20-1 volume 2. 20-2 c h a p t e r 20 accounting for pensions and postretirement benefits...

20-1

Volume 2Volume 2

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C H A P T E R C H A P T E R 2020

ACCOUNTING FOR PENSIONS AND ACCOUNTING FOR PENSIONS AND POSTRETIREMENT BENEFITSPOSTRETIREMENT BENEFITS

Intermediate AccountingIFRS Edition

Kieso, Weygandt, and Warfield

20-3

1. Distinguish between accounting for the employer’s pension plan and

accounting for the pension fund.

2. Identify types of pension plans and their characteristics.

3. Explain alternative measures for valuing the pension obligation.

4. List the components of pension expense.

5. Use a worksheet for employer’s pension plan entries.

6. Describe the amortization of past service costs.

7. Explain the accounting for unexpected gains and losses.

8. Explain the corridor approach to amortizing gains and losses.

9. Describe the requirements for reporting pension plans in financial

statements.

10. Explain special issues related to postretirement benefit plans.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

20-4

Alternative measures of liability

Components of pension expense

Nature of Pension Plans

Accounting for Pensions

Using a Pension Worksheet

Reporting Pension Plans in Financial

Statements

Defined contribution plan

Defined-benefit plan

Role of actuaries

2011 entries and worksheet

Amortization of past service cost


Gain or loss


Recognition of actuarial gains and losses

Within the financial statements

Within the notes to the financial statements

2013 entries and worksheet—a comprehensive example

Special issues

Accounting for Pensions and Postretirement BenefitsAccounting for Pensions and Postretirement BenefitsAccounting for Pensions and Postretirement BenefitsAccounting for Pensions and Postretirement Benefits

20-5

An arrangement whereby an employer provides benefits to employees

after they retire for services they provided while they were working.

Pension PlanAdministrator

Pension PlanAdministrator

ContributionsEmployerEmployer

Retired Employees Benefit Payments Assets &

Liabilities

LO 1 Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

Nature of Pension PlansNature of Pension PlansNature of Pension PlansNature of Pension Plans

20-6

Pension plans can be:

LO 1 Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

Contributory: employees voluntarily make payments

to increase their benefits.

Noncontributory: employer bears the entire cost.

Qualified pension plans: offer tax benefits.

Pension fund should be a separate legal and accounting

entity.


20-7

Defined-Contribution PlanDefined-Contribution Plan Defined-Benefit PlanDefined-Benefit Plan Employer contribution

determined by plan (fixed)

Risk borne by employees

Benefits based on plan value

Benefit determined by plan

Employer contribution varies

(determined by Actuaries)

Risk borne by employer

Actuaries estimate the employer contribution by considering mortality

rates, employee turnover, interest and earning rates, early retirement

frequency, future salaries, etc.


LO 2 Identify types of pension plans and their characteristics.

20-8

Two questions:

(1) What is the pension obligation that a company should

report in the financial statements?

(2) What is the pension expense for the period?

Accounting for PensionsAccounting for PensionsAccounting for PensionsAccounting for Pensions

LO 3 Explain alternative measures for valuing the pension obligation.

20-9 LO 3 Explain alternative measures for valuing the pension obligation.

Employer’s pension obligation is the deferred compensation obligation it has to its employees for their service under the terms of the pension plan.

Alternative measures of the Liability


Illustration 20-3

IASB’s IASB’s choicechoice

20-10


LO 4 List the components of pension expense.

Illustration 20-4Components of AnnualPension Expense

20-11

Service Costs ++1.1.



Components of Pension Expense

Actuarial present value of benefits attributed by the pension

benefit formula to employee service during the period.

Effect on Expense

20-12

Interest on the Liability ++2.2.



Interest for the period on the defined benefit obligation

outstanding during the period.

Interest rate (discount rate) should be those based on high-

quality bonds of currency and term consistent with the

liabilities.


Effect on Expense

20-13

Actual Return on Plan Assets +-+-3.3.



Actual return on plan assets is the increase in pension funds

from interest, dividends, and realized and unrealized changes

in the fair-market value of the plan assets.


Illustration 20-5

Effect on Expense

20-14



Plan amendments often increase benefits for service provided

in prior years.

The cost (past service cost) of providing these retroactive

benefits is allocated to pension expense depending on

whether the benefits vest immediately or not.

Amortization of Prior Service Costs ++4.4.


Effect on Expense

20-15

Gain or Loss +-+-5.5.


Components of Pension Expense Effect on Expense

Volatility in pension expense can result from sudden and

large changes in the fair value of plan assets and by changes

in actuarial assumptions that affect the defined benefit

obligation.


20-16

Pension Work SheetGENERAL JOURNAL ENTRIES MEMO RECORD

Annual Pension Defined Unrecognized UnrecognizedPension Asset / Benefit Plan Past Service Net Gain

Items Expense Cash Liability Obligation Assets Cost or Loss

LO 5 Use a worksheet for employer’s pension plan entries.

The “General Journal Entries”

columns determine the journal

entries to be recorded in the

formal general ledger.

The “Memo Record”

columns maintain balances for

the unrecognized pension items.

Using a Pension Work SheetUsing a Pension Work SheetUsing a Pension Work SheetUsing a Pension Work Sheet

20-17

BE20-3: At January 1, 2010, Blue Diamond Company had plan

assets of $250,000 and a defined benefit obligation of the same

amount. During 2010, service cost was $27,500, the discount rate

was 10%, actual and expected return on plan assets were $25,000,

contributions were $20,000, and benefits paid were $17,500.

Instructions: Prepare a pension worksheet for Blue Diamond for

2010.



20-18


BE20-3: Prepare a pension worksheet for Blue Diamond for 2010.


($7,500) net liability($7,500) net liability




Jan. 1, 2010 (250,000) 250,000 Service costs 27,500 (27,500) Interest costs 25,000 (25,000) Actual return (25,000) 25,000 Contributions (20,000) 20,000 Benefits 17,500 (17,500)

Journal entry 27,500 (20,000) (7,500)

(7,500) (285,000) 277,500

$250,000 x 10%$250,000 x 10%

20-19

Amortization of Prior Service Cost

If benefits from the amendment to the plan

Vest immediately

► recognize the expense and related liability at the

amendment date.

Do not vest immediately

► recognized as an expense on a straight-line basis

over the average remaining period until the benefits

become vested.

LO 6 Describe the amortization of past service costs.

Prior Service CostPrior Service CostPrior Service CostPrior Service Cost

20-20

Illustration: Hitchcock plc amends its defined pension plan on

January 1, 2011, resulting in £300,000 of past service cost. There

are 300 active employees, of which 60 vest immediately (20%)

and 240 (80%) vest in four years. The past service cost applicable

to the vested employees is £60,000 and vests immediately.

Unrecognized past service cost related to the unvested

employees is £240,000 and is amortized over four years.


Prior Service CostPrior Service CostPrior Service CostPrior Service Cost

Illustration 20-10

20-21

E20-7: The following defined pension data of Doreen Corp. apply to the year 2010.


Defined benefit obligation, 1/1/10 (before amendment)

$560,000Plan assets, 1/1/10

546,200Pension liability

13,800On January 1, 2010, Doreen Corp., through plan amendment, grants prior service benefits having a present value of

100,000Discount rate

9%Service cost

58,000Contributions (funding)

55,000Actual (expected) return on plan assets

52,280Benefits paid to retirees

40,000Past service cost amortization for 2010

17,000

Instructions: For 2010, prepare a pension work sheet for Doreen Corp. that shows the journal entry for pension expense.


20-22




Jan. 1, 2010 (13,800) (560,000) 546,200

Past service cost (100,000) 100,000

Jan. 1, 2010, restated (660,000) 546,200 100,000

Service costs 58,000 (58,000)

Interest costs 59,400 (59,400)

Actual return (52,280) 52,280

Amort. of past costs 17,000 (17,000)

Contributions (55,000) 55,000

Benefits 40,000 (40,000)

Journal entry 82,120 (55,000) (27,120)

Dec. 31, 2010 (40,920) (737,400) 613,480 83,000


($40,920) liability($40,920) liability

E20-7

LO 6

20-23

Pension Expense 82,120

Pension Liability 27,120

Cash55,000


E20-7: Pension Journal Entry for 2010.

Dec. 31


20-24

Gain or Loss

Unexpected swings in pension expense can result from:

1. Changes in the fair value of plan assets, and

2. Changes in actuarial assumptions that affect the

amount of the defined benefit obligation.

LO 7 Explain the accounting for unexpected gains and losses.


20-25

Question: What is the potential negative impact on Net

Income of these unexpected swings?

VolatilityVolatility

The profession decided to reduce the volatility with smoothing techniques.

Gains and LossesGains and LossesGains and LossesGains and Losses


20-26


Question: What happens to the difference between the

expected return and the actual return?


Recorded in Net Gain or Loss account.

Amortize amount in excess of corridor to pension expense, over the average remaining service period of active employees expected to receive benefits under the plan.

20-27


Question: What happens with unexpected gains or

losses from changes in the Defined Benefit Obligation?


Recorded in Net Gain or Loss account.

Amortize amount in excess of corridor to pension expense, over the average remaining service period of active employees expected to receive benefits under the plan.

20-28

Corridor Amortization

IASB uses the corridor approach for amortizing the

accumulated net gain or loss balance when it gets too large.

How large is too large?

10% of the larger of the beginning balances of the

defined benefit obligation or the fair value of the plan

assets.

Any accumulated net gain or loss balance above the

10% must be amortized.


LO 8 Explain the corridor approach to amortizing gains and losses.

20-29

BE20-7: Hunt Corporation had a defined benefit obligation of

$3,100,000 and plan assets of $2,900,000 at January 1, 2010.

Hunt’s unrecognized net pension loss was $475,000 at that time.

The average remaining service period of Hunt’s employees is 7

years.

Instructions: Compute Hunt’s minimum amortization of pension

loss.



20-30


Amortization

Defined benefit obligation (3,100,000)$

Plan assets 2,900,000 3,100,000$

Corridor percentage 10%

Corridor amount 310,000

Accumulated loss 475,000

Excess loss subject to amortization 165,000

Average remaining service 7.0

Amortized to pension expense 23,571$ ÷

BE20-7: Compute Hunt’s minimum amortization of pension loss.


20-31

IASB indicates:

Corridor approach results in the minimum amount recognized as an actuarial gain and loss.

Companies may use any systematic method that is faster provided it is used for both gains and losses and is used consistently from period to period.

IASB favors the immediate recognition of actuarial gains and losses.

Actuarial gain or loss can either adjust net income or other comprehensive income.


LO 8

Immediate Recognition of Gains and Losses

20-32

Illustration: Wentworth Company has the following components

of pension expense for 2011.


LO 8

Illustration 20-19

If company decides to report the loss in net income.

Illustration 20-20

20-33

Illustration: If Wentworth Company decides to report the loss in

other comprehensive income.


LO 8

Illustration 20-19

If company decides to report loss in other comprehensive income.

Illustration 20-21

20-34


P20-2: Katie Day Company adopts IAS 19 in accounting for its defined

benefit pension plan on January 1, 2000, with the following beginning

balances: plan assets $200,000; defined benefit obligation $250,000.

Other data are as follows.2010 2011 2012

Annual service cost 16,000$ 19,000$ 26,000$

Discount rate and expected rate of return 10% 10% 10%

Actual return on plan assets 17,000 21,900 24,000

Annual funding (contributions) 16,000 40,000 48,000

Benefits paid 14,000 16,400 21,000

Unrecognized past service cost (plan amended, 1/1/11) 160,000

Amortization of unrecognized past service cost 54,400 41,600

Change in actuarial assumptions, Dec. 31 PBO 520,000

Average remaining service life 15 years 15 years 15 years

20-35




Jan. 1, 2010 - (200,000) 200,000




Unexpected loss (3,000) 3,000


Benefits 14,000 (14,000)

Journal entry 16,000 (16,000) -

Dec. 31, 2010 - (222,000) 219,000 - 3,000


P20-2

20-36


P20-2: Pension Journal Entry for 2010


Cash 16,000

Dec. 31

20-37




Dec. 31, 2010 (222,000) 219,000 3,000

Past service cost (160,000) 160,000

Jan. 1, 2011, restated (382,000) 219,000 160,000 3,000






Benefits 16,400 (16,400)

Journal entry 89,700 (40,000) (49,700)

Dec. 31, 2011 (49,700) (422,800) 264,500 105,600 3,000



P20-2

20-38



Pension Liability

49,700

Pension Expense 89,700Dec. 31

Cash

40,000

20-39




Dec. 31, 2011 (49,700) (422,800) 264,500 105,600 3,000




Unexpected loss (2,450) 2,450



Benefits 21,000 (21,000)

Unexpected liability loss (49,920) 49,920

Journal entry 83,430 (48,000) (35,430)

Dec. 31, 2012 (85,130) (520,000) 315,500 64,000 55,370



P20-2

20-40




Pension Asset/Liability35,430

Cash 48,000

Dec. 31

20-41

Within the Financial Statements

Pension Expense

Pension Asset / Liability

Components of Accumulated Other Comprehensive

Income

Reporting Pension Plans in Financial StatementsReporting Pension Plans in Financial StatementsReporting Pension Plans in Financial StatementsReporting Pension Plans in Financial Statements

LO 9 Describe the requirements for reporting pension plans in financial statements.

20-42

1. Description of the plan and the accounting policy for

recognizing actuarial gains and losses.

2. Schedule showing all the major components of pension

expense.

3. Reconciliation showing how the defined benefit obligation and

the fair value of the plan assets changed from the beginning

to the end of the period.

4. Funded status of the plan and the amounts recognized and

not recognized in the financial statements.



Within the Notes to the Financial Statements

20-43

5. Disclosure of the rates used in measuring the benefit

amounts (discount rate, expected return on plan assets, rate

of compensation).

6. Company’s best estimate of the contributions expected to

be made to the plan in the next year. A table indicating the

allocation of pension plan assets by category and showing

the percentage of or the amount related to the fair value to

total plan assets. In addition, the actual return on the plan is

disclosed, as well as information on how the expected rate

of return is determined.



Within the Notes to the Financial Statements

20-44

Special Issues

Other postretirement benefits

Curtailments and settlements


LO 10 Explain special issues related to postretirement benefit plans.

20-45

IFRS and U.S. GAAP separate pension plans into defined contribution

plans and defined benefit plans. The accounting for defined contribution

plans is similar.

Both IFRS and U.S. GAAP compute unrecognized past service costs

(PSC) (referred to as prior service cost in U.S. GAAP) in the same

manner. However, IFRS recognizes any vested amounts immediately

and spreads unvested amounts over the average remaining period to

vesting. U.S. GAAP amortizes PSC over the remaining service lives of

employees.

20-46

Under IFRS, companies have the choice of recognizing actuarial gains

and losses in income immediately (either net income or other

comprehensive income) or amortizing them over the expected

remaining working lives of employees. U.S. GAAP does not permit

choice.

For defined benefit plans, U.S. GAAP recognizes a pension asset or

liability as the funded status of the plan (i.e., defined benefit obligation

minus the fair value of plan assets). IFRS recognizes the funded

status, net of unrecognized past service cost and unrecognized net

gain or loss.

The accounting for pensions and other postretirement benefit plans is

the same under IFRS. U.S. GAAP has separate standards for these

types of benefits, and significant differences exist in the accounting.

20-47

Copyright © 2011 John Wiley & Sons, Inc. All rights reserved.

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20-1 volume 2. 20-2 c h a p t e r 20 accounting for pensions and postretirement benefits...

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