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New Accounting Rule Hits Common Stocks

by

Adam Starchild


A traditional way to value common stock is by determining its book value, which is what a company would be worth if it sold all its assets and paid all its liabilities. Now, FAS 106, a new accounting procedure that requires companies to show the cost of retiree health benefits in their annual accounting, is changing the way investors look at book value.

Some analysts believe FAS 106 will cause no fundamental change in book value because companies have always had the expense of retiree health benefits.

Not so, say accountants and pension consultants. One major public accounting firm has estimated that the new rule will reduce the book value of the nation's largest industrial companies by 7 percent this year. The firm predicts another 7.8 percent decline in book value over the next 10 years.

The FAS 106 accounting requirement impacts book value in two ways. First, each company effected will take a one-time "catch- up" charge that will immediately reduce book value. The numbers vary among companies, but major corporations have already estimated transition charges of $250 million to more than $2.7 billion against book value.

The second way FAS 106 affects book value is that reported earnings will be reduced by annual charges each year. Because earnings won't be as high, increases in annual book value won't be as great.

Although the cost of retiree health benefits has always been an expense, the mandatory FAS 106 reporting now makes it clear that current and future shareholders are farther back in line when it comes to being paid.

Future health benefits as part of labor costs. Because the costs of retiree health benefits have previously been omitted in accounting, labor costs as reported to shareholders were understated. This resulted in profits being overstated. In short, accounting did not accurately reflect actual costs. Shareholders must now re-evaluate the true earnings power of their corporate shares.

Whether FAS 106 is considered a reduction of earnings, book value or both, it is hard to ignore the fact that it will affect the way common stock is evaluated. Large corporations with strong unions have already felt the effect of FAS 106 on their bottom line.

How the stock market will react to these changes is yet to be seen. If financial analysts overlook the changes in book value and earnings, we will see little change. On the other hand, if analysts choose to see a real decline in book value and earnings, the market could follow to more accurately reflect the true value of the stock.

Either way, you should be aware of FAS 106 and know that, in some way, it will change the way we value common stocks.

About the Author
For twenty years Adam Starchild has been writing books about these subjects, and they are published by a variety of publishers. They are available in many bookstores and public libraries.

For more information on asset protection, see Asset Protection & Becoming Judgment Proof.

Copyright © 1995 by Adam Starchild
The Investor's Library has reprinted this copyrighted article with the permission of the author.


 
 
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