1. Prepared by Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK

2. C H A P T E R 20 Pensions and Other Employee Future Benefits

3. Learning Objectives 1. Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. 2. Identify types of pension plans and their characteristics. 3. Identify the accounting and disclosure requirements for defined contribution plans. 4. Explain alternative measures for valuing the pension obligation. 5. Identify the components of pension expense.

4. Learning Objectives 6. Identify transactions and events that affect the projected benefit obligation. 7. Identify transactions and events that affect the balance of the plan assets. 8. Explain the usefulness of—and be able to complete—a work sheet to support the employer’s pension expense entries. 9. Explain the pension accounting treatment of past service costs.

5. Learning Objectives 10. Explain the pension accounting treatment of actuarial gains and losses, including corridor amortization. 11. Identify the differences between pensions and post-retirement health care benefits. 12. Identify the financial reporting and disclosure requirements for defined benefit plans. 13. Identify the financial accounting and reporting for defined benefit plans whose benefits do no vest or accumulate.

6. Pensions and Other Employee Future Benefits Introduction and Terminology Nature of pension plans Defined contribution plans Defined benefit plans The role of actuaries Defined Benefits that do no Vest or Accumulate Post- employment benefits and compensated absences Defined Benefits that Vest or Accumulate - Basics Alternative measures of the liability Capitalization vs. non-capitalization Components of pension expense Projected benefit obligation and plan assets Basic Illustration Defined Benefits that Vest or Accumulate - Complexities Past service costs Actuarial gains and losses Corridor amortization Other benefits that vest or accumulate Comprehensive illustration Reporting defined benefit plans Plan complexities

7. Pension Plans A pension plan provides benefits to retirees for services provided during employment Employer sponsors and contributes to fund, and incurs the cost of the pension plan Accounting for the employer Pension plan receives the contributions, administers pension assets, and makes pension payments to the beneficiaries Accounting for the pension plan

8. Contributory Employee and employer make contributions to the plan Non-contributory Employers bear the full cost of the pension plan No contributions made by employee Vested Amounts in the plan become the legal property of the employee Employee is entitled to receive benefits even after leaving the employ of the corporation Governed by provincial law Pension Terminology

9. Employer contributes a defined sum to a third party – plan trustee Ownership of plan assets assumed by trustee Employee assumes the economic risk No guarantee made by employer as to benefits paid Cost of the plan in the current year is known with certainty Defined Contribution Plans

10. Liability reported if contribution (funding) is less than required Asset reported if the amount contributed is more than required for the period Disclosure requirements: Annual pension expense amount Nature and effect of matters affecting comparability

11. Defined Contribution Plans: Employers’ Journal Entries Contribution made is less than the pension expense Pension Expense Dr Cash Cr Prepaid/Accrued Cr Liability Contribution made is more than pension expense Pension Expense Dr Prepaid/Accrued Dr Cash Cr Asset

12. Types of Pension Plans Defined benefit pension plan The end benefit is predefined Contributions to fund end benefit based on formula Employee’s years of service and expected salary level at retirement Actuarial assumptions used extensively in accounting for defined benefit plans Cost of the plan in the current year is not known with certainty The employer remains liable to ensure benefit payments Employer is the trust-beneficiary

13. Pension Liability Measurement Vested benefit obligationAccumulated benefit obligation (ABO) Projected benefit obligation (PBO) Pro-rated on service Pro-rated on salaries Pension obligation Present value of the estimated future benefits to be paid to employees Recommended method - CICA Handbook, Section 3461

14. Pension Liability Measurement Projected benefit obligation Pension obligation is measured based on the projected future salaries of the employee at retirement Two methods available Pro-rated on salaries Annual funding based on percentage of total estimated compensation earned by the employee over their career Pro-rated on services Annual funding based on the total estimated benefit being allocated evenly over the years of service of the employee

15. COMPANY TRUST Pension Fund Stream Pension Expense Cash paid to pension plan (funding) Accrued/prepaid pension costs$ Plan Assets Projected Benefit Obligation Employees (pension benefits)

16. Components of Pension Expense Pension Expense Service Cost for Current Year + Interest on the Liability + Expected return on Plan Assets  Amortized Net Actuarial Gain or Loss + or  Amortized Past Service Costs + AmortizedTransitional Asset or Obligation + or 

17. Current service cost The amount of pension benefit earned in the current period Expected Interest on PBO Consider PBO as a long-term liability (albeit off-balance sheet) that accrues interest Interest rate used is the long-term debt rate (if none provided) Applied to the opening PBO balance Components of Pension Expense

18. Expected Return on Plan Assets The assets in the pension plan earn income and this income reduces the eventual cost of the pension Long-term rate of return applied to fair value of plan assets Amortization of Past Service Costs (PSC) PSC are from either the initial adoption of a pension plan or an amendment to improve the existing plan PSC are the present value of those additional future benefits Amortized over the expected average remaining service life of the employee group Components of Pension Expense

19. Amortization of Actuarial Gains/Losses Change in plan’s actuarial assumptions or Plan experiences gains and losses Amortized using “corridor approach” Amortization of Transitional Asset or Obligation Stem from CICA Handbook, Section 3461 (introduced in 2000) When Section 3461 is applied prospectively, any difference in the plan assets and PBO is amortized Amortization period is the Expected Average Remaining Service Life (EARSL) Components of Pension Expense

20. EARSL is the expected average remaining service life of the employee group It is another number determined by the actuary Consider the following example Notes on EARSL

21. Picture a bus full of employees heading for retirement. Given an EARSL of 10 years in 2000, what is a reasonable EARSL in 2001? Are the same employees on the bus at retirement as were on at the beginning? 20002001Retirement Some got on the bus, others got off the bus… A reasonable estimate for 2001 might be 10 years. EARSL

22. Summary of Pension Expense Components and Methods Pension expenseMethod used toEffect on pension componentdetermine cost expense Service CostPresent Value+ 1 Interest ExpenseSettlement rate+ 2 Expected ReturnExpected Rate of Return- on Plan Assets 3 Prior Service CostStraight line (service years)+ 4 Actuarial GainsCorridor method+/- and Losses 5 Transition GainsEARSL+/- and Losses 6

23. PBO Transactions PBO, beginning of period + Current Service Cost + Interest Cost + PSC during period  Benefits paid to retirees + Actuarial Gains  Actuarial Losses = PBO, end of period The PV of total benefits due to employees at retirement Most information relating to PBO provided by actuaries

24. Plan Assets Transactions Plan assets (FV) beginning of period + Employer/employee funding + Expected return  Actual return  Benefits paid out = Plan assets (FV) end of period Funded Status = PBO less FV of plan assets When PBO  Plan Assets plan is underfunded When Plan Assets  PBO plan is overfunded

25. The accrued/prepaid pension cost on the balance sheet represents the difference between what has been recognized as expense and the amount that has been funded since accounting for the defined benefit pension plan CICA Handbook, Section 3461 recommends the noncapitalization approach Pension amounts not required to be recorded by the company PBO, Plan Assets, Unrecognized PSC, Unrecognized Net Actuarial Gains/Losses, Unrecognized Net Transitional Asset/Liability Notes on Pension

26. Used to record both the formal journal entries and the memo entries to keep track of the relevant pension plan items and components The Pension Worksheet

27. General Journal EntriesMemo Record Items Annual Pension Expense Cash Projected Benefit Obligation Plan Assets Prepaid/ Accrued Cost Beginning Balances recorded here Pension transactions are recorded through the worksheet, using debits and credits (all entries must therefore balance) An ending credit balance here is reported with Long-term Liabilities An ending debit balance is reported with other Deferred Charges The Pension Worksheet

28. The Pension Worksheet - Example Bal. 100,000 Cr. 100,000 Dr. a) 9,000 Dr. 9,000 Cr. b) 10,000 Dr. 10,000 Cr. c) 10,000 Cr. 10,000 Dr. d) 8,000 Cr. 8,000 Dr. e) 7,000 Dr. 7,000 Cr. General Journal EntriesMemo Record Items Annual Pension Expense Cash Projected Benefit Obligation Plan Assets Prepaid/ Accrued Cost 9,000 Dr. 8,000 Cr. 1,000 Cr. 112,000 Cr. 111,000 Dr. Journal Entries: Pension Expense 9,000 Prepaid/Accrued 9,000 Prepaid/Accrued 8,000 Cash 8,000 Credit balance reported as a Long-term Liability Debit balance reported as a Deferred Pension Expense with other Deferred Charges

29. Actuarial Gains and Losses Caused by: Changes in market value of plan assets Changes in actuarial assumptions affecting the PBO If changes large enough, including full amount of the gains or losses, it results in substantial fluctuations in reported pension expense Amortization allows for “smoothing” the impact of these changes

30. Actuarial Gains and Losses Over time, accumulated effect of the changes (net gains/losses) may even out Corridor approach adopted to allow for circumstances where no accumulating offset occurs Corridor approach used only when the unrecognized gains/losses are greater than 10% of the larger of the opening balance of the PBO and the FV of Plan Assets Amount calculated under the Corridor Approach uses Beginning Balances only

31. Corridor Approach - Example 200120022003 PBO, January 12,100,0002,600,0002,900,000 FV Plan Assets, Jan. 12,600,0002,800,0002,700,000 Corridor – 10% of the larger of the PBO or PA 260,000280,000290,000 Net Actuarial Loss (current portion) 400,000300,000-0- Cumulative Net Actuarial Loss (Beginning of Year) 0400,000678,182 Amount to be Amortized0120,000388,182 Current Year Amortization021,81870,579 Opening Balance$400,000 Less: Corridor 280,000 $120,000 Amortized over 5.5 years – average remaining service life Opening Balance$678,182 (400,000 – 21,818 + 300,000) Less: Corridor 290,000 $388,182

32. All enterprises must disclose: Amounts recorded in the financial statements Off-balance sheet accounts Underlying assumptions Financial institutions have additional disclosure requirements Reconciliation of PBO and Plan Assets beginning and ending balance Unamortized balances of PSC, Net actuarial Gains/Losses, Net Transitional amounts; and amortization amount for each Disclosure Requirements – Defined Benefit Plans

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