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Government Pension Accounting and Financial Reporting – New Proposed Statement

September 26, 2011

Nikoleta McTigue, CPA

The Governmental Accounting Standards Board (GASB) has proposed an overhaul to the accounting and financial reporting of government pension plans. While current practice treats accounting and financial reporting and how pensions are funded in a similar manner, these changes will result in a separation between accounting and financial reporting and the way pensions are funded. Currently, pension trust funds include pension assets that are set aside to pay for pension benefits, and the statement of activities shows current revenues and current expenses. The longer-term plan obligations are disclosed in the notes to the financial statement. The proposed regulations endeavor to show obligations as they are being accrued rather than when contributions/payments are actually made. The most important changes for government plans are the introduction of net pension liability and changes to measuring pension expense.

The GASB defines a liability as “a present obligation to sacrifice resources that a government has little or no discretion to avoid.”  In the Board’s view, a pension is a form of compensation and should be recorded when it is earned by an employee.  As a liability, this obligation should be recognized on the financial statements and not (as is the case currently) in the notes to the financial statements.  Net pension liability will be calculated as the difference between the total pension liability and the value of pension assets that are set aside to pay for pension benefits.

The measurement of a government’s total pension liability has a three-step process:  project net benefit payments, discount the payments to their present value and attribute the benefits to specific periods. The first step is to project net benefit payments.  The plan’s actuary calculates the plan liability based on a range of demographic and plan characteristics.  If an employer’s past practice and future expectation is that they will grant salary increases or cost-of-living adjustments (COLAs), then these are also included.  Once the projected benefit payments are calculated, they must be discounted to their actuarial present value (the estimated value in today’s dollars).  At present, governments use the expected return rate on plan investments as their discount rate.  The proposed regulations would allow this practice to continue as long as the plan’s assets and contributions (based on historical experience and policy) will be sufficient to make all projected benefit payments.  However, if a plan’s assets and contributions do not fully cover the projected benefit payments, this shortfall is treated like debt and discounted using a high quality (AA) 30-year municipal bond index.  While the interest rate of long duration municipal bonds can vary, it is currently lower than the expected rate of return in most plans—which can increase the net pension liability in the financial statements.  Currently, plans have flexibility in how they attribute the present value of benefits to specific periods.  Under the proposed rules, all governments must use the entry age normal method and do so as a level percentage of payroll.

Pension expense is also addressed by the GASB proposal.  There are a range of modifications to current practices aimed at better reflecting expense.  For example, changes to the terms of pension benefits or projected investment earnings would be immediately incorporated.  While governments can now choose how to recognize the difference between actual investment earnings and projected earnings, this would be standardized.  This shortfall would be deferred and expensed over a five-year period.

The GASB believes that the proposed changes in pension accounting for government entities should better reflect the nature of the obligations and will improve transparency and the usefulness of financial statements.  While the final standard will likely change somewhat from the current proposal, the basic concept that pension expense is a liability and should be recorded in a timely manner in the financial statements should remain.  Look for further updates from Blum Shapiro as the statement is finalized and the impact it will have on governmental pension plans


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