Abstract
Room for discretion is allowed in setting the period for amortizing prior service costs due to a reduction in projected benefit obligation (PBO). The aim of this chapter is to clarify the amount of discretion in management’s choice and the factors influencing it. The situation is examined in which the amortization period for prior service costs is set shorter than that for actuarial gains and losses. The results are summarized as follows. (1) The amortization period for prior service costs due to a PBO decrease, in contrast to a PBO increase, tends not to be conservative. (2) Greater discretion is likely exercised in setting the length of the amortization period for prior service costs, compared with that for actuarial gains and losses. (3) These tendencies likely reflect a goal to reach target earnings quickly. (4) It is, however, possible that this behavior can be deterred through monitoring by foreign or institutional investors. The results imply that, with regard to setting the length of the amortization period for prior service costs due to a PBO decrease, there may be a trade-off between the benefit of reaching target earnings and the cost of greater accountability to shareholders.
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Notes
- 1.
In Japan, the case-law principle concerning abuse of the right to dismiss employees is well developed, and it is difficult to discharge employees. Also, a system of lifetime employment, which does not assume job changes of employees, has been developed. For these reasons, not many companies have a defined contribution (DC) program, which secures the portability of corporate pension benefits, while many companies have adopted a defined benefit (DB) program. The DC plans that started under the Defined Contribution Pension Act, which was implemented in October 2001, are subject to a limit on the contribution amount. Therefore, not many companies have fully shifted to a DC program, and many companies have a DB program.
- 2.
The exposure draft Fair Value Option for Financial Liabilities published in May 2010 by the International Accounting Standards Board proposes modifications to the accounting of liabilities with a concern that, contrary to intuition, the volatility of net profit/loss resulting from the variation in the credit risk of liabilities that companies chose to measure at fair value would not provide useful information to investors.
- 3.
Unless described otherwise, the term “conservative accounting” in this chapter refers to accounting with late recognition of earnings and early recognition of costs.
- 4.
The reason for using the 2010 data is that due to the Third Partial Revision to the Accounting Standards Related to Retirement Benefits, standards were revised so that, starting in the fiscal year that began on April 1, 2009, or later, companies could be asked to use the end-of-period yield regardless of changes in their discount rate over a certain period. For pre-2010 data, too, the average discount rate of the companies in the sample is below the AA-rated corporate bond yield.
- 5.
IIC Partners uses data published by the Japan Security Dealers Association and calculates the AA-rated corporate bond yield as a weighted average of yield data from multiple rating agencies, where the weights are the number of bonds included (http://www.iicp.co.jp/library/corporate_bond/).
- 6.
The Guideline for Applying Corporate Accounting Standards (No. 1, “Accounting Procedures Regarding the Transition from One Retirement Benefit System to Another”) states that PBO can decrease significantly due to a substantial reform of a retirement benefit system conducted as part of a large-scale business improvement plan, and that if other profits and losses caused by the implementation of the plan are recorded at once, the significant PBO decrease entered for the period of its occurrence may reflect the actual situation. It thus can be amortized at once as an extraordinary profit/loss. According to the author’s investigation, in a sample of 2,027 company-year observations (containing companies with reduced retirement benefits), such amortization is identified in 392 observations (19.34 %). For more than a half of them (221 observations, 56.38 %), part of the amount of amortized prior service costs is entered as an extraordinary profit/loss, and the remainder is included in operating profit/loss calculation as a decrease in retirement benefit costs.
- 7.
The sample of companies with a PBO decrease used here is obtained from a sample collected based on the criteria described in Sect. 3.4.
- 8.
A similar result is obtained with regard to the relationship with the ordinary profit expected by management. Moreover, a similar result is obtained when only one of LEV, ROA, and FIRMSIZE, which are highly correlated with one another, is used or when one of them is excluded.
- 9.
With regard to the control variables, the estimation results for both Hypotheses 1 and 2 show that the coefficients of PENSION_SENSITIVITY and PSCSIZE are significantly different from zero. This can be interpreted to mean that the amortization period tends to be set short when prior service costs are large relative to a profit level, but that the tendency weakens when the size of prior service costs is large. It is considered that when great attention is paid to the accounting of prior service costs the tendency to set the amortization period short weakens.
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Sawada, S. (2014). Fair Value Accounting of Pension Liabilities and Discretionary Behavior. In: Ito, K., Nakano, M. (eds) International Perspectives on Accounting and Corporate Behavior. Advances in Japanese Business and Economics, vol 6. Springer, Tokyo. https://doi.org/10.1007/978-4-431-54792-1_7
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