FINANCIAL ACCOUNTING RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY THEORY AND ANALYSIS: TEXT AND CASES 11 TH EDITION

CHAPTER 14 PENSIONS AND OTHER POSTRETIREMENT BENEFITS

Accounting for the Cost of Pension Plans Types of plans  Defined contribution  Defined benefit Actuarial funding methods for defined benefit plans  Cost approach  Benefit approach 1 Accumulated benefits approach 2 Benefits/years of service approach

Historical Perspective ARB No. 47 Accounting Research Study No. 8 APB Opinion No. 8 Measuring total cost Allocating cost to proper accounting period Providing cash to fund the pension plan Disclosure

APB Opinion No. 8 Issues Normal cost Past service cost Prior service cost Actuarial gains and losses

Accounting Method Under APB No. 8 Minimum  Normal cost  Interest on unfunded prior or post service cost  A provision for any vested benefit Maximum  Normal cost  10% of past and prior service cost  Interest equivalent

APB’S Inability to Reach A Conclusion Two views of pensions 1 A means of promoting efficiency  Therefore, pension costs are associated with the plan and not specific individuals 2 A form of supplemental benefits  Therefore, they are related to specific employees

The Pension Liability Issue Issues involved in preliminary views  Period over which to recognize pension costs  How to spread pension cost over periods  Whether to include pension information on balance sheets Balance Sheet Pension Information

The Pension Liability Issue Position taken was that liability should be recognized on the balance sheet Pension benefit obligation + Actuarial present value of accumulated benefits with salary progression – Less pension assets + Plus or minus valuation allowance Opposition by AICPA Balance Sheet

SFAS No. 87 (See FASB ASC 715) Pension information  Should be prepared on the accrual basis  While retaining three fundamental aspects of previous requirements 1. Delayed recognition of certain events 2. Reporting net cost 3. Offsetting assets and liabilities Changes from APB Opinion No 8: 1. Standardized method of measuring pension cost 2. Immediate recognition of a pension liability when the accumulated benefit obligation exceeds the fair value of plan assets 3. Expanded disclosure requirements

Pension Cost Components:  Service cost  Interest cost  Return on plan assets  Amortization of unrecognized prior service cost  Amortization of gains and losses  Amortization of transition amount Minimum liability recognition  When accumulated benefit obligation exceeds plan assets

Disclosures Required Under FASB ASC 715 A description of the plan including  Groups covered  Type of benefit formula  Funding policy  Types of assets held  Significant nonbenefit liabilities  Any matters affecting comparability of information presented Net periodic pension cost by components A schedule reconciling funding status with the amounts reported on the balance sheet by category.

FASB ASC 715: Theoretical Issues Projected benefits approach The settlement rate Return on plan assets Reporting the minimum liability

Accounting for the Pension Fund Requires information on pension plan financial statements  Net assets available for benefits  Changes in net assets  Actuarial present value of accumulated plan benefits  Effects of certain factors

The Employee Retirement Income Security Act (ERISA) Goals 1. Create standards for the operation of pension funds 2. Correct abuses in the handling of pension funds Concerned only with funding policies Does not impact on the determination of periodic pension expense

Other Postretirement Benefits SFAS No. 106 (See FASB ASC 715)  Deals with several benefits offered to retired employees  The most important are health insurance and life insurance These benefits are offered in exchange for current service  Similar to defined benefit pension plans  Should be accounted for as such over the working life of employees Prior treatment was pay-as-you-go Economic consequences arguments of SFAS No. 106

Accounting Treatment Required By SFAS No. 106 (See FASB ASC 715) Service cost Interest Amortization of prior service costs Amortization of transition amount Disclosure Postemployment Benefits

SFAS No. 132 (See FASB ASC ) New requirements including: 1 Standardization of the disclosure requirements for pensions and other postretirement benefits 2 Requiring the disclosure of additional information on changes in the benefit obligation and fair value of plan assets 3 Eliminates some other disclosure requirements The benefit to financial statement users includes disaggregated information on the six components of pension cost

SFAS No : FASB, in conjunction with IASB, added 2-phase review of accounting for pension plans to agenda 1. Address info about DBPP & OPBP – in Notes, but not in financial statements 2. Other financial accounting and reporting issues

SFAS No. 158 Requires recognition of: 1. Overfunding or underfunded DBPP or OPBP on statement of financial position 2. Gains and losses, net of tax, and prior service costs and components 3. DBPP and OPBP assets and obligations on fiscal year-end 4. Disclose certain items in notes

SFAS No. 158 Completed phase one No income statement affect Phase two will reconsider  All aspects of accounting for DBPPS or OPBPs  Possibly requiring companies to disclose gross pension assets and liabilities on balance sheets

Financial Analysis of Retirement Benefits Individual components of pension cost have been found to convey different information to financial statement users Economic consequences of SFAS No. 106 Hershey  Has a defined benefit pension plan  Offers other postretirement benefits Tootsie Roll  Has a defined benefit pension plan  Offers postretirement health care and life insurance benefit plans

International Accounting Standards The IASC has issued two standards affecting accounting for retirement benefits 1. A revised IAS No. 19, “Retirement Costs and Expenses” 2. IAS No. 26, “Accounting and Reporting by Retirement Benefit Plans”

IAS No. 19: Retirement Costs and Expenses Major provisions are: 1. For defined contribution plans:  Periodic contributions are recognized as expenses 2. For defined benefit plans: a) Current service cost should be recognized as an expense b) Past service costs, experience adjustments and changes in assumptions are to be recognized as expenses in a systematic manner over the working life of current employees. c) Preferred method is the accrued benefit valuation method but projected benefit valuation method is acceptable

IAS No. 19: Retirement Costs and Expenses IASB currently engaged in project to amend March 2008: discussion paper issued IASB to issue 3 disclosure drafts 1. Appropriate discount rate for measuring employee benefits 2. Recognition and presentation of changes in defined benefit obligations and plan assets, disclosures, and other issues 3. Accounting for contribution-based promises

IAS No. 19: Retirement Costs and Expenses (Amendment) June 2011, amendment published Deferred initial plans for full review of pension accounting Final amendment requires other comprehensive income presentation changes for pensions only.

IAS No. 19: Retirement Costs and Expenses (Amendment) Amendment:  Requires recognition of changes in net defined benefit liability (asset)  Introduces enhanced disclosures about defined benefit plans  Modifies accounting for termination benefits  Clarifies miscellaneous issues Classification of employee benefits Current estimates of mortality rates Tax and administrative costs Risk-sharing and conditional indexation features  Incorporates other matters submitted to IFRS Interpretations Committee

IAS No. 26: Accounting and Reporting by Retirement Benefit Plans Separate reporting standards for defined benefit and defined contribution pension plans Defined Contribution Objectives provide information about the plan and the performance of investments Defined Benefit provide information that is useful in assessing the relationship between plan resources and future benefits

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