INTERMEDIATE ACCOUNTING Chapter 19 Accounting for Postretirement Benefits © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,

INTERMEDIATE ACCOUNTING Chapter 19 Accounting for Postretirement Benefits © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

1.Understand the characteristics of pension plans. 2.Explain the GAAP for pension plans, including computing pension expense and recognizing pension liabilities and assets. 3.Account for defined benefit pension plans. 4.Understand several important additional issues related to accounting for pension plans. 5.Explain and account for other postretirement benefit plans (OPRBs). Objectives

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. What Types of Pensions Plans Are There? (Slide 1 of 3)  There are two types of pension plans that employers tend to provide their employees:  A defined benefit plan is a type of plan in which the future employee benefit is defined by a formula and the amount that the company contributes into the plan depends on the future needs of the plan.  A defined contribution plan is a type of plan in which the employer’s contribution into the pension fund is based on a formula, so that the future benefits are limited to an amount that can be provided by: The contributions made during the employee’s service to the company. The return earned on the investment of those contributions.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  In addition, companies’ pension plans can be:  A noncontributory plan where the entire pension cost is born by the employer (company)  A contributory plan where employees bear part of the cost of the plan and make contributions from their salaries into the pension fund What Types of Pensions Plans Are There? (Slide 2 of 3)  With respect to Internal Revenue Code (IRC) rules and regulations, pension plans may be either:  A qualified pension plan is a type of pension plan that covers the majority of the company’s employees and limits contributions to certain amounts.  A nonqualified pension plan is a type of pension plan that is not governed by the IRC rules and regulations.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Estimates that the company must make for a defined benefit pension plan include:  How many employees will remain with the company until retirement?  What will employees’ retirement benefits will be at the time?  What pension fund assets will be available to pay retirement benefits?  What will be the length of time the employee will draw retirement benefits?  Actuaries are certified professionals who are trained to determine future risk, estimate probabilities of future events, make price decision, estimate present and future values, and formulate investment strategies. What Types of Pensions Plans Are There? (Slide 3 of 3)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Relationships: Employees, Company, and Asset Management Company

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Accounting for Defined Contributions Plans  Example Hiawatha Corporation was required and contributed $650,000 to its defined contribution plan during 2013 and recorded the transaction as follows: Pension Expense650,000 Cash650,000  Companies are also required to disclose the following two items:  A description of the plan, including employee groups covered, the basis for determining contributions, and the nature and effect of significant matters affecting the comparability of the information for periods presented  The amount of the pension expense recognized during the period

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  In a defined benefit pension plan, employees are promised future payments based on the formula in a pension plan contract.  For example, a company may have a retirement plan under which an employee who retires at age 65 would receive annual retirement income according to the following formula: How Do Companies Account for Defined Benefit Plans? Average of Last 5 Years’ Salary × Number of Years of Service × 0.025  An individual who worked 30 years for the company and had an average salary during the last 5 years of $128,000 would receive annual pension benefit payments of $96,000 per year, calculated as follows: $128,000 × 30 × 0.025 = $96,000

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. What Are the Components of Pension Expense?  GAAP uses the term net periodic pension cost when discussing the cost of a pension plan that is recognized in an employer’s financial statements during an accounting period.  This term is used as opposed to pension expense because a company may capitalize some of its net periodic pension costs as part of an asset.  For simplicity, we will use the term pension expense and assume none of the pension costs are capitalized.  The service cost is the increase in the projected benefit obligation due to employees providing service to the company during the current period.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Interest Cost  The interest cost is the increase in the projected benefit obligation due to the passage of time.  The interest cost is calculated as follows: Interest Cost = Projected Benefit Obligation at the Beginning of the Period × Discount Rate  Interest on the projected obligation accrues because of the passage of time and the interest cost is added to the computation of pension expense.  The projected benefit obligation is the present value of the future retirement payments earned by the employees to date (based on their expected future compensation levels).

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Return on Plan Assets  There are two returns that affect pension expense:  The actual return on plan assets is the dividends and interest earned and the unrealized and realized changes in the fair market of the pension plan assets.  The expected return on plan assets is the expected increase in the plan assets due to investing activities.  When calculating pension expense, GAAP specifies that the actual return should be used.  GAAP requires that the expected return be shown as a separate item when disclosing the amount of pension expense recognized.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Amortization of Prior Service Cost  Often a company will amend its pension plan and this results in an increase in the projected benefit obligation.  Retroactive benefits may also be granted at the initial adoption of a plan.  The cost of these retroactive benefits is the prior service cost.  Amortization of prior service cost assigns 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.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Gain or Loss (Slide 1 of 2)  The gain or loss arises because estimates and assumptions are made about many of the items included in the computation of pension costs and benefits.  Current accounting guidance provide three methods for companies to recognize gains and losses in pension expense:  Immediate recognition in pension expense  Minimum amortization using the corridor approach  Any systematic and rational approach that results in faster amortization than the corridor approach

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Gain or Loss (Slide 2 of 2)  Under the corridor approach, amortization of any net gain or loss is included in the pension expense of a given year if the beginning of the year cumulative net gain or loss exceeds a “corridor.”  The corridor is defined as 10% of the greater of the beginning of the year projected benefit obligation or the beginning of the year fair value of the plan assets.  If amortization is required, the minimum amortization is computed as follows: Cumulative Net Gain or Loss Recorded in Accumulated Other Comprehensive Income Corridor at the Beginning of the Year Minimum Amortization = ‒ Average Remaining Service Period of the Active Employees Expected to Receive Benefits under the Pension Plan

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Summary of the 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 (Immediate Recognition of Amortization of the Cumulative Net Gain or Loss from Previous Periods Using the Corridor Method or Other Reasonable Method)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Obligation (Slide 1 of 2)  The settlement rate (or discount rate) is the rate at which the pension benefits can be effectively settled.  The change in the projected benefit obligation is determined as follows:  The accumulated benefit obligation is the present value of the benefits attributed to employee service provided before a specified date based on the current salary levels.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The vested benefit obligation is the actuarial present value of the vested benefits, which are those benefits that the employee have the right to receive if the employee no longer works for the employer.  The projected benefit obligation will provide the largest and most conservative measure of the pension obligation while the vested benefit will be the smallest measure. Pension Obligation (Slide 2 of 2)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Assets  The actuarial funding method is a method to determine the amounts and timing of employer contributions that will be needed over time to provide for current and future pension benefits.  The market-related value is either the fair market value at the end of each accounting period or a calculated value that recognizes changes in fair value in a systematic or rational manner over not more than 5 years. Beginning Fair Value of Pension Plan Assets +Actual Return on Plan Assets + Contributions (Amount Funded) by the Company ‒ Payments to Retirees =Ending Fair Value of Pension Plan Assets

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Accrued/Prepaid Pension Cost (Slide 1 of 4)  When a company recognizes pension expense, the between pension expense and the amount contributed to the pension fund is recorded in the Accrued/Prepaid Pension Cost account.  The difference between the projected benefit obligation and the fair value of the pension plan assets at the end of the period is the funded status of the pension plan.  If the projected benefit obligation is greater than the fair value of the pension plan assets (the plan is underfunded), the accrued/prepaid pension cost is reported as a liability.  If the projected benefit obligation is less than the fair value of the pension plan assets (the plan is overfunded), the accrued/prepaid pension cost is reported as an asset.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The adjustment to Other Comprehensive Income can be separated into two components:  Retroactive benefits (prior service cost) that have been granted and are amortized into pension expense  Gains or losses (which include the difference between the actual and expected return on plan assets, as well as any actuarial gains or losses) Accrued/Prepaid Pension Cost (Slide 2 of 4)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Accrued/Prepaid Pension Cost (Slide 3 of 4)  Example Draper Company awards retroactive pension benefits to its employees when it adopts its pension plan on January 1, 2013, and incurs $900,000 of prior service costs.  Draper records this initial award as: Other Comprehensive Income: Prior Service Cost900,000 Accrued/Prepaid Pension Cost 900,000  If Draper amortizes the prior service cost to pension expense over a period of 15 years, the company makes the following entry each year: Accrued/Prepaid Pension Cost60,000 Other Comprehensive Income: Prior Service Cost 60,000

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  A company may report the following pension plan asset, pension plan liability, and accumulated other comprehensive income items, depending on the circumstances, on its balance sheet: Accrued/Prepaid Pension Cost (Slide 4 of 4) AssetsLiabilities Prepaid pension cost (debit balance)Accrued pension cost (credit balance) Shareholders ’ Equity Accumulated other comprehensive income: Prior service cost and/or: loss not yet amortized to pension expense (negative element) gain not yet amortized to pension expense (positive element)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Real Report: Pension Disclosures (Partial) (Slide 1 of 10)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Real Report: Pension Disclosures (Partial) (Slide 7 of 10) Questions: 1.How much was JCPenney’s pension expense (cost) for its Primary defined benefit plans for 2010? What were the largest and smallest components? JCPenney’s pension expense for Primary defined benefit plan in 2010 was $221 million (Net Periodic Benefit Expense/Income). The expected (projected) return and interest costs were the largest components, while amortization of service cost was the smallest. 2.Was JCPenney’s 2010 actual return on plan assets for its Primary defined benefit plans greater or less than the expected (projected) return? The actual return on JCPenney’s Primary plan assets of $799 million was greater than the expected return of $352 million.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Real Report: Pension Disclosures (Partial) (Slide 8 of 10) 3.How much are JCPenney’s accumulated and projected benefit obligations for its Primary and Supplementary defined benefit plans at the end of 2010? Why is projected benefit obligation different from the accumulated benefit obligation? At the end of 2010, the accumulated benefit obligation for the Primary plan was $4,100 million and the Primary plan projected benefit obligation was $4,488 million. The difference in these amounts is due to the fact that the projected benefit obligation includes projected salary increases while the accumulated benefit obligation is based on current employee salaries.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Real Report: Pension Disclosures (Partial) (Slide 9 of 10) 4.Is JCPenney’s in a net asset or a net liability position for its pension plans at the end of 2010? For its Primary plans, JCPenney is in a net asset position of $763 million at the end of fiscal year 2010. This amount is equal to the fair value of the plan assets of $5,251 million minus the projected benefit obligation of $4,488 million. However, for it Supplementary plans, JCPenney’s is in a net liability position of $222 million (projected benefit obligation of $222 million minus $0 fair value of plan assets).

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Real Report: Pension Disclosures (Partial) (Slide 10 of 10) 5.If JCPenney had used a lower discount rate for its Primary defined benefit plans during 2010, what would be the effect on 2010 pension expense and 2010 projected benefit obligation? The use of a lower discount rate during 2010 would increase the ending balance in the projected benefit obligation, increase the balance in the accrued pension cost, increase service cost, decrease the actuarial loss, and decrease interest cost for 2010. However, interest cost in 2011 would be higher (because of the increase in the projected benefit obligation at the end of 2010) relative to the amount that would have been reported if the discount rate had not changed.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Demonstrating Accounting for Defined Benefit Pension Plans  We will illustrate various situations using assumed amounts based on the following information for National Company:

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Example The service cost of $400,000 is the only component of pension expense. Because National funds an amount equal to the pension expense, it records the following journal entry on December 31, 2013: Pension Expense Equal to Pension Funding (Slide 1 of 3) Pension Expense 400,000 Cash400,000  National computes pension expense for 2014 as follows: Service cost (given)$420,000 Interest cost ($400,000 PBO at 1/1/2014 × 10% discount rate)40,000 Expected return on plan assets ($400,000 plan assets at 1/1/2014 × 10%) (40,000) Pension expense$420,000

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  National funds an amount equal to the expense and records the following journal entry on December 31, 2014: Pension Expense 420,000 Cash 420,000  For 2015, the service cost is $432,000. The projected benefit obligation and the plan assets at the beginning of 2015 are both $840,000. Pension Expense Equal to Pension Funding (Slide 2 of 3)  At the end of 2014, the projected benefit obligation and fair value of plan assets are calculated as:

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  National funds computes pension expense for 2015 as follows: Service cost (given)$432,000 Interest cost ($840,000 PBO at 1/1/2015 × 10% discount rate)84,000 Expected return on plan assets ($840,000 plan assets at 1/1/2015 × 10%) (84,000) Pension expense$432,000  National records the following entry on December 31, 2015: Pension Expense 432,000 Cash 432,000 Pension Expense Equal to Pension Funding (Slide 3 of 3)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Funding Greater Than Pension Expense (Slide 1 of 5)  National’s pension expense in 2013 is the $400,000 service cost, so the journal entry on December 31, 2013 is: Pension Expense 400,000 Accrued/Prepaid Pension Cost5,000 Cash 405,000  Example Assume the same facts for National Company, except that instead of funding an amount equal to the pension expense, the company funds $405,000 in 2013, $425,000 in 2014, and $435,000 in 2015.  National funds $405,000 in 2013 when the expense is $400,000, so it recognizes an asset, Accrued/Prepaid Pension Cost, of $5,000.  The $5,000 debit balance in Accrued/Prepaid Pension Cost reflects the overfunded status of the pension plan and no adjustment is necessary because there are no prior service costs, gains, or losses.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  National computes its pension expense for 2014 as follows: Service cost $420,000 Interest cost ($400,000 PBO at × 10% discount rate)40,000 Expected return on plan assets ($405,000 plan assets at 1/1/2014 × 10%) (40,500) Pension expense$419,500  The entry to record pension expense and funding of $425,000 for 2014 is recorded as: Pension Expense 419,500 Accrued/Prepaid Pension Cost5,500 Cash 425,000 December 31, 2014: Pension Funding Greater Than Pension Expense (Slide 2 of 5)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  At the end of 2014, the projected benefit obligation and fair value of the pension plan assets are calculated as follows:  No adjustment is necessary because there are no prior service costs or gains or losses, and the $10,500 debit balance in Accrued/Prepaid Pension costs reflects the overfunded status of the pension plan.  National reports this overfunded amount as a noncurrent pension plan asset, Prepaid Pension Cost, on its December 31, 2014, balance sheet. Pension Funding Greater Than Pension Expense (Slide 3 of 5)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  National computes its pension expense for 2015 as follows: Service cost $432,000 Interest cost ($840,000 PBO at 1/1/2015 × 10% discount rate)84,000 Expected return on plan assets ($850,500 plan assets at 1/1/2015 × 10%) (85,050) Pension expense$430,950  The journal entry at the end of 2015 is as follows: Pension Expense 430,950 Accrued/Prepaid Pension Cost4,050 Cash 435,000 December 31, 2015:  The balance in the asset account is now $14,550 ($10,500 + $4,050). Pension Funding Greater Than Pension Expense (Slide 4 of 5)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  At the end of 2015, the projected benefit obligation and fair value of the pension plan assets are calculated as:  The pension plan is overfunded by $14,550 ($1,350,550 ‒ $1,336,000), and National reports this overfunded amount as its pension plan asset, Prepaid Pension Cost, on its December 31, 2015, balance sheet.  No adjustment is needed to the account because there is no prior service cost or gains/losses. Pension Funding Greater Than Pension Expense (Slide 5 of 5)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  National’s pension expense in 2013 is the $400,000 service cost, so the journal entry on December 31, 2013 is: Pension Expense 400,000 Accrued/Prepaid Pension Cost15,000 Cash 415,000  Example Assume the same facts for National Company, except that instead of funding an amount equal to the pension expense, the company funds $415,000 in 2013, $425,000 in 2014, and $440,000 in 2015. The expected return is 11% each year, whereas the actual return is 12% each year. Expected Return Different from Both Actual Return and Discount Rate (Slide 1 of 6)  Because there is neither prior service cost nor gains or losses, the $15,000 balance in the Accrued/Prepaid Pension Cost account already reflects the overfunded status of the pension plan.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  National computes its pension expense for 2014 as follows: Service cost $420,000 Interest cost ($400,000 PBO at 1/1/2014 × 10% discount rate)40,000 Expected return on plan assets ($415,000 plan assets at 1/1/2014 × 11%) (45,650) Pension expense$414,350  The entry to record pension expense and funding of $425,000 for 2014 is recorded as: Pension Expense 414,350 Accrued/Prepaid Pension Cost10,650 Cash 425,000 December 31, 2014: Expected Return Different from Both Actual Return and Discount Rate (Slide 2 of 6)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  At the end of 2014, the projected benefit obligation and fair value of the pension plan assets are calculated as:  At the end of 2014, National’s pension plan is overfunded by $29,800 ($869,800 ‒ $840,000). The Accrued/Prepaid Pension Cost account must be increased by $4,150 ($29,800 ‒ $25,650) by the following entry: Accrued/Prepaid Pension Cost4,150 Other Comprehensive Income: Net Gain/Loss4,150 Expected Return Different from Both Actual Return and Discount Rate (Slide 3 of 6)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  National computes its pension expense for 2015 as follows: Service cost $432,000 Interest cost ($840,000 PBO at 1/1/2015 × 10% discount rate)84,000 Expected return on plan assets ($869,800 plan assets at 1/1/2015 × 11%) (95,678) Pension expense$420,322  The entry to record pension expense and funding of $440,000 for 2015 is recorded as: Pension Expense 420,322 Accrued/Prepaid Pension Cost19,678 Cash 440,000 December 31, 2015: Expected Return Different from Both Actual Return and Discount Rate (Slide 4 of 6)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  At the end of 2015, the projected benefit obligation and fair value of the pension plan asset is computed as follows:  Comparing the projected benefit obligation to the fair value of the plan assets shows that the pension plan is overfunded by $58,176 ($1,394,176 ‒ $1,336,000).  The overfunded amount is compared with the current balance in the Accrued/Prepaid Pension Cost account, which as a debit balance of $49,478, to determine that the account must be increased by $8,698 ($58,176 ‒ $49,478). Expected Return Different from Both Actual Return and Discount Rate (Slide 5 of 6)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  To record the increase, National records the following journal entry: Accrued/Prepaid Pension Cost8,698 Other Comprehensive Income: Net Gain/Loss8,698 Expected Return Different from Both Actual Return and Discount Rate (Slide 6 of 6)  The adjustment is necessary to recognize the “gain” that results from the actual return ($104,376) being greater than the expected return ($95,678).  After this journal entry, the Accrued/Prepaid Pension Cost account has a $58,176 debit balance, which is the amount by which the company’s pension plan is overfunded.  The balance in the Accumulated Other Comprehensive Income account is $12,848 ($4,150 + $8,698), which represents the cumulative gain not recognized in pension expense.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Disclosure of Defined Benefit Pension Plan Information (Slide 1 of 2)  These disclosures for National Company for 2015, using the facts from the previous example, are as follows:

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Disclosure of Defined Benefit Pension Plan Information (Slide 2 of 2)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Example Assume the same facts for National Company, except that the company awarded retroactive benefits to the employees when it adopted the pension plan on January 1, 2013.  National’s actuary computed the prior service cost to be $2 million.  To fund this projected benefit obligation, National decided to increase its contribution by $290,000 per year resulting in the following total contributions each year: Year 2013: $705,000 Year 2014: $715,000 Year 2015: $730,000 Pension Expense Including Amortization of Prior Service Cost (Slide 1 of 7)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Expense Including Amortization of Prior Service Cost (Slide 2 of 7)  National records the projected benefit obligation for the prior service cost at the inception of the plan on January 1, 2013. Other Comprehensive Income: Prior Service Cost2,000,000 Accrued/Prepaid Pension Cost2,000,000  National computes the pension expense for 2013 as follows: Service cost $400,000 Interest cost ($2,000,000 × 10%)200,000 Amortization of prior service cost 100,000 Pension expense$700,000  Given that National funds $705,000 in 2013, the following entry at December 31, 2013, is made. Pension Expense700,000 Accrued/Prepaid Pension Cost5,000 Cash705,000

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Expense Including Amortization of Prior Service Cost (Slide 3 of 7)  The 2013 pension expense includes $100,000 amortization of prior service cost ($2,000,000 ÷ 20 years). Accrued/Prepaid Pension Cost100,000 Other Comprehensive Income: Prior Service Cost100,000  At the end of 2013, the projected benefit obligation and fair value of the pension plan assets is computed as follows:  This results in the pension plan being underfunded by $1,895,000 ($2,600,000 ‒ $705,000).  No adjustment is necessary because there are no gains or losses.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Expense Including Amortization of Prior Service Cost (Slide 4 of 7)  National’s beginning projected benefit obligation is $2,600,000, and the company computes the pension expense for 2014 as follows: Service cost $420,000 Interest cost ($2,600,000 × 10%)260,000 Expected return on plan assets ($705,000 ×11%)(77,550) Amortization of prior service cost 100,000 Pension expense$702,450  The pension expense journal entry on December 31, 2014 is: Pension Expense702,450 Accrued/Prepaid Pension Cost12,550 Cash715,000

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Expense Including Amortization of Prior Service Cost (Slide 5 of 7)  After National makes the $100,000 entry for amortization of prior service cost in 2014, it computes the projected benefit obligation and fair value of the pension plan assets for 2014 as follows:  This results in the pension plan being underfunded by $1,775,400 ($3,260,000 ‒ $1,484,600). However, Accrued/Prepaid Pension Cost has a credit balance of $1,782,450, which means the account must be decreased by $7,050.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Expense Including Amortization of Prior Service Cost (Slide 6 of 7)  National decreases the Accrued/Prepaid Pension Cost account by recording the following entry: Accrued/Prepaid Pension Cost7,050 Other Comprehensive Income: Net Gain/Loss7,050  On January 1, 2015, National computes the pension expense for 2015 as follows: Service cost $432,000 Interest cost ($3,260,000 × 10%)326,000 Expected return on plan assets ($1,484,600 ×11%)(163,306) Amortization of prior service cost 100,000 Pension expense$694,694

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Expense Including Amortization of Prior Service Cost (Slide 7 of 7)  The company funds $730,000 in 2015 and records the following entry on December 31, 2015: Pension Expense694,694 Accrued/Prepaid Pension Cost35,306 Cash730,000  After National makes the $100,000 entry for amortization of prior service cost in 2015, the projected benefit obligation and fair value of the pension plan assets are as follows:  The pension plan is underfunded by $1,625,248, so the Accrued/Pension Cost account is decreased $14,846.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Example The table on the next slide shows the computation of the corridor and net gain or loss included in pension expense for Hall Company for years 2013 through 2016. Step 1: Hall calculates the amounts in the Cumulative Net Loss (Gain) column at the beginning of the year. The $13,000 cumulative net loss shown in the partial chart from the next slide is a result of experience different from that assumed and changes in actuarial assumptions prior to 2013. Pension Expense Including Net Gain or Loss (to Extent Recognized) (Slide 1 of 6)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Example The table on the next slide shows the computation of the corridor and net gain or loss included in pension expense for Hall Company for years 2013 through 2016. Pension Expense Including Net Gain or Loss (to Extent Recognized) (Slide 2 of 6) Step 1: The cumulative net gain or loss at the beginning of the year is calculated.  Hall calculates the amounts in the Cumulative Net Loss (Gain) column at the beginning of the year.  The $13,000 cumulative net loss shown in the partial chart from the next slide is a result of experience different from that assumed and changes in actuarial assumptions prior to 2013.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Expense Including Net Gain or Loss (to Extent Recognized) (Slide 3 of 6) Step 2: The corridor is calculated as 10% of the greater of the beginning projected benefit obligation or beginning of the period fair value of plan assets.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Expense Including Net Gain or Loss (to Extent Recognized) (Slide 4 of 6)  In 2013, the beginning projected benefit obligation of $110,000 is the larger of the two amounts.  Hall multiples the beginning projected benefit obligation by 10 percent to determine the corridor of $11,000. × 10%

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Expense Including Net Gain or Loss (to Extent Recognized) (Slide 5 of 6) Step 3: If the net gain or loss exceeds the corridor, the amount in excess of the corridor is amortized over the remaining service life of active employees.  A company adds any amortization of net loss to pension expense.  It subtracts any amortization of a net gain from pension expense.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Pension Expense Including Net Gain or Loss (to Extent Recognized) (Slide 6 of 6)  The $2,000 excess net loss is the difference between the $13,000 cumulative net loss and the $11,000 corridor.  The company computes each amortization amount by dividing the excess net loss (gain) for that year by the average remaining service life of the active employees expected to receive benefits under the plan.  In this example, a 10-year average service life is assumed. In 2013 the $200 amortization is determined by dividing the $2,000 loss by 10.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Conceptual Issues: Prior Service Cost  Accounting regulators considered four alternative methods for how the prior service cost should be initially considered:  Account for it prospectively.  Recognize the total amount as an expense in the period in which it arises (i.e., the current period) and record a liability.  Recognize the liability and reduce other comprehensive income, and then amortize the prior service coast as a component of pension expense. In addition, the liability is reduced and other comprehensive income is increased as the prior service amount is amortized.  Decrease retained earnings (as a retrospective adjustment because they reflect prior service) and record a liability. (GAAP)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Conceptual Issues: Presentation of Pension Plan Assets  There are two alternative views for accounting by the employer for pension assets:  Funding is a discharge of the pension liability.  The pension liability is not discharged until the retiree receives the pension payment.  The second approach is required by GAAP, except that the projected benefit obligation is netted against the pension plan assets to determine the underfunding (liability) or overfunding (asset).  If a company has multiple defined benefit pension plans, the plans cannot be netted against each and must be reported separately on the balance sheet. (GAAP)

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Conceptual Issue: Pension Liabilities  In making the decision on what liability should be used in pension accounting, regulators examined five alternatives to determine which best met the recognition measure criteria of a liability:  Contribution based on an actuarial funding method  Amount attributed to employee service to date  Termination liability  Amount of vested benefits  Amount payable to retirees  Accounting regulators settled on the second alternative. The only exception made is the projected benefit obligation is netted against the pension plan assets to determine underfunding (liability) or overfunding (asset).

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Reporting Issues  Statement of cash flows disclosures  A company reports the cash it paid to fund its pension plan as a cash outflow in the operating activities section of its statement of cash flows.  If a company uses the indirect method, the adjustment is only for the amount of the accrual for the difference between the expense and the funding. It does not include the amount of the adjustment for over- or underfunding because that amount did not affect income.  Vested benefits  ERISA specifies the minimum vesting requirements that companies must follow.  A company must disclose the vested portion of the accumulated benefit obligation.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Technical Issues: Calculation of Amortization of Prior Service Cost (Slide 1 of 2)  Example At the beginning of 2015, Watts Company has nine employees who are participating in its pension plan and who are expected to receive benefits.  One employee (A) is expected to retire after 3 years, one (B) after 4, two (C and D) after 5, two (E and F) after 6, and three (G, H, and I) after 7 years.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Amortization of Prior Service Cost: Years-of-Future-Service Method

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Technical Issues: Calculation of Amortization of Prior Service Cost (Slide 2 of 2)  Watts includes the calculated amount of amortization in the total pension expense on its income statement for 2013.  To compute the alternative straight-line amortization, Watts calculates the average remaining life of the participating employees as follows: 3(A) + 4(B) + 5(C) + 5(D) + 6(E) + 6(F) + 7(G) + 7(H) + 7(I) 9 employees = 5.56 years  The chart on the next slide shows the computation of the straight- line amortization.  Note on the next slide that in 2018, the amortization is only $40,290, the amount needed to reduce the remaining prior service cost to zero.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Amortization of Prior Service Cost: Straight-Line Method

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Multiemployer Plans  In our examples, we assumed that the pension plan is a single-employer plan.  That is, the plan is maintained by one company for its employees.  In contrast, a multiemployer plan involves two or more unrelated companies in which assets contributed by each company are available to pay benefits to the employees of all the involved companies.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Other Postemployment Benefits  Other postemployment benefits (OPEB) are provided to former employees after employment but before retirement.  Under GAAP, a company must accrue the cost of these benefits during employment and recognize the amount as an expense and a liability if the four criteria for the recognition of compensated absences are met.  Other postemployment benefits include all forms of benefits provided to former employees after their retirement, other than pensions.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Major Differences between Postretirement Healthcare Benefits and Pensions

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Accounting Principles  The expected postretirement benefit obligation (EPBO) is the actuarial present value of the benefits a company expects to pay under the terms of the postretirement benefit plan.  The present value amount is measured as of the balance sheet date.  It is based on the benefits that employees will receive after their expected retirement dates.  The accumulated postretirement benefit obligation (APBO) is the actuarial present value of the benefits attributed to employee service rendered to a specific date.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Net Postretirement Benefit Expense (Slide 1 of 3)  The net postretirement benefit expense that a company reports on its income statement generally includes the following components: Service Cost + Interest Cost ‒ Expected Return on Plan Assets + Amortization of Prior Service Cost + Amortization of Net Gain or Loss = OPRB Expense  The service cost is the actuarial present value of the expected postemployment benefit obligation attributed to services of the employees during the current period.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Net Postretirement Benefit Expense (Slide 2 of 3)  The interest cost is the increase in the accumulated postretirement benefit obligation due to the passage of time.  Interest cost is calculated as follows: Interest Cost = Accumulated Postretirement Benefit Obligation at the Beginning of the Period × Discount Rate  The expected return on plan assets is the expected increase in the plan assets due to investing activities. The expected return is calculated as follows: Expected Return = Fair Value of Plan Assets at the Beginning of the Period × Expected Long-Term Rate of Return on Plan Assets

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Net Postretirement Benefit Expense (Slide 3 of 3)  The prior service cost is the increase (decrease) in the accumulated postretirement benefit obligation that results from plan amendments (and at the initiation of the plan).  The prior service cost is amortized by assigning an equal amount to each remaining year of service until full eligibility for benefits is reached for each plan participant active at the date of the amendment.  Straight-line amortization over the average remaining years of service to full eligibility is also allowed for simplicity.  Net gains or losses are changes in the amount of either the accumulated postretirement benefit obligation or fair value of the plan assets resulting from experience different from that assumed, or from changes in assumptions.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Other Pension Terminology  Because a company usually does not fund the plan, it increases a liability, accrued postretirement benefit cost, each period by an amount equal to the expense.  Attribution is the process of assigning the cost of postretirement benefits to periods of employee service.  The measurement of the accumulated postretirement benefit obligation at the full eligibility date is based on the benefits an employee is expected to receive and the expected retirement date. This results in the attribution period (recognition period) and the measurement period being different.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Attribution Period and Liability Measurement for OPRBs

INTERMEDIATE ACCOUNTING Chapter 19 Accounting for Postretirement Benefits © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,

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INTERMEDIATE ACCOUNTING Chapter 19 Accounting for Postretirement Benefits © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,

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Presentation on theme: "INTERMEDIATE ACCOUNTING Chapter 19 Accounting for Postretirement Benefits © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,"— Presentation transcript:

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