You want to refinance your home. The bank requires an appraisal to determine the current value. The appraiser uses data from 2019. Would you feel good about that? Or let’s say you want to sell your car. You look online for a valuation tool, and they quote numbers from 2018. Would you trust these as valid values for which to advertise your car? Probably not. So, then why do we accept valuations of government pension plans and other pension obligations that could be 30 months old?
As of approximately 2015, governments must report their pension obligations on one of their required financial statements. In governmental accounting, this statement is called the Statement of Net Position, which is like a Balance Sheet in public accounting. This document shows what you won and what you owe.It is where we would list our assets and liabilities, and pensions are clearly a liability due from the government to its retired employees. For many governments it is by far their largest liability. The numbers are difficult to predict and understanding how they are calculated is difficult. Elected officials are the ultimate managers of pensions, but are pensions too complicated for elected officials to understand, much less manage?
Think about the people you know. They are all different ages, have different health considerations, plan to retire at different ages, and have unique personal experiences that form their financial decision-making processes. Well, think of the government needing to take all these issues into consideration when it estimates its amount of pension and other post-retirement benefits (OPEB).
Governments must report this liability for all the people who work for them now and in the past. How do governments calculate the amount they will owe at different points in the future for these obligations? It is this complexity that causes the data in the financial statements to be unclear, and even obsolete by the time it is reported.
Here is how the calculation process works:
Let’s assume the government entity reports its data on June 30th of any given year. Government officials are required to publish their financial statements in a timely manner for the public to review the fiscal health of their local and state governments. The government reports current data for assets such as cash, account receivable and other items to let the citizens know what the government has available to pay its bills. They must also report any debt. However, governments are allowed to usea date that is up to one year ago for reporting their pension or OPEB liabilities due. In other words, the financial statement reported liability for retirement payments may be disclosed as of June 30, 2022, but the actual measurement date could be June 30, 2021, one year earlier.
Adding to this complexity, the government’s pension plans may have an entirely different year end than the government does. According to the rules by the Governmental Accounting Standards Board, governments must use the plan’s year end as the number used to calculate the liability as long as that year end falls between the government’s year end and a one year date prior to this date. This year-end number is already subject to numerous factors like stock market swings. Because pension plans invest in the stock market, the valuation of plans’ assets is subject to the volatility of the market. Think of what has happened to stock prices in the last six months.
This all translates like this: If our retirement plan’s year end is December 31, 2020 and our year end for financial reporting is June 30, 2021, then we must use the value of the plan as of their year end of December 31, 2020 for reporting purposes. If we had the same year end, say December 31, 2020, we could, according to the rules, use the plan’s measurement from 12 months earlier on December 31, 2019 in our calculation and not be in violation. This leads to measurement dates which could be anywhere from six to twelve months old before a single number is entered on our statements.
Ok, so we now have a value of the liability on the Statement of Net Position which could be twelve months old being matched against assets that are valued as of the financial statement date: in other words, today’s assets against yesterday’s liabilities. Think of it this way. If you are applying for a loan, would the bank allow you to use old bills against today's checking account balances? Probably not. They would want to know the current value of your bills in alignment with the current value of your assets. But that isn’t all.
First, here is a tricky problem. Pensions are paid to people from when they retire until they die. Maybe their spouses even get a share. How do pension plans calculate people’s personal retirement decisions and basically, determine their life expectancy? Retirement plans hire actuaries! What is an actuary? Actuaries are experts in evaluating complex future events using numbers and data to make their predictions.
So, the plans hire actuaries to calculate and report the value of the government plans. They calculate the present value of what the plan will need to pay employees in the future for their past service. What? Present value of past service for the future? That seems complicated and it is. It doesn’t matter if the employees still work for the government or did in the past. The plans are looking at current employees and past employees who will draw money sometime in one month to in 25 years. The plans calculate all those complex scenarios and report a cost valued in today’s dollars. And most importantly, this valuation by actuaries may be as much as 24 months old because all of this takes time to calculate. The information pulled by the government from the plan data may be up to 24 months old, and this is perfectly acceptable according to the rules.
So, to summarize, governments have year-end financial statements that they must issue to report the position of government assets and liabilities accurately. A basic principle of accounting is that a balance sheet is a snapshot of an entity’s financial position at one point in time. In the case of governments, the value of its assets and most liabilities is current but pension numbers contain all kinds of dated information. It is possible the government is reporting a number on June 30, 2021 from a retirement plan that ended December 31, 2020. Furthermore, the retirement plan could have a valuation dated December 31, 2018, because the plan may have a valuation that is up to two years old. In other words, the number we are using on our June 30, 2021, Statement of Net Position could come from a valuation on December 31, 2018 – 30 months ago.
Again, I ask the question, why do we accept these are accurate valuations of our current government obligations when they may be 30 months old?
Read the full article on: Accounting Today