the bond universe are assessed for reliability and quality of
pricing and the criteria used to evaluate and eliminate outliers.
We have been advised by some third parties, particularly those involved in
developing hypothetical bond portfolios in the U.S. markets, of refinements to
the bond-matching method resulting from advances in technology and modeling
techniques. Such refinements may require management to exercise additional
judgment when evaluating the reliability and quality of pricing of bonds
selected from the revised bond universe for inclusion in the hypothetical bond
portfolio. If applicable, management should consider the reasonableness of
adjustments or changes to the bond universe that is used to develop the
hypothetical bond portfolio and evaluate whether the changes made are
appropriate for the plan.
Connecting the Dots
Refinements in discount rate models occur from time to time and may be
driven by (1) the availability of new technology or modeling techniques
or (2) changes in available market information. Entities and their
auditors, with the assistance of employee benefits specialists, should
understand the nature of, the reason for, and the appropriateness of the
change(s). Entities should also consider the requirement to use the best
estimate when determining their discount rate selection method. ASC
715-30-55-26 through 55-28 state that an entity may change its method of
selecting discount rates provided that the method results in “the best
estimate of the effective settlement rates” as of the current
measurement date. Changes in the method used to determine that best
estimate should be made when facts or circumstances change. If the facts
or circumstances do not change from year to year, it would generally be
inappropriate for an entity to change the basis of selection. Changes to
an entity’s choice of discount rate selection method, as well as
refinements to a given discount rate selection method, are viewed as
changes in estimate, and the effect would be included in actuarial gains
and losses and accounted for in accordance with ASC 715-30-35-18 through
35-21.
It is important for entities that make refinements to the discount rate
selection method to consider the impact of the change in estimate on
disclosures. Specifically, entities should consider the disclosure
requirements in ASC 250-10-50-4, under which an entity must disclose the
material effect of changes in accounting estimates on income statement
and earnings-per-share measures, and ASC 715-20-50-1(k) and (r), under
which an entity must disclose (1) the discount rate used to determine
the benefit obligation and net periodic benefit cost as well as (2) an
explanation for any significant change in the benefit plan obligation
not otherwise apparent in the other required disclosures of ASC 715.
Entity’s Use of a Yield Curve
To support its discount rate, an entity may elect to use a yield curve
constructed by an actuarial firm or other third party. Many such yield curves
are supported by a white paper or other documentation that discusses how the
yield curves are constructed.
Management should understand how the yield curve it has used to develop its
discount rate was constructed as well as the universe of bonds included in the
analysis. If applicable, management should also consider evaluating and reaching
conclusions about the reasonableness of the approach the third party applied to
adjust the bond universe used to develop the yield curve.
We have been advised by some third parties, particularly those constructing yield
curves for non-U.S. markets (e.g., the eurozone and Canada), that because of a
lack of sufficient high-quality instruments with longer maturities, they have
employed a method in which they adjust yields of bonds that are not rated AA by
an estimated credit spread to derive a yield representative of an AA-quality
bond. This bond, as adjusted, is included in the bond universe when the third
party constructs its yield curve. Management should understand the adjustments
made to such bond yields in the construction of those yield curves and why those
adjustments are appropriate.
In recent years, we have held discussions with actuarial firms regarding the
incorporation of longer-duration bonds (bonds with stated maturities in the
range of up to 80–100 years) in the development of the yield curve. There is
significant judgment involved in the development of yield curves, particularly
when longer-duration bonds are used, since there often are no observable market
rates across the full spectrum of maturities. Management should understand and
consider evaluating the reasonableness of how the additional bonds included in
the bond universe are evaluated for reliability of pricing by considering
parameters such as screening for potential outliers. In a manner similar to the
discussion of hypothetical bond portfolios above, management should consider the
reasonableness of any revisions to the yield curve construction method in such
circumstances and decide whether the changes made are appropriate for the
plan.
Mortality Assumption
Many entities rely on their actuarial firms for advice or recommendations related to
demographic assumptions, such as the mortality assumption. Frequently, actuaries
recommend published tables that reflect broad-based studies of mortality. Under ASC
715-30 and ASC 715-60, each assumption should represent the “best estimate” for that
assumption as of the current measurement date. Entities should consider whether the
mortality tables used and adjustments made (e.g., for longevity improvements) are
appropriate for the employee base covered under the plan.
In 2014, the Retirement Plans Experience Committee (RPEC) of the
Society of Actuaries (SOA)4 released a new set of mortality base tables (RP-2014) and a new companion
mortality improvement scale (Scale MP-2014). In 2019, the SOA released a new set of
mortality base tables (Pri-2012) that include more current data than
the RP-2014 tables. Generally, we would expect an entity to use the Pri-2012
mortality tables because they are based on experience more current than that
reflected in the RP-2014 tables. However, the selection of a mortality assumption
should take into consideration an entity’s specific facts and circumstances,
including actual plan mortality experience to the extent credible.
Each year from 2015 through 2021, the SOA has released an annual updated mortality
improvement scale that incorporates the latest available historical mortality data.
In 2021, the SOA released Scale MP-2021, which reflects the historical U.S. population
mortality experience through 2019. Therefore, MP-2021 does not reflect any
historical or potential future effects of COVID-19, as explained in the SOA’s
October 2021 report Mortality Improvement Scale MP-2021. For 2022, for
the first time in several years, the SOA elected not to release a new mortality
improvement scale. In October 2022, the SOA released the report RPEC 2022 Mortality Improvement Update (the “2022
report”), which discusses the relevant research. The 2022 report shows that the
newest mortality data available from 2020 were severely affected by COVID-19;
however, as noted in the report, the “impact of COVID-19 on mortality rates . . .
has not been evenly dispersed by geography, race, sex, or socio-economic level,” and
the “excess death rates have also varied substantially from period to period with
pronounced peaks and less-elevated valleys.” Therefore, the SOA believes that it
would not be appropriate to incorporate the higher rates of mortality experienced
from 2020 without adjustments.
As further noted in the 2022 report, the SOA in April 2021 “released MIM-2021 (SOA
2021), a new mortality improvement model that is a single structure for actuarial
practitioners across different practice areas to create mortality improvement
projections.” Concurrently with its release of the 2022 report, the SOA released
MIM-2021-v3, an updated version of this model. The 2022 report observes that the
“functionality [of MIM-2021-v3] enables practitioners to model their selected
assumption for the effects of the pandemic on mortality.”
While entities should consider the most recent mortality information available when
determining their mortality assumptions for the fiscal year-end pension accounting
and any applicable remeasurement dates, the selection of mortality base tables and
improvement scales requires judgment and should take into account an entity’s
specific facts and circumstances. It is advisable for entities, with the help of
their actuaries, to (1) continue monitoring the availability of updates to mortality
tables, longevity improvement scales, and related experience studies and (2)
consider reflecting these updates in the current-year mortality assumption,
including whether the COVID-19 pandemic may affect the potential mortality
trends.
Entities should consider documenting the factors used (including any recommendation
by their actuaries) in selecting this year’s mortality assumption for their defined
benefit plan, including how they evaluated (1) the currently available base tables
and mortality improvement scales and (2) subsequent information.
Expected Long-Term Rate of Return
The expected long-term rate of return on plan assets5 is a component of an entity’s net periodic benefit cost and should represent
the average rate of earnings expected over the long term on the funds invested to
provide future benefits (existing plan assets and contributions expected during the
current year). The long-term rate of return is set as of the beginning of an
entity’s fiscal year (e.g., January 1, 2022, for a calendar-year-end entity). If the
target allocation of plan assets to different investment categories has changed from
the prior year or is expected to change during the coming year, an entity should
consider discussing with its actuaries and independent auditors whether an
adjustment to its assumption about the long-term rate of return is warranted.
In August 2021, changes to ASOP 276 became effective. Management generally engages an actuarial specialist to
assist in measuring pension obligations for financial reporting purposes. The
assumptions used to measure the pension obligation are the responsibility of
management. Before the changes in ASOP 27, actuarial specialists often would
specifically disclaim any assessment regarding the expected long-term rate of return
assumption when management selected the assumption and the actuary was not directly
involved in the analysis supporting the selection. Under the new revisions to ASOP
27, an actuary is required to assess the reasonableness of each economic assumption
that was not selected by the actuary.7 Accordingly, actuaries are now expected to assess the reasonableness of the
long-term rate of return assumption, and actuarial reports in most cases may no
longer disclaim an assessment of that assumption. An actuary’s assessment of
reasonableness of the long-term rate of return assumption does not change
management’s responsibility for the assumption or eliminate the requirement that the
independent auditor assess and mitigate any applicable risk of material misstatement
associated with the assumption.
Other Postretirement Benefit Plans — Health Care Cost Trend Rate and Discount Rate
ASC 715-60-20 defines “health care cost trend rate” as an “assumption about the
annual rates of change in the cost of health care benefits currently provided by the
postretirement benefit plan. . . . The health care cost trend rates implicitly
consider estimates of health care inflation, changes in health care utilization or
delivery patterns, technological advances, and changes in the health status of the
plan participants.” The health care cost trend rate is used to project the change in
the cost of health care over the period for which the plan provides benefits to its
participants. Many plans use trend rate assumptions that include (1) a rate for the
year after the measurement date that reflects the recent and expected future trend
of health care cost increases, (2) gradually decreasing annual trend rates for each
of the next several years, and (3) an ultimate trend rate that is used for all
remaining years. Entities should consider whether the COVID-19 pandemic may change
the health care cost trend rate — specifically, by assessing whether changes in
claims between periods correlate with changes in caseloads and corresponding
restrictions, thereby altering the timing of employees’ health care treatments.
Historically, the ultimate health care cost trend rate had been less than the
discount rate. While discount rates have started to rise in 2022, the discount rate
for some plans may still be below the ultimate health care cost trend rate given
that discount rates in recent prior years have been at near-record lows. Some
parties have raised concerns regarding this phenomenon since expectations of
long-term inflation rates are assumed to be implicit in both the health care cost
trend rate and the discount rate. In such situations, entities should consider all
the facts and circumstances of their plan(s) to determine whether the assumptions
used (e.g., ultimate health care cost trend rate of 5 percent and a discount rate
below that) are reasonable. Entities should also remember that (1) the discount rate
reflects spot rates observable in the market as of the plan’s measurement date,
since it represents the rates at which the defined benefit obligation could be
effectively settled on that date (given the rates implicit in current prices of
annuity contracts or the rates of return on high-quality fixed-income investments
that are currently available and expected to be available during the benefits’
period to maturity), and (2) the health care cost trend rate is used to project the
change in health care costs over the long term (which, as discussed above, includes
the effects of changes other than inflation).
For economic reasons related to the current high rate of inflation, initial and
short-term trend rates are also rising. These increases may not have been reflected
in recent experience because of the delayed effect of health care cost changes
caused by the contractual nature of insurance and provider contracting; therefore,
entities should assess the need to adjust recent experience to reflect the best
estimate of expected short- and long-term trends.
Other Considerations Related to Assumptions
In measuring each plan’s defined benefit obligation and recording the net periodic
benefit cost, financial statement preparers should understand and consider
evaluating and reaching conclusions about the reasonableness of the underlying
assumptions, particularly those that could be affected by continuing financial
market volatility. ASC 715-30-35-42 states, in part, that “each significant
assumption used shall reflect the best estimate solely with respect to that
individual assumption.”
Entities should consider comprehensively assessing the relevancy and reasonableness
of each significant assumption on an ongoing basis (e.g., by considering the impact
of significant developments that have occurred in the entity’s business as well as
employees’ long-term behavioral changes). Management should establish processes and
internal controls to ensure that the entity appropriately selects each of the
assumptions used in accounting for its defined benefit plans. The internal controls
should be designed to ensure that the amounts reported in the financial statements
properly reflect the underlying assumptions (e.g., discount rate, estimated
long-term rate of return, mortality, turnover, health care costs) and that the
documentation maintained in the entity’s accounting records sufficiently
demonstrates management’s understanding of and reasons for using certain assumptions
and methods (e.g., the method for determining the discount rate). Management should
also consider documenting the significant assumptions used and the reasons why
certain assumptions may have changed from the prior reporting period.
A leading practice is for management to prepare a memo supporting the following:
- The basis for each significant assumption used.
- How management determined which assumptions were significant from a range of potential assumptions, when applicable.
- The consistency of significant assumptions with relevant industry, regulatory, and other external factors, including (1) economic conditions; (2) the entity’s objectives, strategies, and related business risks; (3) existing market information; (4) historical or recent experience; and (5) other significant assumptions used by the entity in other estimates.
- For issuers that identify pension and other postretirement benefit obligations as critical accounting estimates, how management analyzed the sensitivity of its significant assumptions to change.
Presentation and Disclosure
In August 2018, the FASB issued ASU 2018-14,8 which amended ASC 715 to add, remove, and clarify disclosure requirements
related to defined benefit pension and other postretirement plans. The ASU’s changes
related to disclosures are part of the FASB’s disclosure framework project, which
the Board launched in 2014 to improve the effectiveness of disclosures in notes to
financial statements.
ASU 2018-14 added requirements for an entity to disclose the following:
- The weighted-average interest crediting rates used in the entity’s cash balance pension plans and other similar plans.
- A narrative description of the reasons for significant gains and losses affecting the benefit obligation for the period.
- An explanation of any other significant changes in the benefit obligation or plan assets that are not otherwise apparent in the other disclosures required by ASC 715.
All calendar-year companies adopted the ASU no later than December 31, 2021. We have
observed diversity in practice related to the format of, and detail provided in, the
narrative description of the reasons for significant gains and losses and other
significant changes. In terms of format, SEC registrants have (1) added footnotes to
the rollforwards of pension obligations and assets, (2) added a separate discussion
to narratively describe significant gains and losses, or (3) included discussions of
the results. The detail provided has ranged from a short description attributing
changes to updated discount rates to detailed discussions that attribute significant
gains or losses to each relevant assumption (e.g., discount rate, mortality).
SEC Staff Views
The SEC staff has commented on disclosures related to how registrants account for
pension and other postretirement benefit plans and how significant assumptions
and investment strategies affect their financial statements. Further,
registrants may be asked how they concluded that assumptions used for their
pension and other postretirement benefit accounting are reasonable relative to
(1) current market trends and (2) assumptions used by other registrants with
similar characteristics. For example, the SEC’s Division of Corporation Finance
(the “Division”) has requested that registrants explain significant differences
in actual experience and estimates. The Division has also raised questions about
specific plan assets and significant concentrations of risk and required
enhanced disclosures in accordance with ASC 715-20-50-1(d).
For more information, see Section 2.17 of Deloitte’s
Roadmap SEC
Comment Letter Considerations, Including Industry
Insights.
Disclosures of Critical Accounting Policies and Estimates
The SEC staff has requested more quantitative and qualitative information
about the nature of registrants’ assumptions. In particular, the staff has
focused on the discount rate and the expected return on plan assets.
Further, the staff has asked registrants how their disclosures in the
critical accounting estimates section of MD&A align with their
accounting policy disclosures in the notes to the financial statements. The
staff expects registrants to provide qualitative and quantitative
information necessary for investors to understand the estimation uncertainty
of the registrants’ critical accounting policies and estimates in MD&A,
as opposed to merely duplicating documentation from the accounting policy
disclosures in the financial statement footnotes.
In addition, the SEC staff has indicated that it may be appropriate for a
registrant to disclose:
- Whether a corridor is used to amortize the actuarial gains and losses and, if so, how the corridor is determined and the period for amortization of the actuarial gains and losses in excess of the corridor.
- A sensitivity analysis estimating the effect of a change in assumption regarding the long-term rate of return. This estimate should be based on a reasonable range of likely outcomes.
- How the registrant calculates historical returns to develop its expected rate of return assumption. If use of the arithmetic mean to calculate the historical returns produces results that are materially different from the results produced when the geometric mean is used to perform this calculation, it may be appropriate for the registrant to disclose both calculations.
- The reasons why the expected return has changed or is expected to change in the future.
- The effect of plan asset contributions during the period on profit or loss, when this effect is significant. The SEC staff has indicated that additional plan asset contributions reduce net pension costs even if actual asset returns are negative because the amount included in profit or loss is determined through the use of expected, as opposed to actual, returns. Consequently, such information can provide an understanding of unusual or nonrecurring items or other significant fluctuations so that investors can ascertain the likelihood that past performance is indicative of future performance.
Connecting the Dots
When evaluating critical accounting estimates in
accordance with PCAOB Auditing Standard 2501,9 auditors are required to obtain an understanding of how
management analyzed the sensitivity of its significant assumptions
to change on the basis of other reasonably likely outcomes that
would have a material effect on the registrant’s financial condition
or operating performance. Therefore, registrants should expect that
auditors may continue to expand their audit procedures to better
understand how management analyzes the significant assumptions that
may affect the measurement of the defined benefit obligation and
certain plan assets.
Non-GAAP Measures
In recent years, the SEC renewed its focus on non-GAAP measures resulting
from concerns about the increased use and prominence of such measures, the
nature of the adjustments, and the increasingly large difference between the
amounts reported for GAAP and non-GAAP measures. In response to increasing
concerns about the use of non-GAAP measures, the Division updated its
Compliance and Disclosure Interpretations in May 2016,
October 2017, and April 2018 to provide additional guidance on what it
expects from registrants when they use these measures. Some registrants
present non-GAAP measures that adjust for items related to defined benefit
pension plans. For example, a registrant may adjust to remove (1) all
non-service-related pension expense, (2) all pension expense in excess of
cash contributions, or (3) the amortization of actuarial gains and losses.
Some registrants that immediately recognize all actuarial gains and losses
in earnings present non-GAAP measures that remove the actuarial gain or loss
attributable to the change in the fair value of plan assets from a
performance measure and include an expected return. The SEC staff has
observed that these pension-related adjustments can be confusing without the
appropriate context about the nature of the adjustment. The staff suggested
that registrants clearly label such adjustments and avoid the use of
confusing or unclear terms in their disclosures.
For more information, see Section 4.16 of Deloitte’s
Roadmap Non-GAAP Financial Measures and Metrics.
Footnotes
1
The views presented in this publication are specific to U.S.
GAAP. For entities that use another reporting framework, such as
IFRS® Accounting Standards, preparers are encouraged to
discuss the accounting implications with their advisers as appropriate.
2
For titles of FASB Accounting Standards
Codification (ASC) references, see Deloitte’s
“Titles of Topics and Subtopics in the FASB Accounting
Standards Codification.”
3
See ASC 715-30-15-6.
4
The SOA is a leading provider of actuarial research, and its
mortality tables and mortality improvement scales are considered by many
plan sponsors as a starting point for developing their mortality
assumptions.
5
As defined in ASC 715-30, the “expected return on plan
assets is determined based on the expected long-term rate of return on plan
assets and the market-related value of plan assets.”
6
Actuarial Standards Board Actuarial Standard of Practice
(ASOP) No. 27, Selection of Economic Assumptions for Measuring Pension
Obligations.
7
Other than prescribed assumptions or methods set by law, or
assumptions disclosed in accordance with Section 4.2(b) of ASOP 27.
8
FASB Accounting Standards Update (ASU) No. 2018-14,
Disclosure Framework — Changes to the Disclosure Requirements for
Defined Benefit Plans.
9
PCAOB Auditing Standard No. 2501,
Auditing Accounting Estimates, Including Fair Value
Measurements.