ACCOUNTING FOR PENSIONS AND POSTRETIREMENT BENEFITS C H A P T E R 20 ACCOUNTING FOR PENSIONS AND POSTRETIREMENT BENEFITS Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield

Learning Objectives Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. Identify types of pension plans and their characteristics. Explain alternative measures for valuing the pension obligation. List the components of pension expense. Use a worksheet for employer’s pension plan entries. Describe the amortization of unrecognized prior service costs. Explain the accounting procedure for recognizing unexpected gains and losses. Explain the corridor approach to amortizing unrecognized gains and losses. Explain the recognition of a minimum liability. Describe the requirements for reporting pension plans in financial statements.

Accounting for Pensions and Postretirement Benefits Nature of Pension Plans Accounting for Pensions Using a Pension Worksheet Reporting Pension Plans in Financial Statements Defined contribution plan Defined-benefit plan Role of actuaries Alternative measures of liability Recognition of net funded status Components of pension expense 2010 entries and worksheet Amortization of prior service cost 2011 entries and worksheet Gain or loss 2012 entries and worksheet Within the financial statements Within the notes to the financial statements Pension note disclosure 2013 entries and worksheet—a comprehensive example Special issues

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 Plan Types of Pension Plans Defined-Contribution Plan Defined-Benefit Plan Employer contribution determined by plan (fixed) Risk borne by employees Benefits based on plan value Benefit determined by plan Employer contribution varies (determined by Actuaries) Risk borne by employer Actuaries estimate the employer contribution by considering mortality rates, employee turnover, interest and earning rates, early retirement frequency, future salaries, etc. LO 2 Identify types of pension plans and their characteristics.

Accounting for Pensions Two questions: What is the pension obligation that a company should report in the financial statements? What is the pension expense for the period? LO 3 Explain alternative measures for valuing the pension obligation.

Accounting for Pensions The employer’s pension obligation is the deferred compensation obligation it has to its employees for their service under the terms of the pension plan. Alternative measures of the Liability Illustration 20-3 FASB’s choice LO 3 Explain alternative measures for valuing the pension obligation.

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.

+ + +- + +- Accounting for Pensions Components of Pension Expense 1. Effect on 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.

Accounting for Pensions Components of Pension Expense Effect on Expense 1. Service Costs + Actuarial present value of benefits attributed by the pension benefit formula to employee service during the period. LO 4 List the components of pension expense.

Accounting for Pensions Interest on the Liability Components of Pension Expense Effect on Expense 2. Interest on the Liability + Interest for the period on the projected benefit obligation outstanding during the period. The interest rate (settlement rate) should reflect the rate at which companies can effectively settle pension benefits. LO 4 List the components of pension expense.

Accounting for Pensions Actual Return on Plan Assets Components of Pension Expense Effect on Expense 3. Actual Return on Plan Assets +- The actual return on plan assets is the increase in pension funds from interest, dividends, and realized and unrealized changes in the fair-market value of the plan assets. LO 4 List the components of pension expense.

Accounting for Pensions Amortization of Prior Service Costs Components of Pension Expense Effect on Expense 4. Amortization of Prior Service Costs + Plan amendments often increase benefits for service provided in prior years. The cost (prior service cost) of providing these retroactive benefits is allocated to pension expense over the remaining service-years of the affected employees. LO 4 List the components of pension expense.

Accounting for Pensions Components of Pension Expense Effect on Expense 5. Gain or Loss +- Volatility in pension expense can result from sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. 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.

Using a Pension Work Sheet 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.

Using a Pension Work Sheet BE20-3: At January 1, 20100, KRC Company had plan assets of $280,000 and a projected benefit obligation of the same amount. During 2010, service cost was $27,500, the settlement rate was 10%, actual and expected return on plan assets were $25,000, contributions were $20,000, and benefits paid were $17,500. Instructions: Prepare a pension worksheet for KRC for 2010. LO 5 Use a worksheet for employer’s pension plan entries.

Using a Pension Work Sheet BE20-3: Prepare a pension worksheet for KRC for 2010. ($280,000 x 10%) ($10,500) net liability LO 5 Use a worksheet for employer’s pension plan entries.

Using a Pension Work Sheet Note the following about the Work Sheet: The balance in the Pension Asset / Liability column should equal the net balance in the memo record – this is the “net funded position” of the pension plan. If a credit balance, Pension liability; if a debit balance, Pension asset. For each transaction or event, the debits must equal the credits. LO 5 Use a worksheet for employer’s pension plan entries.

Prior Service Cost Amortization of Prior Service Cost Company should not recognize the retroactive benefits as pension expense entirely in the year of amendment. Employer should recognize the pension expense over the remaining service lives of the employees who are expected to benefit from the change in the plan. Amortization Method: Board prefers a years-of-service method. SFAS No. 158 allows use of the straight-line method. LO 6 Describe the amortization of prior service costs.

Using a Pension Work Sheet E20-7: The following defined pension data of Rydell Corp. apply to the year 2010. Projected benefit obligation, 1/1/10 (before amendment) $560,000 Plan assets, 1/1/10 546,200 Pension liability 13,800 On January 1, 2010, Rydell Corp., through plan amendment, grants prior service benefits having a present value of 120,000 Settlement rate 9% Service cost 58,000 Contributions (funding) 65,000 Actual (expected) return on plan assets 52,280 Benefits paid to retirees 40,000 Prior service cost amortization for 2010 17,000 Instructions: For 2010, prepare a pension work sheet for Rydell Corp. that shows the journal entry for pension expense. LO 6 Describe the amortization of prior service costs.

Using a Pension Work Sheet – E20-7 Solution on notes page ($135,720) liability

Using a Pension Work Sheet E20-7: Pension Journal Entry for 2010. Dec. 31 Pension Expense 83,920 OCI - PSC 103,000 Pension Liability 121,920 Cash 65,000 LO 6 Describe the amortization of prior service costs.

Gains and Losses Gain or Loss Unexpected swings in pension expense can result from: Changes in the market value of plan assets, and Changes in actuarial assumptions that affect the amount of the projected benefit obligation. LO 7 Explain the accounting for unexpected gains and losses.

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 Question: What happens to the difference between the expected return and the actual return? Answer Recorded in Net Gain or Loss account. Amortize amount in excess of corridor to pension expense, over the average remaining service period of active employees expected to receive benefits under the plan. LO 7 Explain the accounting for unexpected gains and losses.

Gains and Losses Question: What happens with unexpected gains or losses from changes in the Projected Benefit Obligation (PBO)? Answer Recorded in Net Gain or Loss account. Amortize amount in excess of corridor to pension expense, over the average remaining service period of active employees expected to receive benefits under the plan. 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.

Gains and Losses BE20-7: Shin Corporation had a projected benefit obligation of $3,100,000 and plan assets of $3,300,000 at January 1, 2010. Shin’s also had a net pension actuarial loss of $465,000 in accumulated OCI at January 1, 2020. The average remaining service period of Hunt’s employees is 7.5 years. Instructions: Compute Shin’s minimum amortization of the actuarial loss. LO 8 Explain the corridor approach to amortizing gains and losses.

Gains and Losses ÷ BE20-7: Compute Shin’s amortization of the loss. LO 8 Explain the corridor approach to amortizing gains and losses.

Using a Pension Work Sheet P20-2: Jackson Company adopts acceptable accounting for its defined benefit pension plan on January 1, 2009, with the following beginning balances: plan assets $200,000; projected benefit obligation $250,000. Other data are as follows. LO 8 Explain the corridor approach to amortizing gains and losses.

Using a Pension Work Sheet P20-2: Pension Work Sheet for 2009 * * Expected Return on Plan Assets $200,000 x 10% = $20,000 ($57,000) Solution on notes page LO 8 Explain the corridor approach to amortizing gains and losses.

Using a Pension Work Sheet P20-2 Pension Journal Entry for 2009 Dec. 31 Pension Expense 21,000 OCI – Gain/Loss 3,000 Pension Asset/Liability 3,000 Cash 16,000 LO 8 Explain the corridor approach to amortizing gains and losses.

Using a Pension Work Sheet * Actual return = Expected Return P20-2: Pension Work Sheet for 2010 * * Actual return = Expected Return Solution on notes page ($217,700) liability LO 8 Explain the corridor approach to amortizing gains and losses.

Using a Pension Work Sheet P20-2 Pension Journal Entry for 2010 Dec. 31 Pension Expense 95,100 OCI - PSC 105,600 Pension Asset/Liability 160,700 Cash 40,000 LO 8 Explain the corridor approach to amortizing gains and losses.

Using a Pension Work Sheet P20-2: Pension Work Sheet for 2011 * Solution on notes page * Plug ($203,400) liability LO 8 Explain the corridor approach to amortizing gains and losses.

Using a Pension Work Sheet P20-2 Pension Journal Entry for 2010 Dec. 31 Pension Expense 83,430 OCI - Gain/Loss 52,370 OCI - PSC 41,600 Pension Asset/Liability 46,200 Cash 48,000 LO 8 Explain the corridor approach to amortizing gains and losses.

Reporting Pension Plans in Financial Statements Within the Financial Statements Pension expense Pension Asset / Liability Components of Accumulated Other Comprehensive Income LO 9 Describe the requirements for reporting pension plans in financial statements.

Reporting Pension Plans in Financial Statements Within the Notes to the Financial Statements Major components of pension expense. Reconciliation showing how the projected benefit obligation and the fair value of the plan assets changed. Amounts recognized in accumulated other comprehensive income that have not yet been recognized in pension expense, showing separately the net gain or loss and prior service costs, and the amounts to be recognized is pension expense in the next year. LO 9 Describe the requirements for reporting pension plans in financial statements.

Reporting Pension Plans in Financial Statements Within the Notes to the Financial Statements Disclosure of the rates used in measuring the benefit amounts (discount rate, expected return on plan assets, rate of compensation). Table indicating the allocation of pension plan assets by category (e.g., types of investments). The expected benefit payments to be paid to current plan participants for each of the next five fiscal years and in the aggregate for the five fiscal years thereafter. LO 9 Describe the requirements for reporting pension plans in financial statements.

Reporting Pension Plans in Financial Statements Special Issues The Pension Reform Act of 1974 Pension Terminations LO 9 Describe the requirements for reporting pension plans in financial statements.

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.”

Accounting Guidance In December 1990, the FASB issued rules on “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” These rules cover for healthcare and other “welfare benefits” provided to retirees, their spouses, dependents, and beneficiaries. Other welfare benefits include life insurance offered outside a pension plan; medical, dental, and eye care; legal and tax services; tuition assistance; day care; and housing assistance.

Differences Between Pension Benefits and Healthcare Benefits Illustration 20A-1 LO 10 Identify the differences between pensions and postretirement healthcare benefits.

Differences Between Pension Benefits and Healthcare Benefits Measuring the future payments for healthcare benefit plans is so much more difficult than for pension plans. Many postretirement plans do not set a limit on healthcare benefits. The levels of healthcare benefit use and healthcare costs are difficult to predict. Increased longevity, unexpected illnesses (e.g., AIDS, SARS, and avian flu), along with new medical technologies and cures, cause changes in healthcare utilization. LO 10 Identify the differences between pensions and postretirement healthcare benefits.

Postretirement Benefits Accounting Provisions Attribution Period - period of time over which the postretirement benefit cost accrue. Illustration 20A-2 LO 10 Identify the differences between pensions and postretirement healthcare benefits.

Postretirement Benefits Accounting Provisions Obligations Under Postretirement Benefits Expected postretirement benefit obligation (EPBO) is the actuarial present value as of a particular date of all benefits a company expects to pay after retirement to employees and their dependents. Accumulated postretirement benefit obligation (APBO) is the actuarial present value of future benefits attributed to employees’ services rendered to a particular date. LO 10 Identify the differences between pensions and postretirement healthcare benefits.

Postretirement Benefits Accounting Provisions Postretirement Expense Service Cost Interest Cost Actual Return on Plan Assets Amortization of Prior Service Costs Gains and Losses LO 10 Identify the differences between pensions and postretirement healthcare benefits.

Illustrative Accounting Entries 2010 Entries and Worksheet Illustrative Accounting Entries Illustration: The use of a worksheet in accounting for a postretirement benefits plan, assume that on January 1, 2010, Quest Company adopts a healthcare benefit plan. The following facts apply to the postretirement benefits plan for the year 2010. Plan assets at fair value on January 1, 2010, are zero. Actual and expected returns on plan assets are zero. Accumulated postretirement benefit obligation (APBO), January 1, 2010, is zero. Service cost is $54,000. No prior service cost exists. Interest cost on the APBO is zero. Funding contributions during the year are $38,000. Benefit payments to employees from plan are $28,000. LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.

Illustrative Accounting Entries 2010 Entries and Worksheet Illustrative Accounting Entries Illustration 20A-4 Journal Entry

Illustrative Accounting Entries Recognition of Gains and Losses Gains and losses represent changes in the APBO or the value of plan assets. Gains and losses are recorded in other comprehensive income. The Corridor Approach Amortization Methods LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.

Illustrative Accounting Entries 2011 Entries and Worksheet Illustrative Accounting Entries Illustration: The following facts apply to the postretirement benefits plan for Quest Company for the year 2011. Actual return on plan assets is $600. Expected return on plan assets is $800. Discount rate is 8 percent. Increase in APBO due to change in actuarial assumptions is $60,000. Service cost is $26,000. Funding contributions during the year are $18,000. Benefit payments to employees during the year are $5,000. Average remaining service to expected retirement: 25 years. LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.

Illustrative Accounting Entries 2011 Entries and Worksheet Illustrative Accounting Entries Illustration 20A-6 Journal Entry

Illustrative Accounting Entries Amortization of Gains and Losses in 2012 Illustration 20A-8 LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.

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