1. 20-1 Prepared by Coby Harmon University of California, Santa Barbara Intermediat e Accounting Prepared by Coby Harmon University of California, Santa Barbara Westmont College INTERMEDIATE ACCOUNTING F I F T E E N T H E D I T I O N kieso weygandt warfield team for success Prepared by Coby Harmon University of California, Santa Barbara Westmont College Edited by Dr. Joe Morris Southeastern Louisiana University

2. 20-2 PREVIEW OF CHAPTER Intermediate Accounting 15th Edition Kieso Weygandt Warfield 20

3. 20-3 6.Describe the amortization of prior service costs. 7.Explain the accounting for unexpected gains and losses. 8.Explain the corridor approach to amortizing gains and losses. 9.Describe the requirements for reporting pension plans in financial statements. After studying this chapter, you should be able to: LEARNING OBJECTIVES 1. 1.Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. 2. 2.Identify types of pension plans and their characteristics. 3. 3.Explain alternative measures for valuing the pension obligation. 4. 4.List the components of pension expense. 5. 5.Use a worksheet for employer’s pension plan entries. Accounting for Pensions and Postretirement Benefits 20

4. 20-4 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 We will be studying pensions from the point of view of the employer

5. 20-5 Pension plans can be:  Contributory: employees voluntarily make payments to increase their benefits.  Noncontributory: employer bears the entire cost.  Qualified pension plans: offer tax benefits. Pension fund should be a separate legal and accounting entity. Nature of Pension Plans LO 1

6. 20-6 6.Describe the amortization of prior service costs. 7.Explain the accounting for unexpected gains and losses. 8.Explain the corridor approach to amortizing gains and losses. 9.Describe the requirements for reporting pension plans in financial statements. After studying this chapter, you should be able to: LEARNING OBJECTIVES 1. 1.Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. 2. 2.Identify types of pension plans and their characteristics. 3. 3.Explain alternative measures for valuing the pension obligation. 4. 4.List the components of pension expense. 5. 5.Use a worksheet for employer’s pension plan entries. Accounting for Pensions and Postretirement Benefits 20

7. 20-7 Defined-Contribution Plan Defined-Benefit Plan  Employer contribution determined by plan (fixed by contract)  Benefits based on plan earnings and value  Risk borne by employees  Employer contribution varies (determined by actuaries)  Benefit determined by plan formula  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

8. 20-8 6.Describe the amortization of prior service costs. 7.Explain the accounting for unexpected gains and losses. 8.Explain the corridor approach to amortizing gains and losses. 9.Describe the requirements for reporting pension plans in financial statements. After studying this chapter, you should be able to: LEARNING OBJECTIVES 1. 1.Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. 2. 2.Identify types of pension plans and their characteristics. 3. 3.Explain alternative measures for valuing the pension obligation. 4. 4.List the components of pension expense. 5. 5.Use a worksheet for employer’s pension plan entries. Accounting for Pensions and Postretirement Benefits 20

9. 20-9 Two basic questions in accounting for pensions: 1)What is the pension obligation that a company should report in the financial statements? 2)What is the pension expense (net periodic pension cost) for the period? Accounting for Pensions LO 3

10. 20-10 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 Illustration 20-3 FASB’s choice LO 3

11. 20-11 Net Funded Status 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 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. Funded Status = FV of plan - PBO

12. 20-12 6.Describe the amortization of prior service costs. 7.Explain the accounting for unexpected gains and losses. 8.Explain the corridor approach to amortizing gains and losses. 9.Describe the requirements for reporting pension plans in financial statements. After studying this chapter, you should be able to: LEARNING OBJECTIVES 1. 1.Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. 2. 2.Identify types of pension plans and their characteristics. 3. 3.Explain alternative measures for valuing the pension obligation. 4. 4.List the components of pension expense. 5. 5.Use a worksheet for employer’s pension plan entries. Accounting for Pensions and Postretirement Benefits 20

13. 20-13 Accounting for Pensions Illustration 20-4 Components of Annual Pension Expense LO 4

14. 20-14 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 (Discounted PV of future benefits earned by employees during the current period. Increases PBO each year.) Effect on Expense LO 4

15. 20-15 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: Based on rates of return on high-quality fixed-income investments currently available, whose cash flows match the timing and amount of the expected benefit payments. Effect on Expense LO 4

16. 20-16 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 * *[FAS 158 allows employers to use expected return (multi-year average) on plan assets to smooth out short-term volatility in pension expense.]

17. 20-17 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

18. 20-18 Gain or Loss+-5. Accounting for Pensions Components of Pension Expense Effect on Expense LO 4 Volatility in pension expense can result from sudden and large changes in the 1) Fair value of plan assets and 2) Projected benefit obligation Company recognizes (amortizes) gains or losses in pension expense using the corridor method (illustrated later)

19. 20-19 6.Describe the amortization of prior service costs. 7.Explain the accounting for unexpected gains and losses. 8.Explain the corridor approach to amortizing gains and losses. 9.Describe the requirements for reporting pension plans in financial statements. After studying this chapter, you should be able to: LEARNING OBJECTIVES 1. 1.Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. 2. 2.Identify types of pension plans and their characteristics. 3. 3.Explain alternative measures for valuing the pension obligation. 4. 4.List the components of pension expense. 5. 5.Use a worksheet for employer’s pension plan entries. Accounting for Pensions and Postretirement Benefits 20

20. 20-20 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

21. 20-21 Illustration: On January 1, 2014, Zarle Company provides the following information related to its pension plan for the year 2014. 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 2014. Using a Pension Work Sheet LO 5

22. 20-22 Using a Pension Work Sheet Prepare a pension worksheet for 2014. ($100,000 x 10%) ($1,000) net liability LO 5 Illustration 20-8

23. 20-23 Pension Journal Entry LO 5 Illustration 20-8 Pension Expense 9,000 Cash 8,000 Pension Asset/Liability 1,000

24. 20-24 6.Describe the amortization of prior service costs. 7.Explain the accounting for unexpected gains and losses. 8.Explain the corridor approach to amortizing gains and losses. 9.Describe the requirements for reporting pension plans in financial statements. After studying this chapter, you should be able to: LEARNING OBJECTIVES 1. 1.Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. 2. 2.Identify types of pension plans and their characteristics. 3. 3.Explain alternative measures for valuing the pension obligation. 4. 4.List the components of pension expense. 5. 5.Use a worksheet for employer’s pension plan entries. Accounting for Pensions and Postretirement Benefits 20

25. 20-25 Amortization of Prior Service Cost A company should not recognize the retroactive benefits as pension expense in the year of a plan amendment. Employer should recognize the pension expense over the remaining service lives of the employees who are expected to benefit from the change in the plan. Prior Service Cost Amortization Method:  Board prefers a years-of-service method.  Employers may use straight-line amortization over the average remaining service life of the employees. LO 6

26. 20-26 Stockholders’ Equity Temporary (Nominal) AccountsPermanent (Real) Accounts RevenuesExpensesOCIPICREAOCI Net Income Comprehensive Income OCI includes: 1.Unrealized gains/losses on AFS securities 2.Certain foreign currency translation gains/losses 3.Pension adjustments: PSC and G/L A Review of OCI and AOCI LO 5

27. 20-27 Companies do not recognize separately these two items in the accounts and in the financial statements: A company must disclose in notes to the financial statements, but not in the body of the financials. Projected benefit obligation. Pension plan assets. Individually off the books— but net amount on the books Pension Items Not Recognized in the Financial Statements LO 5

28. 20-28 Some items are recognized in other comprehensive income; changes in these items are amortized into expense through smoothing techniques. Prior service costs. Actuarial gains and losses. AOCI—on the books Pension Items Recognized in the Financial Statements LO 5

29. 20-29 E20-7: The following defined pension data of Rydell Corp. apply to the year 2014. Using a Pension Work Sheet Projected benefit obligation, 1/1/14 (before amendment) $560,000 Plan assets, 1/1/14 546,200 Pension liability 13,800 On January 1, 2014, Rydell Corp., through plan amendment, grants prior service benefits having a present value of 120,000 Settlement rate 9% Service cost 58,000 Contributions (funding) 65,000 Actual (expected) return on plan assets 52,280 Benefits paid to retirees 40,000 Prior service cost amortization for 2014 17,000 Instructions: For 2014, prepare a pension work sheet for Rydell Corp. that shows the journal entry for pension expense. LO 6

30. 20-30 Using a Pension Work Sheet ($135,720) liability ($680,000 x 9%)

31. 20-31 Pension Expense 83,920 Other Comprehensive Income (PSC) 103,000 Pension Asset/Liability 121,920 Cash65,000 Using a Pension Work Sheet JE Dec. 31 LO 6

32. 20-32 6.Describe the amortization of prior service costs. 7.Explain the accounting for unexpected gains and losses. 8.Explain the corridor approach to amortizing gains and losses. 9.Describe the requirements for reporting pension plans in financial statements. After studying this chapter, you should be able to: LEARNING OBJECTIVES 1. 1.Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. 2. 2.Identify types of pension plans and their characteristics. 3. 3.Explain alternative measures for valuing the pension obligation. 4. 4.List the components of pension expense. 5. 5.Use a worksheet for employer’s pension plan entries. Accounting for Pensions and Postretirement Benefits 20

33. 20-33 Actuarial Gain or Loss Unexpected swings in pension expense can result from two sources: 1.Sudden and large changes in the fair value of plan assets, and 2.Changes in actuarial assumptions that affect the amount of the projected benefit obligation. Gains and Losses LO 7

34. 20-34 Question: What is the potential negative impact on net income of these unexpected swings? Volatility The profession decided to reduce the volatility with smoothing techniques. Gains and Losses LO 7

35. 20-35 Smoothing Unexpected Gains and Losses on Plan Assets  Companies include the expected return on the plan assets as a component of pension expense, not the actual return in a given year.  Companies record asset gains and asset losses in an account, Other Comprehensive Income (G/L), combining them with gains and losses accumulated in prior years.  They accumulate the asset and liability gains and losses in Accumulated Other Comprehensive Income (via closing entries) and report on the balance sheet in the stockholders’ equity section. Gains and Losses LO 7

36. 20-36 6.Describe the amortization of prior service costs. 7.Explain the accounting for unexpected gains and losses. 8.Explain the corridor approach to amortizing gains and losses. 9.Describe the requirements for reporting pension plans in financial statements. After studying this chapter, you should be able to: LEARNING OBJECTIVES 1. 1.Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. 2. 2.Identify types of pension plans and their characteristics. 3. 3.Explain alternative measures for valuing the pension obligation. 4. 4.List the components of pension expense. 5. 5.Use a worksheet for employer’s pension plan entries. Accounting for Pensions and Postretirement Benefits 20

37. 20-37 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% must be amortized. Gains and Losses LO 8 Corridor = 10% of the greater of the beginning balances of the: 1)PBO 2)MRV of plan assets

38. 20-38 Illustration: Data for Callaway Co.’s projected benefit obligation and plan assets over a period of six years. Gains and Losses LO 8 Illustration 20-14 Computation of the Corridor

39. 20-39 Gains and Losses LO 8 Illustration 20-15 Graphic Illustration of the Corridor

40. 20-40 Gains and Losses LO 8 BE20-7 (adapted): Shin Corp. has the following data: 1/1/2013 1/1/2014 Plan assets$3,300,000$3,500,000 PBO$3,100,000$3,600,000 Shin also had a net pension actuarial loss of $465,000 in AOCI at January 1, 2013 (on balance sheet). During 2013 Shin had an actuarial gain of $47,000. The average remaining service period of Shin’s employees is 7.5 years for 2013 and 10 years for 2014. Instructions: Compute Shin’s amortization of the actuarial loss for years 2013 and 2014.

41. 20-41 Gains and Losses LO 8 BE20-7 Adapted: BE20-7 Adapted: Compute Shin’s amortization of the gain/loss in years 2013 and 2014.

42. 20-42 Using a Pension Work Sheet P20-2: Jackson Company adopts acceptable accounting for its defined benefit pension plan on January 1, 2013, with the following beginning balances: plan assets $200,000; projected benefit obligation $250,000. Other data are as follows. LO 8

43. 20-43 Using a Pension Work Sheet P20-2: Pension Work Sheet for 2013 ($57,000) * Expected Return on Plan Assets $200,000 x 10% = $20,000 * LO 8

44. 20-44 Using a Pension Work Sheet P20-2 Pension Journal Entry for 2013 Pension Expense 21,000 OCI – Gain/Loss 2,000 Pension Asset/Liability 7,000 Cash 16,000 Dec. 31 LO 8

45. 20-45 Using a Pension Work Sheet P20-2: Pension Work Sheet for 2014 ($217,700) liability * Actual return = Expected Return * LO 8

46. 20-46 Pension Expense 95,100 Other Comprehensive Income (PSC) 105,600 Pension Asset/Liability 160,700 Cash40,000 Dec. 31 Using a Pension Work Sheet P20-2 Pension Journal Entry for 2014 LO 8

47. 20-47 Using a Pension Work Sheet P20-2: Pension Work Sheet for 2015 ($203,400) liability * Plug * LO 8

48. 20-48 Using a Pension Work Sheet P20-2 Pension Journal Entry for 2015 Pension Expense 89,370 Pension Asset/Liability14,300 Other Comprehensive Income (G/L) 14,070 Other Comprehensive Income (PSC)41,600 Cash48,000 Dec. 31 LO 8

49. 20-49 6.Describe the amortization of prior service costs. 7.Explain the accounting for unexpected gains and losses. 8.Explain the corridor approach to amortizing gains and losses. 9.Describe the requirements for reporting pension plans in financial statements. After studying this chapter, you should be able to: LEARNING OBJECTIVES 1. 1.Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. 2. 2.Identify types of pension plans and their characteristics. 3. 3.Explain alternative measures for valuing the pension obligation. 4. 4.List the components of pension expense. 5. 5.Use a worksheet for employer’s pension plan entries. Accounting for Pensions and Postretirement Benefits 20

50. 20-50 Within the Financial Statements  Recognition of the net funded status of the plan (balance sheet)  Pension expense (income statement)  Actuarial gains and losses/prior service cost (components of AOCI on balance sheet) Reporting Pension Plans in Financial Statements LO 9

51. 20-51  The Pension Reform Act of 1974  Pension Terminations Special Issues Reporting Pension Plans in Financial Statements LO 9 (These topics will not be covered on Exam 3.)

52. 20-52 Not Covered on Exam 3 APPENDIX APPENDIX 20A ACCOUNTING FOR POSTRETIRMENT BENEFITS

53. 20-53 RELEVANT FACTS – Similarities  IFRS and GAAP separate pension plans into defined contribution plans and defined benefit plans. The accounting for defined contribution plans is similar.  IFRS and GAAP recognize a pension asset or liability as the funded status of the plan (i.e., defined benefit obligation minus the fair value of plan assets). (Note that defined benefit obligation is referred to as the projected benefit obligation in GAAP.)  IFRS and GAAP compute unrecognized past service cost (PSC) (referred to as prior service cost in GAAP) in the same manner. However, IFRS recognizes past service cost as a component of pension expense in income immediately. GAAP amortizes PSC over the remaining service lives of employees.

54. 20-54 RELEVANT FACTS - Differences  IFRS and GAAP include interest expense on the liability in pension expense. Regarding asset returns, IFRS reduces pension expense by the amount of interest revenue (based on the discount rate times the beginning value of pension assets). GAAP includes an asset return component based on the expected return on plan assets.  Under IFRS, companies recognize both liability and asset gains and losses (referred to as remeasurements) in reserves immediately. These gains and losses are not “recycled” into income in subsequent periods. GAAP recognizes liability and asset gains and losses in AOCI and amortizes these amounts to income over remaining service lives, using the “corridor approach.” LO 12

55. 20-55 At the end of the current period, Oxford Ltd. has a defined benefit obligation of $195,000 and pension plan assets with a fair value of $110,000. The amount of the vested benefits for the plan is $105,000. What amount related to its pension plan will be reported on the company’s statement of financial position? a.$5,000. b.$90,000. c.$85,000. d.$20,000. IFRS SELF-TEST QUESTION LO 12

56. 20-56 At January 1, 2014, Wembley Company had plan assets of $250,000 and a defined benefit obligation of the same amount. During 2014, service cost was $27,500, the discount rate was 10%, actual and expected return on plan assets were $25,000, contributions were $20,000, and benefits paid were $17,500. Based on this information, what would be the defined benefit obligation for Wembley Company at December 31, 2014? a.$277,500. c. $27,500. b.$285,000. d. $302,500. IFRS SELF-TEST QUESTION LO 12 $250,000 27,500 25,000 (17,500) $285,000

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