In class yesterday, I stumbled upon an interesting apparent inconsistency between accounting for pensions and the accounting for compensated employee absences, which I had taught several weeks ago.

When teaching my students about accruing for vacation pay, I observed that it seemed that if we knew for certain that employees were likely to get a raise between the date they earned their vacation and the date that they took it, we should probably measure the expense and liability at the amount we actually expected to spend when the vacation days are used.  The textbook approach, which I presume to be GAAP as well as typical practice, ignores this and records the accrual at the current wage rate.

As we discussed the measurement of pension obligations yesterday in class, I pointed out that the rules governing pension accounting (ASC 715-30-25) dictate that measurement of the obligation must include the effects of future expected salary increases (that is, the projected benefit obligation is the measure of choice to be used in recognition of the net pension asset or liability in the balance sheet).

I thought that this revealed an interesting contrast in thinking about the measurement of liabilities.  On the one hand, one can argue that the likelihood of future salary increases in an economy with non-negative consumer price changes is extremely high; accordingly, in thinking about the ultimate settlement of a liability that is linked to salary levels, it makes sense to include and forecast such increases.  On the other hand, one can argue that the firm does not have a present obligation for the component of future pension or vacation payments that is based on salary increases that have not yet happened — essentially questioning whether that part of the liability meets the definition of a liability.

I’d be interested in others’ thoughts about this.  For example, could one say that compensated employee absence liabilities are understated and pension obligations are overstated?  Do financial statement users see it this way?