Chapter 21: Accounting for Pensions and Postretirement Bennefits

Chapter 21: Accounting for Pensions and Postretirement Bennefits
Intermediate Accounting, 10th Edition Kieso, Weygandt, and Warfield Chapter 21: Accounting for Pensions and Postretirement Bennefits Prepared by Krishnan Ranganathan, Angelo State University, San Angelo, Texas

Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)
Types of Pension Plans Accounting Standard: “SFAS 87: Accounting for Pension Plans” [1985] A pension plan provides benefits to retirees for services provided during employment There are defined contribution and defined benefit plans 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

DEFINED CONTRIBUTION PLANS
Employer contributes a defined sum to a (third party) plan trust Plan accumulates assets and makes distributions to retirees Employer’s expense is equal to annual contribution needed [employees are beneficiaries] If contribution made is less than pension expense , employer accrues a liability If contribution > expense, employer accrues an asset 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Defined Contribution Plans: Employers’ journal entries
Contribution made is less than the pension expense Pension expense Dr Cash Cr Prepaid/Accrued Cr Liab Contribution made is more than pension expense Pension expense Dr Prepaid/Accrued Dr Cash Cr Asset 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Defined Benefit Plans The employee is promised a certain amount of BENEFITS at retirement (usually periodic) The trust accumulates assets The employer remains liable to ensure benefit payments Employer is the trust-beneficiary 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Defined Benefit Plans Employer can recapture excess plan assets from the pension plan, if employer settles the pension obligation of the employees (this is called a benefit settlement) The accounting guidelines for plan termination are contained in SFAS 88 (the companion standard) The plan is an accounting entity separate from the employer 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

A Note on Record-Keeping: Employer’s and Plan’s Books
The employer keeps certain accounts in its own books and certain other accounts [related to the pension plan] in MEMO form. Memo means: outside the employer’s formal books. “Off-balance sheet” is another way of saying it. The pension work sheet keeps track of all relevant entries. The debit and the credit entries are split between formal books and memo records! 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Interaction of Employers’ Formal Books and Memo Records
OF ACCOUNT record annual amounts, such as: pension cost, return on plan assets and other amounts to be annually amortized or recognized MEMO RECORDS ARE MAINTAINED BY EMPLOYER REGARDING TOTAL PLAN ASSETS AND TOTAL EMPLOYEE OBLIGATION Amounts are periodically recognized in formal accounts 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

General format of Employer’s Books and Memo Entries
Formal Books Memo Record Pension Cash Pre/ expense Acc PBO Plan UPSC Assets Service cost Interest Actual Return 1,000 dr 1,300 dr 1,100 cr 1,000 cr 1,300 cr 1,100 dr 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Pensions - Terminology
A plan is said to be “funded”, when employer makes contributions to trust In contributory plans, employees bear part of the cost or contribute voluntarily In non-contributory plans, employer bears the entire cost In qualified plans, employer can deduct its contributions and get a tax free status of earnings from fund assets 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Employer contributions are defined
Benefit And Contribution Plans: A Comparison Contribution Plans Benefit Plans Employer contributions are defined Retiree benefits depend on fund performance Retirees bear the investment risk Retiree benefits are a fixed amount Employer contributions to the plan depend on promised benefits to retirees Employers bear the investment risk 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Actuaries and Pension Accounting
Pension calculations involve ACTUARIAL ASSUMPTIONS These are probability estimates Assumptions involve: MORTALITY RATES, EMPLOYEE TURNOVER, FUTURE SALARIES, INT. RATES. 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Alternative Definitions of Employee-Obligation
Determining employer’s pension obligations to employees Projected Benefit Obligation: Benefits to vested and Nonvested employees at retirement pay PBO Accumulated Benefit Obligation: current salary Benefits payable to Vested and Nonvested emps: current pay ABO Vested Benefit Obligation: current salary Benefits payable to vested emps at current pay 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Measurement of Pension Cost: Components
Service cost Interest cost Actual return on plan assets Amortization of unrecognized prior service cost Gains and losses: Plan assets and pension liability 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Pension Cost: Service Cost Component
Service cost is the expense caused by the increase in PBO payable to employees because of services rendered during the current year 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Pension Cost: Service Cost Component
RET 1 year of additional service Additional PBO benefits payable at retirement due to additional year of service The present value of the additional PBO payable [as of year end] Service Cost 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Pension Cost: Interest Cost Component
Pensions are deferred compensation The promised employee benefits are a liability of the company The company pays interest on the beginning balance of the PBO The settlement rate determines the interest expense. 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Settlement Rate and Discount Rate
Note that the SFAS 87 refers to a DISCOUNT rate and a SETTLEMENT rate. The settlement rate determines the amount of employee benefits payable , if all employee obligations were hypothetically settled today The discount rate is used to discount pension benefits (payable in future) to present value amounts 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Actual Return on Plan Assets
Plan assets end of the plan year less: Plan assets at the beginning of the plan year less: Employer contributions to the plan during the year add: Employee benefits paid out of plan assets during the year 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Computing Actual Return on Plan Assets: Example
Beginning of year PENSION TRUST End of year Plan assets $2,000 Employer Contributions into trust $300 Retiree benefits paid $200 Plan assets $2,370 Actual return on plan assets = $2,370 - $2,000 - $300 + $200 = $270 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Note on Actual Return on Plan Assets and Expected Return
Pension expense is reduced by estimated return on assets (computed by the actuary.) The estimated return is computed as: the expected rate of return on assets [times] the market-related value of assets [ an average $] Any differences between actual and estimated returns are periodically amortized to pension expense 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

= Computing The Estimated Return On Assets EST.RETURN Expected Rate of
Market- Related Value of Assets = This value is based on a moving average [5 years or less] of market value changes 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Adjusting Estimated Return on Plan Assets: Example
Data: Actual return on assets: $18,000 Estimated return: $17,000 Unexpected Gain: $ 1,000 Determine the pension expense 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Adjusting for Estimated Return on Plan Assets: Example
Recording the actual return: Plan Assets [Memo] ,000 Pension Expense ,000 Memo only Employer books Adjusting estimated return: Pension Expense ,000 Unexpected Gains & Losses ,000 Amortized Net effect: Pension Expense is $17,000 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Why We Adjust Pension Expense for Estimated Return on Plan Assets
Using the actual return on assets will expose funding pattern to swings in market fluctuations Actuaries use an estimated return based on an expected rate of return and an average value of plan assets The average value is a calculated value based on a moving average [five years or less] 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Why We Adjust for Estimated Return on Plan Assets...
Any differences between actual and estimated returns are recorded in an Unexpected Gains and Losses account and amortized to pension expense This procedure insulates pension calculations from sudden market value changes. 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Amortizing Unrecognized Gains and Losses
Unrecognized gains and losses are deviations of actual amounts from estimated amounts Amortize the Unrecognized Gains & Losses only if the Unrecognized Gains & Losses EXCEED 10% of: the greater of the PBO OR market-related value (both as of the beginning of the year) Amortize over the remaining service life of active employees 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Amortizing Unrecognized G & L...
Beginning of year: PBO $2,000 $2,200 Market related value of plan assets $1, 950 $2,300 Unrecognized net loss $ $210 [annual $: given] Service life: 5 years There are no prior unrecognized gains/ losses 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

For year 2000: 10% of the greater of the PBO or the Market related value of plan assets at beginning 10% of $2,000 = $200 Unrecognized gains and losses to be amortized = $220 less $200 = $20 Amortize over 5 year = $20 / 5 = $4 Pension Expense $4 [in books] Unrecognized G & L $4 [memo] 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

For year 2001: 10% of the greater of the PBO or the Market related value of plan assets at beginning 10% of $2,300 = $230 Cumulative Unrecognized gains and losses to be amortized = $220 + $210 less $4 = $426 Less 10% PBO floor ($230) = $196 Amortize over five years: $196/5 = $39.2 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Unrecognized Prior Service Cost [UPSC]: Definition
Employees may be granted additional pension benefits for services performed in PRIOR periods. Benefits may be granted : upon INITIAL plan adoption, or through a plan amendment. Interest cost is based on PBO + UPSC 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Unrecognized Prior Service Cost [UPSC]: Accounting
The UPSC is allocated to pension expense based on the remaining service-years of the concerned employees. Unamortized Unrecognized Prior Service Cost is shown on books of pension plan: NOT on company’s books. The employer records only the periodic amortization of Prior Service Cost. 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Amortizing Unrecognized Prior Service Cost
XYZ company grants a prior service cost of $130,000 on Affected employees: 80 Expected retirement: 30 at end of 2000 and 50 at end of 2001 Show the amortization of prior service cost and journalize pension expense for the year 2000 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Amortizing Unrecognized Prior Service Cost...
Employees working in [before retirement] = weighted 2000: 80 / 130 [times] $130,000 = $ 80,000 2001: 50 / 130 [times] $130,000 = $ 50,000 Pension Expense ,000 Unrecognized PSC ,000 Formal books Memo record 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Gains and Losses: A Further Note
There are TWO types of gains and losses: Unrecognized gains and losses Unrecognized Net Transition Asset or Obligation at adoption of SFAS 87 Net Transition Asset or Obligation indicates the funded status of the plan at adoption of SFAS 87 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Actuarial G & L and Transition Asset or Obligation
In both cases, total amounts are shown only on books of the pension plan Employer records ONLY the annual amortization For Unrecognized gains and losses, there is a 10% test (called the 10% CORRIDOR test) For transition gains and losses, use 15-year straight-line amortization 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Synopsis of Pension Cost components and Methods
Pension cost Method used to Effect on pension component determine cost cost Service Cost Present Value + 1 Interest Expense Settlement rate + 2 Estimated Return Expected Rate of Return - on Plan Assets 3 Prior Service Cost Amortization (service years) + 4 Unrecognized Gains Corridor method +/- and Losses 5 Transition Gains 15 year straight line +/- and Losses 6 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Prepaid and/or Accrued Pension Cost in Employer’s Books
Prepaid or Accrued cost is the difference between: total periodic pension cost recognized, and pension cost actually funded If pension cost is less than funded amount, it is prepaid cost If pension cost is more than the funded amount, it is accrued cost 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Prepaid/Accrued Pension cost : Journal Entry - Example
At : Pension expense: $12,000; Funded amount: $11,000 Provide the journal entry Pension Expense $12,000 Cash $11,000 Prepaid/Accrued Pension Cost $ 1,000 All accounts are in formal books The debit / credit to Pre/Accrued is determined annually. 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

PENSION LIABILITY DISCLOSURES
SFAS 87 requires an IMMEDIATE recognition of pension liability in employer’s books, if: the accumulated benefit obligation is more than the fair value of plan assets at balance sheet date. It is the ABO - not the PBO - that controls. It is the fair value of plan assets - not their market related value - that is used. If the fair value of plan assets exceeds the accumulated benefit obligation, an asset may not be recorded. 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Minimum Liability - Examples
Given: FMV of plan assets = $3,000 Accumulated benefit obligation = $5,000 Projected benefit obligation = $ 6,500 Ignore unrecognized prior service cost Determine the minimum liability to be recognized under the following independent assumptions: Recorded accrued pension cost: $300 (liability) Recorded prepaid pension cost: $250 (asset) 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Minimum Liability: Example
ABO = $5,000 - FMV = $3,000 Unfunded accumulated benefit obligation (minimum liability) = $2,000 Accrued Pension Cost $300 (already recorded) Minimum liability to be recognized = $2,000 less $300 = $1,700 Prepaid pension cost $250 (already recorded) Minimum liability to be recognized = $2,000 plus $250 = $2,250 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Minimum Liability, UPSC, Deferred Pension Cost and Excess Additional Liability Unfunded ABO (minimum liability) to be recognized = ABO less Fair value of plan assets If there is unrecognized prior service cost and the minimum liability exceeds the prior service cost, then: record a deferred pension cost up to the amount of the unrecognized prior service cost record an excess over UPSC for the excess of the minimum liability over the PSC) 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Minimum Liability: Deferred Pension Cost and Contra-Equity (Example 1)
Minimum Liability to be recognized: $2,500 Unrecognized Prior Service Cost: $2,000 Assume no prepaid/accrued pension cost Intangible- Def.Pens.Cost $ 2,000 Excess over UPSC $ Additional Liability $2,500 Excess is contra-equity See illustration 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Minimum Liability, UPSC, Deferred Pension Cost and Excess Additional Liability Minimum liability $2,500 Excess over UPSC $ 500 Contra equity item Deferred pension cost $2,000 UPSC $2,000 Intangible asset (up to UPSC) 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Deferred Pension Cost, Accrued Pension Cost and Contra-Equity (Example 2) Min. Liab to be recognized: $2,500 Unrecognized Prior Service Cost: $2,000 Prepaid/Accrued Pension Cost $ Credit Unfunded ABO (minimum liability): $ 2,500 less: Prepaid/Accrued Cost $ = Additional pension liability to be recognized $ 2,300 Intangible- Def.Pens.Cost $2,000 Excess over UPSC $ 300 Additional Pens.Liab $2,300 Excess is contra- equity 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

Deferred Pension Cost, Accrued Pension Cost and Contra-Equity (Example 3) Unfunded ABO (Minimum liability) to be recognized: $2,100 Unrecognized Prior Service Cost: $2,000 Prepaid/Accrued Cost $ 200 Cr Minimum liability $2,100 less: Prepaid/Accrued cost $ 200 = Additional liability to be recognized $1,900 Intangible- Def.Pens.Cost ,900 Additional Pension Liability ,900 No contra-equity account is recorded 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

SFAS 106: Post-Retirement Benefits Other Than Pensions
Accounting for Healthcare Benefits and Other welfare benefits Beneficiaries include retirees, spouses, dependents and designated beneficiaries. Standard required a change from pay-as-you-go to accrual method. Accounting under SFAS No. 106 parallels accounting under SFAS No. 87 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

SFAS No. 87 and SFAS No. 106: A Comparison
Item Pensions Post-Ret Ben Treatment Funding Usually funded Not funded Benefit amount Defined Uncapped Predictability Reasonable Difficult 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

SFAS No. 106: Terminology Service Cost Accumulated Post Retirement Benefit Obligation Expected Post Retirement Benefit Obligation Present value of benefits attributed to employee services during the period Present value of all benefits at a specific date Present value of all benefits assuming continued employment 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

SFAS No. 106: Terminology Active employees not eligible for benefits Expected postretirement benefit obligation Active employees eligible for benefits Accumulated postretirement benefit obligation Retirees and dependents receiving benefits Present value of future benefits at a particular date 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

SFAS No.106: Attribution Period
Date of Hire Beginning Eligibility Retirement 3 1 5 Plan Amendment 2 Vesting Date 4 FASB Attribution period Prior Service Cost 12/31/2018 Intermediate Accounting, 10th Edition, Ch. 21 (Kieso et al.)

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Chapter 21: Accounting for Pensions and Postretirement Bennefits

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Chapter 21: Accounting for Pensions and Postretirement Bennefits

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