Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Pensions and Other Postretirement Benefits Chapter 17

17-2 Nature of Pension Plans

17-3 Contributions are defined by agreement. Employer deposits an agreed-upon amount into an employee- directed investment fund. Employee bears all risk of pension fund performance. Plan Characteristics Defined Contribution Pension Plans

17-4 Employer is committed to specified retirement benefits. Retirement benefits are based on a formula that considers years of service, compensation level, and age. Employer bears all risk of pension fund performance. Plan Characteristics Defined Benefit Pension Plans

17-5 Pension Expense—An Overview The annual pension expense reflects changes in both the pension obligation and the plan assets.

17-6 The Pension Obligation 1.Accumulated benefit obligation (ABO) The actuary’s estimate of the total retirement benefits (at their discounted present value) earned so far by employees, applying the pension formula using existing compensation levels. 2.Vested benefit obligation (VBO) The portion of the accumulated benefit obligation that plan participants are entitled to receive regardless of their continued employment. 3.Projected benefit obligation (PBO) The actuary’s estimate of the total retirement benefit (at their discounted present value) earned so far by employees, applying the pension formula using estimated future compensation levels. (If the pension formula does not include future compensation levels, the PBO and the ABO are the same.)

17-7 The Pension Obligation

17-8 Projected Benefit Obligation

17-9 Pension Plan Assets The pension plan assets are not reported separately in the balance sheet but are netted together with the PBO to report either a net pension asset (debit balance) or a net pension liability (credit balance). The higher the expected return on plan assets, the less the employer must actually contribute. On the other hand, a relatively low expected return means the difference must be made up by higher contributions.

17-10 Funded Status of the Pension Plan OVERFUNDED Market value of plan assets exceeds the actuarial present value of all benefits earned by participants. UNDERFUNDED Market value of plan assets is below the actuarial present value of all benefits earned by participants.

17-11 Reporting the Funded Status of Pension Plan Projected Benefit Obligation (PBO) - Plan Assets at Fair Value Underfunded / Overfunded Status Projected Benefit Obligation (PBO) - Plan Assets at Fair Value Underfunded / Overfunded Status This amount is reported in the balance sheet as a Pension Liability or Pension Asset.

17-12 The Relationship Between Pension Expense and Changes in the PBO and Plan Assets

17-13 Gains and Losses Only if a net gain or net loss exceeds the “corridor” is a charge to pension expense allowed.

17-14 Corridor Amount The corridor amount is 10% of the greater of PBO at the beginning of the period. Fair value of plan assets at the beginning of the period. Or

17-15 Gains and Losses If the beginning net unrecognized gain or loss exceeds the corridor amount, amortization is recognized using the following formula... Net unrecognized gain or loss at beginning of year Average remaining service period of active employees expected to receive benefits under the plan Corridor amount ־

17-16 Comprehensive Income Comprehensive income is a more expansive view of income than traditional net income.

17-17 Comprehensive Income

17-18 Postretirement Benefits Other Than Pensions Estimated medical costs in each year of retirement Estimated medical costs in each year of retirement Estimated net cost of benefits Estimated net cost of benefits Retiree share of costRetiree costMedicarepaymentsMedicarepayments Less: Equals: Net Cost of Benefits Many companies also furnish other postretirement benefits to their retired employees.

17-19 Postretirement Benefit Obligation 1. Expected Postretirement Benefit Obligation (EPBO) – The actuary's estimate of the total postretirement benefits (at their discounted present value) expected to be received by plan participants. 2. Accumulated Postretirement Benefit Obligation (APBO) – The portion of the EPBO attributed to employee service to date.

17-20 Accounting for Postretirement Benefit Plans Other Than Pensions Measuring Service Cost Attribute a portion of the accumulated postretirement benefit obligation to each year as the service cost for that year.

17-21 End of Chapter 17