1 Accounting for Postemployment Benefits C hapter 19

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Accounting for Postemployment

Benefits

Accounting for Postemployment

Benefits

Chapter19

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1. Understand the characteristics of pension plans.2. Explain the historical perspective of accounting

for pension plans.3. Explain the accounting principles for defined

benefit plans, including computing pension expense and recognizing pension liabilities and assets.

4. Account for pensions.5. Understand disclosures of pensions.

ObjectivesObjectives

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6. Explain the conceptual issues regarding pensions. 7. Understand several additional issue related to

pensions. 8. Explain other post-employment benefits. 9. Account for OPEBs.10. Explain the conceptual issues regarding OPEBs.11. Understand present value calculations for

pensions. (Appendix)

ObjectivesObjectives

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Characteristics of Pension PlansCharacteristics of Pension Plans

A pension plan requires that a

company provide income to its retired employees in return

for services they provided during their

employment.

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Characteristics of Pension PlansCharacteristics of Pension Plans

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

the basis of the employees earnings and length of service with

the company.

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Pension RelationshipsPension Relationships

Company

Provide service during employment

Employees

Receive rights to pension benefits during retirement

Payments during retirement

Make payments (fund) (affected by

ERISA and the Tax Code)

Funding Agency (for pension plan)

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Recognize expense (and perhaps asset or liability)

Financial Statements

Pension RelationshipsPension Relationships

CompanyFunding Agency (for pension plan)

Financial Statements

FASB Statements No. 87, 88, and 132

FASB Statement No.

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Prepared according to GAAP

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Internal Revenue Code Qualifications Allow--

Internal Revenue Code Qualifications Allow--

Employer contributions to be deductible for income tax purposes.

Pension fund earnings to be exempt from income tax.

Employer contribution to the pension fund not to be taxable to the employees until pension benefits are actually received.

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Defined Benefit Pension PlansDefined Benefit Pension Plans

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.

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Defined Benefit Pension PlansDefined Benefit Pension PlansProjected Benefit Obligations at Beginning of Period = Present Value of Benefits Earned to Date

Plan assets at Beginning of Period at Fair Value

Interest = Projected Benefit x Discount Cost Obligation Rate

Expected Return on Plan Assets During Period

Projected Benefit Obligation Grows to Equal Expected Retirement Obligation

Assets Grow to Equal the Amounts Needed to Pay Retirement Benefits

Assets Used to Pay Retirement Benefits

Retirement

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Why is it considered

unrecognized?

Why is it considered

unrecognized?

Amortization of Unrecognized Prior Service Cost


The retroactive benefit to a pension plan is the prior

service cost.

The retroactive benefit to a pension plan is the prior

service cost.

Prior service cost is not recorded in the accounts in the period

granted. Instead, it is included amortized and included in

computation of pension expense.

Prior service cost is not recorded in the accounts in the period

granted. Instead, it is included amortized and included in

computation of pension expense.

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Date of Amendment or Adoption

Unrecognized Prior = Present Value of Benefit from the Service Cost Amendment or Adoption to be Received During Retirement

Unamortized Prior Service Cost is Amortized Over Average Remaining Service Life of Employees

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Gain or LossGain or Loss

A gain or loss arises because actuaries make assumptions about many of the items included in the computation of

pension costs and benefits.

A gain or loss arises because actuaries make assumptions about many of the items included in the computation of

pension costs and benefits.

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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.

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Amortization of any unrecognized net loss from previous periods (added to compute pension expense), or

Amortization of any unrecognized net gain from previous periods (deducted to compute pension expense).

Amortization of any unrecognized net loss from previous periods (added to compute pension expense), or

Amortization of any unrecognized net gain from previous periods (deducted to compute pension expense).


The gain or loss components of pension expense generally consists of one of the following items:

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Components of Pension ExpenseComponents of Pension Expense

Service cost = Present value of benefits earned during the year using the discount rate

+ Interest expense = Projected benefit obligation at beginning of the year x Discount rate

- Expected return on plan assets = Fair value of plan assets at the beginning of the year x Expected long-term rate of return on plan assets

+ Amortization of prior service cost = Present value of additional benefits/modification of the plan amortized over the remaining service lives of active employees

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

+

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Additional Pension LiabilityAdditional Pension Liability

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

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.

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Additional Pension LiabilityAdditional Pension Liability

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.

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DisclosuresDisclosures

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

specific information about a defined benefit pension plan. These items

are shown in Slide 20.

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

specific information about a defined benefit pension plan. These items

are shown in Slide 20.

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DisclosuresDisclosures

1. A reconciliation of the beginning and ending balances of the projected benefit obligation.

1. A reconciliation of the beginning and ending balances of the projected benefit obligation.

2. A reconciliation of the beginning and ending balances of the fair value of the plan assets.

2. A reconciliation of the beginning and ending balances of the fair value of the plan assets.

3. The funded status of the plan, the amounts not recognized on the balance sheet, the amounts not recognized on the balance sheet, including the amount of any unamortized prior service cost, the amount of any unrecognized net gain or loss, the amount of any remaining unamortized, unrecognized net obligation or net asset existing at the adoption of FASB Statement No. 87, the net pension prepaid asset or accrued liability; and any intangible asset and the related amount of accumulated other comprehensive income.

3. The funded status of the plan, the amounts not recognized on the balance sheet, the amounts not recognized on the balance sheet, including the amount of any unamortized prior service cost, the amount of any unrecognized net gain or loss, the amount of any remaining unamortized, unrecognized net obligation or net asset existing at the adoption of FASB Statement No. 87, the net pension prepaid asset or accrued liability; and any intangible asset and the related amount of accumulated other comprehensive income.

4. The amount of pension expense.

4. The amount of pension expense.

5. The amount included within other comprehensive income from a change in the additional pension liability.

5. The amount included within other comprehensive income from a change in the additional pension liability.

6. The discount rate, the rate of compensation increase, and the expected long-term rate of return on the plan assets.

6. The discount rate, the rate of compensation increase, and the expected long-term rate of return on the plan assets.

7. The amounts and types of securities included in the plan assets.

7. The amounts and types of securities included in the plan assets.

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Pension Expense Equal to FundingPension Expense Equal to FundingFacts for the Carlisle Company

1. The company adopts a pension plan on January 1, 2001. No retroactive benefits were granted to employees.

2. The service cost each year is: 2001, $400,000; 2002, $420,000; 2003, $432,000.

3. The projected benefit obligations at the beginning of each year is: 2002, $400,000; and 2003, $840,000.

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 2002).

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Pension Expense Equal to FundingPension Expense Equal to Funding

December 31, 2001:

Pension Expense 400,000Cash 400,000

December 31, 2002:


Service cost (assumed) $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


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Pension Expense Equal to FundingPension Expense Equal to Funding

December 31, 2003:




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

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Pension Expense Greater Than Pension Funding


December 31, 2001:

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

Carlisle Company funds $385,000 in 2001, $400,000 in 2002, and $415,000 in 2003.

Carlisle Company funds $385,000 in 2001, $400,000 in 2002, and $415,000 in 2003.

LiabilityLiabilityLiabilityLiability

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December 31, 2002:






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December 31, 2003:






The balance in the liability account is $57,150

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Pension Fund Less Than Pension Funding and Expected Return Different

From Discount Rate


From Discount Rate

December 31, 2001:

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

Cash 415,000

Carlisle Company funds $415,000 in 2001, $425,000 in 2002, and $440,000 in 2003. The

expected and actual return is is 11%.


expected and actual return is is 11%.

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December 31, 2002:


Cash 425,000




From Discount Rate


From Discount Rate

The balance in the asset account is $25,650

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December 31, 2003:


Cash 440,000



The balance in the asset account is $44,872


From Discount Rate


From Discount Rate

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Pension Expense Including Amortization of Unrecognized

Prior Service Cost


Prior Service Cost


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.

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

December 31, 2001:


Prior Service Cost


Prior Service Cost

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

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December 31, 2002:


Prior Service Cost


Prior Service Cost

Service cost (assumed) $420,000 Interest cost ($2,600,000 x 10%) 260,000 Expected return on plan assets ($675,000 x 10%) (67,500) Amortization of unrecognized prior service cost 100,000 Pension expense $712,500

Service cost (assumed) $420,000 Interest cost ($2,600,000 x 10%) 260,000 Expected return on plan assets ($675,000 x 10%) (67,500) Amortization of unrecognized prior service cost 100,000 Pension expense $712,500

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December 31, 2003:


Prior Service Cost


Prior Service Cost

Service cost (assumed) $432,000 Interest cost ($3,260,000 x 10%) 326,000 Expected return on plan assets ($1,412,500 x 10%) (141,250) Amortization of unrecognized prior service cost 100,000 Pension expense $716,750

Service cost (assumed) $432,000 Interest cost ($3,260,000 x 10%) 326,000 Expected return on plan assets ($1,412,500 x 10%) (141,250) Amortization of unrecognized prior service cost 100,000 Pension expense $716,750

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Computation of Net Gain or LossComputation of Net Gain or Loss

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)

2001 $13,000 $110,000 $100,000 $11,000 $2,000 $200

2002 (2,300) 135,000 130,000 13,500 ---- ----

2003 18,700 168,000 170,000 17,000 1,700 170

2004 27,500 230,000 215,000 23,000 4,500 450

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Assume the following facts for the Devon Company at the end of 2001:


Recognition of Additional Pension Liability


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

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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

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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

obligations $ 200,000

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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 150,000Additional Pension Liability 150,000

December 31, 2001

ContinuedContinuedContinuedContinued

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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.


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Deferred Pension Cost 120,000Excess of Additional Pension Liability Over Unrecognized Prior Service Cost 30,000

Additional Pension Liability 150,000


December 31, 2001

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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

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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


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Additional Pension Liability 130,000Deferred Pension Cost 130,000

December 31, 2002

Unfunded accumulated benefit obligations $80,000 Prepaid/accrued pension cost (liability) (60,000)

Additional pension liability $20,000

Unfunded accumulated benefit obligations $80,000 Prepaid/accrued pension cost (liability) (60,000)

Additional pension liability $20,000

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.

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Other Postemployment BenefitsOther Postemployment Benefits

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?

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Beneficiary Retired employee (some Retired employee,residual benefit to spouse, andsurviving spouse) dependents

Benefits Defined, fixed dollar Not limited, paid asamount, paid monthly used, varies

geographically

Funding Funding legally required Usually not funded and tax deductible because not legally

required and not taxdeductible

Other Postemployment BenefitsOther Postemployment Benefits

Item Pensions Healthcare

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OPEB ExpenseOPEB Expense

Service cost Interest cost Expected return on plan assets Amortization of unrecognized prior service cost Gain or loss Recognition of the obligation or asset existing at

the date of the initial adoption of the statement

Service cost Interest cost Expected return on plan assets Amortization of unrecognized prior service cost Gain or loss Recognition of the obligation or asset existing at

the date of the initial adoption of the statement

The net postretirement benefit expense includes the following components:

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Illustration of Accounting for OPEBS


Livingston Company adopts a healthcare plan for retired employees on January 1, 2001. At that time

the company has two employees and one retired employee. The discount rate is 10%, all employees were hired at age 25 and will become eligible full benefits at age 55. The retired employee was paid $1,500 postretirement healthcare benefits in 2001.

The company determines its accumulated postretirement benefit obligations to be $100,000.

Livingston Company adopts a healthcare plan for retired employees on January 1, 2001. At that time

the company has two employees and one retired employee. The discount rate is 10%, all employees were hired at age 25 and will become eligible full benefits at age 55. The retired employee was paid $1,500 postretirement healthcare benefits in 2001.

The company determines its accumulated postretirement benefit obligations to be $100,000.


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Service cost (actuarially determined) $ 1,100Interest cost ($100,000 x 0.10) 10,000Expected return on plan assets 0Amortization of unrecognized prior service cost ($100,000 ÷ 5) 20,000Gain or loss 0Amortization of transition obligation 0Postretirement Benefit Expense $31,100

Service cost (actuarially determined) $ 1,100Interest cost ($100,000 x 0.10) 10,000Expected return on plan assets 0Amortization of unrecognized prior service cost ($100,000 ÷ 5) 20,000Gain or loss 0Amortization of transition obligation 0Postretirement Benefit Expense $31,100


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Postretirement Benefit Expense 31,100Accrued Postretirement Benefit

Cost 31,100

December 31, 2001

Accrued Postretirement Benefit Cost 1,500Cash 1,500

To record the payment of retirement benefits

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Chapter19

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1 Accounting for Postemployment Benefits C hapter 19