Company will change policy for recognizing pension plan expenses from current practice of smoothing.
Wanting to give investors a clearer picture of its operating performance Honeywell today announced it would change its accounting for pension expenses. The company feels the move will put its reported earnings more in line with its peers. It also reiterated its plan to take advantage of low interest rate and make a sizeable contribution to its US pension plan this year and next.
Like many companies, Honeywell had used accounting methods that smooth asset returns and amortizes deferred gains or losses over time. Many critics of this approach feel that this type of accounting could be manipulated to hide earnings losses or inflate their gains. Critics of the change to mark-to-market on the other hand, question the timing in that it comes when returns are more likely to be rising. The switch thus allows Honeywell to recognize gains in its pension investments immediately and significantly reduce pension expense going forward.
“Congratulations to Honeywell on doing the prudent thing for pensions,” said Ron Ryan, CEO of Ryan ALM, an asset and liability consulting firm. “Current accounting measures distort economic reality by smoothing and by using hypothetical discount rates that are higher than market rates.” Mr. Ryan added that by adopting marked-to-market accounting, companies can “provide accurate information on assets that cannot be managed versus their true objective: funding liabilities.”
Adopting MTM also readies Honeywell’s books for IFRS, which is on track to introduce mark-to-market accounting for pensions over the next two years. While international accounting has proposed removing the so-called corridor option, Honeywell is maintaining one: 10 percent of the Greater of Fair Value Plan Assets or Pension Benefit Obligation (PBO), meaning gains or losses within this corridor will remain in OCI
Pension expense will be presented as two separate elements going forward, which supports claims that the accounting change will provide investors a clearer picture of operating expense as a result.
In its announcement Honeywell also reiterated its plan to contribute $600mn to its US plan this year and another billion in 2011. The move to MTM should not have any impact on these contributions.
Adopting the new accounting regime isn’t without big costs to the company. Honeywell said earnings per share for 2010 are now expected to be approximately $1.86 per share, vs. the prior estimate of approximately $2.52. The company will also apply the accounting “retrospectively” and therefore reported net income in 2009 will be reduced by approximately $605mn (or $0.80 per share), and reported net income in 2008 by approximately $1.9bn (or ~$2.68 per share). The stock was performing well as news of the change broke, so it appears the market approves.