accounting for pensions and postretirement benefits

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Accounting for Pensions and Postretirement

Benefits

InstructorInstructorAdnan ShoaibAdnan Shoaib

PART II: Corporate Accounting Concepts and PART II: Corporate Accounting Concepts and IssuesIssues

Lecture 23Lecture 23

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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 prior service costs.

7. Explain the accounting procedure 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.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

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Alternative measures of liability

Recognition of net funded status

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

2012 entries and worksheet

Amortization of prior service cost


Gain or loss


Within the financial statements

Within the notes to the financial statements

Pension note disclosure

2015 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

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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

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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.


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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.

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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.

8 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

FASB’s choice

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LO 4 List the components of pension expense.

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Service Costs ++1.1.



Components of Pension Expense

Actuarial present value of new benefits earned by

employees during the period.

Effect on Expense

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Interest on the Liability ++2.2.



Interest for the period on the projected benefit obligation

outstanding during the period.

Interest rate (settlement rate) should be those based rates of

return on high-quality fixed-income investments currently

available, whose cash flows match the timing and amount of

the expected benefit payments.


Effect on Expense

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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

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Plan amendments often increase benefits for service provided

in prior years.

Company allocates the cost (prior service cost) of providing

these retroactive benefits to pension expense in the future,

specifically to the remaining service-years of the affected

employees.

Amortization of Prior Service Costs ++4.4.


Effect on Expense

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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 projected benefit obligation.


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Pension Work SheetGENERAL JOURNAL ENTRIES MEMO RECORD

Prior Pension ProjectedPension Service Asset / Benefit Plan

Items Expense Cash Costs (PSC) Gain/Loss Liability Obligation Assets

Other Comprehensive Income (OCI)

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

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.

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At January 1, 2012, Beaty Company had plan assets of

$280,000 and a projected benefit obligation of the same

amount. During 2012, service cost was $27,500, the settlement

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 Beaty for 2012.



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Pension Projected Pension Asset / Benefit Plan

Items Expense Cash PSC Gain/Loss Liability Obligation Assets

Jan. 1, 2010 0 (280,000) 280,000

Service costs 27,500 (27,500)

Interest costs 28,000 (28,000)

Actual return (25,000) 25,000

Contributions (20,000) 20,000

Benefits paid 17,500 (17,500)

Journal entry 30,500 (20,000) (10,500)

Dec. 31, 2010 - - (10,500) (318,000) 307,500

MEMO RECORD GENERAL JOURNAL ENTRIES

OCI


Prepare a pension worksheet for Beaty for 2012.


($280,000 x 10%)($280,000 x 10%)

($10,500) net liability($10,500) net liability

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Note the following about the Work Sheet:



The balance in the Pension Asset / Liability column

should equal the net balance in the memo record – this is

the “net funded position” of the pension plan. If a credit

balance, Pension liability; if a debit balance, Pension

asset.

For each transaction or event, the debits must equal the

credits.

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Amortization of Prior Service Cost

Company should not recognize the retroactive benefits as

pension expense entirely in the year of amendment.

Employer should recognize the pension expense over the

remaining service lives of the employees who are expected to

benefit from the change in the plan.

LO 6 Describe the amortization of prior service costs.

Prior Service CostPrior Service CostPrior Service CostPrior Service Cost

Amortization Method:

Board prefers a years-of-service method.

SFAS No. 158 allows use of the straight-line method.

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The following defined pension data of Rydell Corp. apply to the year 2012.


Projected benefit obligation, 1/1/12 (before amendment)

$560,000Plan assets, 1/1/12

546,200Pension liability

13,800On January 1, 2012, Rydell Corp., through plan amendment, grants prior service benefits having a present value of

120,000Settlement rate

9%Service cost

58,000Contributions (funding)

65,000Actual (expected) return on plan assets

52,280Benefits paid to retirees

40,000Prior service cost amortization for 2012

17,000

Instructions: For 2012, prepare a pension work sheet for Rydell Corp. that shows the journal entry for pension expense.


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Pension Projected Pension Gain / Asset / Benefit Plan

Items Expense Cash PSC Loss Liability Obligation Assets Dec. 31, 2010 (13,800) (560,000) 546,200

PSC 120,000 (120,000)

Bal. Jan. 1, 2010 (680,000) 546,200


Interest costs 61,200 (61,200)

Asset Return (52,280) 52,280

Amort. PSC 17,000 (17,000)



Journal entry 83,920 (65,000) 103,000 (121,920)

AOCI -12/31/2011 -

Dec. 31, 2012 103,000 - (135,720) (759,200) 623,480

MEMO RECORD GENERAL JOURNAL ENTRIES

OCI


($135,720) liability($135,720) liability

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Pension Expense 83,920

Other Comprehensive Income (PSC) 103,000

Pension Asset/Liability 121,920

Cash65,000


Pension Journal Entry for 2012.

Dec. 31


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Gain or Loss

Unexpected swings in pension expense can result from:

1. Sudden and large changes in the fair value of plan

assets, and

2. Changes in actuarial assumptions that affect the

amount of the projected benefit obligation.

Gains and LossesGains and LossesGains and LossesGains and Losses

LO 7 Explain the accounting for unexpected gains and losses.

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Question: What is the potential negative impact on Net Income of these unexpected swings?

Volatility

The profession decided to reduce the volatility with smoothing techniques.



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AnswerAnswer

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.


Question: What happens to the difference between the expected return and the actual return?


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Question: What happens with unexpected gains or losses from changes in the Projected Benefit Obligation (PBO)?

AnswerAnswer

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.


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Corridor Amortization

FASB invented 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 projected

benefit obligation or the market-related value (which may

equal 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.

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Shin Corporation had a projected benefit obligation of

$3,100,000 and plan assets of $3,300,000 at January 1, 2012.

Shin’s also had a net pension actuarial loss of $465,000 in

accumulated OCI at January 1, 2012. The average remaining

service period of Shin’s employees is 7.5 years.

Instructions: Compute Shin’s minimum amortization of the

actuarial loss.



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Compute Shin’s amortization of the loss.


Amortization

Projected benefit obligation (3,100,000)$

Plan assets 3,300,000 3,300,000$

Corridor percentage 10%

Corridor amount 330,000

Accumulated loss 465,000

Excess loss subject to amortization 135,000

Average remaining service 7.5

Amortized to pension expense 18,000$

÷


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Jackson Company adopts acceptable accounting for its defined benefit pension plan on January 1, 2011, with the following beginning balances: plan assets $200,000; projected benefit obligation $250,000. Other data are as follows.

2011 2012 2013

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

Settlement rate and expected rate of return 10% 10% 10%

Actual return on plan assets 18,000 22,000 24,000

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

Benefits paid 14,000 16,400 21,000

Prior service cost (plan amended, 1/1/12) 160,000

Amortization of prior 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


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Pension ProjectedPension Gain / Asset / Benefit Plan

Items Expense Cash PSC Loss Liability Obligation AssetsBal. Jan. 1, 2011 (50,000) (250,000) 200,000


Interest 25,000 (25,000)

Return on assets (18,000) 18,000

Unexpected loss (2,000) 2,000



Journal entry 21,000 (16,000) 2,000 (7,000)

AOCI - 12/31/10 -

Dec. 31, 2011 - 2,000 (57,000) (277,000) 220,000

OCI

GENERAL JOURNAL ENTRIES MEMO RECORD


Pension Work Sheet for 2011

($57,000)($57,000)* Expected Return on Plan Assets $200,000 x

10% = $20,000

**


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Pension Journal Entry for 2011


OCI – Gain/Loss 2,000


Cash 16,000

Dec. 31


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Pension ProjectedPension Gain / Asset Benefit Plan

Items Expense Cash PSC Loss Liability Obligation AssetsBal. Jan. 1, 2012 2,000 (57,000) (277,000) 220,000

Prior service costs 160,000 (160,000)

Adj Bal., 1/1/12 (437,000) 220,000


Interest 43,700 (43,700)


Amort. of PSC 54,400 (54,400)



Journal entry 95,100 (40,000) 105,600 (160,700)

AOCI - 12/31/11 2,000

Dec. 31, 2012 105,600 2,000 (217,700) (483,300) 265,600

GENERAL JOURNAL ENTRIESOCI

MEMO RECORD



($217,700) liability($217,700) liability* Actual return = Expected Return

**


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Other Comprehensive Income (PSC) 105,600


Cash40,000

Dec. 31




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Pension ProjectedPension Gain / Asset / Benefit Plan

Items Expense Cash PSC Loss Liability Obligation AssetsBal. Dec. 31, 2012 105,600 2,000 (217,700) (483,300) 265,600


Interest 48,330 (48,330)


Unexpected loss (2,560) 2,560

Amort. of PSC 41,600 (41,600)



Liability gain (16,630) 16,630

Journal entry 89,370 (48,000) (41,600) (14,070) 14,300

AOCI - 12/31/12 105,600 2,000

Dec. 31, 2013 64,000 (12,070) (203,400) (520,000) 316,600

GENERAL JOURNAL ENTRIESOCI

MEMO RECORD



($203,400) liability($203,400) liability* Plug * Plug

**


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Other Comprehensive Income (G/L) 14,070

Other Comprehensive Income (PSC)41,600

Cash48,000

Dec. 31

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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.

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Within the Notes to the Financial Statements

1. Major components of pension expense.

2. Reconciliation showing how the projected benefit obligation and

the fair value of the plan assets changed.

3. A disclosure of the rates used in measuring the benefit amounts

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

compensation).



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4. A table indicating the allocation of pension plan assets by

category (equity securities, debt securities, real estate, and other

assets), and showing the percentage of the fair value to total plan

assets.

5. The expected benefit payments to be paid to current plan

participants for each of the next five fiscal years and in the

aggregate for the five fiscal years thereafter. Also required is

disclosure of a company’s best estimate of expected contributions

to be paid to the plan during the next year.



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6. The nature and amount of changes in plan assets and benefit

obligations recognized in net income and in other comprehensive

income of each period.

7. The accumulated amount of changes in plan assets and benefit

obligations that have been recognized in other comprehensive

income and that will be recycled into net income in future periods.

8. The amount of estimated net actuarial gains and losses and prior

service costs and credits that will be amortized from accumulated

other comprehensive income into net income over the next fiscal

year.



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The Pension Reform Act of 1974

Pension Terminations



Special Issues

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Illustrative Accounting Entries

LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.

2012 Entries and Worksheet

Illustration: The use of a worksheet in accounting for a postretirement benefits plan, assume that on January 1, 2012, Quest Company adopts a healthcare benefit plan. The following facts apply to the postretirement benefits plan for the year 2012.

► Plan assets at fair value on January 1, 2012, are zero.

► Actual and expected returns on plan assets are zero.

► Accumulated postretirement benefit obligation (APBO), January 1, 2012, is zero.

► Service cost is $54,000.

► No prior service cost exists.

► Interest cost on the APBO is zero.

► Funding contributions during the year are $38,000.

► Benefit payments to employees from plan are $28,000.

ACCOUNTING FOR POSTRETIRMENT BENEFITS

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Illustrative Accounting EntriesIllustration 20A-4

Journal Entry



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Recognition of Gains and Losses



Gains and losses represent changes in the APBO or the value

of plan assets. Gains and losses are recorded in other

comprehensive income.

The Corridor Approach

Amortization Methods


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Illustration: The following facts apply to the postretirement benefits plan for

Quest Company for the year 2013.

► Actual return on plan assets is $600.

► Expected return on plan assets is $800.

► Discount rate is 8 percent.

► Increase in APBO due to change in actuarial assumptions is $60,000.

► Service cost is $26,000.

► Funding contributions during the year are $18,000.

► Benefit payments to employees during the year are $5,000.

► Average remaining service to expected retirement: 25 years.



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Illustrative Accounting EntriesIllustration 20A-6

Journal Entry



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Amortization of Gains and Losses in 2014



Illustration 20A-8


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RELEVANT FACTS

IFRS and GAAP separate pension plans into defined contribution plans and defined benefit plans. The accounting for defined contribution plans is similar.

Both IFRS and GAAP compute unrecognized past service costs (PSC) (referred to as prior service cost in GAAP) in the same manner. However, IFRS recognizes any vested amounts immediately and spreads unvested amounts over the average remaining period to vesting. GAAP amortizes PSC over the remaining service lives of employees.

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RELEVANT FACTS

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. GAAP does not permit choice; actuarial gains and losses are reported in “Accumulated other comprehensive income” and amortized to income over remaining service lives.

For defined benefit plans, 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.

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End of Lecture 23End of Lecture 23End of Lecture 23End of Lecture 23

accounting for pensions and postretirement benefits

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