Retirement Benefits

Question: Assume that one of the employees for the Michigan Company is currently thirty-four years old and

is entitled to retirement benefits starting at the age of sixty-five. Michigan has promised to continue paying

health care and life insurance premiums for all retirees as long as they live1.For this employee, no postretirement

benefits will be paid for thirty-one years (65 less 34) but then an unknown payment amount will continue for

an unknown period of time. “What Should Decision-makers Know So That Good Decisions Can

Be Made about an Organization?”, the challenge presented to accountants as a result of future uncertainty was

discussed. Probably no better example can be found than postretirement benefits. For example, if this employee

lives to be ninety-four, these insurance payments will continue until sixty years into the future.

The employee is helping the company generate revenues currently so that, once again, the related expense should

be recognized now according to the matching principle. Although this obligation might extend for decades, both

the expense and related liability are recorded when the person is actually working for the company and earning

these benefits.

How is the amount of this obligation possibly determined? An employee might retire at sixty-five and then die

at sixty-six or live to be ninety-nine. Plus, estimating the cost of insurance (especially medical insurance) over

several decades into the future seems to be a virtually impossible challenge. The skyrocketing cost of health care

is difficult to anticipate months in advance, let alone decades. The dollar amount of the company’s obligation

for these future costs appears to be a nebulous figure at best. In this textbook, previous liabilities have been

contractual or at least subject to a reasonable estimation prior to recognition. How is the liability calculated that

will be reported by a company for the postretirement benefits promised to its employees?

Answer: As shown by the Alcoa example, postretirement benefits are estimated and reported according to U.S.

GAAP while employees work. Because of the length of time involved and the large number of variables (some of

which, such as future health care costs, are quite volatile), a precise determination of this liability is impossible.

In fact, it may be the most uncertain number found on any set of financial statements. FASB apparently believes

that reporting a dollar amount for postretirement benefits, despite its inexactness, is more helpful than omitting

the expense and liability entirely. Decision makers need to understand that these reported balances are no more

than approximations.