1. Accounting for Postemployment Benefits C hapter 20 COPYRIGHT © 2010 South-Western/Cengage Learning

2. 2 Review Objectives listed on Page 1010 in the textbook. Objectives

3. 3 A defined benefit plan specifically states either the benefits to be received by employees after retirement or the method of determining such benefits. The method usually is determined on the basis of the employee’s earnings and length of service with the company. Defined Benefit Plans $100,000 average salary × 30 years × 0.0257 = $77,100 pension per year $100,000 average salary × 30 years × 0.0257 = $77,100 pension per year

4. 4 Most companies design their pension plans to meet the Internal Revenue Code rules: 1.There is a maximum amount of employer contributions that is deductible for income tax purposes. 2.Pension fund earnings are exempt from income taxes. 3.Employer contributions to the pension fund are not taxable to the employees until they receive their pension benefits. Internal Revenue Code Rules

5. Terms to remember  Projected Benefit Obligation (PBO)  Accumulated Benefit Obligation  Service Cost  Interest Cost  Prior Service Cost 5

6. 6 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

7. 7 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 Costxxx Other Comprehensive Income: Net Gain/Lossxxx

8. 8 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.

9. 9 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

10. 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 10 Projected Benefit Obligation

11. 11 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

12. 12 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 – See page 1024 in Text Assume the following facts for the Carlisle Company: ContinuedContinued

13. 13 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). Pension Expense Equal to Pension Funding

14. 14 Pension Expense Equal to Pension Funding December 31, 2010 Pension Expense400,000 Cash 400,000 December 31, 2011 Pension Expense420,000 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 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

15. 15 2011 Projected Benefit Obligation 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

16. 16 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

17. 17 Note that the interest cost and the return on the plan assets offset each other each year Pension Expense Equal to Pension Funding December 31, 2012 Pension Expense432,000 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

18. 18 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, 2010 Pension Expense400,000 Accrued/Prepaid Pension Cost5,000 Cash 405,000 AssetAsset

19. Accrued/Prepaid Pension Cost Accrued/Prepaid Balance Projected benefit obligation – Fair value of plan assets ($5,000) $400,000 – $405,000 = 19

20. 20 Additional Examples: 1-Pension Expense Greater to Pension Funding – See page 1026 of the Text 2- (Example C – Page 1027) - Pension Expense Less Than Pension Funding, and Expected Return on Plan Assets Different from Both Actual Return and Discount Rate 3- (Example D – Page 1029) - Pension Expense Including Amortization of Prior Service Cost 4 – (Example E – Page 1032) - Pension Expense Including Amortization of Prior Service Cost 5 – (Example F – Page 1034) - Pension Expense Including Amortization of Prior Service Cost

21. 21 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

22. 22 Pension Expense Including Net Gain or Loss December 31, 2010 Accrued/Prepaid Pension Cost200 Other Comprehensive Income: Net Gain/Loss200 In 2010 the $200 amortization that the company adds to pension expense as the amortized net loss is determined by dividing the $2,000 excess net loss by the 10-year average service life. In addition to recording the journal entry to record pension expense, the company would also record the following:

23. 23 According to GAAP, a company must disclose specific information about a defined benefit pension plan, including the following: Disclosures – Page 1035

24. 24 1.A reconciliation of the beginning and ending amounts of the projected benefit obligation 2.A reconciliation of the beginning and ending fair value of the plan assets Disclosures 3.The components of the pension expense 4.The discount rate used and the expected long- term rate of return on plan assets

25. 25 1.Funding to funding agency is a discharge of the pension liability. 2.Pension liability is not discharged until the retiree receives the pension payment. Conceptual Alternatives: Balance Sheet Presentation of Pension Plan Assets GAAP requires alternative 2.

26. 26 Pension Legislation A company must fund its pension plan each year at an amount that at least equals the service cost for the year plus the amount needed to amortize any underfunding over a maximum of seven years.

27. 27 Summary of Journal Entries – Similar to Example 20-7 1.Record pension expense. 2.Record prior service cost. 3.Record difference between expected return and actual return. 4.Record amortization of prior service cost. 5.Record amortization of cumulative gain or loss. 6.Record changes in projected benefit obligation (not illustrated in text). ---------------------------------------------------- 7.Close Other Comprehensive Income to Accumulated Other Comprehensive Income. Entries to Accrued/Prepaid Pension Cost and Other Comprehensive Income:

28. 28 GAAP requires that a company record a loss and a liability for termination benefits when the following two conditions are met: 1.The employee accepts the offer. 2.The amount can be reasonably estimated. Termination Benefits Paid to Employees – Page 1049

29. 29 IFRS vs. U.S. GAAP See Page 1049

30. 30 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? Other Postemployment Benefits

31. 31 BeneficiaryRetired employee (someRetired employee, residual benefit tospouse, and dependents surviving spouse) BenefitDefined, fixed dollar Not limited, paid as used, amount, paid monthlyvaries geographically FundingFunding legally requiredUsually not funded and tax-deductible because not legally required and not tax- deductible Item Pensions Healthcare Major Differences Between Postretirement Healthcare Benefits and Pensions See Exhibit 20-3

32. 32 1.Service cost 2.Interest cost 3.Expected return on plan assets 4.Amortization of prior service cost 5.Amortization of the net gain or loss The net postretirement benefit expense that a company recognizes includes the following components: OPEB Expense

33. 33 Livingston Company adopts a healthcare plan for retired employees on January 1, 2010. 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 for full benefits at age 55. The retired employee was paid $1,500 postretirement healthcare benefits in 2010. The company determines its accumulated postretirement benefit obligation to be $100,000. The average remaining service life is 5 years. Accounting for OPEBsContinuedContinued

34. 34 Service cost (actuarially determined)$ 1,100 Interest cost ($100,000 × 0.10)10,000 Expected return on plan assets0 Amortization of prior service cost ($100,000 ÷ 5)20,000 Gain or loss 0 Postretirement Benefit Expense$31,100 Service cost (actuarially determined)$ 1,100 Interest cost ($100,000 × 0.10)10,000 Expected return on plan assets0 Amortization of prior service cost ($100,000 ÷ 5)20,000 Gain or loss 0 Postretirement Benefit Expense$31,100 Accounting for OPEBs ContinuedContinued

35. 35 Illustration of Accounting for OPEB Other Comprehensive Income: Prior Service Cost100,000 Accrued Postretirement Benefit Cost100,000 January 1, 2010 Postretirement Benefit Expense31,100 Accrued Postretirement Benefit Cost31,100 December 31, 2010

36. 36 Accrued Postretirement Benefit Cost1,500 Cash1,500 Illustration of Accounting for OPEB Accrued Postretirement Benefit Cost20,000 Other Comprehensive Income: Prior Service Cost20,000 To record the payment of retirement benefits: To record amortization of prior service cost:

37. 37 Relevance and Reliability  Accrual accounting more relevant than cash- basis accounting.  Expenses matched with revenues.  Income Statement more relevant by including OPEB expense.  OPEB costs cannot be measured with sufficient reliability.  Health care plans require medical costs, trend rate, and marital and dependency status in retirement.

38. Sample Problems & Solutions  Exercise 20-7  Exercise 20-8  Exercise 20-13  Problem 20-3  Problem 20-10 38

39. Exercise 20-7 39

40. Exercise 20-8 40

41. Exercise 20-13 Page 1 of 4 41

42. Exercise 20-13 Page 2 of 4 42

43. Exercise 20-13 Page 3 of 4 43

44. Exercise 20-13 Page 4 of 4 44

45. Problem 20-3 Page 1 of 2 45

46. Problem 20-3 Page 2 of 2 46

47. Problem 20-10 Page 1 of 5 47

48. Problem 20-10 Page 2 of 5 48

49. Problem 20-10 Page 3 of 5 49

50. Problem 20-10 Page 4 of 5 50

51. Problem 20-10 Page 5 of 5  5.Liability: Accrued pension cost $110,090 51

52. Q & A  ? 52

53. 53 C hapter 20 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.