accounting for postemployment benefits c hapter 20 an electronic presentation by norman sunderman...

Accounting for Postemployment

Benefits

Chapter20

An electronic presentation by Norman Sunderman Angelo State University

An electronic presentation by Norman Sunderman Angelo State University

COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Intermediate AccountingIntermediate Accounting 10th edition 10th edition

Nikolai Bazley JonesNikolai Bazley Jones

2

Defined Contribution Plans

The employer employer contributes a defined sumcontributes a defined sum to a third party to a third party plan trust.plan trust.

Amounts to be funded are determined by the plan.

The plan invests the contributed assets, which earn

income, and makes distributions to retirees.

There is no promise for specific future benefits.

Market risk is borne by the employee.

Accounting for the firm is relatively straightforward.

For profit companies contribute to 401(k) plans and non-

profit organizations contribute to 403(b) plans.

3

A pension plan requires that a

company provide income to its retired employees in return

for services they provided during their

employment.

Characteristics of a Pension Plan

4

The retirement income, normally paid monthly, usually is determined on

the basis of the employees earnings and

length of service with the company.

Defined Benefit Plans

$50,000 average salary X 2.5% per year X 30 years= $37,500 pension per year

$50,000 average salary X 2.5% per year X 30 years= $37,500 pension per year

5

Most companies design their pension plans to meet the Internal Revenue Code qualifications, which state that:1. Employer contributions are deductible for

income tax purposes when paid.

2. Pension fund earnings are exempt from income taxes.

3. Employer contributions to the pension fund are not taxable to the employees until they receive their pension benefits.

Internal Revenue Qualifications

6

The employee is promised a certain amount of benefits promised a certain amount of benefits

at retirementat retirement. The amount received is based upon variables such as

-Years of service

-Ending salary or average of best (three) years

-Multiplier, such as 2.5% per year of service

-Age, if retiring early, a deduction will be made The employer remains liable for the benefits and bears

the market risk. The employer is the trust-beneficiary. The accounting by the firm is complex.

The employee is promised a certain amount of benefits promised a certain amount of benefits

at retirementat retirement. The amount received is based upon variables such as

-Years of service

-Ending salary or average of best (three) years

-Multiplier, such as 2.5% per year of service

-Age, if retiring early, a deduction will be made The employer remains liable for the benefits and bears

the market risk. The employer is the trust-beneficiary. The accounting by the firm is complex.

Defined Benefit Plans

7

The projected benefit obligation is the actuary’s

estimate of the present value of benefits attributed to date based on future salary levels.

The projected benefit obligation is the actuary’s

estimate of the present value of benefits attributed to date based on future salary levels.

Projected Benefit Obligation

8

The accumulated benefit obligation is the actuary’s

estimate of the present value of benefits attributed to date

based on current salary levels.

The accumulated benefit obligation is the actuary’s

estimate of the present value of benefits attributed to date

based on current salary levels.

Accumulated Benefit Obligation

9

Components of Pension Expense

1. +Service cost for the year. Increases pension expense.2. +Interest on projected benefit obligation (liability).

Beginning PBO times the discount or settlement rate. Increases pension expense.

3. -Expected return on plan assets during the year. Fair value of plan assets at beginning of year times expected long-term rate of return on plan assets. Generally decreases pension expense.

4. +Amortization of prior service cost = Present value of additional benefits/modification of the plan amortized over the remaining service lives of active employees. Generally increases pension expense.

5. +Gain or loss = Amortization of the cumulative unrecognized net gain or loss from previous periods in excess of the corridor.

10

Service cost is the actuarial present value

of the benefits attributed by the pension benefit

formula to service rendered by the

employees during the current period.

Service cost is the actuarial present value

of the benefits attributed by the pension benefit

formula to service rendered by the

employees during the current period.

Service Cost

11

Interest cost is the increase in the

projected benefit obligation due to the

passage of time.

Interest Cost

12

The expected return on plan assets, if positive, will decrease pension

expense.

The expected return on plan assets, if positive, will decrease pension

expense.

Expected Return on Assets

The expected return on plan assets is the

expected increase in plan assets due to

investing activities.

The expected return on plan assets is the

expected increase in plan assets due to

investing activities.

13

When a defined benefit plan is either initiated or amended, credit is often

given to employees for years of service provided before the date of initiation or

amendment.

When a defined benefit plan is either initiated or amended, credit is often

given to employees for years of service provided before the date of initiation or

amendment.

Prior Service Cost

14

The retroactive benefit to a pension

plan is the prior service cost.

The retroactive benefit to a pension

plan is the prior service cost.

Unrecognized Prior Service Cost

Prior service cost is not recorded in the accounts in

the period granted. Instead, it is amortized and included

in the computation of pension expense.

Prior service cost is not recorded in the accounts in

the period granted. Instead, it is amortized and included

in the computation of pension expense.

15

Prior service cost may be amortized over future service periods of

employees active at the time of the plan amendment using either the straight-

line or years-of-service method.

Prior service cost may be amortized over future service periods of

employees active at the time of the plan amendment using either the straight-

line or years-of-service method.

Methods of Amortization

16

The average remaining service life of employees

expected to receive benefits is calculated by

dividing the total future service years by the

number of employees.

Total future service years = average remaining service life

Number of employees expected to receive benefits

The average remaining service life of employees

expected to receive benefits is calculated by

dividing the total future service years by the

number of employees.

Total future service years = average remaining service life

Number of employees expected to receive benefits

Straight-line Method

17

The Board prefers a years-of-service

amortization method where

unrecognized prior service cost is

divided by the number of future

service years to be worked by

participating employees, to obtain a

cost per service-year. This cost per

service-year is multiplied by the

number of service years consumed

each year.

The Board prefers a years-of-service

amortization method where

unrecognized prior service cost is

divided by the number of future

service years to be worked by

participating employees, to obtain a

cost per service-year. This cost per

service-year is multiplied by the

number of service years consumed

each year.

Years-of-Service Method

18

A gain or loss in plan assets arises because of changes in the stock

market and because of changes in actuarial assumptions.

A gain or loss in plan assets arises because of changes in the stock

market and because of changes in actuarial assumptions.

Gain or Loss

19

The gain or loss is not recognized in the period in which it occurs, so it is called an unrecognized net gain or

loss.

The gain or loss is not recognized in the period in which it occurs, so it is called an unrecognized net gain or

loss.

Gain or Loss

20

Amortization of Gain or Loss

The minimumminimum amortization required is computed by dividing the total unrecognized gain or loss subject to amortizationsubject to amortization at the beginning of the year by the average remaining service period of active employees expected to receive benefits.

The amount subject to amortization is the excess of 10% of the larger of the beginning balances of the projected benefit obligation and the market-related asset value. Use absolute values.

The minimumminimum amortization required is computed by dividing the total unrecognized gain or loss subject to amortizationsubject to amortization at the beginning of the year by the average remaining service period of active employees expected to receive benefits.

The amount subject to amortization is the excess of 10% of the larger of the beginning balances of the projected benefit obligation and the market-related asset value. Use absolute values.

21

1. Amortization of any unrecognized net loss from previous periods is added to compute pension expense, or

2. Amortization of any unrecognized net gain from previous periods is deducted to compute pension expense.

1. Amortization of any unrecognized net loss from previous periods is added to compute pension expense, or

2. Amortization of any unrecognized net gain from previous periods is deducted to compute pension expense.

Amortization of Gain or Loss

22

Cumulative Projected Fair Excess Unrecognized Benefit Value Unrecognized Recognized Net Loss Obligation of Plan Net Loss Net Loss Year (Gain) Actual Assets Corridor (Gain) (Gain)

2007 $13,000 $110,000 $100,000 $11,000 $2,000 $200

2008 (2,300) 135,000 130,000 13,500 ---- ----

2009 18,700 168,000 170,000 17,000 1,700 170

2010 27,500 230,000 215,000 23,000 4,500 450

Assume the average remaining service period

is 10 years.

Computation of Net Gain or Loss

ComponentComponentof pensionof pension

expenseexpense

ComponentComponentof pensionof pension

expenseexpense

DivideDivideBy 10 yearsBy 10 years

Use January 1 cumulative gain or loss for computation.

23

Facts for the Carlisle Company1. The company adopts a pension plan on

January 1, 2007. No retroactive benefits were granted to employees.

2. The service cost each year is: 2007, $400,000; 2008, $420,000; 2009, $432,000.

3. The projected benefit obligations at the beginning of each year is: 2008, $400,000; and 2009, $840,000.

ContinuedContinuedContinuedContinued

Pension Expense Equal to Funding

24

4. The discount rate is 10%.5. The expected long-term rate of return on plan

assets is 10%.6. The company adopts a policy of funding an

amount equal to the pension expense and makes a payment at the end of each year.

7. Plan assets are based on the amounts contributed each year, plus a return of 10%, less $20,000 to retired employees (beginning 2008).


25

December 31, 2007:

Pension Expense 400,000Cash 400,000

December 31, 2008:



Service cost (from actuary) $420,000 Interest cost ($400,000 x 10%) 40,000 Expected return on plan assets ($400,000 x 10%) (40,000 )Pension expense $420,000


26

Balance

Plan Assets

Cash from 2007 400,000 Paid to

Return 2008 40,000 retirees

Cash from 2008 420,000 2008

20,000

Bal. 1/1/09 840,000

27

December 31, 2009:


Note that the interest cost and the return on the plan assets offset each other each year.

Note that the interest cost and the return on the plan assets offset each other each year.


Service cost (from actuary) $432,000 Interest cost ($840,000 x 10%) 84,000 Expected return on plan assets ($840,000 x 10%) (84,000)Pension expense $432,000

Service cost (from actuary) $432,000 Interest cost ($840,000 x 10%) 84,000 Expected return on plan assets ($840,000 x 10%) (84,000)Pension expense $432,000

28

December 31, 2007:

Pension Expense 400,000Cash 385,000Prepaid/Accrued Pension Cost 15,000

Carlisle Company funds $385,000 in 2007, $400,000 in 2008, and $415,000 in 2009.

Carlisle Company funds $385,000 in 2007, $400,000 in 2008, and $415,000 in 2009.

LiabilityLiabilityLiabilityLiability

Pension Expense Greater Than Funding

29

Service cost (from actuary) $420,000 Interest cost ($400,000 x 10%) 40,000 Expected return on plan assets ($385,000 x 10%) (38,500

)Pension expense $421,500

Service cost (from actuary) $420,000 Interest cost ($400,000 x 10%) 40,000 Expected return on plan assets ($385,000 x 10%) (38,500

)Pension expense $421,500

December 31, 2008:


(Liability balance now $15,000 + $21,500)


30

December 31, 2009:


The balance in the liability account is $57,150($15,000 + $21,500 + $20,650)




31

December 31, 2007:

Pension Expense 400,000Prepaid/Accrued Pension Cost 15,000

Cash 415,000

Carlisle Company funds $415,000 in 2007, $425,000 in 2008, and $440,000 in 2009. The

expected and actual return is 11%.


expected and actual return is 11%.

Pension Fund Less Than Pension Funding and Expected

Return Different From Discount Rate

32

December 31, 2008:Pension Expense 414,350Prepaid/Accrued Pension Cost 10,650

Cash 425,000

The balance in the asset account is $25,650



Service cost (assumed) $420,000 Interest cost ($400,000 x 10%) 40,000 Expected return on plan assets ($415,000 x 11%) (45,650 )Pension expense $414,350

Service cost (assumed) $420,000 Interest cost ($400,000 x 10%) 40,000 Expected return on plan assets ($415,000 x 11%) (45,650 )Pension expense $414,350

33

December 31, 2009:

Pension Expense 420,322Prepaid/Accrued Pension Cost 19,678

Cash 440,000

The balance in the asset account is $44,872The balance in the asset account is $44,872



Service cost $432,000 Interest cost ($840,000 x 10%) 84,000 Expected return on plan assets ($9,800 x 11%) (95,678 )Pension expense $420,332

Service cost $432,000 Interest cost ($840,000 x 10%) 84,000 Expected return on plan assets ($9,800 x 11%) (95,678 )Pension expense $420,332

34


company awarded retroactive benefits to employees. The unrecognized prior service

costs were estimated to be $2 million. Carlisle decided to increase its contribution by $290,000 per year. The $2 million is amortized over 20

years.


company awarded retroactive benefits to employees. The unrecognized prior service

costs were estimated to be $2 million. Carlisle decided to increase its contribution by $290,000 per year. The $2 million is amortized over 20

years.

Pension Expense Including Amortization of Unrecognized

Prior Service Cost

35

Pension Expense 700,000Cash ($385,000 + $290,000) 675,000Prepaid/Accrued Pension Cost 25,000

December 31, 2007:

Service cost $400,000 Interest cost ($2,000,000 x 10%) 200,000 Amortization of unrecognized prior service cost 100,000 Pension expense $700,000

Service cost $400,000 Interest cost ($2,000,000 x 10%) 200,000 Amortization of unrecognized prior service cost 100,000 Pension expense $700,000


Prior Service Cost

36


December 31, 2008:

Service cost (assumed) $420,000 Interest cost ($2,600,000 x 10%) 260,000 Expected return on plan assets ($675,000 x 11%) (74,250

) Amortization of unrecognized prior service cost 100,000 Pension expense $705,750

Service cost (assumed) $420,000 Interest cost ($2,600,000 x 10%) 260,000 Expected return on plan assets ($675,000 x 11%) (74,250



Prior Service Cost

37


December 31, 2009:

Service cost $432,000 Interest cost ($3,260,000 x 10%) 326,000 Expected return on plan assets ($1,421,000 x 11%) (156,310


Service cost $432,000 Interest cost ($3,260,000 x 10%) 326,000 Expected return on plan assets ($1,421,000 x 11%) (156,310



Prior Service Cost

38

The accumulated benefit obligation in excess of the fair

value of the plan assets is a measure of the obligation of the

company based on the legal concept of a liability.

The accumulated benefit obligation in excess of the fair

value of the plan assets is a measure of the obligation of the

company based on the legal concept of a liability.

Additional Pension Liability

39

The additional pension liability “adjusts” the company’s

existing pension liability or asset to the amount of the

unfunded accumulated obligation.

The additional pension liability “adjusts” the company’s

existing pension liability or asset to the amount of the

unfunded accumulated obligation.


40

Assume the following facts for the Devon Company at the end of 2007:


Projected benefit obligation $2,000,000Accumulated benefit obligation 1,200,000Plan assets (fair value) 1,000,000Prepaid/accrued pension cost (liability) 50,000Unrecognized prior service cost 300,000

Projected benefit obligation $2,000,000Accumulated benefit obligation 1,200,000Plan assets (fair value) 1,000,000Prepaid/accrued pension cost (liability) 50,000Unrecognized prior service cost 300,000

Recognition of Additional Pension Liability

41

Accumulated benefit obligation– Fair value of plan assets= Unfunded Accumulated Benefit

Obligation– Prepaid/accrued pension cost

(credit balance)or + Prepaid/accrued pension cost (debit

balance) = Additional Pension Liability


42

Remember that the difference between the two benefit

obligations is that the PBO includes assumed future pay increase, whereas the ABO is based on current pay levels.

Remember that the difference between the two benefit

obligations is that the PBO includes assumed future pay increase, whereas the ABO is based on current pay levels.


Accumulated benefit obligation $1,200,000

Plan assets (fair value) (1,000,000)

Unfunded accumulated benefit

obligation $ 200,000

43

The unfunded accumulated benefit obligation of

$200,000 is the minimum liability that the company

must recognize.

The unfunded accumulated benefit obligation of

$200,000 is the minimum liability that the company

must recognize.


Accumulated benefit obligation $1,200,000

Plan assets (fair value) (1,000,000)

Unfunded accumulated benefit

obligation $ 200,000

44

Unfunded accumulated benefit obligations $ 200,000

Prepaid/accrued pension cost (liability) (50,000)

Additional pension liability $150,000

Unfunded accumulated benefit obligations $ 200,000

Prepaid/accrued pension cost (liability) (50,000)

Additional pension liability $150,000

Deferred Pension Cost (intangible asset) 150,000Additional Pension Liability 150,000

December 31, 2007


45

Assume Devon Company has an unrecognized prior service cost of $120,000.

Assume Devon Company has an unrecognized prior service cost of $120,000.

The intangible asset cannot exceed the unrecognized

prior service cost.



46

Deferred Pension Cost (intangible asset) 120,000Excess of Additional Pension Liability Over Unrecognized Prior Service Cost (contra equity) 30,000

Additional Pension Liability 150,000


December 31, 2007


47

Stockholders’ Equity

Common stock $600,000 Additional paid-in capital 230,000 Retained earnings 170,000 Accumulated other comprehensive income (loss): Excess of additional pension liability over unrecognized prior service cost (30,000)Total stockholders’ equity $970,000



48



Accumulated benefit obligation 1,300,000Plan assets (fair value) 1,220,000Prepaid/accrued pension cost (liability) 60,000Unrecognized prior service cost 110,000

Accumulated benefit obligation 1,300,000Plan assets (fair value) 1,220,000Prepaid/accrued pension cost (liability) 60,000Unrecognized prior service cost 110,000



49

60,000

Prepaid/Accrued Additional Liability

150,000

20,000

Unfunded ABOMinimum Liability(not a real account)

80,000

Additional Liability

130,000

50

Additional Pension Liability 130,000Deferred Pension Cost (intangible asset) 100,000Excess of Additional Liability Over Unrecognized Prior Service Cost 30,000

December 31, 2008:

Accumulated benefit obligation $1,300,000Plan assets (fair value) 1,220,000 Unfunded accumulated benefit obligations 80,000Prepaid/accrued pension cost (liability) (60,000)

Additional pension liability (balance) $20,000

Accumulated benefit obligation $1,300,000Plan assets (fair value) 1,220,000 Unfunded accumulated benefit obligations 80,000Prepaid/accrued pension cost (liability) (60,000)

Additional pension liability (balance) $20,000


51

Since the additional liability is less than the unrecognized prior service cost, the company does not include any reduction in its accumulated other comprehensive income for

the year.

Since the additional liability is less than the unrecognized prior service cost, the company does not include any reduction in its accumulated other comprehensive income for

the year.


52

If the fair value the plan assets is more than the accumulated benefit obligation. No further calculations

are needed.

If the fair value the plan assets is more than the accumulated benefit obligation. No further calculations

are needed.


53

According to FASB Statement No. 132R, a company must disclose

specific information about a defined benefit pension plan.

According to FASB Statement No. 132R, a company must disclose

specific information about a defined benefit pension plan.

Disclosures

54

Many companies offer additional benefits to former

employees after their retirement--widely referred

to as OPEB.

Many companies offer additional benefits to former

employees after their retirement--widely referred

to as OPEB.What are the major differences between

postretirement healthcare benefits and pensions?

What are the major differences between

postretirement healthcare benefits and pensions?

Other Postemployment Benefits

55

The change in the deferred tax rules from FASB Statement No. 96 to FASB Statement No. 109, which

made it easier for a company to recognize deferred tax assets.

The change in the deferred tax rules from FASB Statement No. 96 to FASB Statement No. 109, which

made it easier for a company to recognize deferred tax assets.

Interaction with Deferred Income Taxes

56

Chapter20

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