[Senate Hearing 109-1047]
[From the U.S. Government Publishing Office]


                                                       S. Hrg. 109-1047
 
                      FASB'S PROPOSED STANDARD ON 
  ``EMPLOYERS' ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POST- 
                           RETIREMENT PLANS'' 

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                                   ON

 EXAMINING A FINANCIAL ACCOUNTING STANDARDS BOARD (FASB) PROPOSAL THAT 
WILL PROVIDE ENHANCED TRANSPARENCY OF CORPORATE ACCOUNTING FOR DEFINED 
            BENEFIT PENSION AND OTHER POST-RETIREMENT PLANS

                               __________

                             JUNE 14, 2006

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate/
                            senate05sh.html

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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire        DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina       ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida

             Kathleen L. Casey, Staff Director and Counsel

     Steven B. Harris, Democratic Staff Director and Chief Counsel

                          Justin Daly, Counsel

              Stephen R. Kroll, Democratic Special Counsel

                 Dean V. Shahinian, Democratic Counsel

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)






















                            C O N T E N T S

                              ----------                              

                        WEDNESDAY, JUNE 14, 2006

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Sarbannes............................................     2
    Senator Allard...............................................     2
    Senator Enzi.................................................     3

                               WITNESSES

Robert H. Herz, Chairman, Financial Accounting Standards Board...     5
    Prepared statement...........................................    22
    Response to written questions of:
        Senator Enzi.............................................    48
        Senator Bunning..........................................    51
Sir David Tweedie, Chairman, International Accounting Standards 
  Board..........................................................     7
    Prepared statement...........................................    36
    Response to written questions of:
        Senator Enzi.............................................    54
        Senator Bunning..........................................    56

              Additional Material Supplied for the Record

FASB's Proposed Standard on ``Employers' Accounting for Defined 
  Benefit Pension and Other Post-Retirement Plans''..............     *

* Retained in Committee files

                                 (iii)


                      FASB'S PROPOSED STANDARD ON
     ``EMPLOYERS' ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER
                        POST-RETIREMENT PLANS''

                              ----------                              


                        WEDNESDAY, JUNE 14, 2006

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:29 a.m., in 
room SD-538, Dirksen Senate Office Building, Senator Richard 
Shelby (Chairman of the Committee) presiding.

          OPENING STATEMENT OF CHAIRMAN RICHARD SHELBY

    Chairman Shelby. Today, the Banking Committee will examine 
a Financial Accounting Standards Board (FASB) proposal that 
will provide enhanced transparency of corporate accounting for 
defined benefit pension and other post-retirement plans. Sound 
and transparent accounting standards are the lifeblood of the 
capital markets. Financial reporting must reflect economic 
reality. If it does not, investors will lose confidence in the 
integrity of our markets. It is that simple.
    To establish high-quality accounting standards, the 
standard setter must have an open process to consider the views 
of all interested parties, and it must possess unquestioned 
independence. The FASB proposal, the first phase of a two-phase 
project, would require employers to recognize on their balance 
sheets the overfunded or underfunded status of their single 
employer benefit pension plans and other post-retirement 
benefits. This accounting change would make financial 
statements more accurate, complete, and reliable.
    I applaud FASB for embarking on this important project and 
offer my continued support for their independent judgment. The 
effort to bring transparency to pension accounting is part of a 
larger effort to not only harmonize global accounting 
standards, but also to improve their quality. The Securities 
and Exchange Commission, the FASB, and the International 
Accounting Standards Board, IASB, are working together on this 
important endeavor.
    This morning, we will hear testimony from two witnesses. 
Neither one is a stranger to the Committee. Mr. Robert Herz is 
Chairman of the FASB, and Sir David Tweedie is Chairman of the 
IASB. I welcome both of them back to the Committee and look 
forward to their statements.
    Senator Sarbanes.

               STATEMENT OF SENATOR PAUL SARBANES

    Senator Sarbanes. Well, Mr. Chairman, I want to commend you 
for your continued attention to the importance of the work of 
the Financial Accounting Standards Board and the International 
Accounting Standards Board. Of course, Bob Herz and Sir David 
Tweedie are no strangers to this Committee, and I am pleased to 
join with you in welcoming them back this morning.
    The statements of both of our witnesses outline potential 
problems with the present accounting rules for defined benefit 
pension plans. Some of those potential problems are perhaps 
inherent in the nature of defined benefit pension plans 
themselves, especially the possibility that assets will shift 
in value or will not be adequately matched to the maturity of 
pension obligations.
    Others may reflect difficulties of predicting future 
employment and industry health, difficulties not foreseen 
several decades ago, and others may reflect inconsistencies or 
loopholes in the statutes governing pension funding. But both 
organizations, as I understand it, have undertaken a serious 
reexamination of these issues, and that is now underway.
    There is, of course, debate over implementation costs, when 
to measure benefit obligations and associated assets, 
appropriate effective dates, transition periods, and whether 
special rules are needed for nonpublic companies, nonprofit 
organizations, and cooperatives. Some have expressed concern 
about the impact immediate balance sheet disclosure could have 
on companies and, hence, their ability to continue to fund the 
benefit plans. Others, of course, have emphasized that an 
accounting system for public companies that does not adequately 
disclose the size and impact of obligations of this nature can 
hardly be called transparent. So I join with you in looking 
forward to learning more about these issues today, and I join 
with you, as always, in welcoming Sir David and Bob Herz back 
before the Committee.
    Chairman Shelby. Thank you, Senator Sarbanes.
    Senator Allard.

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Well, Mr. Chairman, again, I would like to 
thank you for holding this hearing. This is a major proposal 
that will have significant implications for business, so I 
appreciate the opportunity to learn more about what FASB is 
doing. As part of this debate, we cannot lose sight of the 
voluntary nature of the current retirement benefit systems. 
Certainly it is important to have fair, consistent, accurate, 
and transparent reporting. However, we must also be cognizant 
of the potential to disincentivize employers from providing 
benefits. As with all important regulatory decisions, I hope 
that FASB is taking an appropriate amount of time and giving 
adequate consideration to the comments it receives. Such 
expansive decisions are better done right than done fast.
    I look forward to the testimony of our witnesses, and it 
will be most helpful as we continue to monitor progress on this 
issue.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Enzi.

                 STATEMENT OF SENATOR MIKE ENZI

    Senator Enzi. Thank you, Mr. Chairman, and I really 
appreciate your holding this hearing today on revising our 
Nation's accounting standards for pension plans and retirement 
health benefits and their convergence with the international 
accounting standards. This hearing could not be timelier as we 
approach the retirement of the baby-boom generation. Day after 
day, the newspaper headlines are filled with stories of large 
and small companies struggling with legacy costs, especially in 
the retirement benefits area.
    After his last appearance before the Banking Committee a 
couple years ago, Sir David Tweedie and I had the opportunity 
to meet in the Committee's anteroom. The original topic of 
discussion was intended to be about the use of stock options 
grants in the United States and in Europe; however, the topic 
quickly changed to a discussion on accounting standards for 
retirement benefits. At that time both of us had agreed that 
accounting for retirement benefits was one of the bigger 
challenges for the accounting industry. We both thought the 
issue dwarfed the issue of stock options.
    Sir David spoke of his experience with companies in legacy 
industries and the U.K.'s pension turmoil. We both recognized 
that the problem was looming over the horizon in the United 
States. Little did we know how correct that would be.
    Mr. Chairman, as you know, last year I took over the 
chairmanship of the Committee on Health, Education, Labor, and 
Pensions. One of my first orders of business was to begin 
drafting legislation to revise our pension laws under ERISA to 
ensure that defined benefit pension plans are fully funded and 
do not become a burden on the Pension Benefit Guaranty 
Corporation, PBGC. Currently, we have convened a conference 
committee with the House to resolve the difference between the 
House and Senate bills. I have got to say this would be a whole 
lot easier if we were just initiating the policy for pensions 
to start, but they have been in effect for years and years, and 
any change that we make affects past actions as well as future 
actions. It is complicated because the plans already exist, so 
our option is not to start over. Our option is to transition so 
that we make sure that people that worked hard for years and 
years with the anticipation of retirement can retire and that 
the funds are made strong and complete.
    Now, while pension accounting, pursuant to the funding 
rules for ERISA and the Tax Code, are much different than 
generally accepted accounting practices, there are vital 
lessons to be learned. FASB is making the right decision to 
update retirement benefits accounting standards at this time. 
The current standards do not accurately tell the story of the 
true cost of liability a company may owe for future 
obligations. The first stage may appear to be a modest change, 
but even a modest change in this volatile area can be 
significant, particularly when you take into consideration the 
changes that the pensions bill are going to be making at the 
same time. These are not being done in opposition to each 
other. They are being done in conjunction with each other. But 
it is important that there be a lot of communication so that 
one is not undoing the process of strengthening that the other 
is doing.
    The real work will come when FASB engages in Phase 2 of its 
initiative to look at the methodologies behind the numbers. 
Today we are on the verge of an evolution in our pension and 
retirement health care system. Companies are making the 
decision to no longer provide defined benefit plans and 
retirement health care due to escalating costs. In addition, 
study after study shows that Americans in general do not have 
enough money to live through their golden years.
    Now, as FASB and the International Accounting Standards 
Board consider changes to accounting rules, I would offer them 
guidance to do so in a manner that would not cause companies to 
immediately stop retirement benefits. Any significant change 
must be done with sufficient transition periods in place and 
time for companies to adjust and to plan ahead. Our employees' 
retirement benefits are too important not to take the time to 
get this right the first time.
    I have commended FASB before for having a Small Business 
Advisory Committee, and I think that has helped with some 
significant decisions. Perhaps there could be a temporary 
committee that would also work on the retirement benefit thing 
to bring in the expertise of people that have been working in 
that for years to make sure that what we are doing on pensions 
legislation and what you are doing on standards will be 
conjunctive rather than opposing.
    Mr. Chairman, as this is a hearing on accounting standards, 
I would also like to add a comment on the recent revelations on 
the manipulation in the marketplace on stock options. If there 
can be good news out of this, it appears that the backdating 
scandal appears to have happened before the implementation of 
Sarbanes-Oxley. Thankfully, provisions in the act require much 
faster disclosure of executives who exercise stock options 
rights. This and vigilant oversight by the SEC should put an 
end to it. However, I am very disturbed by the Enron-type 
shenanigans that appear to have gone on with stock option 
backdating. This is just another lessons that the manipulation 
of accounting standards is wrong. It is criminal, and those who 
are manipulating the markets must be punished.
    Now, when we discussed stock options and accounting a 
couple of years ago, the discussion I brought to the table was 
about entrepreneurship and broad-based employee stock option 
plans. I still believe that companies should have these tools 
available to them. Legislation introduced would have 
immediately expensed and disclosed executive stock options. 
Executives should not be permitted to manipulate executive 
stock options to the detriment of employees and shareholders. I 
fully support Chairman Cox and the SEC Enforcement Division to 
crack down on that abusive practice.
    Mr. Chairman, I thank you for holding this hearing.
    Chairman Shelby. Senator Bunning.
    Senator Bunning. No opening statement. Thank you.
    Chairman Shelby. I want to welcome again both of you to the 
Committee. Sir David, I know you travel a lot. We are glad to 
have you here. Thank you. Your written testimony will be made 
part of the record. Bob, we will start with you.

  STATEMENT OF ROBERT H. HERZ, CHAIRMAN, FINANCIAL ACCOUNTING 
                        STANDARDS BOARD

    Mr. Herz. Thank you, Chairman Shelby and Ranking Member 
Sarbanes, and other Members of the Committee. I am here on 
behalf of the Financial Accounting Standards Board, and I want 
to thank you for this opportunity to discuss our current 
project to improve the employers' accounting for defined 
benefit pension plans and other post-retirement benefits.
    Our ultimate goal in that project is to develop, in 
cooperation with the IASB, a high-quality principles-based 
global standard for accounting for these obligations. I am 
therefore very pleased that Sir David is also here with me 
today.
    As you probably know, we are working very closely with our 
international colleagues on a number of key projects, including 
the development of a common conceptual framework, topics like 
accounting for business combinations, financial instruments, 
financial statement presentation, revenue recognition, and a 
number of other projects designed to reduce the differences 
between U.S. GAAP and international financial reporting 
standards, and in the process to improve both of our respective 
standards. Sir David will elaborate further on these efforts to 
bring about high-quality global accounting standards.
    With regard to the post-retirement benefit project, we have 
undertaken that project because current accounting standards do 
not provide complete and transparent information about 
employers' obligations and costs relating to these benefit 
promises. Our proposed changes in the first phase of our two-
phase project would require employers to recognize the over or 
underfunded status of their defined benefit pension plans and 
other post-retirement benefit plans on their balance sheets. We 
believe these changes would more faithfully report the 
underlying economic effects of those plans and increase the 
transparency, completeness, and usefulness of financial 
statements for shareholders, creditors, employees, retirees, 
and others.
    The second broader phase of the project, which will begin 
after completing the first phase, will address a broad range of 
accounting and reporting issues in the area of post-retirement 
benefits. Before discussing further details about this project, 
I would like to provide you with a little bit of background on 
the FASB.
    We are, of course, an independent, private-sector 
organization. Our independence from enterprises, auditors, and 
others is fundamental to achieving our mission to establish and 
improve standards of financial accounting and reporting for 
both public and private enterprises. Through the FASB, 
accounting standards are set by an independent group of experts 
who carefully develop proposed rules through an open, public 
deliberative process which contributes to overall confidence in 
the capital markets.
    Financial reporting is meant to tell it like it is and not 
to allow distortions or the skewing of information that favors 
particular companies or industries, particular types of 
transactions, or particular political, social, or economic 
goals other than that of sound reporting.
    While bending standards to favor or retain a particular 
outcome may seem attractive to some, in the long run, biased 
accounting standards can lead to mistakes in private and public 
investment decisions.
    Because our actions affect so many organizations, our 
decision process must be open, thorough, and as objective as 
possible. So our rules of procedure require an extensive and 
thorough public due process. It involves public meetings, 
public roundtables, meetings with many interested parties, and 
exposure of our proposed standards to external scrutiny and 
public comment, and in making our judgments we must balance the 
often-conflicting perspectives of various interested parties in 
order to make independent, objective decisions guided by 
fundamental concepts and key qualitative characteristics of 
financial reporting.
    In November of 2005, our Board unanimously decided to add a 
comprehensive project to our agenda to reconsider the existing 
accounting guidance for defined benefit pension plans and other 
post-retirement benefits. That decision responded to many 
requests from users of financial statements, preparers and 
auditors, our advisory committees, the staff of the Securities 
and Exchange Commission, the Pension Benefit Guaranty 
Corporation, and many others, to remedy deficient rules that 
have resulted in unclear and misleading financial reporting for 
defined benefit plans and other post-retirement benefits.
    What are the key concerns? First, the current standards 
permit an employer sponsoring such plans to delay recognition 
through a complex series of smoothing mechanisms of the 
economic events that result in great distortions of the costs 
and obligations that are reported. Current requirements also 
relegate important information about the benefit plans and 
their status to the notes in the financial statements. 
Additionally, the existing reporting of benefit costs obscures 
the employers' reported results of operations by combining the 
effects of compensation, investing, and financing activities.
    We decided to conduct our project in two phases. The first 
phase of the project focuses on recognizing on the employers' 
balance sheet the overfunded or underfunded status of its post-
retirement benefit plans. The second, broader phase of the 
project will address other more complex issues, including how 
best to recognize and display in reported earnings or other 
comprehensive income, the various elements that affect the cost 
of providing post-retirement benefits. A key issue to be 
explored there will be whether and to what extent should the 
current smoothing mechanisms relating to pension costs and 
other post-retirement benefit costs be allowed to continue, or 
should it be eliminated or at least simplified.
    We will also examine issues such as how best to measure the 
obligations, in particular, obligations under plans with lump 
sum benefit features, cash balance plans and multi-employer 
plans, and whether more or different guidance should be 
provided regarding measurement assumptions.
    Since our November 2005 decision, the Board and staff have 
held three public meetings to discuss the Phase 1 project. We 
have discussed it at meetings with our advisory committees and 
with other interested groups. We have also discussed it at 
numerous venues across the country.
    So after about 4 months of public due process, in March of 
this year we unanimously agreed to issue the Phase 1 proposal 
for public comment. The Phase 1 proposal would require 
employers to recognize the overfunded or underfunded status of 
their post-retirement benefit plans on their balance sheets. 
For example, for defined benefit pension plans, the amount of 
what is called the projected benefit obligation would be 
compared to the value of the related plan assets. If the 
projected benefit obligation exceeds the plan assets, the 
difference would be reported as a liability on the employers' 
balance sheet, that is, it is in an underfunded position with a 
corresponding decrease net of any tax effects to the employers' 
reported equity. Conversely, if the value of the plan assets 
exceeds the projected benefit obligation, the difference would 
be reported as an asset with a corresponding increase net of 
any tax effects in the employers' reported equity.
    The Phase 1 proposal would also require that employers 
measure the plan assets and obligations as of the date of their 
financial statements. In contrast, current accounting standards 
permit them to be measured at dates up to 3 months earlier. The 
proposed changes would require recognition of the overfunded or 
underfunded status by the end of this fiscal year for calendar 
year-end companies. For public companies, the change in the 
measurement dates to bring it to the fiscal year end would be 
delayed for another year to 2007, and for private companies, 
they would be given another year, to 2008.
    The comment period for the Phase 1 proposal ended on May 
31. The Board plans to hold public roundtable meetings later 
this month on the proposal to ensure that we understand the 
views and positions of interested parties. While our staff is 
currently analyzing and summarizing the over 200 comment 
letters we have received, from my own reading of the letters, 
some of the key issues and concerns raised by respondents focus 
on the measurement of the underfunded or overfunded status, the 
proposed effective dates, and the proposed requirement to 
measure plan assets and liabilities as of the employers' fiscal 
year end.
    After the roundtable meetings, the Board will then begin 
public redeliberations on the Phase 1 proposal. Our 
redeliberations will focus on the key issues raised by 
constituents, and only after carefully evaluating the input 
received will the Board consider whether to issue a final 
standard on Phase 1, which, of course, requires approval by a 
majority of our Board. Once we do that, assuming we do it, the 
Board will begin Phase 2 of the project.
    Chairman Shelby, before handing over to Sir David, I would 
like to take this opportunity to thank you and Senator Sarbanes 
and other Members of the Committee for all your efforts in 
recent years to improve the integrity of financial reporting, 
and for your support of our work. Many thanks.
    Chairman Shelby. Sir David.

    STATEMENT OF SIR DAVID TWEEDIE, CHAIRMAN, INTERNATIONAL 
                   ACCOUNTING STANDARDS BOARD

    Mr. Tweedie. Thank you very much, Mr. Chairman, Ranking 
Member Sarbanes, Members of the Committee. May I say, as ever, 
it is a great pleasure to be here in the United States, the 
finest country that anyone ever stole.
    [Laughter.]
    Mr. Tweedie. I must say that it is a great opportunity to 
discuss a topic that I care deeply about, as Senator Enzi 
reminds me. I am a baby boomer, and this is an issue--I may not 
look it--but this is an issue that does start to creep up on 
you.
    I think the real area though is the fact that between the 
FASB and the IASB, we could make real progress in changing 
accounting systems that are deficient, distort behavior, have 
intergenerational consequences, and could lead to great cost, 
as Senator Enzi emphasized, to taxpayers.
    We are in the process now of adding a project onto our 
active agenda. We intend to work very closely, as Bob said, 
with the FASB, and I am delighted that Bob is here with me 
today. He has been a great advocate of international standards, 
and has provided essential leadership in our convergence 
program with the United States'.
    Perhaps before I turn to post-retirement benefits, I could 
put IASB's work into context. The FASB and the SEC helped form 
our constitution, which makes it quite clear that our objective 
is to come up with one single set of high-quality global 
standards. Since I first appeared before this Committee in 
February of 2002, 100 countries now allow or require 
international standards to be used, including the European 
Union, which requires them for consolidated accounts of listed 
companies. This also includes Australasia and South Africa. 
China is starting next year. Canada is going to shift in a few 
years time. Japan, we have a major convergence program with. 
Israel is coming in in 2008, and Chile the following year.
    In all of this, the cooperation of the FASB has been 
essential, and our major objective now is to converge with the 
United States so we do indeed have one single set of standards 
and not two, as we have at present. The idea is, companies 
worldwide want access to markets on both sides of the Atlantic, 
and the convergence program is a major way of getting there.
    Shortly after Bob became Chairman, we signed the Norwalk 
Agreement with the FASB, whereby we were trying to remove the 
differences in our various standards. By 2010, 1,000 companies 
using international standards will be registered with the SEC, 
and we see that number growing. It was taking too long, 
however, to get rid of these differences, and with the help of 
Bob and the SEC, we produced what is known as the Roadmap, a 
way in which we can get rid of these differences rather faster, 
and a method by which we can remove the reconciliation required 
when you list in the U.S. markets, using standards from another 
jurisdiction, and that has become a source of major contention 
among companies worldwide, and probably stopping several of 
them coming to the United States. We hope we can get rid of the 
need for reconciliation in the next 2 to 3 years.
    The program is split into two parts. First there is a 
short-term phase, whereby we look at differences we know we can 
get rid of quite quickly, and we will just make a few changes 
to paragraphs in standards. FASB are doing some and we are 
doing some. Others, where the standards are perhaps outdated or 
too complicated, while we could converge them, we think that 
would be a waste of resources, and we intend to write jointly a 
new standard. These cover various issues including financial 
instruments. If you have read the International Financial 
Instrument Standard, if you understand it, you have not read it 
properly. These are the sort of situations that affect, I 
think, probably the U.S. standard too, and what we want to do 
is write a new one. Post-retirement benefits fit into this 
class as well.
    Bob and I often hear that accounting should not affect 
behavior, but the trouble is poor accounting masks the problem 
and leads to bad behavior. The overall deficit about a year 
ago, and the European Union companies in the Dow Jones Stoxx 
Index was $146 billion at today's exchange rates. The U.K. FTSE 
Index, the top 100 U.K. companies, showed deficits of $68 
billion this time last year. The trouble is the international 
standard and present U.S. GAAP obscures the issue. To put it 
very simply, if we had a pension fund which had assets of $40 
million and liabilities of $40 million, and the assets fell by 
$10 million, you would have a deficit of $10 million. That is 
not how they are generally shown.
    What happens is we have smoothing mechanisms. The first 
comes in to say, well, some of that deficit will be market 
noise, we measure that at 10 percent or whatever is the higher, 
the liabilities or assets. The liabilities are the higher at 
40. We take $4 million off the deficit of 10. We then spread 
that deficit of $10 million over the active working lives of 
the employees, say 10 years, and you end up with a deficit 
shown in the accounts of $600,000.
    Now, as I have often said, explain that one to your 
grandmother. You may as well take the $10 million and divide it 
by the cube root of the number of miles to the moon and 
multiply it by your shoe size.
    [Laughter.]
    Mr. Tweedie. It really does not mean a thing. Nor 
disclosure, as we have discovered, in the case of share auction 
option accounting does not help. It really is not taken 
seriously enough, and that is why in the United Kingdom, one of 
the last things I did while I was Chairman of the U.K. 
Standards Board was introduce a new standard on pensions, FRS 
17 which actually shows a whole deficit on balance sheet, and 
this is very similar to what Bob and the FASB are doing just 
now.
    I thought it might be helpful to the Committee to explain 
what happened when we did that. When we first announced it, 
British companies split 50/50 for and against. The main 
argument was this was just a snapshot and could be distorted. 
We also required though that the trend is shown, so this 
deficit or surplus over the last 5 years is shown, and that 
very quickly showed that the deficits were getting worse. The 
problem exposed was we launched at not an ideal time. We 
launched at the beginning of the bear markets, so asset values 
fell. But what people did not realize was the effect on 
liabilities.
    The first thing that happened, people have developed a very 
bad habit of living longer, and it has just got to stop.
    [Laughter.]
    Mr. Tweedie. The second factor was that interest rates 
fell. Now, that is normally a good thing, but the trouble was 
so did annuity rates. So if you promise someone a pension of 
10,000 and annuity rates are at 10 percent, that will be a 
capital sum required of 100,000. If they fall to 5 percent, you 
need 200,000. So what happened was assets fell and liabilities 
rose in the funds at the same time, and it was not noticed.
    The interesting thing, 2 or 3 years after we introduced the 
standard, the atmosphere had completely changed. As several 
senior executives said to me, pensions are now being discussed 
in the board room, it is no longer a hidden matter which was 
never revealed in the accounts.
    We decided, when we became the IASB, to amend our pension 
standard to allow the U.K. proposal to be one of the options. 
Interestingly enough, 15 major U.K. companies wrote in, all of 
them suggesting that we do allow the FRS 17 approach, and two 
of the major business groups, the Association of British 
Insurers and the Confederation of British Industry, also 
supported it. That is quite a change from a few years earlier. 
Companies now see what they can promise.
    This, as I know you are aware, is a huge issue. Our job is 
to make sure that people can make informed decisions, the 
question of the risk to the company, the question of the risk 
to the individual, and if the company cannot make the promises, 
the risk to the taxpayer.
    FRS 17, like the FASB's first stage, was an incremental 
change. There are still defects that are in Phase 2 of Bob's 
project in which we hope to join in. We still allow an assumed 
return on assets for the future, and some of these assumed 
returns have been heroic. Now we need to look at the issue in a 
more comprehensive manner. We intend to add to the agenda, and 
again, like Bob, we intend to try and do it in two phases.
    We will join in, I suspect, and do something very similar 
to that Bob has already proposed. We also intend that while the 
timing of our first phase and some of the things that we deal 
with may differ slightly from Bob's, we will still end up with 
a common standard. It is just a case of the movement toward it. 
We are intending to look at not only the smoothing mechanisms, 
but can we do something on the gains and assets, the 
curtailments, the presentations, the disclosures?
    FASB is leapfrogging us at the moment, and we will catch up 
with our first phase, and then we will end up with the same 
standard. The work that we do will help FASB. The work FASB 
does will help us.
    Retirement income depends on state-provided pensions, 
private savings and company schemes. Our job is to make sure 
that companies' schemes are on the same basis, and if they are 
not, people at least are aware of that. Good accounting will 
not solve the problem, but it makes the issues transparent. It 
helps the company. It means that they have to manage it. The 
problem is obvious. It is not an instant liability as a payable 
on inventory would be. It is simply something that has to be 
met. It helps investors because they see the cash-flow 
implications. It helps employees because they now understand 
the risk, and it helps public officials because they now 
realize what the problem really is.
    Interestingly, we are finding British companies are now 
explaining the problem quite clearly. We are getting 
disclosures something like, ``We have a deficit of 50 million. 
We intend to put an extra 5 million a year into the fund. We 
intend to change the fund slightly. We expect the return on the 
existing assets to be in the region of 4 percent. If that all 
happens, we will be back in equilibrium in 2010. The effect on 
profits, assuming they are maintained at current levels, will 
be 1.3 percent, and the problem is starting to disappear and be 
managed.''
    It will not be easy. I always liken standard setting to 
American football. To an outsider American football is really 
just a big committee meeting, punctuated by extreme moments of 
violence----
    [Laughter.]
    Mr. Tweedie. And I expect that this process may be 
something similar.
    It is important very much to get all views. As Bob said, we 
have major due process, but this--and I very much agree with 
Senator Enzi--is one of the major issues facing us, not only in 
accounting, but in public policy too.
    Thank you, sir.
    Chairman Shelby. Thank you both. Harmonizing international 
accounting standards is an important project and has been given 
added importance recently by the cross-border consolidation 
exchanges. We will start with you, Sir David. Would you just 
touch again on the major accounting issues that you see that 
are likely to present the most difficult challenges with 
respect to convergence in that context?
    Mr. Tweedie. I do not see them being a challenge to 
convergence because I think both boards are very keen that we 
do converge, and we have had nothing but cooperation, but I 
think the issues that are going to be controversial are 
certainly out there. We know, for example, leases is one where 
again we are thinking of putting that on our agenda right now.
    Chairman Shelby. Leases?
    Mr. Tweedie. Leases, yes. One of my big ambitions is 
actually flying an aircraft that is on an airline's balance 
sheet before I die.
    [Laughter.]
    Mr. Tweedie. Basically, the leasing standards worldwide are 
harmonized, but none of them work. There are massive off-
balance sheet amounts that are reflected both in the rights to 
the asset on the asset side, but also liabilities that 
companies cannot escape from. These are missing.
    Financial instruments is going to be a challenge. It took 
our predecessors 12 years to come up with our present 
controversial standard. That is another one we are working 
actively with the FASB to look at.
    Consolidations, the question of special purpose vehicles, 
we too are looking at what is being done in the United States 
and seeing if that is the answer internationally, whether we 
can improve upon it, if we can. We will obviously be back 
discussing it with the FASB. The whole question of 
consolidation here is, when should you bring a company in as a 
subsidiary. Is it when you have 50 percent plus one of the 
equity or is it when you control it? And these are issues, big, 
deep, philosophical issues that we have to resolve.
    Chairman Shelby. Bob, you want to comment on that?
    Mr. Herz. Yes, I would add just one or two other issues 
that I think are important. One is the whole area of 
intangibles. We are doing a lot of projects on the--I call it 
the liability side of the balance sheet, so to speak, but on 
the asset side the area of intangibles is one where accounting 
right now does not capture the value drivers of many businesses 
in the modern era, and so figuring out whether or not financial 
statements can better capture that, or is there other 
information that can be provided, I think----
    Chairman Shelby. How substantial is this?
    Mr. Herz. Well, since it is very hard to measure, what we 
do know, rightly or wrongly, is that the difference between the 
market value of many companies and their book value, there is a 
big gap there. Some of that goes up and down with the stock 
market, but there is often a big gap that remains. It depends 
on what type of company, but certainly we also know that when 
one company buys another company or when people are analyzing a 
company seriously to make major investments in it, they look at 
all these kinds of things, really, what are the value drivers 
of the business, the know-how, the people assets, the customer 
loyalty and retention, those kinds of things. In U.S. 
accounting, those are only generally captured when they are 
either purchased or there is a business combination. If they 
are internally generated, there is no accounting for that 
asset, whereas, actually in the international standards, 
sometimes there is some accounting where there is ability to 
demonstrate that it is likely to prove to be beneficial with 
some degree of certainty. I think that is a real important 
area.
    I think the area of fair value also, and to what degree 
beyond where you have established markets should that be used 
versus historical cost notions, is a very important one and one 
that we are going to be taking up starting later this year in 
our joint project to relook and merge our respective conceptual 
frameworks.
    Chairman Shelby. Bob, I have another question. Mr. 
Chairman, I should say. The comment period for your proposal 
ended a couple of weeks ago. FASB has received more than 200 
comment letters, I understand. Could you describe somewhat to 
the Committee what some of the more common reactions have been?
    Mr. Herz. Yes. And, again, this is from my own reading. I 
read the letters as they come in. Our staff then produces a 
very comprehensive analysis of the comment letters, which they 
are in the process of doing right now. But from my own reading, 
some of the issues that commentators have focused on--well, 
first of all, I think most people agree that the current 
accounting model needs fixing.
    One of the issues in Phase 1 that they focused on is 
whether the measurement of the underfunded or overfunded status 
should be what is called the projected benefit obligation, or 
what is called the accumulated benefit obligation. The 
projected benefit obligation includes what is called a salary 
progression assumption for future increases in salary that 
would then, in effect, determine what the benefits--the value 
of the benefits that you have earned today by current service. 
The accumulated benefit obligation excludes those future salary 
potential increases.
    I think a number of companies have focused also on the 
issue of what we propose that for a calendar year-end company, 
that they put these liabilities, or in some cases, assets on 
their balance sheet by the end of this fiscal reporting year, 
so 12/31. Some companies said they do not know if they have 
enough time to do that. I do not think it is the issue of 
making the calculations because the calculations are already 
made and disclosed in the footnotes, so all that is available, 
but it is the issue of things like they may have loan covenant 
issues, other plans, internal compensation plans that may work 
on book value numbers, for example. This will obviously change 
book values. That is another comment.
    A third set of comments relates to our proposal that the 
measurements be done as of the end of the company's fiscal year 
end. Right now the rules allow companies to do those 
measurements up to 3 months before the fiscal year end, and 
people are saying that with tighter reporting deadlines that 
have been put in place in the last few years, that just adds an 
extra degree of burden. So those are all comments, and many 
other comments that we will carefully consider.
    Chairman Shelby. Sir David, would you just briefly describe 
for the Committee for the record, you have the role of the 
Securities and Exchange Commission and the Roadmap, which aims 
to eliminate by 2009 the reconciliation requirements for 
foreign companies listed in the United States. We have talked 
about this before I think in London one time.
    Mr. Tweedie. Indeed, sir. The SEC has played a major role, 
along with the FASB. It has become quite clear that as we move 
on convergence, companies outside the United States are really 
saying, well, where is the reward for this? If we are doing 
this, do we still have to keep reconciling to U.S. standards? 
Do we have to wait until they are identical? We think probably 
by about 2011 we will be getting pretty well the same answers, 
whether it is international or U.S. standards. That is now 
leading I think to political pressure in some countries, 
leading to the threat that, well, if we have to reconcile, why 
shouldn't U.S. companies across here, which may have debt 
borrowings or whatever, why should they not have to reconcile 
as well? That is a waste of resource and something that should 
not really be resorted to.
    So I think the SEC is helping us by trying to set out this 
Roadmap, things we can do quickly and are pretty confident we 
can do that, and also they have helped us set out the agenda of 
the issues they think are really important to them. What they 
are really saying is we know you do not have to complete these 
when we consider whether or not to remove the reconciliation, 
but provided the program is continuing and it is quite clear 
there is going to be a convergence toward the end, then we are 
willing to consider that, probably in a couple of years time.
    I think that has assuaged a lot of the concern. 
Internationally it has been a very constructive move and we are 
very grateful to them for bringing forward the idea.
    Chairman Shelby. Thank you.
    Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman. I want 
to welcome both of our witnesses again before the Committee. It 
is very helpful to have their testimony.
    First of all, I take it there is complete agreement that 
the objective here is to develop a single set of international 
accounting standards that will be used worldwide? Is that 
correct?
    Mr. Tweedie. It is indeed. We, for example, think with the 
post-retirement standard, we will end up with an almost 
identical standard. The idea is we can get it in identical 
words. Americans have a congenital inability to spell properly, 
but apart from that, we want them to be exactly the same there.
    [Laughter.]
    Senator Sarbanes. What is your time frame for achieving 
this objective?
    Mr. Herz. I will hazard a kind of a speculated, somewhat 
educated prognostication.
    Senator Sarbanes. Well, you have got it obfuscated pretty 
well already.
    [Laughter.]
    Mr. Herz. Yes, thank you. As Sir David said, I think that 
around the rest of the world, good parts of the world are 
adopting international financial reporting standards and 
continue to do that. You then look at which of the major 
markets that have not done that and what is going on. One of 
them is clearly us. We have our program of closely working with 
Sir David. Another one is Japan, where we have actually started 
to almost triangulate the effort. Their standards have 
historically been patterned more on ours, but they also want to 
move toward international standards.
    The third major market is Canada, and they have announced 
that within 5 or so years they will try and move from their 
standards, which again are very similar to U.S. standards, to 
international standards.
    So the real key has become us and Japan, I think, in terms 
of at least major global capital markets. I could foresee one 
chain of events being--and, again, this is just one 
possibility, but certainly one genuine possibility--that we 
continue our efforts; other things that are going on, including 
the SEC, will start to review the filings of international 
financial reporting standards filers that are coming into the 
United States now. They are going to embark on a program to 
look at those carefully over the next years to understand 
whether there seems to be consistency or not in their 
application. You know, are they applied relatively consistently 
in Greece versus in Australia, which I would suspect the first 
time around for people who have adopted whole new standards, is 
quite a challenge, and you cannot expect perfection to begin 
with. But I think effort at continuous improvement over the 
next few years would enable the SEC to consider and probably 
lifting that reconciliation requirement.
    If that happens, I think there will probably be some U.S. 
filers that in certain industries where a lot of their 
competitors are using international standards, who will say, 
well, why cannot we also use those standards? I think that will 
probably be studied, and then sometime, given that we are 
continuing to make them more and more similar and common, the 
SEC will say, OK, for U.S. domestic filers, you can also use 
the international standards. After a couple years of that maybe 
people will say, gee, they seem like you have made enough 
progress on convergence to say why are we maintaining two sets 
of standards at this point? The differences are not significant 
enough any more. I think that will be the point at which we 
have essentially met this objective.
    I think it is still a 8- to 10-year process in my own view, 
even being optimistic.
    Senator Sarbanes. Want to add anything to that, Sir David?
    Mr. Tweedie. I think to finalize it, looking even at this 
project, the FASB has projected an 8-year period to finally 
finish the pensions project. We can do a lot in the meantime. I 
think probably in 5 years time, the differences will be pretty 
small, we will be really getting very close. There will still 
be a few, but we will be working on those, and I see it in 
about an 8-year time frame if I had to say when.
    Senator Sarbanes. I wanted to just follow up on that, and 
as something that Bob Herz sort of mentioned in the course of 
his answer just now. It is one thing to get convergence on the 
standards, it seems to me another thing to get convergence or 
acceptability on the implementation of the standards. What is 
your view on that part of the question?
    Mr. Herz. Well, I think probably Sir David is better at 
answering that. I think the issue is, the one that I mentioned, 
is that to what extent and over what period will there be 
consistent application in different jurisdictions around the 
world where they are coming from? They are used to their old 
standards and the different cultural differences.
    Senator Sarbanes. Do you use standards that have been 
adopted, which are the international standards, as I understand 
it, are they being--the International Financial Reporting 
Standards, are they being enforced or monitored by a EU 
organization or by separate national organizations in each of 
the EU countries?
    Mr. Tweedie. It is a mixture of the two, Senator. What is 
happening in Europe, there is a committee of the securities 
regulators called CESRFin, and it is really trying to pool 
together the national regulators who in fact they have a common 
enforcement mechanism, and there is a lot of peer review going 
in, views about decisions taken, interpretations and so on. So 
they are trying to coordinate on a European wide basis.
    I think, as Bob was hinting at--and the SEC has been very 
clear about it--that the standard setters can only provide one 
leg of this stool. We also need good auditing, because if the 
standards are not audited properly, then it will not work, as 
we have seen from the past in your work, sir on the Sarbanes-
Oxley Act. We need corporate governance to make sure that their 
decisions are taken in the atmosphere of trying to produce a 
fair presentation, and the forfeit is enforcement. So all of 
these are going to come together. I suspect the SEC may well be 
selective, saying, well, this part of the world is doing it 
properly, this part is not, and we do not trust it in the 
meantime. And they may well decide to break on these bases. 
Even though the standards are being used, we are not quite sure 
how well they are being used, and that is what the SEC is going 
to check.
    Senator Sarbanes. If I could put one final question.
    Chairman Shelby. Go ahead.
    Senator Sarbanes. Senator Enzi raised this, and I think 
Senator Allard also alluded to it. In considering the pension 
issue, which is now under examination, as I understand it, how 
much attention is being paid to the fact that these business 
enterprises were allowed to proceed in a certain way in dealing 
with a pension issue. It is now being proposed, well, those 
standards are inadequate and they do not provide an accurate 
reflection, and therefore, they should be changed. Senator 
Enzi, I think, said something about, well, you know, there is 
not much problem if it had been that way from the very 
beginning, but it has not been that way. So we are confronted, 
I guess, to some extent with a transition problem, or 
alternatively, what the impact would be of requiring an 
immediate change on these defined benefit retirement plans, 
which are under attack for other reasons as well at the moment.
    So it does raise some difficult questions about what the 
impact would be on retirement plans that have been in effect 
for a substantial period of time, that people, in effect, have 
done all their planning in relation to and relied upon, and 
some are even saying that an immediate change, that some of 
these enterprises would go under. They would be catapulted into 
the red in a substantial manner. Now, that only to some extent 
underscores the nature of the problem that you are seeking to 
correct, but it does confront you with an important transition 
problem it seems to me. What is the thinking on that?
    Mr. Herz. Well, I think the thinking in our Phase 1 
proposal was limited to the balance sheet and to put that 
right, so to speak. Most of the comments we got in leading up 
to that was that more of the controversy and the notion that 
this will be the final straw that will abandon the plan, freeze 
the benefits. More of the commentary came around Phase 2. What 
are you going to do with reported earnings, which are not 
affected in Phase 1?
    I would also say that it is very hard to predict these 
kinds of things. What we do now is that there has been a 
pronounced flight away already over the last 20 years or so 
from defined benefit plans. I think statistics I saw from the 
Department of Labor were that over the last 20 or so years, the 
number of defined benefit plans has gone down by something like 
80 percent, and that is long before we talked about doing 
anything in terms of the accounting.
    We also hear that the reactions of some companies will be, 
well, in order--if I have to present the liability, maybe I 
ought to do some more funding in order to reduce the liability 
or get on a program to reduce it, a la what Sir David described 
as some of the U.K. reaction. Some of it has also been that 
whether it is real or speculation, that there may be a move by 
some companies to change the way they invest the plan assets, 
to more closely match fund the obligation. Therefore, they 
might switch from less equities to more bonds in their 
portfolio.
    Again, as a layman, that seems to me that increasing the 
funding and better matching the obligation would seem to better 
secure the benefits. I think part of the problem is that the 
existing accounting has gotten us to this point of masking some 
of the issues, and that may have led to over promising of 
benefits, and certainly some of the accounting mechanics Sir 
David talked about, the assumed rate of return assumption, have 
in many minds led to very undesirable behaviors as far as the 
investment profile of the pension plan assets.
    A wise man told me once in this whole area--which I am sure 
you all know public policy very much--but certainly in 
accounting, that when you make changes, things will change, 
behavior will change, but it is not like a basketball, it does 
not bounce straight up and down. It is kind of like a football, 
it bounces side to side and hard to predict.
    Senator Sarbanes. Did you have to deal with that problem?
    Mr. Tweedie. No, and I think the interesting thing, looking 
at the U.K. position--and there are others more expert than I 
that could give you details on this--but since we produced the 
pension standard, there has been a marked change in the debate. 
The national financial papers are full of pension issues, and 
many companies, I think, have now realized for the first time--
and so have their employees. British Airways, for example, a 
couple of years ago I think its deficit was somewhere in the 
region of, if it was in dollars, it would be something like 
$2.4 billion, which is about 44 percent of its market 
capitalization at the time. That was a huge deficit. And they 
have been in discussions with their employees. They have 
stopped paying dividends because they feel they have to fill 
this hole. They have put more money into the fund. They are now 
suggesting that their employees are going to have to work 
longer and perhaps some of the benefits might have to change, 
but they have made promises that it is very difficult to keep I 
think. So they are looking at it very carefully, how they can 
manage their way out of it.
    The advantage, I think, of showing the numbers is that we 
are talking about a long-term issue, it does not have to be 
funded tomorrow. So the question is how do they do it over the 
period in which they have to meet the commitments? And I think 
a lot of companies are doing it very seriously. They are taking 
the details and the problems of the schemes into account. They 
are trying to do it over a long term, but they have actually 
got a serious debate going now, and they are planning their way 
through it, whereas, the danger was that suddenly they realized 
they could not possibly meet this under any circumstances, and 
then bankruptcies follow and the pension falls to pieces. It 
has now become a big issue in the United Kingdom in takeovers, 
where the pension regulator is demanding money is put into 
funds to hold the deficits rather than just be distributed to 
shareholders and so on.
    So there is a lot of behavioral change which has actually 
safeguarded pensions.
    Chairman Shelby. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman. I found this 
hearing enlightening, and thank you for holding it.
    Senator Enzi, who had to leave here earlier, has asked me 
to make sure that we protected his ability to be able to submit 
questions.
    Chairman Shelby. We will leave the record open. He is very 
interested in this issue and is a very good member of this 
Committee. We will leave the record open for his questions.
    Senator Allard. Yes, for his questions, if you would, 
please.
    I have a question to Mr. Herz to start with. You said that 
you had an opportunity to look at a lot of the responses that 
were coming in. Were you able to assess a difference between 
the responses from large companies as opposed to medium and 
small companies? Was there any differential that you could pick 
up in their response?
    Mr. Herz. I guess the one thing that I recall from some of 
the letters is that when you are dealing with smaller 
companies, particularly private companies, they have a lot more 
arrangements related to their book value. They have the book 
value stock plans, for example. Their loan covenants may be 
crafted differently, as well in some public companies. So any 
time you do something that will affect their stockholders 
equity, those things become a matter of discussion.
    Other than that, I think there were some--there are the 
issues of resource availability to change the measurement date, 
and I think we took that into account by giving the private 
companies a 2-year window in order to get--recognizes there may 
be only so many actuaries to go around at a point in time.
    Senator Allard. This is for Sir David. You have co-ops in 
the United Kingdom like we have co-ops here. My understanding 
is that with the post-retirement kind of proposal we have here, 
you had some problems with that in the United Kingdom in the 
fact that some of those co-ops were closing; is that correct?
    Mr. Tweedie. Not so much because of the pension schemes. I 
think there were other reasons for that. But certainly----
    Senator Allard. Go into that detail for me, how that is----
    Mr. Tweedie. I would have to come back to you, Senator, 
really on the detail of that, because it did not become a huge 
issue when we did it with the co-ops, frankly. This may have 
emerged later, but--and I am not so familiar with the United 
Kingdom as I used to be--basically, the issue, a lot of the 
companies had actually defined contribution schemes, so they 
were not caught up in the benefit issue. And a lot of our 
smaller companies have those too. This may be something that I 
will have to ask the U.K. Standards Board to see what problems 
they have. They are coming to see us next week to deal with 
leasing and pensions, so it will be well worthwhile having a 
discussion with them, and I will raise that point and get back 
to you if I may.
    Senator Allard. I would appreciate that very much. I think 
it would be very helpful in our deliberations here.
    Mr. Herz, have you given us a time frame in which you 
intend to complete this project on pension funds?
    Mr. Herz. Well, right now, we, for Phase 1, our current 
plan would be to begin redeliberations based upon the input we 
get through that over the summer, and finish probably by the 
end of the third quarter on Phase 1. Phase 2, I think, our 
staff has not drawn up a detailed project plan yet, but I think 
it will be a more than 1-year and probably 2- or 3-year 
exercise because there are a number of very complicated issues.
    Senator Allard. Then once you have put things into place, 
then there is going to be an implementation period after that.
    Mr. Herz. Right.
    Senator Allard. I gather from your comments, this is going 
to be a phased-in implementation process?
    Mr. Herz. Well, for Phase 1, the putting of the assets and 
liabilities on the employers' balance sheets, we are proposing 
that to be done at the end of the companies' fiscal year ends 
that end starting with the December 31 fiscal year end reports. 
The measurement dates, change in the measurement date to bring 
it to year end, rather than 3 months before. By the way, a lot 
of companies already do it as of year end. It is probably 50/50 
as to whether people avail themselves of that lag option. That 
is phased in. For public companies it would be phased in in 
2007, or for private companies 2008.
    As to once we look at Phase 2 and whatever we come up with, 
whether there will be a phase-in period for that, certainly 
there will be a gap between when we finalize any Phase 2 
standard and when it would have to be implemented.
    Senator Allard. So you will be talking about everybody 
being on the same fiscal year; is that what you are----
    Mr. Herz. Not the same fiscal years. They will have to 
measure the plan assets and liabilities as of their fiscal year 
end.
    Senator Allard. I see, OK. That is going to take us a while 
to get all through this process.
    Mr. Herz. I think by the time we have a comprehensive, 
reworked global standard--because we are going to be working 
very closely with the IASB on that--in place, it may be 3 or 
more years is my best guess.
    Senator Allard. I would like to have you just kind of go 
over some of the issues that you saw that sort of spurred you 
to move forward to address pension and other post-retirement 
benefit accounting, and also, when was the last time that we 
really addressed this issue?
    Mr. Herz. Well, going to the second part of your question, 
the existing standard for defined benefit pension plans was 
issued I think in 1985. The existing standard for other post-
retirement benefits, which are primarily retiree health care 
coverage, was issued I think in 1990 or 1991. There have been 
some tweaks since then. There has been enhanced footnote 
disclosures put in since then as well, but not a comprehensive 
relook at it.
    I think the issue started to really come to light at the 
turn of this century, at the turn of the Millennium with what 
people called the perfect storm of pensions. The equity values 
went way down because the stock market bubble, the value of the 
liabilities, as Sir David gave in his example, went up because 
of decreasing interest rates, and so the degree of underfunding 
became more and more pronounced, and, of course, in some cases 
was almost all the companies could take in certain industries.
    I think that coupled with that, there began to become a 
realization that the mechanics of the existing accounting, 
which borrow a lot from some of the actuarial approaches, 
particularly this assumed rate of return assumption that Sir 
David mentioned. And just to kind of give you a simple example 
of how this kind of works, if you had a billion dollars in 
value in a pension plan, big company, the current accounting 
says assume a long-term rate of return, and that depends on 
your asset mix. The typical asset mix in a pension plan might 
be 60 percent equities and 40 percent bonds, for example, and 
so people would assume a long-term rate of return of, say, 8 
percent. The current accounting says take that 8 percent on the 
billion dollars, and assume that you are going to make $80 
million this year, and you do not only assume it but you 
actually credit, you report of $80 million for that year. Let's 
say the pension assets actually tumble by $200 million, as they 
did in 2001-2002. That difference of $280 million, first what 
you assume versus what actually happened, gets spread over very 
long periods of time. It could be 20 or more years.
    So you are reporting $80 million in earnings, and you are 
taking the $280 million deficit and spreading it over, say, 20 
years, which would be a $14 million number if I am doing my 
math right. And so you would net report pension income that 
year of $66 million, even though your pension plan went down by 
$200 million. A lot of people--Sir David said, ``How can this 
be?'' The answer was, traditionally, the idea was that over a 
long period of time things would even out. But of course, what 
we found was that in a number of companies and industries it 
did not even out. They went over the cliff.
    Senator Allard. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Basically, what you are trying to do, as I 
understand it, with accounting, pension accounting reform, is 
get to the truth of the matter. That is what accounting is 
about, is it not? I know Senator Sarbanes has been very active 
in this whole area, as we all know, of corporate governance and 
accounting standards and seeking the truth and the value of 
something. So this puts a value on a company. I know we, 
Senator Sarbanes and I, worked together on making sure they did 
not politically try to change the way stock options were valued 
because they did have a value or they did not. You know the 
deal there. You are working on it still. Well, at this time, is 
your plan to give companies an opportunity to grow out of their 
dilemma, out of their problems, but to realistically point out 
they have got a real problem, as some of them do?
    Mr. Herz. Yes. I think, as with the analogy with the United 
Kingdom example, our plan is by----
    Chairman Shelby. Sir David pointed out British Airways.
    Mr. Herz [continuing]. ----Phase 1 to highlight the issue 
by putting the issue on the balance sheet which I think there 
puts it front and square. As I said, the issue of broader 
controversy is then how then you report the earnings, should 
there be any smoothing or not? I think people think the assumed 
rate of return thing that I just described needs to go, but the 
debate over whether you should continue any smoothing or not is 
a genuine debate. And I could say----
    Chairman Shelby. How prevalent is the smoothing today going 
on in corporate pension accounting, or has been?
    Mr. Herz. Everybody does it. They do not have to do it but 
there is an election to do basically ongoing mark to market 
accounting in full. They do not have to avail themselves of all 
these smoothing mechanisms, but everybody does.
    Chairman Shelby. But if you keep doing this, you are going 
to suffer under the illusion of problems, you maybe brush them 
aside, you ignore them, and this and that, and then the workers 
who are depending on this are going to be holding the bag, will 
they not, Sir David?
    Mr. Tweedie. That is exactly the problem. What the FASB is 
doing now and what happened in the United Kingdom will 
highlight the issue. The other bits, if you like, are 
refinements. We are not saying that we have got the measurement 
exactly right. We know that there is quite a lot of controversy 
by the interest rates, whether, as Bob said, it is a projected 
measure of an accrued measure. All of this is up for discussion 
in the long-term project, but the fact is, they are not in 
equilibrium, these schemes, and they are showing these 
deficits. And what it has done, I think, as you put it quite 
rightly, Mr. Chairman, is given the company the opportunity to 
say, well, we do not have to pay all this out for 20-30 years, 
but we had better start working on how we fund it because at 
the moment we are not funded. That is what I think it has done, 
it has given them a breathing space.
    I think this reform that Bob is bringing in will save a lot 
of companies that otherwise might have just gone straight into 
the mountainside. They would not realize until too late they 
could not climb high enough.
    Chairman Shelby. It seems to me that a lot of pension 
accounting that I understand has been a joke in a sense, not 
really counting, no transparency, interest rates, you know, the 
returns what they say they are and all this kind of stuff. Is 
that not a real problem for you, Mr. Herz?
    Mr. Herz. Yes. That is exactly why we are taking up this 
project.
    Chairman Shelby. Thank you for doing it. There will be 
opposition in America and probably across the water to doing 
this, but ultimately, accuracy of accounting and the truth of a 
situation is what it is all about, is it not?
    Mr. Herz. Absolutely, and that is why again I wanted to 
take this opportunity to thank the both of you for all your 
efforts in that regard and for the strong message in that 
regard.
    Chairman Shelby. I think you have no other alternative but 
do it and do it right.
    We appreciate both of you appearing here today, and your 
input. Sir David, we are going to continue to work together on 
convergence and a lot of other things that come together 
because of Sarbanes-Oxley and my colleague's legislation.
    Mr. Tweedie. Thank you, sir. Can I echo what Bob has said? 
It is a great pleasure to come here and to discuss things with 
yourself and Senator Sarbanes. We do very much appreciate that 
your idea is the same as ours, transparency and helping the 
economies, and that is exactly what we are after. Thank you for 
your support, sir.
    Chairman Shelby. Senator Sarbanes, you have any comments? 
None?
    Thank you very much. The Committee is adjourned.
    [Whereupon, at 11:41 a.m., the Committee was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]
                  PREPARED STATEMENT OF ROBERT H. HERZ
             Chairman, Financial Accounting Standards Board
                             June 14, 2006

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                                 ______
                                 
                PREPARED STATEMENT OF SIR DAVID TWEEDIE
           Chairman, International Accounting Standards Board
                             June 14, 2006

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                                 ______
                                 

  RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENZI FROM ROBERT H. 
                              HERZ

Q.1. A recently released study of 100 large corporations with 
defined benefit pension plans found that 97 of those 
corporations would suffer a significant reduction in equity if 
FASB implements Phase 1 of the pension accounting project to 
move the footnote disclosure onto the balance sheet. Some 
analysts say that market researchers and analysts already take 
into account the footnote disclosure when making a 
recommendation on a company's stock. I am very concerned about 
this. While it appears to be a relatively minor change, the 
additional red ink on many companies' bottom line will be 
significant. Since our defined benefit system is a voluntary 
system, one could see where companies in the red would file 
bankruptcy to get rid of their pension plans.
    Has FASB looked at any additional studies to see whether 
this might be a possibility?

A.1. The objective of Phase 1 of the FASB's project on pensions 
and other post-retirement benefits is to improve the 
completeness, transparency, and understandability of a 
sponsoring employer's reported obligations related to post-
retirement benefits. At present, important information about 
the financial status of a company's post-retirement benefit 
plans is reported in the footnotes, and not recognized in the 
basic financial statements. That makes it more difficult for 
users of financial information to assess an employer's 
financial position as well as its ability to carry out the 
obligations of its plans. So while sophisticated investment 
analysts and users of financial statements may use the footnote 
disclosures to prepare pro forma financial information that 
more properly reflects the employer's obligations related to 
post-retirement benefits, recognizing the funded status of the 
plans in the sponsor's financial statements will make it easier 
for investors, employees, and others to understand and assess a 
company's financial position, as well as its ability to carry 
out the obligations of its post-retirement benefit plans, 
including pensions.
    The FASB has long believed that disclosure is not an 
adequate substitute for recognition--a belief that is supported 
by studies and years of experience. Many investors focus on the 
primary financial statements rather than the footnotes.
    During the course of our work on this project, we reviewed 
various studies quantifying the extent and magnitude of 
unrecognized liabilities for defined benefit pension and other 
post-retirement benefit plans. Commentators have expressed 
various views on possible actions of employers if and when such 
liabilities are recorded on the employers' balance sheets. For 
example, some believe that certain companies, following the 
already well established trend away from defined benefit 
pension plans, may choose to migrate to defined contribution 
plans. Others contend that recognizing the liability for 
defined benefit pension and other post-retirement benefit plans 
will promote greater security of the promised benefits by 
increasing the incentive for companies to more fully fund such 
obligations and, as discussed in the response to Question 2 
below from Senator Bunning, to adopt more sound investment 
policies related to plan assets, which might also reduce the 
volatility of a plan's funded status.
    As I noted in my testimony at the June 14, 2006, hearing, 
predicting such behavioral impacts is difficult at best. In any 
event, our mission is to establish unbiased accounting 
standards in order to enable the users of financial statements 
to better assess the financial condition and performance of 
enterprises. The accounting standards we establish should not 
be deliberately skewed or biased toward favoring particular 
transactions or types of arrangements or toward achieving 
particular social, political, or economic objectives other than 
sound and transparent reporting to investors and other users. 
In that regard, the proposed requirement to recognize the plan 
surplus or deficit on the employer's balance sheet does not 
alter the underlying economic position, but merely reflects 
that position in the financial statements.

Q.2. As Chairman of the HELP Committee, we have been working on 
pension reform since the beginning of last year. It is quite 
apparent that accounting for pension plans is quite unique in 
that accountants and auditors must rely heavily on third 
parties, such as actuaries, in order to put together the 
accounting statements. As part of Phase 2 of the FASB 
initiative, you will be looking at how the pension and 
retirement health benefits are calculated.
    How will FASB include the actuaries in the process of the 
development of the Statement? Would FASB consider establishing 
a new, perhaps ad hoc, Advisory Board just to gain the 
expertise of the actuaries and other third parties?
    You established a Small Business Advisory Committee, which 
I applaud you for doing. It appears quite effective. A new 
temporary Committee for the pension accounting initiative could 
prove just as productive.

A.2. The FASB establishes project resource groups to provide 
information and practical insights from knowledgeable parties 
on all our major projects. The FASB seeks information and views 
from project resource group members as needed throughout the 
life of a project, for example, to identify issues to be 
addressed as well as to analyze possible alternative 
approaches. Resource group members also perform reviews of 
Exposure Drafts and final Statements prior to finalization.
    A typical project resource group comprises constituents 
from a variety of backgrounds--preparers, auditors, users of 
financial information, subject-matter experts, and 
representatives of the nonpublic, small business sectors (also 
mutual enterprises and not-for-profit sectors when 
appropriate). With regard to our pensions and other post-
retirement benefits project, we intend to form a project 
resource group for Phase 2 of the project. Given the importance 
of actuarial information and calculations in this area, the 
project resource group will certainly include actuaries. 
Moreover, we have already and will continue an active dialogue 
with the actuarial community regarding the project. During 
Phase 1 of the project, we have sought and received significant 
input from actuaries through comment letters, at our public 
roundtables, and through various other discussions.

Q.3. The debate has been going on for years among the banking 
and securities industries as to whether there should be a 
difference in accounting for the bottom line as to which assets 
should be tracked on a mark-to-market basis or whether they 
should be tracked based upon a long-term investment strategy.
    With respect to pension accounting, some have believed that 
pension plan sponsors are trying to build up the portfolio for 
the longer term investment and that the accounting standards 
should reflect that.
    As you move into Phase 2 of the FASB project, what criteria 
should be considered to determine whether mark-to-market 
accounting is appropriate? In addition, what additional costs 
will companies incur to implement mark-to-market accounting? 
Will FASB be doing a cost-benefit analysis on this?

A.3. The FASB decided to conduct the pensions and other post-
retirement benefits project in phases so that issues such as 
those related to measurement of benefit obligations and mark-
to-market accounting could be addressed by leveraging the 
FASB's projects on the conceptual framework and on financial 
statement presentation, which are presently ongoing. The 
conceptual framework establishes the foundation, principles, 
and definitions on which accounting standards rely. The 
conceptual framework, therefore, is essential in analyzing 
economic transactions in order to identify the assets, 
liabilities, gains, and losses that should be represented in 
the financial statements. The financial statement presentation 
project will establish the reporting format for reporting those 
gains and losses.
    Phase 2 of the FASB's pensions and other post-retirement 
benefits project has no predetermined conclusions. The FASB 
will research, analyze, and carefully consider the timing of 
recognition of gains and losses (i.e., what some refer to as 
mark-to-market) but has not prejudged the outcome, which will 
be based on a thorough analysis of the issues. As with all FASB 
decisions, the Board will consider the costs of implementing 
accounting standards compared to the benefits to be derived by 
the improvement in accounting and reporting.
                                ------                                


RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM ROBERT H. 
                              HERZ

Q.1. I would like to ask Mr. Herz about an issue that came up 
in the Finance Committee yesterday that involves FASB. Very 
quickly, Mr. Herz, there was discussion yesterday in the 
Finance Committee about the fact that international accounting 
standards generally do not recognize the LIFO method. I 
understand that FASB and the IASB are involved in discussions 
about the possible convergence of U.S. and international 
accounting standards. However, I understand that the issue of 
inventory accounting generally, and LIFO in particular, is NOT 
on any current agenda. Could you please confirm this for me?

A.1. Your understanding is correct. The issue of inventory 
accounting in general is not on any current agenda for the 
FASB. In 2002, when the IASB decided not to permit the use of 
LIFO internationally, we considered whether to propose 
eliminating its use under U.S. GAAP. We decided against this, 
noting that tax conformity rules would make LIFO elimination 
more difficult in the United States and that companies 
reporting using international financial reporting standards 
(IFRS) that file financial statements in the United States 
could avoid the need to report reconciling items relating to 
inventory accounting by using methods such as FIFO or average 
cost that are acceptable under both U.S. GAAP and IFRS.

Q.2. Your written testimony indicates that some feel that the 
current accounting treatment provides an incentive for 
companies to invest more aggressively than might be appropriate 
for their pension plans. Do you feel this is a real concern?

A.2. A number of knowledgeable commentators have expressed 
these concerns. Current accounting standards permit an employer 
that sponsors defined benefit post-retirement plans to 
recognize investment income based on what management assumes it 
will earn on dedicated plan assets over a long period of time, 
not what it actually earns each year. The period over which 
that assumed investment return is based is the period over 
which the plan assets will be used to pay benefits. That could 
span 30 or more years. Actual investment gains or losses need 
not be recognized as those gains or losses are incurred.
    Some believe that use of this accounting method leads plan 
sponsors to invest in higher risk securities. They therefore 
contend that the present accounting has a bias toward investing 
in higher risk investments that has jeopardized the security of 
promised defined benefits. Accordingly, they advocate that the 
present accounting be eliminated by requiring immediate 
recognition of actual market gains and losses as those gains 
and losses are incurred; potentially causing employers to 
reallocate their plan portfolios away from equity securities 
toward more fixed income securities.

Q.3. What kind of feedback did you get during the open comment 
period? Are there any common concerns you have heard?

A.3. We received approximately 240 comment letters and hosted 2 
public roundtable meetings. Most of the respondents agreed with 
the goal of making financial statements more complete, 
transparent, and understandable. Most auditors, investors, and 
many investment and credit analysts generally agreed with the 
Board's proposal to use the projected benefit obligation (PBO). 
On the other hand, actuaries and plan sponsors generally 
disagreed with the way pension benefit obligations are proposed 
to be measured. They advocated measuring those obligations as 
the accumulated benefit obligation (ABO) versus the PBO. The 
difference between the two measures is that the PBO includes 
the effect of assumed future salary increases on the obligation 
for salary-based promised benefits while the ABO does not. As 
with each of the major components of the proposal, the Board 
carefully deliberated this issue before reaching a final 
consensus to use the PBO.
    Respondents made numerous other comments, including those 
related to retrospective application of the proposed changes 
and other features of the proposed Statement that the FASB is 
carefully redeliberating.

Q.4. and Q.5. The Projected Benefit Obligation used in the 
proposed standard requires accounting for assumed future salary 
increases even though these increases are not owed under any 
contract between employer and employee. Do you think it is 
misleading to reflect such a liability as it is not yet an 
obligation of the employer?
    I am sure you are aware of discussions in the business 
community about the use of Accrued Benefit Obligation as the 
appropriate measure for the balance sheet instead of the 
Projected Benefit Obligation. Do you agree and why or why not?

A.4. and A.5. The determination of future cash flows used to 
develop measures of pension obligations makes a variety of 
assumptions about the future based on the existing agreement 
between the employer and the employee. Examples include 
assumptions about obligations that will vest in the future, 
assumptions about future growth of cash balance and other lump-
sum benefits, assumptions about early retirement benefits that 
are not fully actuarially reduced, and assumptions about 
employee turnover, retirement, and life expectancy, as well as 
assumptions about future inflation and about increases in 
compensation for plans that base the pension benefit on final 
or career average pay.
    As discussed in the response to Question 3, the difference 
between the PBO and the ABO is that the PBO includes the effect 
of assumed future salary increases in the calculation of 
benefits payable for service to date, while the ABO does not 
factor this into the determination of the obligation.
    As described below, when the Board issued Statement 87, it 
concluded that the PBO was the most relevant measure of the 
pension obligation. Some have suggested that because employers 
have discretion to grant or not to grant increases in 
compensation, the measure of a company's pension obligation 
should ignore the effect of future salary increases on benefits 
earned to date.
    The FASB's conceptual framework does not limit liabilities 
to those that are legally enforceable. Liabilities include 
constructive, equitable, and moral obligations. Furthermore, 
the definition of a liability encompasses the duty or 
responsibility that entails settlement by probable future 
transfer or use of assets and the duty or responsibility 
obligates a particular entity, leaving it little or no 
discretion to avoid the future sacrifice. Current accounting 
standards, as well as the Board's proposal, require employers 
to assume future increases in compensation that they expect to 
grant as they affect the benefits promised for current or past 
service. This is consistent with the way many other long-term 
liabilities are currently recognized in financial statements.
    The issue is whether and, if so, how to include the effects 
of future increases in compensation when a defined benefit 
plan's formula incorporates compensation in determining the 
pension benefit. Some of the factors for measuring the pension 
obligation as the PBO include:

    a.  The Board concluded in Statement 87 that the PBO is the 
most relevant measure of the benefit obligation after extensive 
debate of the issue. The Board's current decision to retain 
that conclusion in Phase 1 of the project, therefore, is 
consistent with that prior conclusion.
    b.  Most users of financial statements believe the PBO 
better reflects the employer's economic obligation and the 
terms of the substantive plan.
    c.  Using a measure of the obligation other than the PBO 
might necessitate changing how other assumptions are 
determined, specifically the discount rate, which implicitly 
includes the impact of expected inflation. Views on that issue 
are described in paragraphs 140-142 of Statement 87's basis for 
conclusions.
    d.  Further, as noted in paragraph 139 of Statement 87's 
basis for conclusions:

Among those respondents who argued that obligations dependent 
on future compensation increases are excluded by the definition 
of a liability, very few were prepared to accept a measure of 
net periodic pension cost that was based only on compensation 
to date. The Board notes that under the double entry accounting 
system, recognition of an accrued cost as a charge against 
operations requires recognition of a liability for that accrued 
cost. Thus, excluding future compensation from the liability 
and including it in net periodic pension cost are conflicting 
positions.

    e.  For most plans that provide post-retirement benefits 
other than pensions, there is no measure of the obligation that 
is analogous to the ABO in a pension plan. Therefore, if the 
Board was to require that the ABO be used to measure the 
pension obligation, the Board also would have to determine the 
equivalent measure for other post-retirement benefits. Thus, 
the issue is broader than pension plans alone.
    f.  Including assumed future increases in compensation in 
the benefit obligation reflects the different employer 
commitment and employee expectation between a flat benefit plan 
and a final pay or career average pay plan.

    Some also have suggested that the ABO is the amount at 
which the obligation could be settled, assuming the employer 
terminates or freezes the plan. In considering this issue, we 
have noted that the ABO does not necessarily represent the 
amount at which the obligation could be settled in an arm's-
length transaction with an independent third party. That 
settlement amount would likely be affected by factors not 
presently reflected, or measured differently from those 
included, in the ABO as presently measured. The result could be 
a settlement amount that could be higher or lower than the ABO. 
Further, we do not believe that the accounting for a presently 
ongoing arrangement between the employer and the employee 
should assume a different arrangement than what is presently 
understood between the employer and the employee. Any future 
event or transaction that alters that arrangement should be 
recognized when that event or transaction takes place. Phase 2 
of our project will include a comprehensive examination of 
alternative measurement approaches.
    The Board is currently redeliberating the Phase 1 Proposal. 
In our redeliberations, we are addressing many key issues 
raised by constituents during the comment phase of the project. 
We expect to complete redeliberations soon and issue a final 
standard for Phase 1 shortly thereafter. Once the final 
Statement on Phase 1 is issued, the Board will begin Phase 2 of 
the project.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENZI FROM SIR DAVID 
                            TWEEDIE

Q.1. Recently, the United Kingdom has been undertaking pension 
reform. When we met a couple of years ago, accounting reform 
for pension plans was high on your list due to the trouble of 
companies in legacy industries.
    Could you provide us with greater detail of the U.K. 
experience of having to deal with the accounting for old-line 
companies as compared to companies without legacy burdens?

A.1. By legacy industries and old-line companies we assume that 
you are referring to industries with substantial union labor 
such as steel, mining, heavy industry, and airlines. Such 
companies will tend to have mature pension plans that are large 
compared to the company itself. For example, in the United 
Kingdom, the 2005 Lane Clark and Peacock survey reported the 
following figures for 2004:

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    Under FRS 17, the United Kingdom accounting standard, the 
accounting for pension plans in such companies reflects the 
economic reality that the pension plans are large compared with 
the size of the company. However, to prevent the balance sheet 
of the entity from being overshadowed by the pension deficit, 
FRS 17 requires the pension deficit to be presented separately 
after all other net assets. Similarly, the retained earnings of 
the entity are presented both before and after the impact of 
the pension deficit.
    A further concern was expressed that the recognition of a 
deficit in full on the balance sheet would reduce retained 
earnings to a level such that it would not be possible, under 
company law, to pay dividends. However, under U.K. company law, 
the availability of retained earnings for the payment of 
dividends is assessed by reference to the separate financial 
statements of the parent, not the consolidated financial 
statements. FRS 17 does not require recognition of group plans 
in the separate financial statements of the parent or the 
individual financial statements of the subsidiaries in the 
group if the individual companies cannot identify their share 
of the plan assets and liabilities.
    The international standard on pensions, IAS 19, permits the 
use of FRS 17 accounting as one of the permitted options.

Q.2. The debate has been going on for years among the banking 
and securities industries as to whether there should be a 
difference in accounting for the bottom line as to which assets 
should be tracked on a mark to market basis or whether they 
should be tracked based upon a long term investment strategy.
    With respect to pension accounting, some have believed that 
pension plan sponsors are trying to build up the portfolio for 
the longer term investment and that the accounting standards 
should reflect that.
    As you move into Phase 2 of the FASB project, what criteria 
should be considered to determine whether mark to market 
accounting is appropriate? In addition, what additional costs 
will companies incur to implement a mark to market accounting? 
Will FASB be doing a cost benefit analysis on this?

A.2. While the Senator's question is directed to the Phase 2 of 
the FASB project, it is applies equally to the IASB's work on 
pension accounting. FASB Statement 87 (issued in 1985) requires 
that the assets of a pension plan be measured at fair value. In 
1993, revisions to IAS 19, the international standard, required 
plan assets to be measured at fair value. The U.K.'s most 
recent standard, FRS 17, continued this well-established 
practice. The question, then, is not whether accounting 
standards should change to mandate fair value in this case, 
they already do. The question is whether the accounting 
standards should include devices designed to smooth the income-
statement effect of changes in plan assets. Those same devices 
have been widely criticized as masking economic reality. On 
balance, I agree with many of those criticisms.
    Critics often complain that fair value is a ``snapshot'' 
and assert that they are investing pension assets ``for the 
long term.'' I certainly heard those criticisms at the U.K. 
Accounting Standards Board. Rather than introducing arbitrary 
smoothing mechanisms, FRS 17 requires that companies disclose 4 
years of trend information. Financial statement users can form 
their judgements from 4 years of real information, rather than 
having to untangle 4 years of smoothed information.
    The Senator also asks about the costs companies will incur 
to implement fair value measurement of plan assets. As noted 
above, there is no incremental cost, nor can I see any savings 
from failing to measure plan assets at fair value. Indeed, the 
cost of implementing and tracking the various smoothing 
mechanisms, and of preparing the disclosures needed to explain 
their effects, far outweighs the cost of measuring fair value. 
We should also note that financial statement users--including 
analysts, shareholders, lenders, regulators, unions, suppliers, 
and others--incur significant costs in attempting to understand 
the effects of the smoothing mechanisms inherent in FASB 
Statement 87, IAS 19, and to a lesser degree, FRS 17.
                                ------                                


RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM SIR DAVID 
                            TWEEDIE

Q.1. In some cases it is appropriate for companies to close 
defined benefit plans when they become a potential liability 
for the taxpayer. In your testimony, you cite such closings in 
the United Kingdom as a positive occurrence under the same 
reasoning. Do you think that companies with otherwise viable 
defined benefit programs are choosing to close these programs 
as a result of the pension accounting standard being 
implemented by the U.K. Accounting Standards Board?

A.1. We have anecdotal evidence that the accounting under FRS 
17 raised the profile of pension plans with Boards of 
directors. I would argue that FRS 17 resulted in companies 
becoming more aware of the liabilities arising from the pension 
plan and the associated risks. This, together with changes in 
the regulatory environment, may have led to companies to 
conclude that their pension plans were no longer an 
economically viable method of providing employee compensation. 
I do not think that companies that regard defined benefit plans 
as an economically appropriate method of providing employee 
compensation have closed their plans just because of the 
accounting required under FRS 17. FRS 17 simply provides 
transparent and objective information about the cost and risks 
of providing a defined benefit pension.

Q.2. Is there an alternative accounting standard that could 
provide accountability and transparency, but not unnecessarily 
force employers out of pension programs?

A.2. Standard setters often hear that accounting standards will 
change behavior. Yet, if the standard reveals information to 
the capital markets, and market participants find the 
information useful, why should accounting standards withhold 
that information? There may be implications. Management may 
change its behavior. But the role of the accounting standards, 
as I see it, is to provide the capital markets with the most 
useful and neutral information possible.
