© 2005 by Robert F. Halsey, all rights reserved Agenda Pensions Deferred Taxes.
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Transcript of © 2005 by Robert F. Halsey, all rights reserved Agenda Pensions Deferred Taxes.
© 2005 by Robert F. Halsey, all rights reserved
Agenda
Pensions
Deferred Taxes
© 2005 by Robert F. Halsey, all rights reserved
Defined contribution plans (401k)
Pension expense xxxCash (contribution) xxx
Employees
Company Trustee
Employees
Employees
$$
$
$
© 2005 by Robert F. Halsey, all rights reserved
Defined Benefit Plans Promise to pay annuity to employee
after retirement, usually based on final salary and years of service
IOU to employees - Pension plan assets/liabilities stay with company until paid/satisfied
Accounting issues: Recognition of assets/liabilities on B/S Recognition of pension expense in I/S
© 2005 by Robert F. Halsey, all rights reserved 7© 2005 by Robert F. Halsey
Fair Market Valueof the Pension Assets
Future Benefits as promised by the
company
Present value of the Projected Benefit Obligation (PBO)
Accrued Pension Asset / Liability (Balance Sheet)
PV
Balance Sheet Presentation
Basic Accounting Entry
Pension expense (I/S) 100
Accrued pension liability (B/S) 25
Cash (B/S) 75
• pension expense is determined first
• accrued (prepaid) pension liability is a function of cash contribution
If contribution > expense dr prepaid pension cost (asset)
If contribution < expense cr accrued pension liability
• amount of cash contribution does not determine expense
© 2005 by Robert F. Halsey
Service cost (determined by actuaries)
+ Interest cost (BOY PBO x discount rate)
- Expected return (BOY investments x L-T ROR)
Pension expense
Overview - Pension Expense
Average rates used by Companies
© 2005 by Robert F. Halsey, all rights reserved
Basic Pension Example
Pension plan assets, Jan 1 350,000
Projected Benefit Obligation, Jan 1 490,000
Discount rate 8.5%
Service cost for year 40,000
Company contributions 30,000
Expected return on plan assets (9%) 31,500
Actual return on plan assets 49,700
Benefits paid to retirees 34,400
a. Compute pension expense for the year.
Pension plan assets, Jan 1 350,000
Projected Benefit Obligation, Jan 1 490,000
Discount rate 8.5%
Service cost for year 40,000
Company contributions 30,000
Expected return on plan assets (9%) 31,500
Actual return on plan assets 49,700
Benefits paid to retirees 34,400
b. Compute the balance in the PBO at the end of the year.
Pension plan assets, Jan 1 350,000
Projected Benefit Obligation, Jan 1 490,000
Discount rate 8.5%
Service cost for year 40,000
Company contributions 30,000
Expected return on plan assets (9%) 31,500
Actual return on plan assets 49,700
Benefits paid to retirees 34,400
c. Compute the balance in the pension plan assets at the end of the year.
Pension plan assets, Jan 1 350,000
Projected Benefit Obligation, Jan 1 490,000
Discount rate 8.5%
Service cost for year 40,000
Company contributions 30,000
Expected return on plan assets (9%) 31,500
Actual return on plan assets 49,700
Benefits paid to retirees 34,400
d. Prepare the pension journal entry for the year.
JE JE JE Memo Memo Memo
Items Annual Pension Expense
Cash Prepaid/Accrued Pension Cost
PBO Plan Assets Unrecognized (gains) losses
Bal Jan 1
Service cost
Interest cost
Return on plan assets
Contributions
Benefits
Journal entry
Balance Dec 31
Pension Entries Template
© 2005 by Robert F. Halsey, all rights reserved
3M mini-case1. How much pension expense (revenue) does 3M report in its 2004
income statement? 2. 3M reports a $627 million expected return on plan assets as an offset to
2004 pension expense. Approximately, how is this amount computed? What is the actual gain or loss realized in 2004 on its plan assets? What is the purpose of using this estimated amount instead of the actual gain or loss?
3. What factors affected its 2004 pension liability? What factors affected its 2004 plan assets?
4. What does the term ‘funded status’ mean? What is the funded status of the 2004 3M retirement plans? What amount of asset or liability does 3M report on its 2004 balance sheet relating to its retirement plans? What factors account for the difference between these two amounts?
5. 3M reduced its discount rate from 6.75% to 6% in 2004. What effect(s) does this reduction have on its balance sheet and its income statement?
6. What effect does a change in the expected return have on reported income? Is it unambiguous?
7. What effect does a change in the expected rate of compensation have on the balance sheet and income statement?
© 2005 by Robert F. Halsey, all rights reserved
© 2005 by Robert F. Halsey, all rights reserved
Minimum Liability
How computed? (ABO - FMV Pension Investments)
How recorded / reported?Intangible Asset* xxx
Additional Pension Liability xxx (amt to yield ABO)
* Dr OCI for excess of minimum liability > PSC
© 2005 by Robert F. Halsey, all rights reserved
Deferred Taxes
There are differences between pre-tax income (10-K) and taxable income (tax return) Straight line depreciation for books and
accelerated for tax Restructuring accruals reduce book income,
but are not a tax deductible expense until paid
Therefore, tax expense does not equal taxes payable
Differences result in deferred tax liabilities and deferred tax assets
© 2005 by Robert F. Halsey, all rights reserved
Accounting entry
Income tax expense xxx (plug) ➂
Def Tax asset/liab xxx / xxx ➁
Tax payable xxx ➀
Note: DTAs/DTLs can be debited or credited. Income tax expense is the plug figure to balance the entry. This is a balance sheet approach
Valuation allowance All assets must be tested for impairment
before issuance of F/S, including DTAs DTAs are only an asset if they provide future
benefits (e.g., company will generate future taxable income to utilize available credits – loss carryforwards are an example)
If DTAs wil not be realized, must provide an allowance Effect is to reduce DTA and increase tax
expense when allowance is created, the opposite when reversed
© 2005 by Robert F. Halsey, all rights reserved
Amazon mini-case
1. How much pre-tax profit, tax expense, and net income did the company report for 2004? 2. For its tax expense, how much is currently payable and how much is due to changes in
deferred tax assets and liabilities? 3. What deferred tax assets and liabilities does the company report in total? Are the assets and
liabilities reported separately or netted on the balance sheet? 4. What are the major categories of deferred tax assets and liabilities? How might these arise? 5. The company reports net operating loss carry forwards. Generally, these relate to taxable
losses that, under the IRS code, can be carried forward to future years to reduce taxable income in those years. If it is unlikely that the NOL’s will be used before they expire, the company must set up a valuation allowance to reduce the deferred tax asset, just like the allowance for doubtful accounts. What will be the effect on current profitability if a company establishes a deferred tax asset valuation allowance?
6. What changes does Amazon report in its deferred tax valuation allowance account for 2004? Describe what prompted the change and the effect the change had on its reported income?
7. As an analyst, how should you view deferred tax asset valuation accounts? 8. In general, for growing manufacturing companies that typically report a large deferred tax
liability, how should you view the deferred tax asset or liability? That is, does the liability represent a future cash outflow? Under what circumstances?