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Pensions and Employee Benefits at Ford and Toyota
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The cost of pensions and other post-employment benefits
The main concern that has been addressed in this paper is the rising expenditure on retirement benefits as discussed by Miller, Douglas, Laura (2006). This is mainly affecting General Motors and Ford Motor Company. This is seen from the fact that financial analysts have predicted that such a rapid increase may force one of the big motor vehicle companies out of business. The increase in retirement and health-care costs coupled with the poor financial market performance have increased pension liabilities to offset the pension assets. This symbolizes a poor business trend since companies depend of the assets available to them to cover their liabilities.
Ford was started with the primary aim of making cars affordable for the people and the entrepreneur successfully introduced the conveyer belt system of assembling vehicles. Henry Ford was also concerned about his employees since he believed their happiness contributed to higher yields. He proved this by hiring people from minority groups such as immigrants and treating them fairly. The entrepreneur got into numerous contracts to ensure fair compensation of the employees. The first was in 1941 which made him the highest paying employer in the industry. A subsequent contract in 1948 was the first to introduce pension plans. Following the 1970s oil crisis, Ford and UAW decided to shift their primary focus to quality, customer satisfaction and security for the future.
Toyota: starting fresh
Toyota came up with a new strategy for their retirement liability. This they did by hiring young employees who gave them a competitive advantage. These lot showed less interest in joining unions which made it easy for the company to get away with no guarantee for their limited pension plans. As of 2003, the company only had 49 retirees allowing the company to have the minimal expenditure of healthcare costs and retirement benefits costs. This has been alleged to be one of the reasons behind the company’s success in the USA motor vehicle market. Toyota and Nissan decided to use contribution plans to support the traditional pension plans already in existence.
Putting a figure on benefit costs:
The UAW negotiated a contract in the 1990s under which the company differed the employee compensation. According to this contract, the employees were paid up to 95% of their earnings even without work without affecting their eligibility for pensions upon retiring. This moved very costly since these legacy costs amounted to 2.3% of the company’s revenue in 1999. This value grew to 5% in 2004. The health care costs increased steadily as well. In 2002, the healthcare costs of UAW for all retirees totaled to $4.5 million (Miller, Douglas, Laura, 2006).
Criticism of the mandatory accounting treatment:
The investment community was not taking the heat quietly. This growth in expenses symbolized a decrease in the profits that were shared out to them. As a result, the decision to push back. Most of the estimates that were used to calculate the retirement benefits were found to be faulty and unjustifiable. These included the timing of future payments, length of employment, mortality, health-care requirements and cost-escalation rates. These efforts to pushback bore fruits when Ford reduced its health inflation rate to 9% resulting in a reduction of the benefit liabilities by $3.8 billion. The investors, as well as financial analysts, called for reforms in the accounting for pensions. This is primarily in the union-based and labor-intensive industries where the expenditure on retirement benefits was soaring very high. These gave a false image of the dominant economic performance of companies in the country. It also forced companies to pay exorbitant retirement benefits to employees who are no longer part of the active workforce in the company.
Management’s discussion and analysis of financial conditions and results of operations:
According to Miller, Douglas, Laura (2006), the shareholder’s equity rose by $6.1 billion in 2003. This has significant growth has been attributed by the management to the reduction in the pension liability as well as foreign currency translation adjustments. The company has also signed a contract with the UAW under which it is required to sponsor defined benefit pension plans all over the world. Under this contract, most of the hourly employees are covered. The company is expected to provide specified levels of pension benefits to retirees who have been covered by the agreement. These calculations of the retirement benefit schemes are depended upon the assumptions that are discussed in the notes to the financial statements, and according to those assumptions, these expenses are expected to drop by $80 million in 2004. The company states that in 2003, it made over $2 billion of discretionary cash contributions to their US pension funds. The credit rating of a company reflects the score that the agency that is conducting the rating process gives the company concerning its the credit risk that is associated with securities issued by the company. Each agency uses a different criterion that it considers reasonable for evaluating the company. In this specific case, a low rating was given. The company attributes this to the concerns of the rating agencies regarding the automotive cash flow and profitability, declining market share, excess industry capacity, industry pricing pressure and rising healthcare costs in 2001. The specific concern in this particular analysis is the increase in health care costs. This increase was growing at a very high rate until some adjustments were made to save the companies from closing down.
Financial estimates and forecasts are used to predict the financial performance of the company in the foreseeable future. These estimates are not always accurate due to the unanticipated occurrences such as natural calamities, changes in legislation among others. In this particular case, the significant risk factors include price competition, a decline in industry sales, lower-than-anticipated market acceptance of the company’s new and existing products, as well as a market shift from the truck sales in the US. These factors are likely to result in little sales for the Ford company. Their occurrence will automatically result in reduced sales hence making the accounting forecasts not very reliable.
Critical accounting estimates
Pensions; these estimates are based on assumptions that include the present value of projected future pension payments and salary changes in the future. Once these figures are established, the company can decide on the timing of these payments. They are also used to calculate the contributions that are made by the employees to the retirement benefit scheme. The company’s healthcare cost trend is arrived at by analyzing historical data that has been collected concerning these costs. These projections are also very critical in decision making.
The management is confident that despite the fluctuation in currency exchange rates that have been experienced, the company’s profits have steadily increased as well as the capital efficiency over the past ten years. The company also estimates that if the future prices of used vehicle decline, the financial services will be affected negatively since charges will have to be increased to offset the estimated residue values. Toyota company benefited from revising their pension plans in 2001 and 2002 which resulted in reduced post-employment obligations. This has allowed the company to reduce the difference between pension liabilities and assets (Miller, Douglas, Laura, 2006).
G. S., Douglas, J. S., Laura, E.D. (2006). Accounting for pensions and employee benefits at Ford and Toyota. Boston, MA: Harvard Business School Press.