Balance sheets and income statements have different time perspectives. Income statements tell a story about performance over a period of time, while balance sheets, in theory, tell a story about financial position at a point in time.
Income statements and balance sheets each lead to a bottom line that should inform the residual claim the enterprise is accountable to. On the income statement, revenue less expenses leave what is left over for the ultimate claim on the enterprise. On the balance sheet, assets less liabilities leave a net position.
For state and local governments, accounting standards have developed the Statement of Activities (the income statement) and the Statement of Net Position (the balance sheet). For decades, however, the Statement of Net Position excluded retirement benefit obligations from the debts, which have blossomed into the largest liabilities for many state and local governments.
In fiscal 2015, governments began including these debts, as they were finally required to do so. But the face of the balance sheet did not include investment assets supporting retirement plans, or the full liability estimated for those assets to support. Instead, they included the net pension liability – the full liability less the invested assets. Given that the vast majority of retirement plans operate with less assets than measured liability, this led to a large increase in reported debt, and significant deterioration in the net position.
But the way in which governments include this net liability on the balance sheet (the Statement of Net Position) has some very curious features. One of the strangest can be illustrated with a statement by Moody’s Investor Service a few days ago.
In a press release titled “Unfunded US state pension liabilities surge in fiscal 2017 due to poor investment returns,” Moody’s first paragraph reads as follows:
“The majority of US states experienced a sharp increase in their adjusted net pension liabilities (ANPL) in fiscal year 2017, owing to poor investment returns in fiscal 2016, Moody's Investors Service says in a new report. However, favorable investment returns in fiscal 2017 and 2018 are expected to lead to a decline in pension liabilities for the next two fiscal years.”
Fiscal 2016 ended, for most states, on June 30 2016. How can that lead to deterioration in net position for year-end fiscal 2017, you ask?
In turn, consider how Moody’s can accurately 'forecast' pension liabilities declining for the next two fiscal years, given that investment returns were so favorable over the past two years ended June 30, 2018.
So much for that “point in time” perspective for balance sheets.