Copyright © 2011 GRS – All rights reserved.

New Pension Accounting Standard:

A Game Changer!

NATURE COAST CHAPTER

GOVERNMENT FINANCE OFFICERS ASSOCIATION

(LOCAL CHAPTER OF THE FGFOA)

Wednesday, October 16, 2013

Citrus Hills Golf and Country Club

Hernando, Florida

Bert A. Martinez, CPAPurvis, Gray and Company, LLC

Senior Audit ManagerSarasota Office

BAM@purvisgray.com

Introduction

Two new GASB Statements have been issued in June of 2012;►GASB No. 67 – Financial Reporting for

Pension Plans, an amendment of GASB No. 25• Effective for Plans in FYE 2014

►GASB No. 68 – Accounting and Financial Reporting for Pensions, an amendment of GASB No. 27 • Effective for Employers in FYE 2015

2

Introduction

The GASB’s long and deliberative process►Added to research agenda in January 2006►Added to project agenda in April 2008►Invitation to Comment issued in March 2009►Preliminary Views issued in June 2010►Exposure Drafts issued June 2011►Since then, the GASB has reaffirmed most of the

ED►Final Standards adopted and issued June 2012

3

The Presentation in 1 Slide

The Big Picture►Local Governments will now be required to

record the liability for their unfunded defined benefit pension plan obligations to their employees within their economic resource based financial statements, rather than merely disclosing this amount in the notes to the financial statements as was previously required under GASB No. 27.

►The formula for calculating the liability is similar to the old UAAL found in notes to FS under GASB 27, with some differences in how the components are calculated.4

Scope

Provisions apply to employers with employees covered under:► defined benefit pension plans and► defined contribution account balance plans

Provisions apply to employers with employees covered under:►Single employer plans (e.g., local plans)►Agent multiple employer plans►Cost sharing multiple employer plans (e.g., FRS)

5

Scope (continued)

Provisions apply to financial statements that use the economic resources measurement focus►Government-wide/proprietary fund financial

statements►Not governmental funds statements

Provisions apply to all employers subject to GASB standards for issuing GAAP financials:►States and school districts►Cities and counties►Other governments and districts

6

Implementation

New Standard’s Provisions are Retroactive

►Balance sheet liability - restate with a beginning balance

►Deferred inflow/outflows accounts - restate with beginning balances if information to do so is available, else start with zeroes

►Unlike OPEB’s transition treatment ( which may soon change)

7

Significant Provisions

“Worse” Provisions:

►Heavy use of deferred inflow and deferred outflow accounts (GASB No. 63)

►Immediate recognition in pension expense of all plan changes; some say this is good

►Much more disclosure; some say a little more would be good

►More costly to comply►Pension expense method will cause more

confusion than clarity

8

Significant Provisions

“Worser” Provisions:

►The new rules for cost sharing employers (e.g., Florida counties and school districts in FRS) will be just like the new rules for employers with local plans

►Throw away everything you ever knew about govt. pension accounting

►Lots more work with communications challenges

►Large new liability on the balance sheet►Unstable/volatile income statements and

balance sheets9

Significant Provisions

It could have been even “worster” (since the ED):

►The GASB delayed the effective date for the employer financial statements - FYE 2015

►But still FYE 2014 for standalone Plan financials

►Since the ED, the GASB made several cost-reducing changes:

• Combined actuarial gains/loss for actives and inactives• Measurement date anytime between reporting date

and prior fiscal year end; gives more time to prepare entries and disclosures10

The GASB Files for Divorce !

Government-wide employer accounting and funding have been delinked, decoupled, . . .

DIVORCED !

11

The Marriage

Government-wide employer accounting and actuarial funding/contributions have been ONE

Old GASB Statement No. 27 (current)►The employer’s obligation is to fund the plan►The accounting expense (APC) --

an actuarial funding contribution►The balance sheet liability --

contributionshortfall

12

Member

PlanEmploy

erFunding Obligation

The Marriage

Government-wide pension accounting expense was based on the Annual Required Contribution (the “ARC”) for sole and agent employers

The ARC was: ► usually a reasonable number for funding

purposes,► determined under fairly stable methods,► a benchmark – users knew if a government was

funding its pension obligation adequately, and► known in time for budgeting a funding

contribution

13

The Divorce

Accounting and actuarial funding will be separate

The GASB has found a new, completely new, way to define the government-wide expense and liability

“We do accounting; actuaries do funding.” – Bob Attmore, GASB Chairman

14

The Marriage

Remember how the GASB looked at it this way:

Old GASB Statement No. 27 (current)►The employer’s obligation is to fund the plan►The accounting expense (APC) --

an actuarial funding contribution►The balance sheet liability --

contributionshortfall

15

Member

PlanEmploy

erFunding Obligation

The Divorce

Now the GASB is looking at it this way:

New GASB Statement No. 68►The employer’s obligation is “ultimately to the

members” ►The accounting expense -- not determined w.r.t.

to anyactuarial funding contribution

16

Plan

Member

Employer

Benefit

Obligatio

n

►The balance sheet liability --an unfunded actuarial accruedliability

The Divorce

Accounting expense will not be viable for funding►Too volatile for contributing

No more ARC, APC or NPO

Two sets of numbers –►One set for accounting and financial reporting

purposes►One set for actual funding/contribution purposes

17

Net Pension Liability (NPL)

The Net Pension Liability is the new, different and much larger balance sheet liability - the entire Unfunded Actuarial Accrued Liability

NPL = Total Pension Liability (TPL) minus

Fair Value of Plan Assets (FVA) (aka Plan Net Position)

TPL is calculated using only one actuarial cost method, to achieve better comparability

18

Total Pension Liability (TPL)

TPL = Actuarial Accrued Liability (AAL) determined under the traditional Entry Age normal (EA) actuarial cost method

Not the so-called Ultimate EA Not the Frozen Entry Age or Frozen Initial Not the Projected Unit Credit method

19

Total Pension Liability (TPL)

The interest discount rate used to calculate the TPL is determined by a specific and complex process►No details in this presentation because:►“Most” Florida plans will likely use only the

long-term expected rate of return (LTeROR) for the interest discount rate

Disclosure will require that you describe how you determined your LTeROR

20

Net Pension Liability (NPL)

To summarize so far, the balance sheet liability is the Net Pension Liability (NPL)

NPL = Total Pension Liability (TPL) minus

Fair Value of Plan Assets (FVA)(aka Plan Net Position)

21

Statement of Activities

Expense is “based on” the change in the NPL from one year to the next

There are many reasons for the NPL changing from one year to the next

There are many different components of the total change in NPL from one year to the next; and different components are treated differently

22

Statement of Activities

NPL = TPL minus FVA

The total change in NPL is separated into:

►Changes in the TPL from one year to the next and

►Changes in the FVA from one year to the next

23

Statement of Activities

These components of each year’s change in the TPL and FVA are either:►Immediately recognized in the expense in full,

OR►Gradually recognized in the expense and

deferred• Some components are amortized/recognized over the

average expected service life of plan members• One component is recognized over a fixed five year

period.

Gradually recognized components of change may be amortized for expense recognition using straight-line, level-percent-of-pay, etc.

24

Statement of Activities

Immediate recognition of TPL changes:►Service cost (normal cost) attributed to the year►Interest (at the discount rate) on last year’s TPL►Actual benefits paid for the year►All plan benefit changes►Other changes in the TPL from one year to the

next Gradual recognition TPL change:

►Assumption changes►Actuarial gains/losses (liability side)

25

Statement of Activities

Immediate recognition of FVA changes:►Projected investment earnings►Actual benefits paid for the year►Administrative expenses paid for the year►Actual contributions made for the year by

employer(s), by employees, by retirees and by other sources without a “legal obligation” to contribute

►Other changes in the FVA from one year to the next

Gradual recognition FVA change:►Difference between projected investment

earnings and actual investment earnings for the year

26

Nine High-Level Implications

1. A new and very large balance sheet liability

2. Pension expense (or pension income) 3. Unstable financial statements4. Spot light on pension liabilities5. Communication challenges6. Re-visit funding policies 7. Additional disclosures8. A lot of work9. Get it right

27

Nine High-Level Implications

1. Net Pension Liability (NPL):a new and very large balance sheet liability

2. Pension expense - or pension income

28

Nine High-Level Implications

3. Unstable employer financial statements . . .

► due to the use of the fair value of plan assets, instead of a smoothed actuarial value, as the offset to the TPL in the balance sheet liability (NPL)

► due to immediate recognition of benefit changes

► due to short amortization/recognition of other sources of change in the TPL

► due to short amortization/recognition of investment return deviations from expected29

Nine High-Level Implications

4. Spot light on pension liabilities . . .

► Moves the liability from the Notesto the Balance Sheet

► Pension liability will have a higher profile in the CAFR

► Could make the government’s Net Assets (now being called Net Position) to be negative when it would otherwise have been positive

► Could add more fuel to pension roll-back movement

30

Nine High-Level Implications

5. Communication challenges . . .

► With the press, legislators, local elected officials, plan trustees, participating employers, your city manager - executive director - superintendent, etc.

► “So which is the true unfunded liability?”► “So which is the true expense?”► Delete ARC, APC and NPO from our

vocabulary► Forget everything you knew about

government pension accounting31

Nine High-Level Implications

6. Re-visit funding policies

► Cannot just lean on an ARC to set funding level

► City and Board jointly adopt a Funding Policy• Actuarial cost method• Robust, disciplined, unbiased and well-documented

process for setting the long-term expected rate of return

• Amortization periods and methods• Target dates for funded ratios• Other related matters such as risk management,

volatility management, etc.32

Nine High-Level Implications

7. Additional disclosures – Typically:► In the Notes to Financials

• Changes in NPL• Significant Assumptions – discount rate, mortality,

etc.• Numerous other disclosures

► In the Required Supplementary Information• 10 Year table(s) for: TPL, Plan Net Position, NPL,

Net Position as a % of TPL, Covered Payroll (PR), NPL as % of Covered Payroll, Required & Actual Contributions, Covered PR, Contributions as % of PR.

• Other disclosures

33

Nine High-Level Implications

8. A lot more work

► For the implementation year and► For subsequent years

► More actuarial work► More preparer work► More auditor work► More work More costs

34

Nine High-Level Implications

8. A lot more work (continued)

►One actuarial report for funding purposes• Methods are driven by Funding/Contribution Policy• Timing is driven by budget timetable

►One actuarial report (or two) for accounting purposes• Methods are driven by the GASB standard• Timing is driven by the GASB Standard and CAFR

timetable

35

Nine High-Level Implications

8. A lot more work (continued)

►Much more disclosure language and tables for preparer

• This presentation did NOT cover very much of the substantial amount of disclosures in the Notes and RSI for the employer’s FS or for the plan’s FS

►More work and attention by auditors

36

Nine High-Level Implications

9. Get it right

► The GFOA is watching (Certificate of Achievement)

► Taxpayers and their watchdog groups are watching

► The press is watching► The SEC is watching

37

Employer Liability (Asset)

Item Current treatment Future treatment

Employer Liability (Asset)

Employer ARCv. actual employer contribution(cumulative effect over time)

Total employer pension liabilityv. plan net position(as of the reporting date)

38

Assume for example, that an employer previously contributed the full amount of it ARC each year. Also assume the following facts for the current year:

• Actuarially determined employer contribution = $100;• Actual employer contribution = $90;• Total employer pension liability (end of period) = $10,000; and• Plan net position (end of period) = $9,300

Currently, the employer would report a $10 liability (NPO) as a result of its failure to fully fund its actuarially determined contribution for the current year:

Employer Liability (Asset) cont.

39

Actuarially determined employer contribution $100Less: Actual employer contribution 90

NPO (liability) $ 10

In the future, the employer would instead report a $700 liability that represented the amount by which its total pension liability exceeded plan net position:

Total employer pension liability $10,000Less: Plan net position 9,300

Employer net pension liability $ 700

Discount Rate

Item Current treatment

Future treatment

Discount rate

Long term investment yield for the plan

Single rate that blends• The long-term expected rate of return on plan investments (funded portion of projected payments)• High quality tax-exempt municipal bond index rate (unfunded portion of projected payments)

40

Actuarial Method

Item Current treatment

Future treatment

Actuarial Methodused for accounting and financial reporting

Method used for funding purposes

Single method = entry age (even if another method is used for funding purposes)

41

Pension Expense

Item Current treatment Future treatment

Pension expense

ARC(adjusted for the cumulative effect of prior under and overfunding)

Composite effect of changes in the employer’s net pension liability (except for deferred outflows/inflows of resources)

42

Deferral and Amortization

Item Current treatment

Future treatment

Effects of a change in benefits

Amortize over a period not to exceed 30 years

• Recognize pension expense immediately to the extent the change is attributable to prior service• Amortize the balance over the remaining service life of the affected individual

43

Changes in Economic and Demographic Assumptions

Item Current treatment Future treatment

Effect of changes in economic and demographic assumptions

Amortize over a period not to exceed 30 years

Amortize over the remaining service life of the affected individuals (immediate recognition as part of pension expense for those who are no longer active employees)

44

Differences between Economic and Demographic Assumptions and Actual Experience

Item Current treatment Future treatment

Effect of differences between economic and demographic assumptions and actual experience

Amortize over a period not to exceed 30 years

Amortize over the remaining service life of the affected individuals (immediate recognition as part of pension expense for those who are no longer active employees)

45

Difference between the Expected Rate of Return on Plan Investments and Actual Experience

Item Current treatment Future treatment

Effects of differences between the expected rate of return on plan investments and actual experience

Amortize over a period not to exceed 30 years

Amortize over a five-year closed period

46

Cost-sharing defined benefit plans

47

Assume, for example, the following facts regarding a cost-sharing pension plan and one of its participating employers (City of Example):

Total pension liability—all participating employers $10,000Total plan net position $8,500Contractually required contributions for current period

City of Example: $5Employers—total: $100

Actual contributions for current periodCity of Example: $5Employers—total: $100

Further assume that the contributions of participating employers are expected to remain stable over the long term in relation to employer contributions in total.

Cost-sharing defined benefit plans (cont.)

48

Currently, the City of Example would not report any liability since it paid its contractually required contribution in full. In the future, however, the City of Example will have to report its proportionate share of the total net pension liability, calculated as follows:

Total pension liability—all participating employers $10,000Less: Total plan net position 8,500

Net pension liability—all participating employers $ 1,500

City of Example’s proportionate share of total contribution effort:$5 City of Example/$100 employers in total = 5%

City of Example’s proportionate share of total net pension liability:$1500 Net pension liability—all participating employersx .05 City of Example’s proportionate share of contribution effort$ 75 Net pension liability—City of Example

GASB Implementation Guide to Statement No. 67

49

Intended to serve as a reference guide and an instructional tool to help readers in applying provisions of Statement No. 67 Released in June 2013, one year after Statement No. 67 was approved Questions and Answers (pages 1 to 27) – these ninety-nine Q&A’s are serve two purposes: 1) Ready references for implementers who may encounter similar questions or situations. 2) Provide a basis for resolving issues that an implementer may apply to a question or situation not specifically addressed in this Guide. Glossary of terms (forty) are presented in Appendix 1 (pages 29 to 33) as they are used in Statement 67. The terms may have different meanings in other contexts. Appendix 2 (pages 35 to 48) – Summary of the Standards of Governmental Accounting and Financial Reporting of this Statement for state and local government pension plans. Includes a summary of the notes to financial statements and required supplementary information.

50

GASB Implementation Guide to Statement No. 67

Appendix 3 (pages 49 to 92) – presents expanded illustrations from Statement 67, along with two additional illustrations developed for this Guide.

1) Calculation of Money-Weighted Rate of Return – required by para- graph 30b(4) of No. 67. Considers the changing amounts actually invested during a period and weights the amount of pension plan investments by the proportion of time they are available to earn a return during that period. 2) Reconciliation of Amounts Presented in the Financial Statements to Amounts Used in Determining Money-Weighted Rate of Return – key components include beginning and ending investments, and net external cash flows into and out of pension plan investments. 3) Calculation of the Discount Rate – example of the projections and calculations used to determine the discount rate as required by para- graphs 40 to 45 of Statement No. 67. a) Table 1 – Projection of Contributions – assumed to be projected cash flows into and out of pension plan.

51

GASB Implementation Guide to Statement No. 67

Appendix 3 (Continued) 3) Calculation of the Discount Rate b) Table 2 – Projection of Pension Plan’s Fiduciary Net Position - the beginning of each period c) Table 3 – Actuarial Present Values of Projected Benefit Payments – assume long term expected rate of return 4) Determination of Certain Amounts to Be Presented in a Pension Plan’s Required Supplementary Information Schedule of Contrib- ution-Related Information 5) Financial Statements, Note Disclosures, and Required Supple- mentary Information for a SINGLE Employer Pension Plan 6) Financial Statements, Note Disclosures, and Required Supple- mentary Information for a MULTIPLE Employer Pension Plan

Topical Index (pages 93 to 97)

Copyright © 2011 GRS – All rights reserved.

New Pension Accounting Standard:

A Game Changer!

NATURE COAST GOVERNMENT FINANCE OFFICERS ASSOCIATION

(LOCAL CHAPTER OF THE FGFOA)

Wednesday, October 16, 2013

Citrus Hills Golf and Country Club

Hernando, Florida

Bert A. Martinez, CPAPurvis, Gray and Company, LLC

Senior Audit ManagerSarasota Office

BAM@purvisgray.com