Earnings Management in the Context of Pension Accounting: A Case

ABSTRACT This case simultaneously examines pension accounting and earnings management. It is designed around a real-world company although the company name in the case is fictional. Several key concepts are demonstrated in this case: earnings management incentives, earnings management techniques, pension accounting, and accounting choice. Pension accounting involves several accounting estimates and choices. This case demonstrates how and why managers might make these choices opportunistically to manage earnings. Also, pension accounting is a difficult topic. Thus, learning the concepts in the case format provides a stronger frame of reference for the various concepts and mechanics involved in the calculation of pension expense, the reported pension asset or liability on the balance sheet, and the economic pension asset or liability. Finally, the case provides an excellent frame of reference for understanding how earnings can be managed and why managers might wish to manage earnings. INTRODUCTION Hacksaw Manufacturing is a 90-year-old company that manufactures hacksaws and replacement blades. The company is the leader in its competitive industry and is closely and widely followed by the investment community. Consensus analysts' forecasts of the 2004 earnings per share (EPS) are $0.36, a nearly 6% increase over the $0.34 EPS reported in the prior year. Management attributes the expected increase to cost-savings measures in Hacksaw operations. Anne Treston is the controller and you are the assistant controller at the company. The company treasurer is nearing retirement. At that time, Anne and you are in line to become treasurer and controller, respectively. Because of these imminent promotions to greater responsibilities, Anne encouraged you to earn a Master of Business Administration degree in an evening program at the local university and even allows you to use some time during the day to complete your course work. Anne is pulling together information to finalize the 2004 financial statements. She has set aside this morning to concentrate on the financial reporting for Hacksaw's pension plan for the year ended December 31, 2004. She has gathered the following: a. General ledger account balance information and footnote information put together by staff accountant, Jay Wells. See exhibit A. b. Actuarial summary information provided by Feldman Actuarial Associates. See exhibit B. c. Pension fund activity provided by the pension fund administrator, Capital Partners. See exhibit C. d. Some information regarding industry pension trends supplied Manufacturers Controllers Association (STMCA). See exhibit D. Before taking on her morning's task, Anne logs on to the company computer network to check e-mail messages and to check Hacksaw's stock price behavior since the market opened for trading about one hour earlier. Her e-mail includes notice of a meeting later in the afternoon with the CEO and the treasurer to go over the operating results before they are announced to the public. To this end, the CEO requests that Anne bring her best estimate of 2004 earnings to the meeting. Her check of the market finds that Hacksaw stock is having a quiet morning, trading up in price by about . 1% on a morning when the overall market is trading up about . 1% as well. Satisfied that this is a normal business day, Anne turns her attention to the pension plan. However, at that moment, her phone rings. The caller is the elementary school nurse. He demands that Anne pick up her son immediately because her son is ill and at risk of infecting other students. Meanwhile, you had been using some quiet time this morning at the office to catch up on an accounting course-related project that you and your fellow group members are preparing on earnings management (see Exhibit E for an excerpt from the project that was prepared by one of the fellow group members). Anne delegates her pension plan-related questions to you before leaving to care for her ill son. …