The Informativeness of Reclassified Items: Evidence from Pension Accounting

Abstract

The FASB Invitation to Comment (2016) questions whether it should continue to allow employers to recognize pension-related actuarial gains/losses and increases/decreases in prior service costs in other comprehensive income (OCI), close them to accumulated other comprehensive income (AOCI), and subsequently reclassify them to earnings. The question arises because reclassification adjustments affect earnings many periods after the economic event that gave rise to them. We use hand-collected data to assess the usefulness of pension-related reclassifications related to actuarial gains/losses (RECLASS_GL) and prior service cost adjustments (RECLASS_PSC), OCI amounts (OCI_GL and OCI_PSC), and AOCI amounts (AOCI_GL and AOCI_PSC) for predicting pension expense and pension cash contributions. We find RECLASS(GL and PSC), OCI_GL, and AOCI(GL and PSC) are useful predictors of pension expense, while OCI_PSC is not. In contrast, we find that only OCI_GL and AOCI_GL are useful predictors of cash contributions to the pension fund. Additional tests provide evidence that RECLASS_GL and OCI_GL exhibits explanatory power for firms’ market value of equity, but AOCI_GL does not. Using firm’s estimates of year ahead RECLASS_GL, we also provide evidence that the unexpected portion of RECLASS_GL exhibits explanatory power for firms’ short window market-adjusted returns. Together this suggests that the market prices the pension related actuarial gains/losses included in comprehensive income for the current year (RECLASS_GL and OCI_GL), but not the gains/losses contained in the balance sheet (AOCI_GL), even though these amounts are useful predictors of future pension expense and pension cash contributions.