Reporting of Pension Loans (#115)
/In this episode, we discuss a new accounting rule relating to the reporting of participant loans against a pension plan. Key points made are noted below.
This episode is about the new Accounting Standards Update number 25 for 2010. It’s called Reporting Loans to Participants by Defined Contribution Pension Plans. It impacts a lot of companies, though only in a very minor way.
This new ASU was released by the Emerging Issues Task Force – and, since the EITF deals with smaller technical issues that that’s what we’ve got here – a smaller technical issue. But it impacts a lot of people, because it applies to how you report your 401k plan.
The ASU is about how you classify loans to employees under defined contribution benefit plans. Most everyone has a defined contribution benefit plan, and in most cases, it’s the 401k plan.
Here’s where it gets interesting. If an employee has a 401k account, and he wants to borrow money against it with a loan, then from the company’s perspective, that loan is an investment. And you’re supposed to record an investment at its fair value.
To record a loan at its fair value takes some work, because you’re supposed to do an analysis of things like the market interest rate, and the borrower’s credit risk, and historical default rates. I would be willing to bet that very few companies anywhere on the planet have been going to that much effort. So essentially, we have an area of GAAP that everyone’s been ignoring.
Instead, we all take the easy path, which is simply to record the unpaid amount of principal on the loans, and maybe the accrued interest, and just assume that its close enough to fair value. And why not? It’s easier and it’s probably pretty close to the real situation.
So, the EITF has made official what everyone’s already been doing. According to the ASU, you now record these loans as notes receivable, and you measure them at their unpaid principal balance, plus any accrued but unpaid interest. This is what we call recognizing the status quo.
And they gave some good reasons for it. These loans aren’t really an investment, because the plan can’t sell the loans to a third party, which it can do with a real investment.
And, if the employee defaults on the loan, he was borrowing against his own plan assets, so who cares? That just means that there’s no credit risk.
But there is a small twist to be aware of, and this will change your reporting slightly. You’re supposed to segregate these loans from other plan investments, which means that you should report them separately. And the new classification is called Notes Receivable from Participants, and it is a plan asset.
So in short, you no longer have to do what you weren’t doing anyways, though the reporting changes slightly.