Hoping to get answers from CPAs, as this is a GAAP reporting issue and the expense subject matter is not eligible for tax deduction anyway. Haven't heard from Matt Sova lately, but Old Jack is out there like a vulture, ready to pounce on innocent posters. Lots of tax people who post frequently are also CPAs.
At issue is the disclosure in the financial statements of an estimated liability for defined benefit plans. For a Fortune 500 company, this could be billions of dollars, and is often the single largest liability on the balance sheet. Extremely germane to the calculation of this liability is the estimated earnings of the trust fund over the projected consummation of the funding and benefit cycle. (For purposes of discussion lets ignore the effect of retiree medical benefits for simplicity's sake)
A scenario develops at a large publicly-traded company (Ajax?) where you are involved in auditing the financial statements. It has been a lackluster year, with stock prices moving mostly sideways and a poor record of meeting projections. The chairman of the board is paying a handsome audit fee to the CPA firm. Ajax' president has only lukewarm support among the major stockholders.
The president then proposes what seems to be a brilliant strategy. The sinking fund for this defined benefit liability is projected to earn 8.25% in the calculation of the liability and associated pension expense in the financial statements, soon to be published. However, changing the projection to 8.75% will drastically reduce the size of the liability by perhaps tens of millions of dollars. The offset to this on the P&L reduces the pension expense by the same amount, and this positive effect drops tens of millions onto the Ajax bottom line. The change in project costs Ajax absolutely no cash, not even for income taxes.
It may seem improbable to some that such a small change would bring a gazillion dollar effect unless you are familiar with the calculation. Firstly, remember that the effect of the 0.5% increase is rippled through 30 years, and the resulting profit is reportable in only one year - namely this year. Secondly, remember that this liability is huge and only a single digit percentage reduction in that liability is mega-millions, again compressed into a one-year pick-up on the profits.
Ajax wants to make the change in its financials. The change is not the result of good management, and Ajax has invested zero money and zero time in this dramatic upswing in profits, earnings-per-share, P/E ratio. Ajax has not done a single thing performance-wise to bring about such good fortune. The change means that Ajax has exceeded projections, the traded price of stock goes up, and the president exercises numerous stock options to make himself even more wealthy.
The audit seniors in your firm huddle amongst themselves. If actuaries are involved, Ajax has already succeeded in paying them to revise their projections and concur with the change. If the projections prove later to be too ambitious it will be YEARS before this is known, and the Ajax president and even audit seniors will be either retired or far removed from being blamed.
As a CPA, what do you do? Ajax will change audit firms if you don't agree to this. And the change is in such a subjective area that who could EVER blame anyone for not knowing the rate of return 20-30 hence? And for what anyone knows, this latest projection could just as easily be right as wrong.
I don't think there's any question what you do. If I were an audit senior, I think I would be agreeable to the change, as there appears to be little reason not to agree. I've seen CPAs routinely ignore overstated inventories and receivables that are more a problem than this.
If you've read this far, thank you, but you might be wondering is there point to all this? If there is, it might be that our perception of safety in SEC reporting regulations should be re-examined. But for the most part, I would like to hear from you.
Not a tax subject, neither is the reading exciting, but a stimulating subject to those who deal with such situations.
Regards, Ron J.
At issue is the disclosure in the financial statements of an estimated liability for defined benefit plans. For a Fortune 500 company, this could be billions of dollars, and is often the single largest liability on the balance sheet. Extremely germane to the calculation of this liability is the estimated earnings of the trust fund over the projected consummation of the funding and benefit cycle. (For purposes of discussion lets ignore the effect of retiree medical benefits for simplicity's sake)
A scenario develops at a large publicly-traded company (Ajax?) where you are involved in auditing the financial statements. It has been a lackluster year, with stock prices moving mostly sideways and a poor record of meeting projections. The chairman of the board is paying a handsome audit fee to the CPA firm. Ajax' president has only lukewarm support among the major stockholders.
The president then proposes what seems to be a brilliant strategy. The sinking fund for this defined benefit liability is projected to earn 8.25% in the calculation of the liability and associated pension expense in the financial statements, soon to be published. However, changing the projection to 8.75% will drastically reduce the size of the liability by perhaps tens of millions of dollars. The offset to this on the P&L reduces the pension expense by the same amount, and this positive effect drops tens of millions onto the Ajax bottom line. The change in project costs Ajax absolutely no cash, not even for income taxes.
It may seem improbable to some that such a small change would bring a gazillion dollar effect unless you are familiar with the calculation. Firstly, remember that the effect of the 0.5% increase is rippled through 30 years, and the resulting profit is reportable in only one year - namely this year. Secondly, remember that this liability is huge and only a single digit percentage reduction in that liability is mega-millions, again compressed into a one-year pick-up on the profits.
Ajax wants to make the change in its financials. The change is not the result of good management, and Ajax has invested zero money and zero time in this dramatic upswing in profits, earnings-per-share, P/E ratio. Ajax has not done a single thing performance-wise to bring about such good fortune. The change means that Ajax has exceeded projections, the traded price of stock goes up, and the president exercises numerous stock options to make himself even more wealthy.
The audit seniors in your firm huddle amongst themselves. If actuaries are involved, Ajax has already succeeded in paying them to revise their projections and concur with the change. If the projections prove later to be too ambitious it will be YEARS before this is known, and the Ajax president and even audit seniors will be either retired or far removed from being blamed.
As a CPA, what do you do? Ajax will change audit firms if you don't agree to this. And the change is in such a subjective area that who could EVER blame anyone for not knowing the rate of return 20-30 hence? And for what anyone knows, this latest projection could just as easily be right as wrong.
I don't think there's any question what you do. If I were an audit senior, I think I would be agreeable to the change, as there appears to be little reason not to agree. I've seen CPAs routinely ignore overstated inventories and receivables that are more a problem than this.
If you've read this far, thank you, but you might be wondering is there point to all this? If there is, it might be that our perception of safety in SEC reporting regulations should be re-examined. But for the most part, I would like to hear from you.
Not a tax subject, neither is the reading exciting, but a stimulating subject to those who deal with such situations.
Regards, Ron J.
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