Pensions & Other Post Employment Benefits – after SFAS No. 158
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Transcript of Pensions & Other Post Employment Benefits – after SFAS No. 158
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Pensions & Other Post Employment Benefits – after SFAS No. 158Includes certain slides provided by authors of Skousen, Stice & Stice and Kieso, Weygandt & Warfield Intermediate Accounting textbooks, as modified and adapted by Teresa Gordon
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Contributory Plan Non-Contributory Plan Defined Contribution Plan Defined Benefit Plan
Types of plans
A Pension Plan is an arrangement whereby an employer provides benefits (payments) to employees after they retire for services they provided while they were working.
Pension PlanAdministrator
ContributionsEmployer
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 Plans
Some pension plans are:
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.
Nature of Pension Plans
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Defined contribution plansA plan that provides benefits based solely on what has been contributed and the earnings thereon
< 401(k) > Amounts to be funded are determined
by the plan No promise for specific future
benefits. Independent third party holds assets Risk borne by employee Accounting relatively straightforward
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Defined benefit plansA pension plan that determines the amount of benefit to be provided Contributions based on estimated
amounts needed to meet expected payments
Form versus substance of trust Risk borne by employer Accounting by employer is
complicatedActuaries estimate the employer contribution by considering mortality rates, employee turnover, interest and earning rates, early retirement frequency, future salaries, etc.
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Chart from UK but trend is probably same in US
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Defined Benefit Pension Plan
Employer Current Employees
Services
Wages and Salaries
Pension Fund
Cont
ribut
ions
Retired EmployeesDefined Benefits
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Pension ApproachesBefore FASB 87 & 88: “pay as you go” or “noncapitalization”
FASB 87 & 88 Capitalization approach Full obligation reported only in notes
FASB 158 Pension & post-retirement benefit cost is
same as FASB 87 Full obligation is now reported on balance
sheet Additional items now on statement of
comprehensive income
Recognition of the Net Funded StatusCompanies must recognize on their balance sheet the full overfunded or underfunded status of their defined-benefit pension plan. The overfunded or underfunded status is measured as the difference between the fair value of the plan assets and the projected benefit obligation.
Accounting for Pensions
LO 3 Explain alternative measures for valuing the pension obligation.
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Capitalization approach to pensions:
Employer has full liability for benefits related to service already rendered by employee Expense is recognized as employees work
(service cost) and this increases the liabilityLiability balance increases every year since present value of future benefits is larger (less time remains to cash outflow) Liability is reduced through payments to
retireesAssets of the plan are considered pledged, collateral against a liability Liability less designated assets reported on
balance sheet (net presentation)
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Measures of Pension Liability
VestedBenefit
Obligation
AccumulatedBenefit
Obligation
ProjectedBenefit
Obligation
Benefits forvestedemployeesat currentsalaries
Benefits for vested and non-vested employees at current salaries
Benefits for vested and nonvested employees at future salaries
(GAAP)PV of ExpectedCash Flows
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Interest/return ratesDiscount rate Rates on high-quality fixed-income
investments with maturities consistent with expected payments to retirees Generally equivalent to a portfolio of
zero-coupon bonds with appropriate maturities
Expected rate of return Based on long-term rate of return
anticipated given investment of plan assets
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What happens whenInterest rates increase?
Interest rates decrease?
Service Costs
Interest on the Liability
Actual Return on Plan Assets
Amortization of Prior Service Costs
Gain or Loss
+++-++-
Accounting for Pensions
LO 4 List the components of pension expense.
Components of Pension Expense1.2.3.4.5.
Effect on Expense
Companies do not recognize two main items in the accounts and in the financial statements:
Pension Items Not Recognized
LO 5 Use a worksheet for employer’s pension plan entries.
Some items are recognized in other comprehensive income; changes in these items are amortized into expense through smoothing techniques.
Prior service costs. Actuarial gains and losses.
A company must disclose in notes to the financial statements, but not in the body of the financials.
Projected benefit obligation.Pension plan assets.
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A working paper for pensions
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)
This is very similar to the one in textbook
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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Accounts on Employer’s Books
Net Periodic Pension Cost (Expense) Amount recognized by the employer
on the income statement Pension expense includes six basic
elements (more later)Other comprehensive income Up to three amounts reported for
changes in balance of AOCI amounts (see next slide)
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Working Paper – Pension Expense
Pension Worksheet 1 2 3 4 5 6 7 8SFAS NO. 158
Income Stmt BS BS
Pension Expense Cash
Transition (Gain)/Loss
Net actuarial (gain)/loss
Prior Service Cost Funded Status
Projected Benefit
Obligation Plan Assets
BALANCE FORWARD
Service Cost
Interest Cost
Expected return on plan assets
Corridor Amount
AOCI Actuarial (BoY)
Excess
AMORTIZATIONS:
Unrecognized gain/loss
Prior Service Cost
Transition Amount
Contributions to Pension Plan
Retirement Benefits Paid by Plan
Actual Return on Plan Assets
Actuarial Adjustments to PBO
Amounts for journal entry:
AOCI balance forward
BALANCES AT YEAR END
Not on BooksMemorandum AmountsOther comprehensive income stmt
Accounts on Employer's Books
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A working paper for pensions
Interest cost = discount rate * beginning balance in PBO
Expected return = expected return rate * beginning balance in Plan Assets
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Accounts on Employer’s Books
On balance sheet – Net funded position When PBO > Plan Assets, reported as
noncurrent liability (with current liability if there are inadequate plan assets to cover current payments to retirees)
When Plan Assets > PBO, reported as noncurrent asset
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A working paper for pensions
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Accounts on Employer’s Books
Accumulated other comprehensive income (AOCI) Account appears as part of owners’
equity section of balance sheet Three pension related balances
Transition gain or loss Prior service cost Actuarial gains or losses
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A working paper for pensions
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Self-checking featuresEach blue row
must add across to
ZERO
Balance forwards
Balance forwards
Funded status
must equal PBO + Plan
Assets
Plug to balance
JE {row=0
}
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Net Periodic Pension CostNet periodic pension cost (the expense) consists of six basic elements: Service cost Interest cost Expected return on plan assets Amortization (if any) of
Transition gain or lossPrior service costUnrecognized gain or loss
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Pension DefinitionsPrior Service Cost (PSC) Cost of benefits granted for service
rendered prior to the inception of the plan Increases PBO at date of amendment but
cost is amortized to expense over future years
Reduces funded status since PBO is higher Recognized as charge to OCI at date of
plan amendment Amortization method recommended:
Years of service method Straight-line or other methods that
amortize PSC faster are also acceptable
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Actuarial Gains and LossesActuarial assumptions are subject to inaccuracies as time goes by and circumstances change There is a materiality provision for
determining when gains and losses are sufficiently large to require amortization (charge to expense) 10% Corridor Rule
Question: What is the potential negative impact on Net Income of these unexpected swings?
VolatilityThe profession decided to reduce the volatility with smoothing techniques.
Gains and Losses
LO 7 Explain the accounting for unexpected gains and losses.
Corridor AmortizationFASB 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.
Gains and Losses
LO 8 Explain the corridor approach to amortizing gains and losses.
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Kieso, Weygandt & Warfield 11th ed. Illustration 20-14, page 1034
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10% Corridor AmortizationAmortization is required only on the portion of unrecognized net gain or loss that exceeds 10% of the greater of: PBO at beginning of
year, or market-related value
of plan assets at the beginning of the year.
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Settlements & Curtailments
Additional FASB standards govern major changes in pension plans: Settlements
No further obligations to some or all employees
Curtailments Results in significant reduction in expected
years, or No further accrual of benefits
Handling will require further research (primarily FASB 88)
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Pension Disclosures [FAS 132(R)]
Amount and types of assets held Assumptions related to discount rate,
rate of increase in compensation, expected return on plan assets
Alternative amortization policies Past practice or history of regular
benefit increases
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Pension Disclosures [FAS 132(R)]
The details for net periodic pension cost the service cost component. the interest cost component. the expected return on plan assets
[FAS 132] the amortization of PSC, transition
amount and unrecognized gain/loss (separately)
Gain or loss from settlement or curtailment of plan
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Pension Disclosures:Reconciliations
The fair value of plan assets (changes between BOY and EOY)PBO Obligation (changes between BOY and EOY)
Easily obtained from our work paper!
EoY = end of yearBoY = beginning of year
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Pension DisclosuresEmployers with multiple plans Information can be combined but the
computations are made for each individual plan Net position for over-funded plans would
be reported in noncurrent assets Net position for under-funded plans would
be reported in liabilities Part may be reported as a current
liability See next slide
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Current portion of liabilityThe current portion (determined on a plan-by-plan basis) is the amount by which the actuarial present value of benefits in PBO that are payable in the next 12 months* exceeds the fair value of plan assets* As always, the operating cycle might be
longer than 12 months in which case we’d use the operating cycle
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Other Postretirement BenefitsFASB 106
Appendix Material in KWW textAlso changed by FASB No. 158
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Other Post-retirement Benefits
The accounting is similar to pension accounting EXCEPT that the terminology is slightly
differentEPBOAPBO
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Kieso, Weygandt & Warfield 11th ed. Illustration 20A-3, page 1056
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APBO vs EPBO
Prior to the date on which an employee attains full eligibility for the benefits that employee is expected to earn APBO < EPBO
On and after the full eligibility date, APBO = EPBO
In other words EPBO > APBO until the employee has
earned the right to full benefits EPBO = APBO after the employee has
worked long enough to earn full eligibility
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Kieso, Weygandt & Warfield 11th ed. Illustration 20A-2, page 1056
Cost attributed to period from hire to eligibility (vesting)
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Postretirement Benefit Worksheet
Would be the same as a pension worksheet with modified labels at the top Pension Expense becomes
Postretirement Benefit Expense. PBO becomes APBO.
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Working paper for FAS106
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Net periodic postretirement benefit cost.
The expense basically includes the same elements as pension cost: Service cost -- the actuarial present value
of benefits attributed to services rendered by employees during the period.
Interest cost -- the interest on the beginning balance of the accumulated postretirement benefit obligation
Less expected return on plan assets. Amortizations (transition, prior service cost
and unrecognized gain or loss)
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Comparing FASB 87 & 106 Pension benefits Other postretirement benefits
Name of obligation Projected benefit obligation (PBO)
Accumulated postretirement benefit obligation (APBO)
Components of benefit cost
Service cost Interest cost (Expected return) Amortization of
Prior service cost Transition amount Excess gain/loss
Service cost Interest cost (Expected return) Amortization of
Prior service cost Transition amount Excess gain/loss
Plan Assets Most pension plans have assets set aside in a trust which generate returns that help offset the interest cost component of benefit cost.
These arrangements are rarely funded, that is, there are probably no plan assets and therefore no deduction for expected return on plan assets in the computation of postretirement benefit cost.
Disclosure requirements
Extensive, including reconciliation of change in PBO and plan assets
Same as pension but additional disclosures regarding health care inflation rate assumptions and impact
iGAAP and U.S. GAAP separate pension plans into defined-contribution plans and defined-benefit plans. The accounting for defined-contribution plans is similar.
For defined-benefit plans, both iGAAP and U.S. GAAP recognize the net of the pension assets and liabilities on the balance sheet. Unlike U.S. GAAP, which recognizes prior service cost on the balance sheet (as an element of “Accumulated other comprehensive income”), iGAAP does not recognize prior service costs on the balance sheet. Both GAAPs amortize prior service costs into income over the expected service lives of employees.
Another difference in defined-benefit recognition is that under iGAAP companies have the choice of recognizing actuarial gains and losses in income immediately or amortizing them over the expected remaining working lives of employees. U.S. GAAP does not permit choice.
The IASB has recently issued a discussion paper on pensions proposing: (1) elimination of smoothing via the corridor approach, (2) a different presentation of pension costs in the income statement, and (3) a new category of pensions for accounting purposes—so-called “contribution-based promises.”