PART II: Corporate Accounting Concepts and Issues
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PART II: Corporate Accounting Concepts and Issues. Lecture 23. Accounting for Pensions and Postretirement Benefits. Instructor Adnan Shoaib. Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

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Accounting for pensions and postretirement benefits

PART II: Corporate Accounting Concepts and Issues

Lecture 23

Accounting for Pensions and Postretirement Benefits

Instructor

Adnan Shoaib


Learning objectives

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

Identify types of pension plans and their characteristics.

Explain alternative measures for valuing the pension obligation.

List the components of pension expense.

Use a worksheet for employer’s pension plan entries.

Describe the amortization of prior service costs.

Explain the accounting procedure for unexpected gains and losses.

Explain the corridor approach to amortizing gains and losses.

Describe the requirements for reporting pension plans in financial statements.

Learning Objectives


Accounting for pensions and postretirement benefits

Accounting for Pensions and Postretirement Benefits

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

Alternative measures of liability

Recognition of net funded status

Components of pension expense

2012 entries and worksheet

Amortization of prior service cost

2013 entries and worksheet

Gain or loss

2014 entries and worksheet

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 benefits

An arrangement whereby an employer provides benefits to employees after they retire for services they provided while they were working.

Nature of Pension Plans

Pension Plan

Administrator

Contributions

Employer

Retired

Employees

Benefit Payments

Assets &

Liabilities

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


Accounting for pensions and postretirement benefits

Nature of Pension Plans

Pension plans can be:

  • 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.

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


Accounting for pensions and postretirement benefits

Nature of Pension Plans

Defined-Contribution Plan

Defined-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

Actuariesestimate 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.


Accounting for pensions and postretirement benefits

Accounting for Pensions

Two questions:

  • What is the pension obligation that a company should report in the financial statements?

  • What is the pension expense for the period?

LO 3 Explain alternative measures for valuing the pension obligation.


Accounting for pensions and postretirement benefits

Accounting for Pensions

Alternative measures of the Liability

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

FASB’s choice

Illustration 20-3

LO 3 Explain alternative measures for valuing the pension obligation.


Accounting for pensions and postretirement benefits

Accounting for Pensions

LO 4 List the components of pension expense.


Accounting for pensions and postretirement benefits

Accounting for Pensions

Components of Pension Expense

Effect on Expense

1.

Service Costs

+

Actuarial present valueof new benefits earned by employees during the period.

LO 4 List the components of pension expense.


Accounting for pensions and postretirement benefits

Accounting for Pensions

Components of Pension Expense

Effect on Expense

2.

Interest on the Liability

+

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.

LO 4 List the components of pension expense.


Accounting for pensions and postretirement benefits

Accounting for Pensions

Components of Pension Expense

Effect on Expense

3.

Actual Return on Plan Assets

+-

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

LO 4 List the components of pension expense.


Accounting for pensions and postretirement benefits

Accounting for Pensions

Components of Pension Expense

Effect on Expense

4.

Amortization of Prior Service Costs

+

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.

LO 4 List the components of pension expense.


Accounting for pensions and postretirement benefits

Accounting for Pensions

Components of Pension Expense

Effect on Expense

5.

Gain or Loss

+-

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.

LO 4 List the components of pension expense.


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

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.

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


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

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.

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


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

Prepare a pension worksheet for Beaty for 2012.

($280,000 x 10%)

($10,500) net liability

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


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

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.

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


Accounting for pensions and postretirement benefits

Prior Service Cost

Amortization of Prior Service Cost

Company should not recognize the retroactive benefitsas 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.

  • Amortization Method:

    • Board prefers a years-of-service method.

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

LO 6 Describe the amortization of prior service costs.


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

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

Projected benefit obligation, 1/1/12 (before amendment) $560,000

Plan assets, 1/1/12 546,200

Pension liability 13,800

On January 1, 2012, Rydell Corp., through plan amendment,

grants prior service benefits having a present value of 120,000

Settlement rate 9%

Service cost 58,000

Contributions (funding) 65,000

Actual (expected) return on plan assets 52,280

Benefits paid to retirees 40,000

Prior 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.

LO 6 Describe the amortization of prior service costs.


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

($135,720) liability


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

Pension Journal Entry for 2012.

Dec. 31

Pension Expense 83,920

Other Comprehensive Income (PSC) 103,000

Pension Asset/Liability 121,920

Cash65,000

LO 6 Describe the amortization of prior service costs.


Accounting for pensions and postretirement benefits

Gains and Losses

Gain or Loss

  • Unexpected swings in pension expense can result from:

    • Sudden and large changes in the fair value of plan assets, and

    • Changes in actuarial assumptions that affect the amount of the projected benefit obligation.

LO 7 Explain the accounting for unexpected gains and losses.


Accounting for pensions and postretirement benefits

Gains and Losses

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.

LO 7 Explain the accounting for unexpected gains and losses.


Accounting for pensions and postretirement benefits

Gains and Losses

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

Answer

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.

LO 7 Explain the accounting for unexpected gains and losses.


Accounting for pensions and postretirement benefits

Gains and Losses

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

Answer

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.

LO 7 Explain the accounting for unexpected gains and losses.


Accounting for pensions and postretirement benefits

Gains and Losses

Corridor Amortization

FASB invented the corridor approachfor 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.


Accounting for pensions and postretirement benefits

Gains and Losses

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.

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


Accounting for pensions and postretirement benefits

Gains and Losses

Compute Shin’s amortization of the loss.

÷

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


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

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.

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


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

Pension Work Sheet for 2011

*

* Expected Return on Plan Assets $200,000 x 10% = $20,000

($57,000)

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


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

Pension Journal Entry for 2011

Dec. 31

Pension Expense 21,000

OCI – Gain/Loss 2,000

Pension Asset/Liability 7,000

Cash 16,000

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


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

Pension Work Sheet for 2012

*

* Actual return = Expected Return

($217,700) liability

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


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

Pension Journal Entry for 2012

Dec. 31

Pension Expense 95,100

Other Comprehensive Income (PSC) 105,600

Pension Asset/Liability 160,700

Cash40,000

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


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

Pension Work Sheet for 2013

*

* Plug

($203,400) liability

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


Accounting for pensions and postretirement benefits

Using a Pension Work Sheet

Pension Journal Entry for 2013

Dec. 31

Pension Expense 89,370

Pension Asset/Liability14,300

Other Comprehensive Income (G/L) 14,070

Other Comprehensive Income (PSC)41,600

Cash48,000

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


Accounting for pensions and postretirement benefits

Reporting Pension Plans in Financial Statements

Within the Financial Statements

  • Pension expense

  • Pension Asset / Liability

  • Components of Accumulated Other Comprehensive Income

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


Accounting for pensions and postretirement benefits

Reporting Pension Plans in Financial Statements

Within the Notes to the Financial Statements

  • Major components of pension expense.

  • Reconciliation showing how the projected benefit obligation and the fair value of the plan assets changed.

  • A disclosure of the rates used in measuring the benefit amounts (discount rate, expected return on plan assets, rate of compensation).

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


Accounting for pensions and postretirement benefits

Reporting Pension Plans in Financial Statements

Within the Notes to the Financial Statements

  • 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.

  • 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.

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


Accounting for pensions and postretirement benefits

Reporting Pension Plans in Financial Statements

Within the Notes to the Financial Statements

  • The nature and amount of changes in plan assets and benefit obligations recognized in net income and in other comprehensive income of each period.

  • 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.

  • 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.

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


Accounting for pensions and postretirement benefits

Reporting Pension Plans in Financial Statements

Special Issues

  • The Pension Reform Act of 1974

  • Pension Terminations

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


Accounting for pensions and postretirement benefits

ACCOUNTING FOR POSTRETIRMENT BENEFITS

2012 Entries and Worksheet

Illustrative Accounting Entries

  • 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.

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


Accounting for pensions and postretirement benefits

ACCOUNTING FOR POSTRETIRMENT BENEFITS

2012 Entries and Worksheet

Illustrative Accounting Entries

Illustration 20A-4

Journal Entry


Accounting for pensions and postretirement benefits

ACCOUNTING FOR POSTRETIRMENT BENEFITS

Illustrative Accounting Entries

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

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


Accounting for pensions and postretirement benefits

ACCOUNTING FOR POSTRETIRMENT BENEFITS

2013 Entries and Worksheet

Illustrative Accounting Entries

  • 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.

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


Accounting for pensions and postretirement benefits

ACCOUNTING FOR POSTRETIRMENT BENEFITS

2013 Entries and Worksheet

Illustrative Accounting Entries

Illustration 20A-6

Journal Entry


Accounting for pensions and postretirement benefits

ACCOUNTING FOR POSTRETIRMENT BENEFITS

Illustrative Accounting Entries

Amortization of Gains and Losses in 2014

Illustration 20A-8

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


Accounting for pensions and postretirement benefits

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.


Accounting for pensions and postretirement benefits

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.


End of lecture 23

End of Lecture 23


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