United Parcel Service Inc. is changing the way it accounts for gains and losses related to its pension plans. The change has no effect on the actual pension plans.
The shipping company will switch to recording pension-related gains and losses each year, rather than spreading the impact over several years. It follows several other major companies that have recently adopted the accounting method, such as AT&T Inc and International Business Machines Corp.
The accounting change will reduce fourth-quarter earnings by 51 cents a share, but should raise adjusted earnings by 3 cents. Full-year earnings will be reduced by 41 cents, but adjusted earnings will rise by 12 cents.
The company previously forecast adjusted earnings of $4.15 to $4.40 for the year.
United States banks are betting that their insurance is going to pay out as the European financial crisis threatening a trail of defaults.
Five large American banks, including JPMorgan Chase and Goldman Sachs, have more than $80 billion of exposure to the most economically stressed nations (Italy, Spain, Portugal, Ireland and Greece) in the euro currency zone, according to a New York Times analysis of the banks’ financial disclosures.
These banks have made extensive use of a type of financial insurance, called credit-default swaps, to help them offset any losses that might occur if defaults swamped the five troubled nations. Using these swaps, along with other measures, the five banks have cut their theoretical exposure to the troubled countries by $30 billion, to $50 billion.
The Greek government on Sunday appeared close to a deal with the majority of its creditors that would lead to big write-down in the value of its debt. But even a deal could spawn a series of events that could lead to payouts on Greek credit-default swaps. While the Greek swaps would probably be paid, they represent only part of the $602 billion of swaps that have been written on the five troubled countries.
Some market participants now doubt credit-default swaps would work properly during periods of great financial instability. Credit-default swaps were also a big source of systemic weakness in 2008, when the American International Group (AIG) nearly collapsed because it could not make payments on its side of its swaps contracts.
Credit-default swaps can be dangerous because they have the ability to hit one side of the trade with a demand for an overwhelmingly large payout if a default occurs. The bank that sold the protection might then have to post a lot of cash to ensure it would make good on the swap. Large cash calls like that might drain some banks of liquid assets, causing systemic stress.
The accounting method a business uses can have a major impact on the total revenue the business reports as well as on the expenses that it subtracts from the revenue to get the bottom line. Here's how:
Cash-basis accounting: Expenses and revenues aren't carefully matched on a month-to-month basis. Expenses aren't recognized until the money is actually paid out, even if the expenses are incurred in previous months, and revenues earned in previous months aren't recognized until the cash is actually received. However, cash-basis accounting excels in tracking the actual cash available.
Accrual accounting: Expenses and revenue are matched, providing a company with a better idea of how much it's spending to operate each month and how much profit it's making. Expenses are recorded (or accrued) in the month incurred, even if the cash isn't paid out until the next month. Revenues are recorded in the month the project is complete or the product is shipped, even if the company hasn't yet received the cash from the customer.
The way a company records payment of payroll taxes, for example, differs with these two methods. In accrual accounting, each month a company sets aside the amount it expects to pay toward its quarterly tax bills for employee taxes using an accrual (paper transaction in which no money changes hands, which is called an accrual). The entry goes into a tax liability account (an account for tracking tax payments that have been made or must still be made). If the company incurs $1,000 of tax liabilities in March, that amount is entered in the tax liability account even if it hasn't yet paid out the cash. That way, the expense is matched to the month it is incurred.
In cash accounting, the company doesn't record the liability until it actually pays the government the cash. Although the company incurs tax expenses each month, the company using cash accounting shows a higher profit during two months every quarter and possibly even shows a loss in the third month when the taxes are paid.