Stakeholders’ Demand for Conservative Reporting: An Exploration of Accounting for Pension Liabilities
49 Pages Posted: 22 Aug 2017
Date Written: August 15, 2017
We examine whether conservatism in standard setting serves the information needs of primary user groups in a setting where liability measurement is complex and uncertain. Current US GAAP on pension liability measurement straddles two competing perspectives: a going-concern perspective that incorporates future salary increases into estimates of benefit cash flows (PBO), but switches to a settlement perspective for present valuing by using a high-quality corporate bond rate (AA rate). This yields a GAAP pension liability measure that is more conservative than either a fully going-concern-based measure, which uses PBO discounted at a rate that reflects future cash flows (the expected return on pension assets—EROA), or a fully settlement-based measure, which excludes future salary increases (ABO) and discounts using the AA rate.
(1) equity investor valuations imply the use of EROA discounting;
(2) debt investor assessments imply a settlement perspective of AA rate discounting and ABO; and
(3) current GAAP proves to be overly conservative for both primary user groups. Our study highlights a cost of conservatism in pension liability measurement: it detracts from the value- and credit-relevance of financial statements.
Keywords: conservatism, pension accounting, discount rates, actuarial assumptions
JEL Classification: M41
Suggested Citation: Suggested Citation