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Accounting for retirement benefits produces “phantom” earnings – report

December 27, 2012

The cost of pensions gets plenty of attention, both from the companies that sponsor them and their investors.  Other retirement benefits, including medical costs, don’t garner the same scrutiny.

That’s because under federal law, pensions must be funded at certain minimal levels, while  “other post-employment benefits” (OPEB)  have no mandatory funding, no matter how under-funded they may be.

OPEB remain a huge obligation sitting on corporate books, however, and as accounting sleuth Jack Ciesielski ferreted out in a recent report, for many companies they are a growing contributor to earnings.

In recent years, assets set aside for the OPEB plans of the S&P 500 have barely budged, and in 2011, their cumulative obligation promises exceeded plan assets by $225.5 billion, according to Ciesielski’s publication, The Analysts’ Accounting Observer.

While OPEB do not have to be funded ahead of time, they do eventually have to be paid and  companies put millions of dollars in cash into their OPEB obligations every year.

Because of the way the accounting works,  however, many of the companies spending millions in cash on OPEB are at the same time booking income on those plans, income that flows into and increases their reported earnings. This is entirely in keeping with acceptable accounting, Ciesielski explained, and stems largely from the way cutbacks in the plans are accounted for. As companies trim benefits, lay off workers, or freeze these programs entirely, they lower their long-term OPEB obligations. Those gains are accounted for as part of the company’s current  OPEB  income.

OPEB income is not cash earnings like that coming  from ongoing business operations, but even so, it flows into the company’s earnings per share figures.  

“Here’s a situation where accounting principles produce ‘earnings’ implying future cash inflows, when in reality huge cash outflows are occurring,” Ciesielski wrote in the report.

Car maker Ford, power company First Energy and manufacturer Honeywell are some of the companies Ciesielski cited as paying out tens of millions of dollars in OPEB benefits in 2011 while simultaneously reporting tens of millions in OPEB income.

According to the report, at First Energy, retailer J C Penney and health technology firm PerkinElmer, more than 10 percent of 2011 earnings per share came from OPEB income. 

Overall, Ciesielski found that the number of S&P 500 companies enjoying a boost in earnings because of this OPEB accounting rose to 42 in 2011, from 35 in 2010 and 24 in 2007. 

In his report Ciesielski argued that OPEB’s impact on earnings should be easier to spot, and that investors should carefully consider what role these non-cash, non-recurring figures play in a company’s earnings when deciding what is a fair price to pay for its shares.

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