Biased earnings and non-reversing accruals: The impact of delayed recognition under pension accounting (SFAS No. 87)

This study tests the hypothesis that delayed recognition under SFAS No. 87 enables upward biased earnings by allowing aggressive choice of the expected rate of return on plan asset investment (ERR). To evaluate this hypothesis, I examine the time-series properties of pension accrual reversals, deferred losses (or gains), and cumulative unrecognized losses (or gains) under SFAS No. 87. I also assess the interaction between these processes and ERR choices.; Results indicate that the delayed recognition effectively suspends pension accrual reversal, and induces an upward bias in reported earnings over the testing period. The corridor amortization produces highly persistent unrecognized gains or losses and allows deferred losses to persist and accumulate. In addition, cross-sectional regression results show that aggressive ERR choices are associated with positive non-reversing pension accruals, upward bias in sponsoring firms' earnings, and non-offsetting unrecognized losses.; Further analysis suggests that the plan-wise empirical results are not driven by small plans. Thus, the economic significance of the delayed recognition under SFAS No. 87 is far from negligible. Analyses of materiality suggest that the income statement and balance sheet consequences of the upward bias documented in the study are substantial, especially for larger firms. In addition, firm-specific analyses suggest that aggressiveness in exploiting the delayed recognition feature and its amortization scheme are likely to be pervasive among sponsoring firms during the testing period.