20-1 An arrangement whereby an employer provides benefits (payments) to retired employees for services they provided in their working years. Pension Plan Administrator Pension Plan Administrator Contributions Employer Retired Employees Benefit Payments Assets & Liabilities Nature of Pension Plans LO 1

20-2 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 make predictions (called actuarial assumptions) of mortality rates, employee turnover, interest and earnings rates, early retirement frequency, future salaries, and any other factors necessary to operate a pension plan Nature of Pension Plans LO 2

20-3 Defined Benefit Plans Defines benefits that employees will receive when they retire. Benefits are typically a function of an employee’s year’s of service and compensation level. The employer owns, is responsible for, is the beneficiary of the Pension Trust in a Defined Benefit Plan. It is the Employer that is at risk in Defined Benefit Plans. They must contribute enough to meet the cost of future benefit payments.

20-4 Two questions for Defined Benefit Plans: 1)What is the pension obligation that a company should report on the Balance Sheet? 2)What is the pension expense that should be reported for the period on the Income Statement? LO 3 Accounting for Pensions – Defined Benefit Plans

20-5 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 Accounting for Pensions – Defined Benefit Plans Illustration 20-3 FASB’s choice LO 3

20-6 Recognition of the Net Funded Status of the Pension Plan  Companies must recognize on their balance sheet the full overfunded or underfunded status of their defined benefit pension plan. Accounting for Pensions – Defined Benefit Plans LO 3  The overfunded or underfunded status is measured as the difference between the fair value of the plan assets and the projected benefit obligation.

20-7 Accounting for Pensions Illustration 20-4 Components of Annual Pension Expense LO 4

20-8 Service Costs+1. Accounting for Pensions Components of Pension Expense Actuarial present value of benefits attributed by the pension benefit formula to employee service during the period Effect on Expense LO 4

20-9 Interest on the Liability+2. Accounting for Pensions Components of Pension Expense Interest for the period on the projected benefit obligation outstanding during the period The interest rate use is referred to as the settlement rate. Effect on Expense LO 4

20-10 Actual Return on Plan Assets+-3. Accounting for Pensions Components of Pension Expense Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair value of the plan assets. Illustration 20-5 Effect on Expense LO 4

20-11 Accounting for Pensions Components of Pension Expense Plan amendments often include provisions to increase benefits for employee service provided in prior years. Company allocates the cost (prior service cost) of providing these retroactive benefits to pension expense in the future, specifically to the remaining service-years of the affected employees. Amortization of Prior Service Costs+4. Effect on Expense LO 4

20-12 Gain or Loss+-5. Accounting for Pensions Components of Pension Expense Effect on Expense Volatility in pension expense can result from sudden and large changes in the fair value of plan assets and by changes in projected benefit obligation. LO 4

20-13 Actual Returns vs Expected Returns on Plan Assets Actual Returns on Plan Assets (investments) can have a substantial affect on Pension Expense in a given year. In order to smooth out volatility and large fluxuations, actuaries develop an Expected rate of return to get an Expected Return on Plan Assets over a period of time. Companies include the Expected Return on Plan Assets as a component of Pension Expense, NOT the Actual Return. Gains and Losses LO 7

20-14 Asset Gains and Losses LO 7 The difference between the Expected Return and the Actual Return is the “Unexpected Gain/Loss” FASB calls this Asset Gains and Losses Asset Gains – When Actual Return exceeds Expected Asset Losses – When Actual Return is less than Expected Asset Gains and Losses are recorded in OCI Equity

20-15 Liability Gains and Losses LO 7 Accuaries revalue (get a Fair Value) of the Projected Benefit Obligation (Pension Liability) every year as well. “Unexpected Gains and Losses” in the Projected Benefit Obligation are called Liability Gains and Losses Liability Gains – result from Unexpected decreases in the Pension Benefit Obligation. Liability Losses – result from Unexpected increases in the Pension Benefit Obligation. Liability Gains and Losses are recorded in OCI Equity

20-16 Using a Worksheet for Pension Accounting

20-17 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. Using a Pension Worksheet LO 5

20-18 Illustration: On January 1, 2014, Zarle Company provides the following information related to its pension plan for the year Plan assets, January 1, 2014, are $100,000. Projected benefit obligation, January 1, 2014, is $100,000. Annual service cost is $9,000. Settlement rate is 10 percent. Actual return on plan assets is $10,000. Funding contributions are $8,000. Benefits paid to retirees during the year are $7,000. Prepare the pension worksheet for Using a Pension Work Sheet LO 5

20-19 Using a Pension Work Sheet Prepare a pension worksheet for ($100,000 x 10%) ($1,000) net liability LO 5 Illustration 20-8

20-20 Pension Journal Entry LO 5 Illustration 20-8 Pension Expense 9,000 Cash 8,000 Pension Asset/Liability 1,000

20-21 Amortization of Prior Service Cost Prior Service Cost Pension plans may require amendments or adjustments for benefits for emplyee service provided in prior years. This Prior Service Cost is amortized (allocated) to Pension Expense in the future – over remaining service years of the affected employees. LO 6

20-22 Prior Service Cost 1 st The employer initially records ALL of the Prior Service Cost amendment as an Other Comprehensive Income adjustment (Loss) and an increase in the Pension Benefit Obligation at the beginning of the year of the amendment

20-23 Prior Service Cost 2 nd The employer then amortizes the Prior Service Cost out of Other Comprehensive Income, as a component of Pension Expense at the end of each year – over the remaining service lives of the employees.

20-24 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 of the plan assets.  Any Accumulated OCI net gain or loss balance above the 10% corridor must be amortized. Gains and Losses LO 8

20-25 See Class Lecture Note Examples