The tiny change that made AT&T almost $8 billion

Thursday, 23 Jan 2014 | 11:26 AM ET

When it comes to pensions, a guess about a fraction of a percentage point can be worth billions of dollars to big corporations.

On Jan. 22, 2014, telecom giant AT&T posted a $7.6 billion pension-related gain for the fourth quarter. Most of that came from simply changing its assumption about the discount rate on its retirement plan to 5 percent from 4.3 percent.

But just a year earlier, it posted a massive pension loss after lowering its assumption.

So what changed?

While extremely complicated, the simple version of the discount rate in this case is this: the rate companies use to calculate the present value of their future retiree obligations.

In other words, how much you need today to pay your retirees' pensions tomorrow.

Mark-to-Market Accounting: CNBC Explains
How does mark-to-market accounting (also known as fair value accounting) differ from the historical cost of assets, and why would these valuations fluctuate? Salman Khan of the Khan Academy explains.

Pensions having to account for discount rates is nothing new. What has changed, though, is how often they do it.

Many plan sponsors, like AT&T and Verizon, have switched to what is known as mark-to-market accounting. This means they have to adjust their assumptions to match market conditions.

Most choose to do so yearly, which means in a good year the discount rate assumption rises, and in a bad year it falls.

That can lead to huge annual swings, which flow through to the income statement immediately, rather than over a period of years. But as asset management firm SEI said in an October 2013 paper, many analysts were already modeling corporate pensions on a mark-to-market basis anyway.

"The companies might be adopting mark-to-market accounting to avoid confusion by simply recognizing that methods of smoothing are ultimately removed in an analyst's review," the firm said.

By Ben Berkowitz, deputy managing editor news, CNBC.com.

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