Pensions and Other Postretirement Benefits

Pensions and Other Postretirement Benefits
17 Chapter 17: Pensions and Other Postretirement Benefits

Nature of Pension Plans
I agree to make payments into a fund for future retirement benefits for employee services. I am the employee for whom the pension plan provides benefits. The basic nature of a pension plan is that the company and or the employee make contributions to a fund manager. The manager invests the funds and makes payments to retired employees. The amount of the contributions to the fund manager is often determined by an actuary. Sponsor Participant 3

For a pension plan to qualify for special tax treatment it must meet the following requirements: Cover at least 70% of employees. Cannot discriminate in favor of highly compensated employees. Must be funded in advance of retirement through a trust. Benefits must vest after a specified period of service. Complies with timing and amount of contributions. Here are the five conditions that must be met for a pension plan to receive special tax treatment. As an overview, special tax treatment is afforded those plans that are nondiscriminatory as to employees, and that are funded prior to retirement with a trustee. 3

The right to receive earned pension benefits vest (vested benefits) when it is no longer contingent on continued employment. The fourth condition from the previous slide deals with the vesting issue. An amount that is vested is payable to the employee at retirement and is not contingent upon continued employment. 7

Learning Objectives LO1
Explain the fundamental differences between a defined contribution pension plan and a defined benefit pension plan. LO1 Our first learning objective in Chapter 17 is to explain the fundamental differences between a defined contribution pension plan and a defined benefit pension plan.

Defined Contribution Plans
Contributions are established by formula or contract. Employer deposits an agreed-upon amount into an employee-directed investment fund. Employee bears all risk of pension fund performance. A defined contribution pension plan has the amount of the contribution determined by formula or contract. The employer and/or employee deposits an agreed-upon amount into an employee directed investment fund. The employees bear all the risk of pension fund performance. There is no guarantee as to the actual amount of retirement benefits that will be paid to the employee. 5

Defined Contribution Pension Plans
Defined contribution pension plans are becoming increasingly popular vehicles for employers to provide retirement income without the paperwork, cost, and risk generated by the more traditional defined benefit plans. Defined contribution pension plans are becoming increasingly popular vehicles for employers to provide retirement income without the paperwork, cost, and risk generated by the more traditional defined benefit plans. These plans promise defined periodic contributions to a pension fund, without further commitment regarding benefits at retirement. These plans promise defined periodic contributions to a pension fund, without further commitment regarding benefits at retirement.

Defined Contribution Pension Plans
Accounting for these plans is quite simple. Let’s assume that an annual contribution of employee salaries is to be 4% of gross earnings. If employees earned $10,000,000 in salaries during the period, the company would make the following entry: The entry to record pension expense for defined contribution plan is quite easy. We will debit pension expense and credit cash for the contributions made by employees. In this example, employees contributed $400,000 to the plan, so we will debit pension expense for $400,000 and credit cash for the same amount.

Defined Benefit Pension Plans
Employer is committed to specified retirement benefits. Retirement benefits are based on a formula that considers years of service, compensation level, and age. Employer bears all risk of pension fund performance. In a defined benefit pension plan, the employer is committed to a specified retirement benefit for employees. Retirement benefits are based upon actuarially sound computations. The employer bears all the risks of pension fund performance. Our Social Security system is a defined benefit pension plan. 6

Defined Benefit Plan Pension expense is measured by assigning pension benefits to periods of employee service as defined by the pension benefit formula. A typical benefit formula might be: 1% × Years of Service × Final year’s salary So, for 35 years of service and a final salary of $80,000, the employee would receive: 1% × 35 × $80,000 = $28,000 per year In a defined benefit pension plan, pension expense is measured by assigning pension benefits to periods of employee service as defined by the pension benefit formula. Assume you work for a company that has a defined benefit plan that pays annual benefits of 1% times the number of years of service times your final year salary. Suppose you work for the company for 35 years, and your salary during the last year of employment is $80,000. You would be entitled to receive $28,000 per year under the defined benefit formula. 16

Distinguish among the vested benefit obligation, the accumulated benefit obligation, and the projected benefit obligation. LO2 Our second learning objective in Chapter 17 is to distinguish among the vested benefit obligation, the accumulated benefit obligation, and the projected benefit obligation.

Defined Benefit Plan You go to work for Matrix, Inc. on 1/1/07. You are eligible to participate in the company's defined benefit pension plan. The benefit formula is: Annual salary in year of retirement × Number of years of service × 1.5% Annual retirement benefits You are 25 years old when you start work and will accumulate 40 years of service before retiring at age 65. If your salary is $200,000 during your last year of service, you will receive the following annual benefits: $200,000 × × % $120,000 You are not required to make any contributions. The plan vests at the rate of 20% per year. The plan actuary estimates that upon reaching age 65, you will receive payments for 15 years. The actuary uses an 8% discount rate in all present value computations. In the next few slides, we will show you how the actuary calculates the present value of the vested benefit obligation, the accumulated benefit obligation and the projected benefit obligation. Let’s go back to our previous example, where your retirement benefit is your last year’s salary times the number of years of service times 1.5%. You start to work at age 25 and can accumulate 40 years of service before retiring at age 65. If your salary during your last year of service is $200,000, you would be entitled to retirement benefits of $120,000 per year. Let’s assume that the fund vests at the rate of 20% per year. After you retire, the actuary has determined that it’s likely you will receive benefits for approximately 15 years. All the present value computations made by the actuary use an 8% discount rate.

Defined Benefit Plan At December 31, 2007, the end of your first year of service, the actuary must calculate the present value of the pension benefits earned by you during Remember that you will not receive pension benefits until you are 65 and the actuary estimates payments will be made for 15 years after you retire. After one year of service you will have earned $3,000 in pension benefits: Pension benefits = .015 × 1 yr of service × $200,000 Pension benefits = $3,000 Service cost is the present value of these benefits and is calculated as follows: Service cost = $3,000 × × Service cost = $1,277 1Present value of an ordinary annuity at 8% for 15 years. 2Present value of $1 at 8% for 39 years. When you complete your first year of work, your pension benefits are equal to $3,000, assuming your final year of service salary is $200,000. The service cost would be calculated by taking the $3,000 and multiplying it times the present value of an ordinary annuity at 8% for 15 periods. We would then multiply that result by the present value of one dollar at 8% for 39 years. The service cost for the first year would be $1,277.

Pension Obligation Based on the given information, the actuary calculates your Accumulated benefit obligation (ABO) as follows: Retirement benefits = .015 × 1 yr × $25,000 Retirement benefits = $375 ABO = $375 × × ABO = $160 Your Vested benefit obligation (VBO) is calculated as follows: Vested benefits = .015 × 1 × $25,000 × .2 Vested benefits = $75 VBO = $75 × × VBO = $32 The accumulated benefit obligation is calculated in a similar manner, using your current salary level of $25,000. As you can see, the accumulated benefit obligation at the end of your first year would be $160. Your vested benefits is 20% of the accumulated benefit obligation or $75. The vested benefit obligation is the present value of the $75 at 8% for 15 periods or $32.

Pension Obligation The Projected benefit obligation (PBO) differs from the ABO by using your salary projected at retirement rather than your current salary. The actuary calculates your Projected benefit obligation (PBO) as follows: Retirement benefits = .015 × 1 yr × $200,000 Retirement benefits = $3,000 PBO = $3,000 × × PBO = $1,277 The projected benefit obligation is determined by taking the retirement benefits earned in the current period and discounting this amount at 15%. The present value of the benefits is equal to $1,277.

Pension Obligation A reconciliation of the VBO, ABO and PBO would look like this: VBO $ 32 Non-vested benefits ABO $ Adjustment for future salary ,117 PBO $ 1,277 Here is a reconciliation of the vested benefit obligation (VBO), the accumulated benefit obligation (ABO) and the projected benefit obligation (PBO).

Pension Obligation Present value of additional benefits related to projected pay increases. Projected Benefit Obligation Present value of nonvested benefits at present pay levels. Accumulated Benefit Obligation The vested benefit obligation, or the VBO, is the present value of the amounts due to employees at their present pay levels. The accumulated benefit obligation, or ABO, is the present value of the vested and nonvested amounts due to employees at present pay levels. Finally, the projected benefit obligation, or PBO, is the present value of the vested and nonvested amounts due to employees based upon future pay levels. The FASB has opted for the use of the projected benefit obligation. Present value of benefits at present pay levels. Vested Benefit Obligation 21

Describe the five events that might change the balance of the PBO.
Learning Objectives Describe the five events that might change the balance of the PBO. LO3 Our third learning objective in Chapter 17 is to describe the five events that might change the balance of the projected benefit obligation.

Projected Benefit Obligation
The projected benefit obligation changes as a result of the five elements of the pension expense. 21

Pension Obligation Service cost is the increase in the PBO attributable to employee service performed during the period. Current period service cost is the increase in the projected benefit obligation attributable to employee service performed during this period. 21

Interest cost is the interest on the PBO during the period.
Pension Obligation Interest cost is the interest on the PBO during the period. The interest cost is the interest on the projected benefit obligation using the value at the beginning of the period. 21

Pension Obligation Prior service costs result from changes in the pension benefit formula or in amendments to the plan. Prior service cost effects result from changes in the pension benefit formula or plan terms. 21

Pension Obligation Loss or gain on PBO results from required revisions of estimates used to determine PBO. The gain or loss on the projected benefit obligation results from required revisions of estimates used to determine the projected benefit obligation. 21

Pension Obligation Retiree benefits paid are the result of paying benefits to retired employees. The projected benefit obligation is reduced by benefits paid to retired employees. 21

Explain how plan assets accumulate to provide retiree benefits and understand the role of the trustee in administering the fund. LO4 Our fourth learning objective in Chapter 17 is to explain how plan assets accumulate to provide retiree benefits and understand the role of the trustee in administering the fund.

A trustee manages the pension plan assets.
Pension plan assets (like the PBO) are not specifically reported in the balance sheet. A trustee manages the pension plan assets. Pension plan assets are not recognized on the balance sheet of the sponsoring company. The assets are managed by a trustee who reports the results of managing the assets to the company each period. 18

Pension Plan Assets Plan assets change as (a) the investments generate dividends, interest, capital gains, etc., (b) additional cash contributions are added by the employer, and (c) payments are made to retired employees. Assume the following balances and changes for Matrix: ($ in millions) The plan trustee determines the balance in the plan assets at the end of the year by starting with the beginning balance; adding the return on plan assets and contributions made to the trustee; and deducting the benefits paid to retired employees. 18

Describe the funded status of pension plans and how that amount is reported. LO5 Our fifth learning objective in Chapter 17 is to describe how pension expense is a composite of periodic changes that occur in both the pension obligation and the plan assets.

Funded Status of the Pension Plan
OVERFUNDED Market value of plan assets exceeds the actuarial present value of all benefits earned by participants. UNDERFUNDED Market value of plan assets is below the actuarial present value of all benefits earned by participants. A plan is said to be overfunded when the fair market value of the plan assets exceed the actuarially determined present value of all benefits earned by plan participants. The plan is undervalued when the fair market value of the plan assets are below the actuarially determined present value of the benefits. 11

Funded Status of the Pension Plan
Projected Benefit Obligation (PBO) - Plan Assets at Fair Value Underfunded / Overfunded Status This amount is reported in the balance sheet as a Pension Liability if underfunded or a Pension Asset if overfunded. When a plan is underfunded the amount of the underfunding is reported as a pension liability. The amount of overfunding is reported as a pension asset. 11

Describe how pension expense is a composite of periodic changes that occur in both the pension obligation and the plan assets. LO6 Our fifth learning objective in Chapter 17 is to describe how pension expense is a composite of periodic changes that occur in both the pension obligation and the plan assets.

Pension Expense – An Overview
There are five components of pension expense. The first is the service cost earned by employees. Next is the interest element on the pension liability, then a positive return on plan assets reduces pension costs, and a negative return increases pension costs. The next element is the amortization of prior service costs resulting from an amendment of the plan. Finally, we have a gain or loss element from revision of the pension liability and plan assets. 16

Pension Expense Actuaries have determined that Matrix, Inc. has service cost of $150,000 in 2007 and $155,000 in 2008. We can begin the process of determining pension expense for the company. Our actuary has determined that the service cost is $150,000 for 2007, and $155,000 for With this information we can begin the process of calculating pension expense. 24

Service Cost Here is the schedule we will use to calculate our pension expense. 25

Interest cost is calculated as:
Interest cost is the growth in PBO during a reporting period due to the passage of time. Interest cost is calculated as: PBOBeg × Discount rate The interest element is calculated by taking the beginning projected benefit obligation and multiplying it by the discount rate used by the actuary. 26

The actuary uses a discount rate of 10%.
Interest Cost Actuaries determined that Matrix, Inc. had PBO of $500,000 on 1/1/07, and $640,000 on 1/1/08. The actuary uses a discount rate of 10%. Our actuary has determined that the beginning projected benefit obligation for 2007 is $500,000, and $640,000 at the beginning of The actuary uses a discount rate of 10%. 29

Interest Cost 2007: PBO 1/1/07 $500,000 × 10% = $50,000
The interest cost for 2007 is $50,000, that is, $500,000 times 10%. The interest cost for 2008 is $64,000, that is, $640,000 times 10%. 2007: PBO 1/1/07 $500,000 × 10% = $50,000 2008: PBO 1/1/08 $640,000 × 10% = $64,000 30

Trustee’s estimate of long-term rate of return.
Return on Plan Assets The dividends, interest, and capital gains generated by the fund during the period. Actual Return Trustee’s estimate of long-term rate of return. Expected Return Part I The actual return on plan assets is equal to the dividends, interest and capital gains generated by the fund during the period. Part II The expected return on plan assets is the trustee’s estimate of the long-term rate of return on invested funds. 31

Return on Plan Assets The plan trustee reports that plan assets were $450,000 on 1/1/07, and $600,000 on 1/1/08. The trustee uses an expected return of 9% and the actual return is 10% in both years. The fair value of the plan assets at January 1, 2007 is $450,000, and on January 1, 2008 fair value of the asset is $600,000. The trustee used an expected return of 9% for both years, but has earned an actual return of 10% in both years.

Return on Plan Assets 2007 2008 The actual return in 2007 is $45,000, so that amount must be adjusted by $4,500 to arrive at our expected return of $40,500. We perform the same computation for The actual return is calculated as $60,000, but must be adjusted for the difference between actual and expected return of $6,000, to arrive at an expected return on plan assets of $54,000. 33

Return on Plan Assets Since the trustee was able to earn a positive return on plan assets, the return reduces pension expense. 34

Amortization of Prior Service Cost
Prior service cost (PSC) results from plan amendments granting increased pension benefits for service rendered before the amendment. PSC is the present value of the retroactive benefits and increases PBO by that amount. Prior service cost is the present value of the retroactive benefits from modification of the plan formula or amendment to the plan, and increases the projected benefit obligation. The prior service cost is initially recorded as other comprehensive income and then amortized gradually to pension expense. 35

Benefits attributable to prior service are assumed to benefit future periods by: Improving employee productivity. Improving employee morale. Reducing turnover. Reducing demands for pay raises. Here are a few of the reasons that might cause a company to modify its existing pension plan. 36

PSC is amortized over the remaining service period of those employees active at the date of the amendment who are expected to receive benefits under the plan. Prior service costs are usually amortized over the remaining service life of those employees active at the date of amendment of the plan, and who are expected to receive benefits as a result of the amendment. 37

Two approaches to amortizing PSC: Straight-line method Amortize PSC over the average remaining service period. Service method Amortize PSC by allocating equal amounts to each employee’s service years remaining. There are two approaches to the amortization of prior service cost. First, we can amortize these costs over the remaining service life on a straight-line basis. This method is sufficient and simple. The preferred method is called the service method. Under this method, we amortize the prior service costs by allocating equal amounts to each employee’s service years remaining. For very large companies, service method amortization can be quite complex. 38

Effective 1/1/08, Matrix, Inc. amends the retirement plan to provide increased benefits attributable to service performed before 1/1/03, for all active employees. The present value of the increased benefits (PSC) at 1/1/08, is $60,000. The average remaining service life of the active employee group is 12 years. Let’s assume that Matrix amended its pension plan on January 1, The actuary has determined that the prior service costs are $60,000, and should be amortized over the average remaining service life of active employees of 12 years. 39

Since the amendment was not effective until the beginning of 2008, pension expense for 2007 is not affected. 2008: $60,000 PSC ÷ 12 = $5,000 Matrix elects to use straight-line amortization. So in 2008 the amortization of the prior service costs will be $5,000. Recall that prior service costs are initially recorded in other comprehensive income and amortized gradually over future periods. 41

Here is where we stand before we consider the treatment of gains or losses. 43

Gains and Losses This table does a very good job of summarizing the recognition of gains and losses. If the projected benefit obligation is higher than expected, a loss will be recognized. On the other hand, if the return on plan assets is higher than expected, a gain will be recognized. 44

Corridor Amount Amortization is not required if the net unrecognized gain or loss at the beginning of the period is a minimum amount (corridor amount). Not all gains and losses are amortized. Only gains or losses that exceed the corridor amount are considered for amortization. 54

The corridor amount is 10% of the greater of . . .
PBO at the beginning of the period. The corridor amount is 10% of the greater of . . . Or Fair value of plan assets at the beginning of the period. The corridor amount is defined as 10% of the greater of the beginning projected benefit obligation or the beginning fair value of the plan assets. Before a gain or loss would be amortized, it must exceed the corridor amount. The existence of the corridor amount is an effort by the FASB to permit companies to smooth income. Only very large gains or losses exceed the corridor amount and are subject to amortization over an extended period of time.

Net unrecognized gain or loss
Gains and Losses If the beginning net unrecognized gain or loss exceeds the corridor amount, amortization is recognized as . . . Net unrecognized gain or loss at beginning of year Average remaining service period of active employees expected to receive benefits under the plan Corridor amount — We amortize the excess of the net unrecognized gain or loss at the beginning of the year over the corridor amount, by the average remaining service life of active employees. 56

Gains and Losses There was no gain or loss amortized in 2007.
Let’s assume that the net gain for 2008 is $76,000. The average remaining service life of active employees is 12 years. The corridor amount will be 10% of the larger of the projected benefit obligation or the fair value of the plan assets at the beginning of the period. Since the projected benefit obligation exceeds the fair value of the plan assets, the corridor amount will be $64,000. Let’s determine the amortization of the net gain in 2008. 61

Gains and Losses $12,000 ÷ 12 years = $1,000 per year.
The net gain of the $76,000 exceeds the corridor amount by $12,000 and will be amortized over 12 years using the straight-line method. The gain or loss element of the pension expense will be $1,000 in 2008. 61

Pension Expense We have now completed the calculation of our pension expense for 2007 and The pension expense in 2007 is $159,500, and the pension expense in 2008 is $169,000. 62

Record for pension plans the periodic expense and funding as well as new gains and losses and new prior service cost as they occur. LO7 Learning objective number 8 is to record for pension and other postretirement benefit plans the periodic expense and funding as well as new gains and losses and new prior service cost as they occur.

Pension Expense and Funding
Matrix contributed $200,000 to the plan trustee at the end of The journal entries to record the pension activity are: Let’s assume that Matrix and its employees contributed $200,000 to the plan trustee during The journal entry that would be required is to debit pension liability for $200,000 and credit cash for the same amount. Next we record the pension expense (which includes service cost, interest cost, and expected return on plan assets) with a debit pension expense for $159,500, and credit pension liability for $159,500. 62

Pension Expense and Funding
Matrix contributed $200,000 to the plan trustee at the end of 2008. Let’s assume that Matrix and its employees contributed $200,000 to the plan trustee during The journal entry that would be required is to debit pension liability for $200,000 and credit cash for the same amount. Also, we record the pension expense (which includes service cost, interest cost, and expected return on plan assets) with a debit pension expense for $169,000, and credit pension liability for $165,000 which does not include the amortization amounts. The amortization of the net gain and of the prior service cost affect neither the PBO nor the plan assets and thus don’t affect the pension liability. Those two amounts are reported as other comprehensive income. 62

Pension Gains and Losses
For 2008, the actual return on plan assets exceeded the expected return by $4,500. In addition, there was a loss from the actuary change in certain underlying assumptions about the amount of the projected benefit obligation of $12,000. Matrix is required to make the following journal entry: For 2008, the actual return on plan assets exceeded the expected return by $4,500. In addition, there was a loss from the actuary change in certain underlying assumptions about the amount of the projected benefit obligation of $12,000. Matrix will debit a loss in other comprehensive income for $12,000, credit a gain to other comprehensive income of $4,500, and credit the pension liability for the difference -- $7,500. OCI = Other comprehensive income

Comprehensive Income Other comprehensive income (a) is reported periodically as it is created and (b) also is reported as a cumulative amount. There are 3 options for reporting other comprehensive income created during the reporting period. The statement of comprehensive income can be presented as: The accumulated amount of other comprehensive income is reported as a separate item of shareholders’ equity in the balance sheet. As shown in this illustration, there are three options for reporting comprehensive income created during the reporting period. First, it may be show as an expanded version of the income statement. Second, it may be shown within the statement of stockholders’ equity. Finally, it may be disclosed in the notes to the financial statements. The accumulated amount of comprehensive income is reported as a separate item in the shareholders’ equity section of the balance sheet. As an expanded version of the income statement. Within the statement of shareholders’ equity. In a disclosure note.

Understand the interrelationships among the elements that constitute a defined benefit pension plan. LO8 Our sixth learning objective in Chapter 17 is to understand the interrelationships among the elements that constitute a defined benefit pension plan.

Pension Spreadsheet The following four accounts will never appear on the balance sheet. First is the projected benefit obligation, next is the fair value of plan assets, third is the unamortized prior service costs, and finally, we have the unamortized gain or loss. 68

Describe the nature of postretirement benefit plans other than pensions and identify the similarities and differences in accounting for those plans and pensions. LO9 Learning objective number 9 is to describe the nature of postretirement benefit plans, other than pensions, and identify the similarities and differences in accounting for those plans and pensions.

Postretirement Benefit Plan
Encompass all types of retiree health and welfare benefits including . . . Medical coverage, Dental coverage, Life insurance, Group legal services, and Other benefits. Postretirement benefits may include medical coverage, dental coverage, life insurance, group legal services, and other similar benefits. 3

Postretirement Health Benefits and Pension Benefits Compared
Pension Plan Benefits Usually based on years of service. Identical payments for same years of service. Cost of plan usually paid by employer. Vesting usually required. Postretirement Health Benefits Typically unrelated to service. Payments vary depending on medical needs. Company and retiree share the costs. True vesting does not exist. Part I Pension plans are usually based upon the years of service and the cost of the plans are usually paid by the employer. Part II Postretirement health benefits are typically unrelated to past service. The company and the retiree generally share the cost of these plans. 4

The Net Cost of Benefits
Estimated medical costs in each year of retirement Retiree share of cost Medicare payments Less: The net cost of health benefits is determined by taking the estimated medical costs in each year of retirement, and subtracting the retiree’s share of the cost and the medicare payments that will be made. Estimated net cost of benefits Equals: 5

The Net Cost of Benefits
Estimating postretirement health care benefits is like estimating pension benefits, but there are some additional assumptions required: Current cost of providing health care benefits (per capita claims cost). Demographic characteristics of participants. Benefits provided by Medicare. Expected health care cost trend rate. An actuary is usually employed to calculate the estimated postretirement health benefits. The calculation is similar to that used to determine pension benefits, but there are some additional factors that need to be considered. These factors include certain demographics about the participant, benefits likely to be paid by Medicare, and an estimate of expected health-care cost trends.

Explain how the obligation for postretirement benefits is measured and how the obligation changes. LO10 Learning objective number 10 is to explain how the obligation for postretirement benefits is measured and how the obligation changes.

Postretirement Benefit Obligation
Expected (EPBO) The actuary’s estimate of the total postretirement benefits (at their discounted present value) expected to be received by plan participants. The actuary determines the expected total postretirement benefits to be received by plan participants. The accumulated projected benefit obligation is that portion of the expected benefit obligation attributed to employee service, to date. Accumulated (APBO) The portion of the EPBO attributed to employee service to date.

Measuring the Obligation
On December 31, our actuary estimates that the present value of the expected benefit obligation for your postretirement health care costs is $10,250. You have worked for the company for 6 years and are expected to have 30 years of service at retirement. The actuary uses a 6% discount rate. Let’s calculate the APBO. Read through this example, then we will calculate the accumulated projected benefit obligation.

EPBO Fraction attributed to service to date APBO × = $10,250 6 30 = $2,050 × APBO at the beginning of the year. The actuary has determined that the expected projected benefit obligation is $10,250. You have worked for the company for six years, and are expected to work for the company for a total of 30 years. So the accumulated projected benefit obligation at the beginning of the year is $2,050.

To calculate the APBO at the end of the year, we start by determining the ending EPBO. EPBO Beginning of Year × (1 + Discount Rate) = End Part I To calculate the accumulated projected benefit obligation at the end of the year, we start by determining the ending expected projected benefit obligation. We take the expected projected benefit obligation at the beginning of year and multiply it by one plus the discount rate, to arrive at the expected benefit obligation at the end of the year. Part II The expected projected benefit obligation at the beginning of the year was determined to be $10,250. We multiply that amount times 1.06 and arrive at the end of year expected projected benefit obligation of $10,865. At the end of the year, you will have completed seven years of service to the company. We multiply the ending projected benefit obligation times 7 divided by 30, and get the accumulated projected benefit obligation at the end of the year of $2,535. $10,250 × = $10,865 APBO End of Year $10,865 × 7 30 = $2,535

APBO may also be calculated like this: Recall that we calculated the accumulated projected benefit obligation at the beginning of the year to be $2,050. Interest on this amount at 6% is $123. The service cost is one 30th of the expected projected benefit obligation of $10,865, or $362. Our accumulated projected benefit obligation at the end of the year is $2,535. The APBO increases because of interest and the service fraction (service cost).

Attribution The process of assigning the cost of benefits to the years during which those benefits are assumed to be earned by employees, the date of hire to the “full eligibility date”. Attribution is the process of assigning the cost of benefits to the years during which those benefits are assumed to be earned by the employees.

Measuring Service Cost
Pension Benefits Other Postretirement Benefits 100% 0% Pension benefits are earned gradually over the service life of active employees. Other postretirement benefits occur in stair steps. Either the retired employee is fully eligible for postretirement benefits or not. When the retired employee becomes eligible, the benefits will be paid in full. Employees earn benefits gradually. No benefits until full eligibility.

Determine the components of postretirement benefit expense.
Learning Objectives Determine the components of postretirement benefit expense. LO11 Learning objective number 11 is to determine the components of postretirement benefit expense.

Postretirement Benefit Expense
Here is a list of the components of postretirement benefit expense. As you read through the list, you should notice that most of the items have been discussed previously. The only new terms to be remembered are the expected projected benefit obligation and the accumulated projected benefit obligation. The accounting for postretirement benefit expense is very similar to the accounting for pension expense.

Service Method of Allocating Prior Service Cost
Appendix 17 In the appendix to this chapter we will look at the service method of allocating prior service cost. Recall that we previously allocated prior service costs on the straight-line basis.

The Service Method The allocation approach that reflects the declining service pattern of employees is called the service method. The method requires that the total number of service years for all employees be calculated. This calculation is usually done by the actuary. Assume Matrix, Inc. has 2,000 employees and the company’s actuary determined that the total number of service years of these employees is 30,000. We would calculate the following amortization fraction: Part I The allocation method that reflects that the declining service pattern of employees is called the service method. The method requires that we estimate the total number of service years for all employees. This can be quite a daunting task. We usually request our actuary make this computation. Part II Matrix has 2,000 employees and the company’s actuary has determined that the total number of service years of these employees is 30,000. We will use this information to calculate the proper amount of amortization. Part III In the first year, 30,000 total service years will appear in the numerator of the equation, and the 2,000 total employees will appear in the denominator. We will have an average service life in the first year of 15 years. This service life will change from year to year. 30,000 2,000 = 15 average service years

End of Chapter 17 End of Chapter 17.

Pensions and Other Postretirement Benefits

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