1. © 2005 by Robert F. Halsey, all rights reserved Agenda Pensions Deferred Taxes

2. © 2005 by Robert F. Halsey, all rights reserved Defined contribution plans (401k) Pension expensexxx Cash (contribution)xxx Employees CompanyTrustee Employees $ $ $ $

3. © 2005 by Robert F. Halsey, all rights reserved Defined Benefit Plans Promise to pay annuity to employee after retirement, usually based on final salary and years of service IOU to employees - Pension plan assets/liabilities stay with company until paid/satisfied Accounting issues: Recognition of assets/liabilities on B/S Recognition of pension expense in I/S

4. © 2005 by Robert F. Halsey, all rights reserved 7 © 2005 by Robert F. Halsey Fair Market Value of the Pension Assets Future Benefits as promised by the company Present value of the Projected Benefit Obligation (PBO) Accrued Pension Asset / Liability (Balance Sheet) PV Balance Sheet Presentation

5. Basic Accounting Entry Pension expense (I/S)100 Accrued pension liability (B/S)25 Cash (B/S)75 pension expense is determined first accrued (prepaid) pension liability is a function of cash contribution  If contribution > expense  dr prepaid pension cost (asset)  If contribution < expense  cr accrued pension liability amount of cash contribution does not determine expense

6. © 2005 by Robert F. Halsey Service cost (determined by actuaries) + Interest cost (BOY PBO x discount rate) - Expected return (BOY investments x L-T ROR) Pension expense Overview - Pension Expense

7. Average rates used by Companies

8. © 2005 by Robert F. Halsey, all rights reserved Basic Pension Example

9. Pension plan assets, Jan 1350,000 Projected Benefit Obligation, Jan 1490,000 Discount rate 8.5% Service cost for year 40,000 Company contributions 30,000 Expected return on plan assets (9%) 31,500 Actual return on plan assets 49,700 Benefits paid to retirees 34,400 a. Compute pension expense for the year.

10. Pension plan assets, Jan 1350,000 Projected Benefit Obligation, Jan 1490,000 Discount rate 8.5% Service cost for year 40,000 Company contributions 30,000 Expected return on plan assets (9%) 31,500 Actual return on plan assets 49,700 Benefits paid to retirees 34,400 b. Compute the balance in the PBO at the end of the year.

11. Pension plan assets, Jan 1350,000 Projected Benefit Obligation, Jan 1490,000 Discount rate 8.5% Service cost for year 40,000 Company contributions 30,000 Expected return on plan assets (9%) 31,500 Actual return on plan assets 49,700 Benefits paid to retirees 34,400 c. Compute the balance in the pension plan assets at the end of the year.

12. Pension plan assets, Jan 1350,000 Projected Benefit Obligation, Jan 1490,000 Discount rate 8.5% Service cost for year 40,000 Company contributions 30,000 Expected return on plan assets (9%) 31,500 Actual return on plan assets 49,700 Benefits paid to retirees 34,400 d. Prepare the pension journal entry for the year.

13. JE Memo ItemsAnnual Pension Expense CashPrepaid/Accrued Pension Cost PBOPlan AssetsUnrecognized (gains) losses Bal Jan 1 Service cost Interest cost Return on plan assets Contributions Benefits Journal entry Balance Dec 31 Pension Entries Template

14. © 2005 by Robert F. Halsey, all rights reserved 3M mini-case

15. © 2005 by Robert F. Halsey, all rights reserved

16. Minimum Liability How computed? (ABO - FMV Pension Investments) How recorded / reported? Intangible Asset*xxx Additional Pension Liabilityxxx (amt to yield ABO) * Dr OCI for excess of minimum liability > PSC

17. © 2005 by Robert F. Halsey, all rights reserved Deferred Taxes r There are differences between pre-tax income (10-K) and taxable income (tax return) Straight line depreciation for books and accelerated for tax Restructuring accruals reduce book income, but are not a tax deductible expense until paid r Therefore, tax expense does not equal taxes payable r Differences result in deferred tax liabilities and deferred tax assets

18. © 2005 by Robert F. Halsey, all rights reserved Accounting entry Income tax expensexxx (plug) ➂ Def Tax asset/liabxxx/ xxx ➁ Tax payable xxx ➀ Note: DTAs/DTLs can be debited or credited. Income tax expense is the plug figure to balance the entry. This is a balance sheet approach

19. Valuation allowance All assets must be tested for impairment before issuance of F/S, including DTAs DTAs are only an asset if they provide future benefits (e.g., company will generate future taxable income to utilize available credits – loss carryforwards are an example) If DTAs wil not be realized, must provide an allowance  Effect is to reduce DTA and increase tax expense when allowance is created, the opposite when reversed

20. © 2005 by Robert F. Halsey, all rights reserved Amazon mini-case