Pensions and post-retirement
health benefits

For companies with defined contribution plans, no adjustments are necessary. For companies with defined benefit plans (both pension and post-retirement health plans, for which the accounting is similar), some adjustments may need to be made.

In most accounting systems all pension charges, including the impact of surpluses and deficits and the interest cost of obligations, are treated as operating items, which we believe is incorrect.

Adjustment

EBIT should reflect only ongoing service costs. Remove financial items such as the spread between the return on pension assets and the interest cost of the corresponding obligation, and non-operating gains and losses as a result of surpluses and deficits. Allocation of prior gains/losses should be removed from performance measures.

The unfunded portion of a post-retirement obligation (or a net funded deficit) should be added to enterprise value, whilst any funded recoverable surplus should be deducted. The interest cost relating to this liability should be removed from EBIT measures used in conjunction with enterprise value in valuation.