Presentation on theme: "PENSIONS. PENSION PLAN CHARACTERISTICS l Contributory Plan –Employer and employee contribute. –Employees keep their contributions. –Vesting determines."— Presentation transcript:
PENSION PLAN CHARACTERISTICS l Contributory Plan –Employer and employee contribute. –Employees keep their contributions. –Vesting determines employee right to employer contributions. l Defined CONTRIBUTION Plan – Villanova faculty –Specific contributions are promised by the employer. (“Match” $2 for $1 up to 5%) –Specific benefits are NOT promised. –Benefits are a function of the management of the plan assets. Risk/Reward borne by Employee –Pension expense = Cash contributions by employer.
PENSION PLAN CHARACTERISTICS l Defined BENEFIT PLAN (Hydromaint) –Specific benefit payments are promised by the employer. (e.g., at retirement get $2,000 per mo.) –Much More complex accounting. l Funded Pension Plan –Fully funded: Plan Assets = PV of “ABO” (Accumulated Benefit Obligation—using EXISTING compensation levels) –Partially funded: Plan Assets < PV of ABO »Need not be fully funded; plan only needs to have enough assets to meet current payment obligations. »ERISA, tax laws, cash flow impact determines “funding’ –Pension Expense = GAAP (FASB #87)
DEFINED BENEFIT PLANS Pension Expense on Income Statement composed of: 1) Service Cost – “earned” by employees this period (present value of increase in amount paid at retirement for work done this period) 2) Interest cost accrued on Beg. of Year Pension Liability - - the “PBO” (Projected Benefit Obligation—using EXPECTED future compensation levels) 3) “PSC” (Prior Service Cost) amortization – attributed to employee service before plan amendment 4) Plan Asset return – “expected” return on plan assets 5) Gain/loss amortization – adjust expected plan asset return for difference between expected and actual AND for other gains and losses due to changes in estimate that affect PBO (e.g., life expectancy, discount rate, actual age of employees at retirement, employee turnover). These gains and losses are only amortized IF net gain or loss > 10% of plan assets or PBO whichever is larger.
EXAMPLE PLAN ASSUMPTIONS l Employee Data –Hired on 1/1/20x1, Expected to retire on 12/31/20x5, and expected to die on 12/31/20x7. –Earns $10,000 per year from 20x1 to 20x3 and expected to earn $20,000 per year from 20x4 to 20x5. l Plan Data (adopted 1/1/20x3) –Benefits = number of years worked x 1% x highest salary –Discount rate is 5%. (Use present value because will not be paying out money until the future) –Current service cost is fully funded at the end of each year. –Expected rate of return to be earned on plan assets is 10%. –PSC (Prior Service Cost) -- Pension credit given for work years prior to plan adoption date. This PSC is given at time plan adopted on 1/1/20X3. –1/10 th of PSC “voluntarily” funded 1/1/20x3; –3 year amortization of PSC to Pension Expense.
Calculate Prior Service Cost at Plan Adoption Date (1/1/20X3) 20x1 20x220x420x520x620x720x3 1/1/x11/1/x312/31/x312/31/x512/31/x7 Hire Employee Adopt Plan Balance Sheet Date Employee Retires Employee Dies Projected Benefit Obligation (PBO) is the present value of benefits for employee service prior to a particular date based on expected future salary levels.
Calculate Service Cost for 20x3 (First Year of the Plan) 20x420x520x620x7 12/31/x512/31/x7 Employee Retires Employee Dies 20x1 20x220x3 12/31/x3 Balance Sheet Date 1/1/x11/1/x3 Hire Employee Adopt Plan PSC is $ Service Cost is the increase in PBO due to work performed in the current year (20x3).
Calculate Pension Benefit Obligation (PBO) at 12/31/x3 (Current Year End) 20x420x520x620x7 12/31/x512/31/x7 Employee Retires Employee Dies 20x1 20x220x3 12/31/x3 Balance Sheet Date 1/1/x11/1/x3 Hire Employee Adopt Plan PSC is $ Service Cost is $354.17
PBO vs. ABO l Projected Benefit Obligation (PBO) –PV of benefits, based on expected future salary levels l Accumulated Benefit Obligation (AB0) –PV of benefits, based on existing compensation levels (Need ABO vs. Plan Assets at end of year to determine IF need an entry to show “Minimum Liability” on Balance Sheet)
Calculate Accumulated Benefit Obligation (ABO) at 12/31/20x3 20x420x520x620x7 12/31/x512/31/x7 Employee Retires Employee Dies 20x1 20x220x3 12/31/x3 Balance Sheet Date 1/1/x11/1/x3 Hire Employee Adopt Plan PSC is $ Service Cost is $ PBO is $1,062.51
Financial Statement Effects Still would need to check for “Minimum Liability”
RECENT DEVELOPMENTS l SFAS No Employers’ Disclosures about Pensions and Other Postretirement Benefits. –Standardizes disclosures for pensions and other post-retirement benefit plans. –Required disclosures: »Change in PBO. »Change in Plan Assets. »Assumptions for discount rate, expected return on plan assets, and compensation increases. »Components of pension expense (net periodic pension cost).
Recent additional pension disclosures –Investment strategies & targets –Plan asset allocations—equities, fixed assets, real estate, and other –Expected pension benefits to be paid out to retirees – each of next 5 years and total estimate for next 10 years –Estimated cash contribution to plan trustee for next year