1 Pensions (FAS 87); Post Retirement Benefits (FAS 106); Post Employment Benefits (FAS 112); Disclosure about Pensions, etc. (FAS 132 [R]) – amendment of FAS 87,88,106 Dr. Heidemarie Lundblad

2 Pension: Regular payments made to employees after retirement. Covered under ERISA (Employee retirement income security act, 1974) Protected by PBGC (Pension benefit guarantee corporation)

3 Type of Pension Plans: zDefined Benefit Plan zDefined Contribution Plan zCash Balance Plan

4 Defined Contribution Plan z Amount of contribution is predetermined (may be adjusted periodically). Amount of future benefit varies, depends on variety of factors. Employees bear risk..

5 Defined Benefit Plan z Amount of future benefit predetermined on the basis of some type of actuarial model. Contribution depends (may vary) on a variety of factors. Company bears risk.

6 Cash Balance Plan zA controversial hybrid between defined contribution and defined benefit plan. z“Portable” but lower benefits for older employees zEmployer bears risk. For accounting purposes is treated like defined benefit plan

7 Type of Benefit Obligation zProjected Benefit Obligation yPV of pensions earned by employees in previous periods, vested or non vested (based on expected future salary levels)

8 Type of Benefit Obligation zVested Benefit Obligation yOnly vested obligations, based on current salary levels y(amount payable to employees if plan is terminated now)

9 Type of Benefit Obligation zAccumulated Benefit Obligation yVested or non-vested obligations, based on current salary levels y(amount payable to employee if s/he quits now) yTo vest requires five years of service under ERISA

10 Type of Benefit Obligation zUnfunded Accumulated Benefit Obligation yMinimum Liability to be disclosed

11 Type of Service Cost zCurrent Service cost zAccumulated prior service costs

12 Type of Service Cost zCurrent Service cost yPV of pensions earned by employees in the current period

13 Type of Service Cost zAccumulated Prior Service cost yPV of pensions awarded to employees for work in periods prior to adoption of pension plan or yas a result of retroactive changes in the plan. (Amount not yet taken into income) y NOTE: Companies are not required to immediately recognize the expense. Since employees are still working, this cost may be amortized over the remaining service life.

14 Elements of Plan Assets, Pension Expense and Liability zService Cost (current and prior) zPlan Assets zInterest cost zPension Expense zFirm’s Total Obligation zUnfunded (Accrued) Pension Liability or zPrepaid Pension Cost zAmortization of Prior Service Costs zMinimum Pension Liability

15 Elements of Plan Assets, Pension Expense and Liability zPlan Assets yΣ of prior contributions y+/- Σ of income (loss) in prior periods y+/- income (loss) in current period y- Σ payments made to retirees y+ current contribution

16 Elements of Plan Assets, Pension Expense and Liability zInterest cost yBeginning projected benefit obligation X discount rate

17 Elements of Plan Assets, Pension Expense and Liability zPension Expense yCurrent service cost y+ interest cost y- expected return on plan assets y+ amortization of unfunded prior service cost y+/- loss (gain) due to difference between expected and actual return on plan assets y+/- loss (gain) due to difference between expected and actual value of plan assets xRecognized to the extent that gain (loss) exceeds 10% of the greater of obligations or fair value of plan assets

18 Elements of Plan Assets, Pension Expense and Liability zFirms total Obligation yProjected Benefit obligation y+ Accumulated prior service costs y+ accrued interest y=/- changes in plan adopted retroactively y+ Current service cost y- payments made to retirees

19 Elements of Plan Assets, Pension Expense and Liability zUnfunded (Accrued) Pension Liability or Prepaid Pension Cost yDifference between Pension Expense and Funding

20 Elements of Plan Assets, Pension Expense and Liability zAmortization of Prior Service Costs y1. Straight line method: Cost / Average remaining service life of employees y2. Years of future service method: Cost X # of employees working / Σ of expected years of future service

21 Elements of Plan Assets, Pension Expense and Liability zPension Liability yFair Value of Plan Assets minus Projected Benefit Obligation x1. If unfunded pension liability recognize difference in current period and x2. debit Accumulated other comprehensive income (AOCI)