1. Pensions
ACCTG 5120
David Plumlee

2. Important fact… Accounting we are talking about is for the company!
The pension fund is actually managed and accounted for separately
legal and accounting entity of its own…..
We focus on the impact of an asset/liability/expense for payment of the pension obligation from the company’s perspective

3. Pensions: The Big Picture
Funding
Payments
Employer
Pension Fund Trustee
Invests funds to earn a return and payout cash to retiree
Retiree
Benefit Payments

4. Basic questions
What is employer’s liability/asset (how should this be reported on the balance sheet)?
What is the current year’s expense associated with the plan?
We will spend the rest of our class time wresting with the following two issues
what is the liability
what is the expense?
Pretty simple concepts--but lots of ways to measure them and we have to decide the best (or rather (the required amount…..under fas87)

5. Defined Contribution Plan
Employer contracts for an amount to be contributed
Example Plan
The company will make a contribution under the plan equal to a stated percentage of the employee’s current annual salary. The percentages applied vary according to age (see attached table). All employees are required to make a 5% minimum contribution. Ownership of all contributions is fully vested in the participant.
employer sponsored pension plans are either defined contribution plans or defined benefit plans
here is an excerpt from a defined contribution plan
under the terms of this plan the employer agrees to make a contribution of some % of salary
where the specific % depends on the employee’s age
the plan requires employees to make a contribution as well equal to 5% of salary
if the employee does not make his/her contribution to the plan then the employer does not have to make its contribution to the plan either
this is described as a contributory plan
a contributory plan is one in which the employee is required to make contributions as well as the employer
a non-contributory plan on the other hand does not require the employees to make any contribution to the plan
only the employer makes contributions under a non-contributory plan
the terms of the plan also allow for full and immediate vesting of the contributions
what does that mean?
once the contributions have vested they become the property of the employee on whose behalf they we made
so if the employee quits the company they can take the contributions plus any accrued income on them with him or her
it is not unusual for there to be a waiting period before contributions vest since companies don’t want employees joining the company working for a short period of time and then leaving with entitlement to their pension benefits
this is a right that they want employees to earn only after being with the company for a reasonable period of time
questions so far?

6. Defined Contribution Plan
Employee
Employees Company% Wages
< age % $150,000
45 to % $350,000
50 to retirement 11.5 % $200,000
the terms of this particular plan are such that the employers required contribution as a percentage of the employee’s salary varies with the age of the employee
so for example, for employees under the age of 45 the employer makes a contribution to the plan of 7% of salary
for employees between 45 and 49 the percentage increases to 8.5% of their current year salary
and finally at age 50 to retirement it goes up to 11.5%

7. Company contribution
=$1,500,000* $3,500,000* $2,000,000*.115
=$335,000

8. Defined Contribution Example
Benefit period
Total Employment Period

9. Defined Benefit Plan Employer contracts for future payouts
Example Plan
The company agrees to provide to all employees at age 65, an annual pension benefit computed in accordance with the “benefit formula.” Ownership of all benefits becomes fully vested following three years of continuos employment with the company.
life is not so simple when we are facing a defined benefit pension plan
once again here is an excerpt from a typical defined benefit pension plan
please not that these are just examples of defined contribution and defined benefit plans that are representative of plans that you might run into
however, each plan is unique in terms of its particular terms and formulas that are applied to determine either the required contribution for a defined contribution plan or the required pension benefit for a defined benefit plan
under the terms of this particular plan the employer agrees to pay an annual benefit to employees after age 65 equal to an amount that is determined in accordance with the benefit formula (we will take a look at the benefit formula for this plan in a moment)
in this case the benefits become vested in the employee following three years of employment
so if the employee leaves before the three years is up they are entitled to no pension benefit but if they stay beyond three years they are entitled to the annual benefit specified by the formula even if they quit or are fired before retirement

10. Defined Benefit Example
Total Employment Period
Benefit period

11. Determining Employer Contribution
What does the employer need to do?
What is the amount of that liability?

12. Actuarial Assumptions
Assume for an employee who works for this company:
Benefits are $4,000 per year in retirement for every year worked
Expected # of years at company = 20 yrs
Employee will live 15 years beyond retirement
Settlement rate is 6%. (The interest rate implicit in the annuity contract at retirement.)
Expected rate of return 8%. ( The amount that funding will earn.)
so lets say you are an employee of this company and you want to estimate how much your annual pension benefit will be when you retire
you want know if you are going to be able to afford the 3 months in Hawaii every year that you’re planning on
so you sit down and you estimate how much you expect to be earning on average over the last 3 years of employment with the company - lets say that works out to $100,000
and how long you expect to be employed by the company - say 20 years
using this information and the benefit formula how much will your annual pension benefit be?
$40,000
so if everything works out just like you plan you will get $40,000 per year 20 years from now for each year you are retired after the age of 65
at todays rates of inflation that should be about enough to keep you in hamburger but thats about it!
So--now that we have figured out that you hope SS still exists when you retire--how would the employer account for this???
How much is ‘tchnically’ a liability--when is it earned?
All those basic questions….

13. Actuaries Determine Benefits
Current
period
Retirement
Total Employment Period
Actuarial Estimate of Retirement Benefits
= PV of Settlement Rate

14. Actuaries Determine Benefits
Retirement Benefits =
Remaining Employment Period = 20 years
Current
period
Retirement = 15 years

15. Actuaries Determine Funding
So, how much should the company fund this year?
What is that amount in this example?

16. Actuaries Determine Funding
Current
period
Retirement = 15 years
Remaining Employment Period = 20 years

17. Defined contribution vs. benefit plans
Employer’s contribution is based on expected payout
Contract is for payments to retired employees employer bears risk associated with plan performance
Great uncertainty regarding annual pension expense
Contribution
Employer’s contribution to the plan is defined
No promises regarding ultimate pension benefit
Employees bear risk associated with plan performance
No uncertainty regarding annual pension expense

18. Accounting for Defined Contribution Plans
Assume required contribution under terms of plan for 2003 is $335,000
Employer Funding
Contribution Status
Case A: $335, fully funded
Case B: $300, under funded
Case C: $600, over funded
say that the company did this and determined that the contribution required of them under the terms of the plan is $335,000
now the company must decide whether it wants to fund the plan by this amount this year or if its short of cash it might decide to pay a little less than this year and owe the plan some amount which it will have to catch up with interest at a later date, or if it has some extra cash this year the company may decide to pay a little extra this year in advance of future required contributions
so “funding” a plan is the act of making cash contributions to the plan that will be set aside and invested
a funded plan - refers to the status of the plan in terms of how much money has been set aside to date
the funding status of the plan can further be described as “fully funded” i.e. case A, “under funded” i.e. Case B and “over funded - Case C”
any questions so far
then lets look at the accounting for each of these three possible cases

19. Accounting for Defined Contribution Plans
Case A:
Case B:
Case C:
if the company fully funds the plan the entry debits pension expense and credits cash for the required contribution
if however, the company is somewhat short of cash and decides to fund only $300,000 this year then the entry still records pension expense based on the required contribution of $500,000 but now the cash leaving the firm is only $300,000 the other $200,000 is a liability of the company to the pension plan
i.e. the firm owes the plan $200,000 so we credit this to a liability account called “pension obligation” which will be classified as a current or long-term liability depending on how long we expect to owe the money
any questions so far?
then what would the entry look like for case C where we pay in $600,000 even though the required contribution is only $500,000

20. Defined BENEFIT Options
Cash basis accounting
wait until employees retire
expense actual payments to retired employees
Modified cash basis accounting
fund plan prior to retirement
expense funding payments
Accrual basis accounting (FAS 87)
expense pension related cost of services provided in current year by employees
various approaches to accounting for pension expense of defined benefit plans cope with this uncertainty to varying degrees
for example
the company could wait until the employees retire
then when they make actual payments to retirees they could charge these to pension expense at that time
PROBLEMS?
may not have enough money to meet obligation in the future (economic problem)
fail to match the cost of the plan to the period that the employees rendered their service to the company (accounting problem)
how useful is Joe to us sitting in his basement making bird houses after he retries? - not very
so if we wait until that time to charge his pension benefits to expense we will be expensing something for which we get no benefit
we received the benefit of Joe’s service before he retired and so that is when the cost of his plan should be expensed
view the pension plan as deferred salary - if we didn’t have a pension plan we would have had to pay Joe a higher annual salary when he was working
alternatively we could use a modified cash basis
say we recognize that their may be some concern about not having enough money to satisfy the obligation in the future
and we recognize that waiting until Joe retires to start expensing his pension is not entirely correct

21. What is the ‘obligation’?
Given we use an accrual method of accounting there arethree measures of pension obligation
all require input from actuaries about estimated payments required
2 big differences
first is whether we are going to use current salary levels or future salary levels
second is whether amounts ‘due’ to employees that are not vested in plans will be considered an obligation prior to vesting
what is vesting
under ERISA--
must vest fully within 5 years or 20% within three years with another 20% each year until fully vested after 7 years
While these are all theoretical measures of pension obligation--the ones we will use are the PBO and the ABO.
There are times when the ABO (even though it understates the net liability) is used to compute the MINIMUM liability = ABO - plan assets
discuss this more later….
Accumulated benefit obligation (ABO)
Estimate of total retirement benefits based on current salary levels
Vested benefit obligation
Portion of ABO that is vested
Projected benefit obligation (PBO)
Estimate of total retirement benefits based on future salary levels

22. Major Components of a Pension Plan
PBO
actuarial present value of future pension benefits earned to date to be paid to employees in the future
Pension plan assets
value of assets set aside to satisfy obligation
**net pension obligation (asset) =PBO-pension assets**
Pension expense
amount charged to income for the period
so instead the FASB said companies would be required under FAS 87 to account for pension expense using an approach that is consistent with the accrual basis of accounting
using certain assumptions and a specified actuarial approach companies are required to determine the pension cost arising from services rendered by employees in a given year
and regardless of how much you decide to fund this year that is the amount we want you to expense (so even if you don’t put away enough cash this year to meet your future obligation, you need to accrue the expense…)
so under FAS 87 it is very likely that the company will expense an amount which is completely different from the amount that they fund during the period
neither the PBO or the pension plan assets are reported on the balance sheet--but they will determine how much outstanding liability is shown !!!
over the next few classes we are going to take an in-depth look at how we compute pension expense under FAS 87 AND WHY we compute it the way we do
a first step in getting there is to make sure that we are speaking the same language when it comes to the main components of a pension plan - the plan obligation, the plan assets and total pension expense

23. the pension obligation (or more accurately projected benefit obligation) is the actuarial present value of the future pension benefits that the company has promised it will pay to its employees when they retire that have been earned to date--so this is the amount a lot of companies would put into a fund and expense in a given year.
the adjective actuarial just means that this is the present value computed by an actuary one of several actuarial valuation methods and taking into consideration a whole host of assumptions with respect to employee turnover, longevity after retirement, interest rates etc. (I will have a lot more to say about this next class)
the pension plan assets are just the assets which have been set aside to satisfy this obligation
very often the company will make cash contributions to a trustee that will invest and administer the plan assets and make benefit payments to existing retirees out of the plan assets
the difference between the total amount we owe and the assets we have set aside to satisfy that obligation is the company’s net pension obligation (or net pension asset if assets exceed the obligation)
on the balance sheet of the company we could show plan assets under the assets side of the balance sheet and PBO under the liabilities side of the balance sheet , but we end up netting the two and show only the net amount on the balance sheet
so for computation purposes both are important, for disclosure purposes the net under or over funded balance is important
any questions on this?
before we can introduce how each of these is generally computed we first need to get some important terms out on the table

24. Important Terms Benefit payments Funding payments
pension payments to participants
Funding payments
payments made to the trustee to fund the plan
Transition adjustment
“catch-up” adjustment that arose when firms first adopted FAS 87
for example
benefit payments are the actual pension benefit payments made to retirees of the company
funding payments on the other hand are the payments that the employer makes to the trustee to fund the plan
it is out of accumulated funding payments plus interest, dividends and capital gains that benefit payments are made
so benefit payments and funding payments are two very different things and should not be confused with one another
the transition adjustment is the catch up adjustment that firms had to make when they first adopted FAS 87 in 1986/87

25. Important Terms Current service cost (CSC)
present value of benefits earned during the current period
Actual return on plan assets
includes dividends, interest income and capital gains and losses
Expected return on plan assets
anticipated return on plan assets based on the expected long-term rate of return on plan assets
current service cost or service cost is the present value of the benefits earned by employees because they worked the current year for the firm
this is generally the largest component of pension expense
actual return on plan assets is the return generated on the plan assets during the year and includes interest income, dividend income and capital gains less capital losses
the actual return should not be confused with the expected return
one of the assumptions that the actuary makes is the rate of return that they expect the plan assets to earn over the long-term (and it is very unlikely that the average long tem will be the same as any single year return!!)
to the extent that the actual return is greater than the expected return -- then we can say we had good experience this period
that is we had an experience gain

26. Important Terms Experience gain or loss Actuarial gain or loss
difference between actual and expected return on plan assets
Actuarial gain or loss
a change in the value of the PBO resulting from a change in actuarial assumptions
Prior service cost (PSC)
cost of retroactive benefits granted in a plan amendment
on the other hand if we actually earned less than we expected to then we had an experience loss
so experience gains and losses are just the difference between the actual and expected return on plan assets
actuarial gains and losses on the other hand arise when the actuary changes an assumption in his or her computations of the company’s projected benefit obligation
so for example -- say when the actuary last estimated the PBO he/she assumed that on average employees would live until they are 70 but a new study shows that average life expectancy has increased and so he/she decides it is more likely that on average employees will survive until 75
the impact of making that change in assumption in the computation of the projected benefit obligation is going to be to increase the PBO significantly from what we originally computed
since now for every employee we are assuming five more years of pension benefits will have to pay
changes in assumptions that increase the PBO give rise to actuarial losses
and changes in assumptions that reduce the obligation give rise to actuarial gains
FINALLY prior service costs
prior service costs arise when a company retroactively adopts or amends a pension plan
for example say in 1997 wash u adopts a defined benefit pension plan for its faculty
when they adopt the plan they may say, faculty, because you are so loyal and hardworking we will give you credit for years 1995 and 1996 when we compute you pension benefits
so even though the plan is only adopted in 1997, the number of years used in the benefit formula would be 3 as of the end of 1997
the effect of this decision is to incur a huge pension obligation and a need to catch up on the pension related pension expense for 1995 and 1996 at the time that the plan is adopted
we refer to the cost of this obligation as prior service costs

27. Pension Assets opening balance + actual return on plan assets
Pension Fund Trustee
Invests funds to earn a return and payout cash to retiree
opening balance
+ actual return on plan assets
+ funding payments
- benefit payments to retirees
closing balance
we compute the plan assets available at the end of a given year by starting with the opening balance and
adding the actual return on the plan assets during year
and the funding payments made to the trustee during the year by the company
and subtracting any cash payments made to the company’s retirees
any questions so far?

28. Projected Benefit Obligation
opening balance
+ current service cost
+ prior service cost
+ interest on obligation
- benefit payments to retirees
+/- changes in assumptions
(i.e. actuarial gains/losses)
closing balance
Employer
it is important that you quickly become familiar with these terms because they are going to pop into the conversation constantly
armed with this tool bag of terms we can now take a look at how the pension obligation and plan assets change over time and how pension expense is computed
this is just an overview we will come back to each computation in detail next class and on Monday
a company’s pension obligation as at the end of a given year is computed by starting with the amount owing at the beginning of the year
plus the cost of the pension benefits arising from services provided by employees in the current year - this is called current service cost
plus the cost of pension benefits arising from retroactive changes to the plan i.e. prior service cost
plus interest on the obligation
since the pension obligation is stated at present value we have to accrue interest on the amount owing thereby increasing the obligation
the obligation is reduced by any payments actually made to retirees
and finally it can be increased or decreased because of changes in the actuaries assumptions

29. Pension Expense + current service cost
+ interest on pension obligation
- actual return on plan assets
+/- deferral of experience gain/loss
+/- amortization of unrecognized gain/loss
(including experience and actuarial gains/losses)
+ amortization of unrecognized prior service cost
+/- amortization of transition adjustment
pension expense
then finally let’s introduce the pension expense computation
pension expense is the sum of a whole host of components
specifically current service cost plus interest on the pension obligation minus the expected return on plan assets (not the actual return) + amortization of unrecognized prior service cost + amortization of unrecognized gains and losses (arising because we reduced pension expense by expected return not actual return) and amortization of unrecognized changes in assumptions
next class we will spend almost the entire class figuring out how to compute each of these items and why they are computed and treated the way they are

30. Current Service Cost
Actuarial present value of new benefits earned by employees during current period
Current
period
Retirement
Total Employment Period
the current service cost is the actuarial present value of the new pension benefits earned by the firms employees during the year
based on actuarial assumptions--one more year of service is included in the calculations--this is the main component of pension expense
PV of additional retirement benefits

31. Effect of Service Cost
Assume a $500,000 increase of PBO due to additional year of service
Expense
Current service cost increases
in first year of plan, same as for PBO
PBO
Service cost is starting point
Current service cost will increase PBO on an annual basis
Beg Bal $1,300,000
Current SC , $ 500,000

32. Prior Service Cost Credit given to employees for past service
Initiate or amend a plan
Retroactive benefits
really retroactive?
Expectation of future service….
Increases PBO
Amortize PSC for pension expense
Years of service method
prior service cost = $100,000, 5 year amortization

33. Prior Service Cost
Prior service period
PV of benefits due to plan amendment or adoption for past periods
Plan Amendment
Current
period
Retirement
Total Employment Period

34. Effect of PSC PBO Expense Increases by total amount in year of change
amortized into over estimated life of employees effected, beginning with year of change
Beg Bal $1,300,000
Current SC , $ 500,000
PSC , ,000

35. Interest on Pension Obligation
Employee is one year closer to retirement, which increase present value of benefits due to the time value of future benefits
Interest on the pension obligation (i.e. projected benefit obligation) outstanding during the period
= beginning-of-year balance x settlement rate
Assume settlement rate = 10%
or companies can look to the current return on low risk investments to get an estimate of the settlement rate
why low risk investments?
because you want to make sure that if you were to buy assets today to settle the future pension obligation that the returns on those assets are pretty much guaranteed
so you would not want to use the return on risky assets because there is too much uncertainty regarding the future income stream from risky investments
any questions on this?

36. Effect of Interest Increases expense Increases PBO Beg Bal $1,300,000
Current SC , $ 500,000
PSC 100, ,000
Interest 130, ,000

37. Payments and changes in assumptions
Benefit payments reduce PBO
Payments have NO EFFECT on pension expense
Assume $30,000 funding payment
Changes in actuarial assumptions
Increase or decrease PBO
Amortized in pension expense (when too big!)
Assume actuarial assumptions change amount is increase in PBO of $40,000

38. Effect of payments and changes in assumptions
Payments decrease PBO
Changes in actuarial assumptions change PBO
No effect
Changes in actuarial assumptions are amortized into expense using corridor approach
Beg Bal $1,300,000
Current SC , $ 500,000
PSC 100, ,000
Interest 130, ,000
Benefit pmt ( 30,000) 00
Actuarial loss , *

39. Return on Plan Assets Actual return =
Pension Fund Trustee
Actual return =
interest + dividends + cap. gains - cap. losses
Expected return = actuary’s expected rate of return x plan assets
Difference is the ‘experience gain or loss’
the next item is the return on plan assets which typically reduces pension expense for the period
remember that there are two return numbers that are important
the actual return on plan assets which is the sum of interest and dividends for the year and capital gains minimum capital losses
and the expected return on plan assets which is the amount of the return the actuary expected the plan assets to generate during the period based on a long-run average rate of return
can anyone see a problem with including the actual return on plan assets in the computation of pension expense?
could result in wild swings in pension expense
for example the company might be able to achieve a 40% return in the stock market for a given year or should another black Monday hit they might have a return of -60% in that year
the question is whether substantial and perhaps one time events like this should be left in current pension expense
actuaries ignore fluctuations like this when they develop a funding plan
they make an assumption about what the plan assets will earn over the long-term and use this expected rate of return to compute the expected return on plan assets for a given year
the difference between the expected return on plan assets and the actual return on plan assets is called and actuarial gain or loss
the FASB concluded that it was not appropriate to include actual return in the computation of pension expense because of concerns over wild swings such as these

40. Details of expected return
Actual return reduces pension expense with ‘experience’ gains/losses deferred
Net result is EXPECTED return reduces pension expense
Amortize experience gains/losses when they gets too large

41. Return on plan assets Plan assets = $1,000,000
Actual return at 25%= $250,000
Expected return at 11% = $110,000
unexpected gain (i.e. experience gain) = 250, ,000=140,000
Reduce pension expense by $250,000
Defer experience gain of $140,00 (incr. Pension exp.)
so for example lets say we have plan assets of $1,000,000 accumulated in the pension plan to satisfy for the future pension benefits
lets say we expect that over the long haul we will on average generate a return of 11%
let’s also say that this year was a great year for the stock market and in reality we earned a return this year of 25%
the actual return on plan assets = $250,000
the expected return on plan assets = $110,000
so in this case the company had an unexpected (or experience) gain of $140,000
continuing on with the example we started earlier
pension expense would be computed and disclosed in the financial statement footnotes in the following manner
why do we report actual return and then adjusted for the unexpected portion to get back to expected return
why not just report the expected amount?
there is a lot of important information in the actual amount
but the important thing to realize is that on net, pension expense is not reduced by the actual return, but by the expected return

42. Effect of return on plan assets
No effect
Reduces expense by expected return
Actual return less the deferred ‘experience gain/loss’
Beg Bal $1,300,000
Current SC , $ 500,000
PSC 100, ,000
Interest 130, ,000
Benefit pmt ( 30,000)
Actuarial loss , *
Actual return (250,000)
Deferred exp gain ,000

43. Delayed Recognition Under FAS 87
Impact of following items not fully recognized when they occur
experience gains and losses
actuarial gains and losses (i.e. impact of changes in assumptions)
prior service cost
transition adjustment (IGNORE!!)
as a result, the experience gain or loss is not recognized in pension expense when it occurs
instead it is deferred and ultimately effects pension expense at a later date
this is an example of delayed recognition
but this is not the only item which is afforded delayed recognition treatment
delayed recognition treatment is also applied to actuarial gains and losses, prior service costs and the catch up adjustment from adopting FAS 87, i.e. the transition adjustment
this has very significant implications for accounting and reporting of pensions
because it is because of the FASB’s decision to require delayed recognition of these amounts that pensions still give rise to very significant off-balance sheet assets or liabilities
if you know where to look and how to interpret pension footnotes this will not cause a problem but for the uniformed it can lead to serious problems

44. With Full Recognition:
to see why this is so consider what life would be like without delayed recognition
to record CSC we should be debiting pension expense and crediting the pension obligation account
to record the effect of prior service costs arising in the current period because of retroactive initiation or amendment of the plan we should again debit pension expense and credit the obligation
same with accrued interest on the obligation
the entry to record benefit payments would simply debit the pension obligation and credit plan assets
and the impact of changes in assumptions, which are like catch up adjustments to pension expense, would be recorded by debit or crediting the pension obligation as the case may be and debiting or crediting pension expense
as far as the plan assets go, the entry to record the actual return on plan assets would be recorded by debiting plan assets and crediting pension expense
we already talked about how benefit payments would be recorded
and finally contributions or funding payments into the plan would be recorded by debiting plan assets and crediting cash
so if we used an approach of full and immediate recognition of each of these items the balance sheet would show a pension obligation equal to the ending balance in the first column, a pension asset account equal to the ending balance in the second column and total pension expense equal to the total of third column
but FAS 87 does not adopt an approach of full and complete recognition for all items
for psc, return on plan assets and the impact of changes in assumptions, FAS 87 adopts a delayed recognition approach

45. Effect of Delayed Recognition
Prepaid (accrued) pension reported on balance sheet may not equal net pension asset (obligation)
i.e. frequently companies have significant off-balance sheet pension liabilities or pension assets
Total pension expense does not equal the change in the PBO
as a result, the amount of prepaid or accrued pension reported on the balance sheet may not be equal to the net pension obligation or asset computed as the difference between the pension obligation and the plan assets
instead many if not most companies disclose in the footnotes significant off balance sheet pension assets or liabilities that arise because of delayed recognition
in addition,pension expense does not equal the sum of the items shown here but instead includes only an amortized portion of those items that are afforded delayed recognition treatment
so let’s continue looking at the remaining components of pension expense bearing in mind that delayed recognition applies in each case
let’s start with gains and losses - this category includes both to deferred experience gains and losses and deferred actuarial gains and losses

46. The Corridor Approach Minimum amortization
allow gains less losses to accumulate until net amount deferred exceeds a defined threshold
amortization required when beginning-of-year net gain or loss exceeds 10% of maximum opening (PBO or fair value of plan assets)
amortization period is Estimated Average Remaining Service Life of the active employees expected to receive benefits
amount amortized is the EXCESS over the corridor amount.
(beginning net deferred gain/loss - threshold)/EARSL
I said earlier that we will defer gains and losses and only begin to amortize them to pension expense when the unamortized balance is viewed as becoming too large
this is done to smooth out pension expense since we do not want wild fluctuations in pension expense from one period to the next and if our assumptions are unbiased over time gains and losses should net out such that the net balance is relatively minor
but should it get too large then we must reduce it by amortizing the excess to pension expense
all that remains then is some approach to assessing when the the net balance has become too large and this is where the corridor approach comes in
we keep track of the amounts deferred and we do not begin amortizing them to pension expense until they reach a defined threshold
the limits are discussed in the text and they are based on 10% of the PBO or FMV of the plan assets which ever is larger
once that limit is passed such that the total amount deferred to date exceeds the defined threshold then the company must amortize the excess
so they take the difference between the total amount of the actuarial gains and or losses deferred deduct the threshold and then typically using the SL method amortize the excess over a period not to exceed five years
so in any given period in which there are deferred exchange gains and losses there may or may not be an adjustment to pension expense for amortization of previously deferred actuarial gains and losses
the computation I just described is the minimum amount of amortization that firm’s must take
they can, however, amortize at a faster rate if they want to using straightline amortization the full amount of the net gain or loss at the beginning of the period can be written off

47. Corridor Example Beginning fair value of plan assets = $1,000,000
Beginning of year PBO = $ 1,300,000
Beginning of year deferred gain/loss = $180,000
End of year deferred gain = $320,000
EARSL = 10 years
so let’s continue with our previous example
we computed earlier that this year we had an experience gain of the question is, does any of that amount have to be amortized this period and if so how much
well 10% of the opening balance of the greater of the plan assets or the PBO is 130,000
as far as we know the opening balance of the net deferred gains and losses is zero
so this year we have no amortization to take
next year may be a different story since we will have an opening deferred gain of at that point in time which may exceed the corridor

48. Corridor Solution Determine 10% threshold Amortization amount
10% of beginning PBO = $130,000
10% of beginning FV plan assets = $100,000
Amortization amount
Beginning deferred gain/loss = $180,000
Corridor (10% of PBO) ,000 Total amort. Amount $50,000
(This year’s portion $50,000/10=$5,000)

49. Effect of amortization
No effect
Increases expense
Beg Bal $1,300,000
Current SC , $ 500,000
PSC 100, ,000
Interest 130, ,000
Benefit pmt ( 30,000)
Actuarial loss , *
Actual return (250,000)
Deferred exp gain ,000
Amortization ,000

50. What do we record? Journal entry to record pension expense
as calculated above
Entry to record funding payment
Balance to pension asset/liability

51. What is not on the balance sheet?
Unrecognized experience gains/losses
Plan assets include actual return not expected return
Unrecognized prior service cost
PBO includes entire prior service cost not amortized
Unrecognized actuarial gains/losses
PBO includes all actuarial gains/loss

52. Minimum liability
Concerns over underfunded plans with no balance sheet recognition
Requires reporting of ‘minimum liability’
Difference between fair value of plan assets and ABO
Can only report in a liability, not additional asset….
(when ABO is less than FV of plan assets)

53. Recording
Compare minimum liability to balance sheet and adjust for difference
Debit contra equity account for amount related to PSC
Debit balance to Intangible Asset-Deferred Pension Cost
Credit additional pension liability for amount minimum liability exceeds reported liability/asset

54. Minimum Liability Example
Assume no minimum liability attributable to PSC.
Intangible Asset - Deferred Pension Cost $XXXX
Minimum Liability $XXXX
Assume $ 100,000 attributable to PSC.
Intangible Asset - Deferred
Pension Cost $(XXXX-$100k)
Contra Equity Account $100K
Minimum Liability $XXXX