FASB Update andWorking with Auditors
Raymond D. Berry, Consulting ActuaryGrant Thornton, [email protected]
William G. Karbon, EVP and Director of ComplianceCBIZ Benefits and Insurance Services, Inc.
Working With Auditors
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Ray’s Agenda
• NOT ASC 960
• ASC 715 overview – focus on qualified defined benefit plans
– Also applies to non-qualified and foreign plans
• My viewpoints on best practices
• You, your clients, and their auditors should communicate, before any actuarial valuations are performed
3
ASC 715
• ASC = Accounting Standards Codification
• ASC 715 – compensation – retirement benefits, reflected on plan sponsors’ financial statements
• Annual pension expense = net periodic benefit (or pension) cost – P&L
• Annual disclosures = PBO less assets, etc. – balance sheet
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Pension Benefit Obligation
• PBO = present value of accrued benefits but reflecting salary increases through retirement
• ABO = present value of accrued benefits
– Similar to funding target
• PBO less assets = funded status on balance sheet
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Net Periodic Pension Cost
• Service cost
• Interest cost
• Expected return on assets
• Amortization
– Transition asset/obligation
– Prior service cost/credit (plan amendments)
– Actuarial gain/loss (includes changes in assumptions)
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Net Periodic Pension Cost - Smoothing
• Transition and prior service costs are amortized over future years, not fully reflected immediately, unless choose to do so
• Cumulative actuarial gains/losses outside of corridor of greater of PBO and assets amortized over average working lifetime of actives
• Smoothed asset value allowed over not more than five years
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Net Periodic Pension Cost - Smoothing
• Portion of funded status not yet recognized in income is recognized on balance sheet as accumulated other comprehensive income
• Will be recognized over time
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Mark to Market
• Acceptable to recognize gains and losses faster, even immediately
• Will increase volatility of NPBC
• But could use hedging or other investment strategies to lessen volatility
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Mark to Market – Why?
• If losses outside of corridor, must gradually be recognized anyway, taking hit now perhaps give analysts a better picture of company performance
• If terminating plan in near future, take the hit, or most of hit now
• “Transparency”
10
Actuarial Assumptions
• Should be best estimate – IRS prescribed assumptions are not necessarily best estimate
• Technically responsibility of plan sponsor
• Expected input from actuary and/or auditors
• Auditor must confirm in accordance with U.S. GAAP
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Discount Rate
• Based on high-quality corporate bonds as of measurement date
• Government bonds may be necessary in some countries
• Rates as of measurement date – not average for month or longer
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Discount Rate (Continued)
• Cash flow matching of expected benefit payments with appropriate yield curve and solve for single equivalent rate
• Calculation similar to determination of EIR for funding purposes
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Discount Rate (Continued)
• Various acceptable yield curves
• FTSE (formerly Citigroup) commonly used
• Most larger actuarial firms have their own pension curves
• Bond matching also used
• Share calculation with auditor
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Poll #1
How do you determine discount rate?
A. Use FTSE (formerly Citigroup)
B. Use other index
C. Develop own pension curve
D. Other
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Discount Rate (Continued)
• Preferable a separately determined rate for each plan
– Best practice
– Future spinoffs
• Common to use qualified plan rate for SERP, but…
• Often equal to ASC 960 interest rate if using alternative “settlement rate” approach under ASC 960
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Discount Rate – Spot-Rate Approach
• Use individual spot rates instead of single equivalent rate –different rate for service cost and interest cost
• May lower service cost and interest cost and therefore net periodic benefit cost
• Approach is “more refined,” “theoretically correct,” and “more precise”
• PBO does not change – only impacts NPBC
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Discount Rate – Spot-Rate Approach
• SEC will not object
• Prospective change only
• Considered a “change in estimate”
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Discount Rate – Spot-Rate Approach
• Must be considered a preferred method
• Therefore, permanent change, and perhaps required for all plans
• Must disclose effect of this change
• About 45 percent of Fortune 1000 companies with DB plans have adopted (if eligible to do so)
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Discount Rate – Spot-Rate Approach
• Smaller gains and larger losses occur (upward yield curve)
• Larger losses amortized over future years
• Spot-rate approach considered incompatible with bond-matching approach to discount rate determination
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Expected Long-Term Rate of Return
• Not involved in determination of PBO
• May be equal to interest rate under ASC 960 – similarly defined
• Based on expected returns weighted by asset class allocation
• Building block approach – investment consultant for expected returns by class
21
Expected Long-Term Rate of Return
• Trend is downward - roughly from 8.0 to 8.5 percent range to 6.0 to 7.5 percent range
• Expected return by assets class has decreased?
• Asset allocation more conservative
– Frozen plans – glide path
– Risk averse post 2008
• Share determination with auditor
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Poll Question #2
How do you develop long-term rate of return?
A. Building blocks
B. Future capital market expectations
C. Rely exclusively on investment advisor
D. Other
23
Salary Increases
• Need at least some input from plan sponsor
• Needed for PBO but not ABO or hard frozen plans
• Roughly from 4.0 to 4.5 percent range to 3.0 to 4.0 percent range
• Very plan-specific
• Share determination with auditor
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Mortality
• Far more scrutiny last few years
• Best estimate not IRS prescribed tables
• RP-2014 with MP-2018, unless reason not to
• Society of Actuaries produces annual updates
• ASOP – improvement scale
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Mortality
• Several versions of RP-2014
– Collar, income, headcount
• If cash balance plan, far less important
• Non-cash balance lump-sum conversion mortality?
– To be covered later
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Mortality
• ASC 855 subsequent events – audited financial statements should reflect all available information though the date the accounting firm signs the audited financial statements
• May require some rerunning of disclosures
27
Mortality• Description of mortality assumption more complicated
• Are these the same table?
– RP-2006 mortality table with fully generational projection using scale MP-2015
– RP-2014 mortality fully generational using projection scale MP-2015
– RP-2015 projected with scale MP-2015
– RP-2014 adjusted to reflect scale MP-2015 from the 2006 base year and projected forward using scale MP-2015 on a fully generational basis
• Provide details in disclosure report28
Mortality Example• Mortality
– Base table: RP-2014
– Base mortality year: 2006
– Table type: blue collar
– Healthy or disabled: healthy
– Table weighting: benefit
– Blending: separate rates for annuitants and non-annuitants
• Improvement scale
– Base scale: MP-2018
– Projection type: generational
– Convergence year: 2034
– Ultimate improvement rate: one-percent grading to zero percent from 85 to 115
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Retirement Rates
• Depending on plan provisions, retirement decrements may be preferred over single age
• Less need for decrements if early retirement benefits are actuarial equivalent or approximately so
• Recently - ultimate 100-percent decrement rate up to age 70 or later
• Decrement critical if early retirement subsidy, supplements, or OPEB plan
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Other Assumptions
• Withdrawal/termination
• Marital status and spouse age
• COLA
• Cash balance interest-crediting rate
• Optional forms – particularly portion opting for lump sums
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Special Events
• Plan freeze – soft and hard
• Vested terminated participants lump sum windows
• Annuity buy-outs – usually retirees
• Curtailment and/or settlement accounting required in some cases
32
Soft Plan Freeze
• Soft plan freeze – no immediate accounting impact
• Be certain plan sponsor understands this
• PBO could increase in subsequent years even with no change in discount rate – is significant active obligation
• Duration of plan likely to decrease overtime and therefore discount rate to increase over time
33
Hard Plan Freeze
• Hard plan freeze – immediate accounting impact
• Be certain plan sponsor understands this and provide estimated impact – no surprises
• PBO could increase in subsequent years even with no change in discount rate – mostly actives, but less likely than soft freeze
• Duration of plan likely to decrease and therefore discount rate to increase over time
34
Annuity Purchase and Lump Sums
• Both have immediate settlement accounting impact possible
• Be certain plan sponsor understands this and provide estimated impact – no surprises
• Estimate ongoing impact if annuity purchased
• Estimate impact of lump sum window – plan duration could decrease – also could limit to avoid settlement accounting
35
Curtailments
• An event that significantly reduces expected years of service for actives or eliminates the accrual of benefits for a significant number of actives
• Rule of thumb on “significant”:
– Ten percent - curtailment
– Five to ten percent - maybe
– Less than five percent - not a curtailment
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Curtailments
• Plan hard freeze generally requires curtailment accounting, soft freeze does not
• Impacts both balance sheet and P&L
• If net effect of curtailment is a loss, should be recognized as soon as probable and the results can be reasonably estimated. If net effect is a gain, should be recognized when curtailment occurs, which could be date the employees are terminated or the date the pension is suspended, amended, or terminated.
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Settlements
• A transaction that is irrevocable
• Relieves the employer (or the plan) of primary responsibility for a pension obligation and plan assets used to effect the settlement
• Paying lump sums may trigger settlement accounting (lump sums greater than sum of SC and IC)
• Impacts both balance sheet and P&L
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Settlements
• Settlement gains and losses are recorded when the settlement occurs (annuities purchased, lump sums paid, or pension obligation is assumed by someone else)
• Maximum amount should be recognized in earnings if entire PBO is settled
• If only part of PBO is settled, should recognize in earnings a pro-rata portion equal to the percentage reduction in the PBO
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Settlements
• Possible settlements:
– Lump-sum windows
– Ongoing lump sums, particularly for hard frozen plan
• Ideally provide a breakdown of benefit payments for year between lump-sum payments and periodic payments
– Likely question from auditors
– Personally dealt with several situations where missed and disclosures needed to be redone
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Buy Ins
• Annuity purchased by plan not plan sponsor
• A plan asset
• Not settlement accounting
• Several accounting treatments possible – need to value both the value of the annuity as well as the PBO for covered group
More common in Europe
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Hints for Dealing With Auditors
• Providing some information upfront may lessen questions from auditors
• Ideally get sign-off from auditors on assumptions BEFORE performing valuation
– May need to just describe method, as for discount rate
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Hints for Dealing With Auditors
• Separate periodic benefit payments and lump-sum payments
• Label what amendments are reflected in PBO
• Details of gain/loss by source
• Provide asset allocation by major investment classes at beginning and end of fiscal year
• Disclose dollar amount of expenses assumed in SC
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Hints for Dealing With Auditors
• Rationale for each significant assumption or assumption changes
– ASOP 27 and 35 anyway
• Reviewing actuary and responding actuary
– ASOP 21
• Communicate all discussions/amendments regarding a pending termination. Possibly liquidation basis required.
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Hints for Dealing With Auditors
• Describe approach for valuing post-NRD retirements
– For both retirement decrements post-NRD and actives working past NRD
– Suspension of benefits
– Continued accruals only
– Greater of continued accruals and actuarial equivalence
– Concern is possible understatement of PBO
• This issue and many others may be less important depending upon "materiality"
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FASB Update
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Bill’s Agenda
• Updates to ASC 715
– 2017-07
– 2018-14
• Impact of new IRS mortality table on GAAP accounting
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ASC Update 2017-07
• Requires entities to disaggregate current service-cost component from other components of Net Periodic Pension Cost (NPPC)
• Present other components elsewhere in income statement and outside of income from operations
• Better aligns effect of DB plans on operating income with the effect under International Financial Reporting Standards (IFRS)
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ASC Update 2017-07
• Effective dates
– For public entities
• Interim and annual periods beginning after December 15, 2017
• Other entities
– Annual periods beginning after December 15, 2018
– Interim periods in the subsequent annual period
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ASC Update 2017-07
• Employers that do not present a measure of operating income
– Required to include service-cost component in same line item as other employee costs
– All other components of NPPC in a separate line item
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ASC Update 2017-07
• Amendments should be applied retroactively for presentation of service-cost component and other components of the NPPC
• Standard will apply prospectively for the capitalization of service-cost component of NPPC
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ASC Update 2017-07
• Implications:
– Operating income improves for companies if service cost is less than NPPC
– Changes may eliminate perceived need for non-GAAP measure of operating income that excludes certain benefit costs
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ASC Update 2017-07
• Implications:
– Capitalization of only service-cost component may be problematic for utilities, defense contractors, and others that seek recovery of benefit costs
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ASC Update 2017-07
• Facilitates:
– Transition mark-to-market
– Alignment of U.S. GAAP reporting with IFRS accounting
– Recognition of accumulated loss in preparation of plan termination
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ASC Update 2017-07
• Case Study - ABC, Inc.
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2019 2018 2017
Service Cost 83 76 72
Interest Cost 93 90 88
Expected Return on Plan Assets (89) (85) (76)
Amortization of Prior Service Cost 20 20 16
Amortization of Net Loss 8 5 2
Net Periodic Pension Cost 115 106 102
ASC Update 2017-07
• Case Study - ABC, Inc.
– Impact of ASU 2017-07
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2019 2018 2017
Operating Income 83 106 102
Non-Operating Income 32 0 0
ASC Update 2017-07
• Case Study - ABC, Inc.
– Must restate results after effective date of ASU 2017-07
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2019 2018 2017
Operating Income 83 76 72
Non-Operating Income 32 30 30
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• Accumulated loss as of 1/1/18 $10,599,000
• Less 2018 amortization ($614,000)
• Less estimated liability gainif discount rate increases by 0.60% ($1,300,000)
• Estimated accumulated lossas of 12/31/18 $8,685,000 *
* Assumes assets yield 7.00% in 2018
Accumulated LossGAAP Accounting Issues
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• Accumulated loss
– Accelerate amortization
• Outside of operating income
• Change in accounting method?
• Discuss with auditor
• Investment return assumption
– Currently seven percent
Discussion Items
GAAP Accounting Issues
ASC Update 2018-14
• Entities no longer required to disclose:
– Amounts accumulated in other comprehensive income (AOCI) expected to be recognized as components of NPPC
– Amount and timing of plan assets expected to be returned to employer
– Certain related-party disclosures
• Amount of future annual benefits covered by insurance and annuity contracts
• Significant transactions between employer or related parties and plan
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ASC Update 2018-14
• Entities no longer required to disclose:
– Nonpublic entities, reconciliation of opening balances to closing balances measured on a recurring basis in Level 3 of fair-value hierarchy
– Public entities, effect of one-percent change in assumed health care cost trend rates on: (a) aggregate of service and interest cost components on net benefit costs, and (b) benefit obligation for postretirement health care benefits
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ASC Update 2018-14
• Removed disclosures no longer
– Considered to be cost-beneficial
– Clarify specific requirements of disclosures
– Add disclosure requirements considered to be relevant
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ASC Update 2018-14
• Entities will be required to disclose
– Weighted-average interest-crediting rates for cash balance plans and other plans with interest-crediting rates
– An explanation of reasons for significant gains and losses related to changes in the benefit obligation for period
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ASC Update 2018-14
• Weighted-average interest-crediting rates for cash balance plans
– FASB 87 required disclosure of assumptions that have most significant impact on PBO and NPPC
– Interest-crediting rate is typically a significant assumption affecting the PBO and NPPC
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ASC Update 2018-14
• Weighted-average interest crediting rates for cash balance plans
– Disclosure will assist financial statement users to understand how this assumption affects changes in PBO and NPPC and to make meaningful comparisons between reporting entities
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ASC Update 2018-14
• Explanation of reasons for significant gains and losses related to changes in PBO for period
– Currently, no specific requirement to disclose reasons for significant gains or losses
– Reasons for gains and losses related to plan assets are relatively apparent
– Disclosing reasons for significant gains and losses related to changes in PBO will improve transparency and relevance of information to financial statement users
66
ASC Update 2018-14
• Explanation of reasons for significant gains and losses related to changes in PBO for period
– Did not define “significant”
– Decided not to be prescriptive on how significant gains and losses should be determined
– Allows entities to exercise judgment
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ASC Update 2018-14
• Effective dates:
– Public entities
• Fiscal years ending after December 15, 2020
– Other entities
• Fiscal years ending after December 15, 2021
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ASC Update 2018-14
• For all entities, if aggregate disclosures are presented, must disclose the following information for DB plans:
– PBO and fair value of assets for plans with PBOs in excess of assets
– ABO and fair value of assets for plans with ABOs in excess of assets
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Impact of New IRS Mortality on ASC 715
• New IRS mortality can impact ASC 715 pension accounting
– Plan offers lump-sum option
• Significant use of this option
– Conversion of account balances to annuities
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Impact of New IRS Mortality on ASC 715
• Two potential approaches:
– Do not anticipate future updates to IRS-mandated mortality tables
• Pertains only to effects of IRS’ update to its tables used for IRC §417(e) purposes
• Not related to entity’s determination of best estimate of mortality assumption
• Akin to considering a mortality table update as a new law or regulation
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Impact of New IRS Mortality on ASC 715
• Two potential approaches:
– Reflect best estimate of future updates to IRS-mandated mortality tables
• Take into consideration recent IRS regulations and history of annual updates to tables
• Akin to taking into account indirect effects of changes to Social Security benefits or benefit limitation changes
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Impact of New IRS Mortality on ASC 715
• Case study
– Plan benefit formula
• 1.0 percent times average compensation times years of service
– Plan offers lump-sum payment option
– Over 90 percent of participants elect the lump sum form of payment
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Poll Question #3
What mortality table should be used for ASC 715 purposes?
A. Applicable mortality table for distributions subject to IRC§417(e)(3)?
B. Applicable mortality table for distributions subject to IRC§417(e)(3) with projected mortality improvement?
C. Mortality table RP 2014 with MP-current improvement scale, fully generational?
D. Another alternative?
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