Evidence on the Unauditability of Estimated Returns in Pension Plan Accounting and Their Note Disclosures

Abstract

This study empirically analyzes the long term and short term accuracy of over 3000 individual firm pension accounting estimates of rates of return on pension assets over ten consecutive years (2001-2010). We find that the point estimates allowed by GAAP create verifiability challenges for auditors and do not appear to be useful for rational decision making under uncertainty. Moreover, we find that the additional note disclosures of the estimation process may not compensate for the bad accounting that arises from relying on unauditable estimation processes. These findings do not support recent changes to the conceptual framework of financial reporting proposed in the IASB’s July 2013 Discussion Paper. Specifically, the IASB’s proposal to de-emphasize the importance of verifiability and to rely on more note disclosures of the estimation process can reduce the usefulness of financial reporting by adding to estimation uncertainty in the accounting for pension costs. Our study empirically supports the conjectures in Christiansen et al. (2012) about increasing problems with estimation uncertainties of accounting estimates in the current financial reporting environment.