There have been years of improvements to accounting rules for pension plans. So why are more than $1.3 billion in pension liabilities missing from BCE Inc.’s financial statements?

Investors should scrutinize the details of any public company’s pension plan. The impacts on share valuation have always been significant—ever since we first looked at the issue over 15 years ago.

As times have changed, so have the importance and impact of various issues related to company pension plans. Two big factors investors need to pay attention to are changing accounting rules and fluctuating interest rates.

Significant risks to valuation continue to exist, and the impacts can be quite material as evidenced by the BCE example.

This is an improvement

The accounting rules regarding pension plans used to be much worse, allowing companies to use a broad range of smoothing mechanisms. As a result, economic impacts on pension plans were not being reflected in corporate financial statements.

For instance, companies were able to report net pension assets on their balance sheets even when their pension plans were in serious deficit.This led to situations where analysts and investors weren’t including off-balance sheet liabilities in share-price valuation.

Read: Risk aversion weighs on pension funding

In similar fashion, some companies actually used to report pension profits on their income statements, even when their pension plans were in deficit.

Instead of recognizing the pension plan as an expense (like any other employee-related expense), some companies would recognize gains that reduced expenses and actually increased overall income. This is because companies would flatten out the impact of changes in their pension plan’s funded position over an extended time period.

For instance, when the actual results of investing the assets of the plan fell short of expectations, the negative impact of the real results were not reflected in reported income.

Instead, companies were allowed to use very optimistic estimates of what they thought they might earn in the future as a way to boost reported profits in the current period.

Likewise, when companies used to reduce the discount rate on their pension obligation (as a reaction to declining interest rates), the impact was not immediately reflected in the company’s balance sheet. Instead, the negative impact of increasing obligations or declining assets could be smoothed over time.

This required serious accounting adjustments when it came to valuing stocks.

Thankfully, circumstances have improved, and accounting rules now produce a more reasonable economic picture. The billion-dollar pension deficits of companies such as Bombardier, Manulife and Imperial Oil are better-reflected on the balance sheet, giving a more accurate reflection of their total obligations and fiscal leverage.

However, there are still some loopholes in current accounting rules. For instance, multi-employer pension plans remain off balance sheets for companies.

Add a comment

You must be logged in to comment.

Register on Advisor.ca