At Truth in Accounting, we analyze government financial statements and aggregate that data into annual reports. One of our most significant concerns when examining these financial documents is the state of pensions. They are often the most considerable debt a government carries. We fear that the valuation of pensions can be distorted for a few reasons. The first is that pension valuations may be up to thirty months old. This is explained in the linked article. A second reason is that the values reported are subject to an accounting concept called “recognized and realized.”
Accountants must record (recognize) the increases and decreases of investments and other assets in the financial statements we prepare. It gives the investor or taxpayer an idea of what we would gain or lose if we sold an asset at that point in time. The problem is that because investments or other assets have not been sold, we don’t know what we will get (realize) when we trade them in for cash. Thus, our financial statements can look better or worse than our actual financial position.
If you have a 401k, you know what we mean. One day you feel great; your 401k is soaring; the next day, the market loses 1,000 points, and your visions of early retirement vanish. You didn’t really lose or gain (realize) these values, but you sure recognized that they happened. The same goes for governments and corporations. They must record/recognize the losses and gains even if they have no plans to really cash in/realize these changes any time soon.
That leads to the data we analyzed this year. In 2021, the stock market rose an average of 27 percent. Meaning in the financial reports governments issued, they recorded/recognized the upturn in the investments for their pension funds. The increase in the value of the pensions makes it look like they are worth more than in 2020. The reality is that while actual contributions by the government may not have changed, the rise in the market may make the funds look better than they are.
Fast forward to 2022. By the middle of 2022, the stock market had lost approximately 21.3 percent of its value. This will be reflected (recognized) in government reports as a decline in the pensions’ funded status. Of course, it is possible that no actual stock, bonds, or cash exchange ever occurred (were realized) to change these values in either year. Still, the government must record these changes in the published financial reports regardless of whether they received(realized) the amounts.
When you are analyzing your government’s performance and pension position, remember the numbers may be dated and reflect values that are only recognized and may not be realized at the time of the report. Making the financial statements look better or worse than they are in reality.
The question is, is this an intended or unintended consequence? You be the judge.