accounting for postemployment benefits c hapter 20 copyright © 2010 south-western/cengage learning...

Accounting for Postemployment

Benefits

Chapter 20

COPYRIGHT © 2010 South-Western/Cengage Learning

Unit #6

2

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

3

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

4

The service cost is the actuarial present value of the benefits attributed by

the pension benefit formula to services rendered by the

employees during the current period.

The service cost is the actuarial present value of the benefits attributed by

the pension benefit formula to services rendered by the

employees during the current period.

Service Cost

5

The interest cost is the increase in the projected benefit obligation due to

the passage of time.

Interest Cost

6

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 Plan 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.

7

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

8

The cost of these retroactive benefits is

the prior service cost.

The cost of these retroactive benefits is

the prior service cost.

Prior Service Cost

The prior service cost is reported as a liability and as a negative element of other

comprehensive income at the date of the plan amendment.

The prior service cost is reported as a liability and as a negative element of other

comprehensive income at the date of the plan amendment.

9

The prior service cost is amortized by assigning an equal amount to each future

service period of each active employee who, at the date of the amendment, is expected to

receive future benefits under the plan.

The prior service cost is amortized by assigning an equal amount to each future

service period of each active employee who, at the date of the amendment, is expected to

receive future benefits under the plan.

Prior Service Cost

Alternatively, straight-line amortization over the average remaining service life

of active employees may be used for simplicity.

Alternatively, straight-line amortization over the average remaining service life

of active employees may be used for simplicity.

10

A gain or loss from previous periods from changes in the amount of the projected benefit

obligation and the fair value of the pension plan assets resulting from experience different

from that assumed, and changes in the assumptions.

A gain or loss from previous periods from changes in the amount of the projected benefit

obligation and the fair value of the pension plan assets resulting from experience different

from that assumed, and changes in the assumptions.

Gain or Loss

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Any gain or loss that is not recognized in pension expense in the period it occurs is recognized as an asset or liability and as a

component of other comprehensive income.

Any gain or loss that is not recognized in pension expense in the period it occurs is recognized as an asset or liability and as a

component of other comprehensive income.

Gain or Loss

Accrued/Prepaid Pension Cost xxx Other Comprehensive Income: Net Gain/Loss xxx

12

Amortization of Gain or Loss

Amortization of any net gain or loss is included in the pension expense of a given year if, at the beginning of the year, the cumulative net gain or loss from previous periods (included in accumulated other comprehensive income) exceeds a “corridor.”

The “corridor” is defined as 10% of the greater of the actual projected benefit obligation or the fair value of the plan assets.

13

Components of Pension Expense

+ Service cost (Present value of benefits earned during the year using the discount rate)

+ Interest cost (Projected benefit obligation at beginning of the year × Discount rate)

– Expected return on plan assets (Fair value of plan assets at the beginning of the year × Expected long-term rate of return on plan assets)

+ Amortization of prior service cost (Present value of additional benefits granted at adoption or modification of the plan amortized over the remaining service lives of active employees)

+ Gain or loss (Amortization of the cumulative net gain or loss from previous periods in excess of the corridor)

= Pension Expense

Ending Projected Benefit Obligation:

Beginning projected benefit obligation

+ Prior service cost

= Adjusted beginning projected benefit obligation

+ Service cost for period

+ Interest cost on beginning projected benefit obligation

+ Actuarial losses (or – Actuarial gains)

– Payments to retirees

= Ending projected benefit obligation

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Fair Value of Pension Plan Assets

Ending Fair Value of Pension Plan Assets:

Beginning fair value of pension plan assets

+ Actual return on plan assets

+ Contributions (amounts funded) by the company

– Payments to retirees

= Ending fair value of pension plan assets

16

1. The company adopts a pension plan on January 1, 2010. No retroactive benefits were granted to employees.

2. The service cost each year is: 2010, $400,000; 2011, $420,000; 2012, $432,000.

3. The projected benefit obligation at the beginning of each year is: 2011, $400,000; and 2012, $840,000.

Pension Expense Equal to Pension Funding

Assume the following facts for the Carlisle Company:

Assume the following facts for the Carlisle Company:

ContinuedContinuedContinuedContinued

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4. The discount rate is 10%.

5. The expected long-term rate of return on plan assets is 10%, which is also equal to the actual rate of return.

6. The company adopts a policy of funding an amount equal to the pension expense and makes the payment to the funding agency at the end of each year.

7. Plan assets are based on the amounts contributed each year, plus a return of 10% per year, less an assumed payment of $20,000 to retired employees (beginning in 2011).


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December 31, 2010Pension Expense 400,000

Cash 400,000


Cash 420,000

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


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2011 Projected Benefit Obligation


400,000 Beginning projected benefit obligation (2010)

420,000 Service cost (2011)

40,000 Interest cost (2011)

Payment to retired employees (2011) 20,000

840,000 Balance 1/1/12

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2011 Fair Value of Pension Plan Assets

Pension Plan Assets

Beginning fair value (2010) 400,000

Actual return on plan assets (2011) 40,000

Contribution (2011) 420,000

20,000 Payment to retired employees (2011)

Balance 1/1/12 840,000

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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



Cash 432,000

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

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

22

The Carlisle Company funds $405,000 in 2010, $425,000 in 2011, and $435,000 in 2012.

The Carlisle Company funds $405,000 in 2010, $425,000 in 2011, and $435,000 in 2012.

Pension Funding Greater Than Pension Expense

December 31, 2010Pension Expense 400,000Accrued/Prepaid Pension Cost 5,000

Cash 405,000

AssetAssetAssetAsset

Accrued/Prepaid Pension Cost

Accrued/Prepaid Balance

Projected benefit obligation– Fair value of plan assets

($5,000) $400,000 – $405,000=

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24

The balance in the asset account is now $10,500 ($5,000 + $5,500).


Pension Expense Greater to Pension Funding


Cash 425,000



25







840,000 Balance 1/1/12

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Pension Plan Assets





Balance 1/1/12 850,500

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The balance in the asset account is now $14,500 ($5,000 + $5,500 + $4,050).

The balance in the asset account is now $14,500 ($5,000 + $5,500 + $4,050).

Pension Expense Greater to Pension Funding


Cash 435,000



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The Carlisle Company funds $415,000 in 2010, $425,000 in 2011, and $440,000 in 2012. The

expected return is 11% each year, and the actual return is 12% each year.

The Carlisle Company funds $415,000 in 2010, $425,000 in 2011, and $440,000 in 2012. The

expected return is 11% each year, and the actual return is 12% each year.

Pension Expense Less Than Pension Funding, and Expected Return on Plan Assets Different from Both Actual Return and Discount Rate


Cash 415,000

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Cash 425,000




30







840,000 Balance 1/1/12

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Pension Plan Assets





Balance 1/1/12 869,800

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Difference Between Expected and Actual Return

December 31, 2011Accrued/Prepaid Pension Cost 4,150

Other Comprehensive Income: Net Gain/Loss 4,150

Because the 12% actual return is $49,800, which is $4,150 higher than the $45,650 expected return, a journal entry must be made to Accrued/Prepaid

Pension Cost and Other Comprehensive Income for the year.



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Cash 440,000




34








35

The Carlisle Company awarded retroactive benefits to employees when it adopted the pension

plan on January 1, 2010. The prior service cost was estimated to be $2 million, which is to be amortized

over 20 years. Carlisle decided to increase its contribution to $705,000 in 2010, $715,000 in 2011,

and $730,000 in 2012.

The Carlisle Company awarded retroactive benefits to employees when it adopted the pension

plan on January 1, 2010. The prior service cost was estimated to be $2 million, which is to be amortized

over 20 years. Carlisle decided to increase its contribution to $705,000 in 2010, $715,000 in 2011,

and $730,000 in 2012.

Pension Expense Including Amortization of Prior Service Cost

36

As required by GAAP, the prior service cost of $2 million must be recorded as a liability and also as a

negative element of other comprehensive income for the year.

As required by GAAP, the prior service cost of $2 million must be recorded as a liability and also as a

negative element of other comprehensive income for the year.


Other Comprehensive Income: Prior Service Cost 2,000,000

Accrued/Prepaid Pension Cost 2,000,000

37


Cash 705,000

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

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


38

The 2010 pension expense includes $100,000 amortization of prior service cost ($2,000,000 ÷ 20

years). Therefore, the company must record an adjusting entry to increase 2010 other

comprehensive income.

The 2010 pension expense includes $100,000 amortization of prior service cost ($2,000,000 ÷ 20

years). Therefore, the company must record an adjusting entry to increase 2010 other

comprehensive income.


Accrued/Prepaid Pension Cost 100,000Other Comprehensive Income: Prior Service Cost 100,000

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2,000,000 Beginning projected benefit obligation (2010)



2,600,000 Balance 1/1/11

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Pension Plan Assets

Beginning fair value (2010) 0

Actual return on plan assets (2010) 0


Balance 1/1/11 705,000

41


Cash 715,000

Service cost $420,000 Interest cost ($2,600,000 × 10%) 260,000Expected return on plan assets ($705,000 × 11%) (77,550) Amortization of prior service cost 100,000Pension expense $702,450

Service cost $420,000 Interest cost ($2,600,000 × 10%) 260,000Expected return on plan assets ($705,000 × 11%) (77,550) Amortization of prior service cost 100,000Pension expense $702,450


42

The 2011 pension expense also includes $100,000 amortization of prior service cost so the company must record an adjusting entry to increase 2011

other comprehensive income.

The 2011 pension expense also includes $100,000 amortization of prior service cost so the company must record an adjusting entry to increase 2011

other comprehensive income.



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2,000,000 Beginning projected benefit obligation (2010)




3,260,000 Balance 1/1/12

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Pension Plan Assets





Balance 1/1/12 1,484,600

The actual return on plan assets was $7,050 higher than the expected return. Therefore, Other Comprehensive Income should be credited.

The actual return on plan assets was $7,050 higher than the expected return. Therefore, Other Comprehensive Income should be credited.

Recognition of Gain on Plan Assets

Accrued/Prepaid Pension Cost 7,050Other Comprehensive Income: Net Gain/Loss 7,050

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46


Cash 730,000

Service cost $432,000 Interest cost ($3,260,000 × 10%) 326,000Expected return on plan assets ($1,484,600 × 11%) (163,306) Amortization of prior service cost 100,000Pension expense $694,694

Service cost $432,000 Interest cost ($3,260,000 × 10%) 326,000Expected return on plan assets ($1,484,600 × 11%) (163,306) Amortization of prior service cost 100,000Pension expense $694,694


47

The 2012 pension expense also includes the $100,000 amortization of prior service cost, so the

company must record an adjusting entry to increase 2012 other comprehensive income.

The 2012 pension expense also includes the $100,000 amortization of prior service cost, so the

company must record an adjusting entry to increase 2012 other comprehensive income.



48




Because the 12% actual return is $178,152, which is $14,846 higher than the $163,306 expected return, a

journal entry must be made to Accrued/Prepaid Pension Cost and Other Comprehensive Income for

the year.

Because the 12% actual return is $178,152, which is $14,846 higher than the $163,306 expected return, a

journal entry must be made to Accrued/Prepaid Pension Cost and Other Comprehensive Income for

the year.

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Payment to retired employees (2011) 20,000 2,000,000 Beginning PBO (2010)

Payment to retired employees (2012) 20,000420,000 Service cost (2011)




3,398,000 Balance 12/31/12

PBO - Plan Assets = Accrued/Prepaid Pension Costs

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Pension Plan Assets

Beginning fair value (2010) 705,00020,000 Payment to retired employees (2011)

Actual return on plan assets (2011) 84,60020,000 Payment to retired employees (2012)




Balance 12/31/12 2,372,752

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Accrued/Prepaid Pension Cost

Overfunded (2010) 5,000 2,000,000 Prior Service Cost (2010)

Amortization of PSC (2010) 100,000

Overfunded (2011) 12,550


Actuarial Adjustment (2011) 7,050

Overfunded (2012) 35,306


Actuarial Adjustment (2012) 14,846

1,625,248 Balance 12/31/12

PBO – Plan Assets Accrued/Prepaid

Pension Cost

$3,998,000 – $2,372,752 $1,625,248=

52

The average remaining service life of employees expected to receive benefits is calculated by dividing the expected years of service for all

employees by the number of employees.

The average remaining service life of employees expected to receive benefits is calculated by dividing the expected years of service for all

employees by the number of employees.

Calculation of Amortization of Prior Service Cost: Straight-Line Amortization

Average Remaining Service Life

Expected Years of Service

Number of Employees=

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The preferred method assigns an equal amount to each future service period for each active participating employee who is

expected to receive future benefits under the plan.

The preferred method assigns an equal amount to each future service period for each active participating employee who is

expected to receive future benefits under the plan.

Calculation of Amortization of Prior Service Cost: Years-of-Future-Service Method

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

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

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

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

Amortization of Gain or Loss

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Chapter 20

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accounting for postemployment benefits c hapter 20 copyright © 2010 south-western/cengage learning...

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pension plan assets

defined benefit plan

plan amendment

years of service

plan assetsthe

accumulated benefit

future service period

amortization of gain