Pension accounting can produce some odd results, such as companies that report a pension surplus, but which still make ‘deficit reduction’ cash contributions. This illustrates an underlying problem in financial reporting where pension assets and liabilities may not reflect the true economic position of the sponsoring company. We think the increasing closure of defined benefit schemes to new accrual, and the growing trend to de-risk, including the use of pension buy-ins and buy-outs, makes...| The Footnotes Analyst
Defined benefit pension schemes create two leverage effects - financial leverage due to the debt like nature of pension deficits and asset allocation leverage if pension assets are not matched with pension liabilities. In DCF valuation these effects must be correctly, and consistently, included in both the discount rate and free cash flow. We use an interactive model to demonstrate four possible DCF approaches based on enterprise and equity cash flows. Our preferred approach is based on enter...| The Footnotes Analyst
US GAAP and IFRS present the effects pension leverage differently in financial statements, notably leverage arising from pension fund asset allocation. This complicates the comparison and interpretation of performance measures and valuation multiples. We use Delta Air Lines to illustrate the positive impact of the US GAAP ‘expected return’ approach on reported profit, including the effect of optimistic return assumptions. If Delta had applied the IFRS ‘net interest’ approach we estima...| The Footnotes Analyst