Pensions & Other Post Employment Benefits – after SFAS No. 158

Pensions & Other Post Employment Benefits – after SFAS No. 158
4/1/2017 Pensions & Other Post Employment Benefits – after SFAS No. 158 Includes certain slides provided by authors of Skousen, Stice & Stice and Kieso, Weygandt & Warfield Intermediate Accounting textbooks, as modified and adapted by Teresa Gordon Major Categories of Pension Plans Government plans, primarily social security – for FICA both the employer and employee contribute Employer plans Individual plans, such as individual retirement accounts (IRAs)

Types of plans Contributory Plan Non-Contributory Plan
4/1/2017 Types of plans Contributory Plan Non-Contributory Plan Defined Contribution Plan Defined Benefit Plan 3 7 8 8 8

Nature of Pension Plans
A Pension Plan is an arrangement whereby an employer provides benefits (payments) to employees after they retire for services they provided while they were working. Pension Plan Administrator Employer Contributions Retired Employees Benefit Payments Assets & Liabilities LO 1 Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

Nature of Pension Plans
Some pension plans are: Contributory: employees voluntarily make payments to increase their benefits. Noncontributory: employer bears the entire cost. Qualified pension plans: offer tax benefits. Pension fund should be a separate legal and accounting entity. LO 1 Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

Defined contribution plans
4/1/2017 Defined contribution plans A plan that provides benefits based solely on what has been contributed and the earnings thereon < 401(k) > Amounts to be funded are determined by the plan No promise for specific future benefits. Independent third party holds assets Risk borne by employee Accounting relatively straightforward 2 5 6 6 6

4/1/2017 Defined benefit plans A pension plan that determines the amount of benefit to be provided Contributions based on estimated amounts needed to meet expected payments Form versus substance of trust Risk borne by employer Accounting by employer is complicated Actuaries estimate the employer contribution by considering mortality rates, employee turnover, interest and earning rates, early retirement frequency, future salaries, etc. 7 7 7

Chart from UK but trend is probably same in US
4/1/2017 Chart from UK but trend is probably same in US

Defined Benefit Pension Plan
4/1/2017 Defined Benefit Pension Plan Services Employer Current Employees Pension Fund Contributions Wages and Salaries Retired Employees Defined Benefits

Pension Approaches Before FASB 87 & 88: FASB 87 & 88 FASB 158
4/1/2017 Pension Approaches Before FASB 87 & 88: “pay as you go” or “noncapitalization” FASB 87 & 88 Capitalization approach Full obligation reported only in notes FASB 158 Pension & post-retirement benefit cost is same as FASB 87 Full obligation is now reported on balance sheet Additional items now on statement of comprehensive income 14 14

Recognition of the Net Funded Status
Accounting for Pensions Recognition of the Net Funded Status Companies must recognize on their balance sheet the full overfunded or underfunded status of their defined-benefit pension plan. The overfunded or underfunded status is measured as the difference between the fair value of the plan assets and the projected benefit obligation. LO 3 Explain alternative measures for valuing the pension obligation.

Capitalization approach to pensions:
4/1/2017 Capitalization approach to pensions: Employer has full liability for benefits related to service already rendered by employee Expense is recognized as employees work (service cost) and this increases the liability Liability balance increases every year since present value of future benefits is larger (less time remains to cash outflow) Liability is reduced through payments to retirees Assets of the plan are considered pledged, collateral against a liability Liability less designated assets reported on balance sheet (net presentation)

Measures of Pension Liability
4/1/2017 Measures of Pension Liability Benefits for vested and nonvested employees at future salaries Benefits for vested and non- vested employees at current salaries Benefits for vested employees at current salaries Accumulated Benefit Obligation Projected Benefit Obligation Vested Benefit Obligation Go back to PV example and have students compute ABO instead of the PBO Vested Benefit Obligation (VBO) The actuarial present value, using current salary levels, of vested benefits only. Accumulated Benefit Obligation (ABO) The actuarial present value of benefits, vested and non-vested, attributed to the pension formula to employee service rendered to a particular date. Calculations are done without assumptions about future changes in the level of compensation. Projected Benefit Obligation (PBO) The actuarial present value of vested and non-vested benefits attributed to the plan through the pension benefit formula for service rendered to that date based on employees’ future salary levels Future years of service are not forecasted in computing either PBO or ABO PBO assumes future pay increases, ABO does not PBO = ABO: Flat benefit or non-pay-related benefit formulas PBO <> ABO: Final pay or career average pay benefit formulas To do the PVs: Discount rate is the rate required to currently settle benefits and generally based on rates published by the Pension Benefit Guarantee Corp (PBGC). (GAAP) PV of Expected Cash Flows 9

Interest/return rates
4/1/2017 Interest/return rates Discount rate Rates on high-quality fixed-income investments with maturities consistent with expected payments to retirees Generally equivalent to a portfolio of zero-coupon bonds with appropriate maturities Expected rate of return Based on long-term rate of return anticipated given investment of plan assets

What happens when Interest rates increase? Interest rates decrease?
4/1/2017 What happens when Interest rates increase? Interest rates decrease?

+ + +- + +- Accounting for Pensions Components of Pension Expense 1.
Effect on Expense Components of Pension Expense 1. Service Costs + 2. Interest on the Liability + 3. Actual Return on Plan Assets +- 4. Amortization of Prior Service Costs + 5. Gain or Loss +- LO 4 List the components of pension expense.

Pension Items Not Recognized
Companies do not recognize two main items in the accounts and in the financial statements: Projected benefit obligation. Pension plan assets. A company must disclose in notes to the financial statements, but not in the body of the financials. Some items are recognized in other comprehensive income; changes in these items are amortized into expense through smoothing techniques. Prior service costs. Actuarial gains and losses. LO 5 Use a worksheet for employer’s pension plan entries.

A working paper for pensions
4/1/2017 A working paper for pensions

This is very similar to the one in textbook
The “General Journal Entries” columns determine the journal entries to be recorded in the formal general ledger. The “Memo Record” columns maintain balances for the unrecognized pension items. LO 5 Use a worksheet for employer’s pension plan entries.

Accounts on Employer’s Books
4/1/2017 Accounts on Employer’s Books Net Periodic Pension Cost (Expense) Amount recognized by the employer on the income statement Pension expense includes six basic elements (more later) Other comprehensive income Up to three amounts reported for changes in balance of AOCI amounts (see next slide) 4 10 11 11 11

Working Paper – Pension Expense
4/1/2017 Working Paper – Pension Expense We’ll learn the various components of pension expense as we work through the examples

4/1/2017 A working paper for pensions Interest cost = discount rate * beginning balance in PBO Expected return = expected return rate * beginning balance in Plan Assets

4/1/2017 Accounts on Employer’s Books On balance sheet – Net funded position When PBO > Plan Assets, reported as noncurrent liability (with current liability if there are inadequate plan assets to cover current payments to retirees) When Plan Assets > PBO, reported as noncurrent asset 4 10 11 11 11

4/1/2017 A working paper for pensions This is another place to remind students that the TOP and very BOTTOM rows do NOT add across to zero. Instead, PBO + plan assets MUST add to funded status column. If it does not, something is wrong on the workpaper

4/1/2017 Accounts on Employer’s Books Accumulated other comprehensive income (AOCI) Account appears as part of owners’ equity section of balance sheet Three pension related balances Transition gain or loss Prior service cost Actuarial gains or losses 4 10 11 11 11

4/1/2017 A working paper for pensions

Self-checking features
Funded status must equal PBO + Plan Assets Each blue row must add across to ZERO Balance forwards Plug to balance JE {row=0} Balance forwards

Net Periodic Pension Cost
4/1/2017 Net Periodic Pension Cost Net periodic pension cost (the expense) consists of six basic elements: Service cost Interest cost Expected return on plan assets Amortization (if any) of Transition gain or loss Prior service cost Unrecognized gain or loss 7 15 16 16 16

Pension Definitions Prior Service Cost (PSC)
4/1/2017 Pension Definitions Prior Service Cost (PSC) Cost of benefits granted for service rendered prior to the inception of the plan Increases PBO at date of amendment but cost is amortized to expense over future years Reduces funded status since PBO is higher Recognized as charge to OCI at date of plan amendment Amortization method recommended: Years of service method Straight-line or other methods that amortize PSC faster are also acceptable 5 11 12 12 12

Actuarial Gains and Losses
4/1/2017 Actuarial Gains and Losses Actuarial assumptions are subject to inaccuracies as time goes by and circumstances change There is a materiality provision for determining when gains and losses are sufficiently large to require amortization (charge to expense) 10% Corridor Rule 14 24 28 28 25

Gains and Losses Question: What is the potential negative impact on Net Income of these unexpected swings? Volatility The profession decided to reduce the volatility with smoothing techniques. LO 7 Explain the accounting for unexpected gains and losses.

Gains and Losses Corridor Amortization
FASB invented the corridor approach for amortizing the accumulated net gain or loss balance when it gets too large. How large is too large? 10% of the larger of the beginning balances of the projected benefit obligation or the market-related value (which may equal fair value) of the plan assets. Any accumulated net gain or loss balance above the 10% must be amortized. LO 8 Explain the corridor approach to amortizing gains and losses.

Kieso, Weygandt & Warfield 11th ed. Illustration 20-14, page 1034
4/1/2017 Kieso, Weygandt & Warfield 11th ed. Illustration 20-14, page 1034

10% Corridor Amortization
4/1/2017 10% Corridor Amortization Amortization is required only on the portion of unrecognized net gain or loss that exceeds 10% of the greater of: PBO at beginning of year, or market-related value of plan assets at the beginning of the year. 18

Kieso, Weygandt & Warfield 11th ed. Illustration 20-3, page 1025
4/1/2017 Kieso, Weygandt & Warfield 11th ed. Illustration 20-3, page 1025 Subtract Expected Return Only if outside 10% corridor Comparing textbook approach to the way I teach the workpaper Possible 6th item = amortization of transition gain or loss

Settlements & Curtailments
4/1/2017 Settlements & Curtailments Additional FASB standards govern major changes in pension plans: Settlements No further obligations to some or all employees Curtailments Results in significant reduction in expected years, or No further accrual of benefits Handling will require further research (primarily FASB 88) Settlement An irrevocable transaction that relieves the employer of the PBO and eliminates the risk of that obligation. Plan assets are used to satisfy the settlement (e.g., lump-sum payments to employees) Plan termination: Not required for a settlement. They usually involve asset reversions to the employer and a recognition of a gain to the employer. Curtailment A transaction or event the significantly reduces the expected years of service of active employees or eliminates the accrual of benefits for future work of a significant number of active employees. For example, a plant closing. Curtailment gains and losses are accounted for as contingencies (if probable and can be reasonably estimated). 17 30 34 34 31

Pension Disclosures [FAS 132(R)]
4/1/2017 Pension Disclosures [FAS 132(R)] Amount and types of assets held Assumptions related to discount rate, rate of increase in compensation, expected return on plan assets Alternative amortization policies Past practice or history of regular benefit increases 33 36 36

Pension Disclosures [FAS 132(R)]
4/1/2017 Pension Disclosures [FAS 132(R)] The details for net periodic pension cost the service cost component. the interest cost component. the expected return on plan assets [FAS 132] the amortization of PSC, transition amount and unrecognized gain/loss (separately) Gain or loss from settlement or curtailment of plan FASB 132 revised expanded the pension disclosures required 33 36 36

Pension Disclosures: Reconciliations
4/1/2017 Pension Disclosures: Reconciliations The fair value of plan assets (changes between BOY and EOY) PBO Obligation (changes between BOY and EOY) Easily obtained from our work paper! EoY = end of year BoY = beginning of year 18 33 37 37 34

Pension Disclosures Employers with multiple plans
4/1/2017 Pension Disclosures Employers with multiple plans Information can be combined but the computations are made for each individual plan Net position for over-funded plans would be reported in noncurrent assets Net position for under-funded plans would be reported in liabilities Part may be reported as a current liability See next slide FAS 87 Paragraph 36 as amended The employer shall aggregate the statuses of all overfunded plans and recognize that amount as an asset in its statement of financial position. It also shall aggregate the statuses of all underfunded plans and recognize that amount as a liability in its statement of financial position. An employer that presents a classified statement of financial position shall classify the liability for an underfunded plan as a current liability, a noncurrent liability, or a combination of both. The current portion (determined on a plan-by-plan basis) is the amount by which the actuarial present value of benefits included in the benefit obligation payable in the next 12 months, or operating cycle if longer, exceeds the fair value of plan assets. The asset for an overfunded plan shall be classified as a noncurrent asset in a classified statement of financial position.

Current portion of liability
4/1/2017 Current portion of liability The current portion (determined on a plan-by-plan basis) is the amount by which the actuarial present value of benefits in PBO that are payable in the next 12 months* exceeds the fair value of plan assets * As always, the operating cycle might be longer than 12 months in which case we’d use the operating cycle FAS 87 Paragraph 36 as amended The employer shall aggregate the statuses of all overfunded plans and recognize that amount as an asset in its statement of financial position. It also shall aggregate the statuses of all underfunded plans and recognize that amount as a liability in its statement of financial position. An employer that presents a classified statement of financial position shall classify the liability for an underfunded plan as a current liability, a noncurrent liability, or a combination of both. The current portion (determined on a plan-by-plan basis) is the amount by which the actuarial present value of benefits included in the benefit obligation payable in the next 12 months, or operating cycle if longer, exceeds the fair value of plan assets. The asset for an overfunded plan shall be classified as a noncurrent asset in a classified statement of financial position.

Other Postretirement Benefits
4/1/2017 Other Postretirement Benefits FASB Appendix Material in KWW text Also changed by FASB No. 158

Other Post-retirement Benefits
4/1/2017 Other Post-retirement Benefits The accounting is similar to pension accounting EXCEPT that the terminology is slightly different EPBO APBO Expected postretirement benefit obligation (EPBO). The actuarial present value as of a particular date of the postretirement benefits expected to be paid by the employer's plan to or for the employee, the employee's beneficiaries, and any covered dependents pursuant to the terms of the plan. Accumulated postretirement benefit obligation (APBO). The actuarial present value of all future benefits attributed to an employee's service rendered to that date assuming the plan continues in effect and that all assumptions about future events are fulfilled.

Kieso, Weygandt & Warfield 11th ed. Illustration 20A-3, page 1056
4/1/2017 Kieso, Weygandt & Warfield 11th ed. Illustration 20A-3, page 1056 Even MORE assumptions necessary: FASB 106 para 30. The service cost component of postretirement benefit cost, any prior service cost, and the accumulated postretirement benefit obligation are measured using actuarial assumptions and present value techniques to calculate the actuarial present value of the expected future benefits attributed to periods of employee service. Each assumption used shall reflect the best estimate solely with respect to that individual assumption. All assumptions shall presume that the plan will continue in effect in the absence of evidence that it will not continue. Principal actuarial assumptions include the time value of money (discount rates); participation rates (for contributory plans); retirement age; factors affecting the amount and timing of future benefit payments, which for postretirement health care benefits consider past and present per capita claims cost by age, health care cost trend rates, Medicare reimbursement rates, and so forth; salary progression (for pay-related plans); and the probability of payment (turnover, dependency status, mortality, and so forth).

4/1/2017 APBO vs EPBO Prior to the date on which an employee attains full eligibility for the benefits that employee is expected to earn APBO < EPBO On and after the full eligibility date, APBO = EPBO In other words EPBO > APBO until the employee has earned the right to full benefits EPBO = APBO after the employee has worked long enough to earn full eligibility We use APBO (not EPBO) on our postretirement benefit worksheet

Kieso, Weygandt & Warfield 11th ed. Illustration 20A-2, page 1056
4/1/2017 Kieso, Weygandt & Warfield 11th ed. Illustration 20A-2, page 1056 Cost attributed to period from hire to eligibility (vesting) Attribution FAS106 – (apparently not changed by FAS158) 43. An equal amount of the expected postretirement benefit obligation for an employee generally shall be attributed to each year of service in the attribution period (a benefit/years-of-service approach). However, some plans may have benefit formulas that attribute a disproportionate share of the expected postretirement benefit obligation to employees' early years of service. For that type of plan, the expected postretirement benefit obligation shall be attributed in accordance with the plan's benefit formula. 44. The beginning of the attribution period generally shall be the date of hire. However, if the plan's benefit formula grants credit only for service from a later date and that credited service period is not nominal in relation to employees' total years of service prior to their full eligibility dates, the expected postretirement benefit obligation shall be attributed from the beginning of that credited service period. In all cases, the end of the attribution period shall be the full eligibility date. (Paragraphs illustrate the attribution provisions of this Statement.)

Postretirement Benefit Worksheet
4/1/2017 Postretirement Benefit Worksheet Would be the same as a pension worksheet with modified labels at the top Pension Expense becomes Postretirement Benefit Expense. PBO becomes APBO.

4/1/2017 Working paper for FAS106

Net periodic postretirement benefit cost.
4/1/2017 Net periodic postretirement benefit cost. The expense basically includes the same elements as pension cost: Service cost -- the actuarial present value of benefits attributed to services rendered by employees during the period. Interest cost -- the interest on the beginning balance of the accumulated postretirement benefit obligation Less expected return on plan assets. Amortizations (transition, prior service cost and unrecognized gain or loss)

4/1/2017 Comparing FASB 87 & 106 Note that because post-retirement benefit plans other than pensions are generally UNFUNDED (there are no assets), it will almost always be necessary to prorate the liability between current and noncurrent sections of the balance sheet

iGAAP and U.S. GAAP separate pension plans into defined-contribution plans and defined-benefit plans. The accounting for defined-contribution plans is similar. For defined-benefit plans, both iGAAP and U.S. GAAP recognize the net of the pension assets and liabilities on the balance sheet. Unlike U.S. GAAP, which recognizes prior service cost on the balance sheet (as an element of “Accumulated other comprehensive income”), iGAAP does not recognize prior service costs on the balance sheet. Both GAAPs amortize prior service costs into income over the expected service lives of employees.

Another difference in defined-benefit recognition is that under iGAAP companies have the choice of recognizing actuarial gains and losses in income immediately or amortizing them over the expected remaining working lives of employees. U.S. GAAP does not permit choice. The IASB has recently issued a discussion paper on pensions proposing: (1) elimination of smoothing via the corridor approach, (2) a different presentation of pension costs in the income statement, and (3) a new category of pensions for accounting purposes—so-called “contribution-based promises.”

Pensions & Other Post Employment Benefits – after SFAS No. 158

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Pensions & Other Post Employment Benefits – after SFAS No. 158

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