Caterpillar pulled off a nifty trick to add 20% to its already sad earnings

Caterpillar, the gigantic construction and manufacturing equipment firm, posted terrible earnings for the first quarter of 2016.

That should surprise no one given the global slowdown manufacturing. The company hasn't reported positive earnings since 2011.

Thing is, it could've been much, much worse. Caterpillar used some nifty accounting to add 20% to its earnings, according accounting research firm, CFRA. It all has to do with two changes to how the company reports its pension costs.

From the report [emphasis ours]:

CAT made two significant changes to the calculation of pension costs entering 2016 by adopting both (1) a mark-to-market approach to recognizing actuarial losses and expected returns and (2) a spot rate approach to calculating service and interest costs. We estimate that the benefit from these changes will account for approximately 21.5% of CAT’s earnings in 2016. It is important to understand that these changes are non-cash in nature and any earnings growth from the changes will not be sustainable. Further, these changes could be a drag on earnings growth in future years depending on interest rate movements.

So what is a bad situation, is actually much worse without this nifty trick.

The SEC started allowing companies to mark pension costs like this at the end of last year, and Caterpillar announced that it would start doing so in during its Q4 2015 earnings announcement.

Here's the relevant part of that announcement [emphasis ours]:

We have elected to make two changes in accounting for our pension and OPEB plans.

The first is a change in accounting estimate related to discount rates used for calculating pension and OPEB costs.  Beginning in 2016, we will use spot rates rather than weighted average discount rates for determining service and interest costs for plans that utilize a yield curve approach.  This change will have no impact on pension or OPEB liabilities and will be accounted for prospectively as a change in accounting estimate (no change to costs reported in 2015 or prior years).  We expect this change to lower 2016 pension and OPEB service and interest costs by approximately $180 million.

The second is a change in accounting principle for recognizing actuarial gains and losses and expected return on assets for our pension and OPEB plans.  Gains and losses historically recognized as a component of equity and amortized to earnings in future periods will be recognized in earnings in the period in which they occur.  In addition, we will change our policy for recognizing expected returns on plan assets from a market-related value method (based on a three-year smoothing of asset returns) to a fair value method.

Sorry to ruin your day, everyone.

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