2 ACCOUNTING FOR PENSIONS AND POSTRETIREMENT BENEFITS C H A P T E R 20ACCOUNTING FOR PENSIONS AND POSTRETIREMENT BENEFITSIntermediate AccountingIFRS EditionKieso, Weygandt, and Warfield
3 Learning ObjectivesDistinguish between accounting for the employer’s pension plan and accounting for the pension fund.Identify types of pension plans and their characteristics.Explain alternative measures for valuing the pension obligation.List the components of pension expense.Use a worksheet for employer’s pension plan entries.Describe the amortization of past service costs.Explain the accounting for unexpected gains and losses.Explain the corridor approach to amortizing gains and losses.Describe the requirements for reporting pension plans in financial statements.Explain special issues related to postretirement benefit plans.
4 Accounting for Pensions and Postretirement Benefits Nature of Pension PlansAccounting for PensionsUsing a Pension WorksheetReporting Pension Plans in Financial StatementsDefined contribution planDefined-benefit planRole of actuariesAlternative measures of liabilityComponents of pension expense2011 entries and worksheetAmortization of past service cost2012 entries and worksheetGain or loss2013 entries and worksheetRecognition of actuarial gains and lossesWithin the financial statementsWithin the notes to the financial statements2013 entries and worksheet—a comprehensive exampleSpecial issues
5 Nature of Pension Plans An arrangement whereby an employer provides benefits to employees after they retire for services they provided while they were working.Pension PlanAdministratorContributionsEmployerRetiredEmployeesBenefit PaymentsAssets &LiabilitiesLO 1 Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.
6 Nature of Pension Plans 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.LO 1 Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.
7 Nature of Pension Plans Defined-Contribution Plan Defined-Benefit PlanEmployer contribution determined by plan (fixed)Risk borne by employeesBenefits based on plan valueBenefit determined by planEmployer contribution varies (determined by Actuaries)Risk borne by employerActuaries estimate the employer contribution by considering mortality rates, employee turnover, interest and earning rates, early retirement frequency, future salaries, etc.LO 2 Identify types of pension plans and their characteristics.
8 Accounting for Pensions Two questions:What is the pension obligation that a company should report in the financial statements?What is the pension expense for the period?LO 3 Explain alternative measures for valuing the pension obligation.
9 Accounting for Pensions Alternative measures of the LiabilityEmployer’s pension obligation is the deferred compensation obligation it has to its employees for their service under the terms of the pension plan.IASB’s choiceIllustration 20-3LO 3 Explain alternative measures for valuing the pension obligation.
10 Accounting for Pensions Illustration 20-4Components of AnnualPension ExpenseLO 4 List the components of pension expense.
11 Accounting for Pensions Components of Pension ExpenseEffect on Expense1.Service Costs+Actuarial present value of benefits attributed by the pension benefit formula to employee service during the period.LO 4 List the components of pension expense.
12 Accounting for Pensions Interest on the Liability Components of Pension ExpenseEffect on Expense2.Interest on the Liability+Interest for the period on the defined benefit obligation outstanding during the period.Interest rate (discount rate) should be those based on high-quality bonds of currency and term consistent with the liabilities.LO 4 List the components of pension expense.
13 Accounting for Pensions Actual Return on Plan Assets Components of Pension ExpenseEffect on Expense3.Actual Return on Plan Assets+-Actual return on plan assets is the increase in pension funds from interest, dividends, and realized and unrealized changes in the fair-market value of the plan assets.Illustration 20-5LO 4 List the components of pension expense.
14 Accounting for Pensions Amortization of Prior Service Costs Components of Pension ExpenseEffect on Expense4.Amortization of Prior Service Costs+Plan amendments often increase benefits for service provided in prior years.The cost (past service cost) of providing these retroactive benefits is allocated to pension expense depending on whether the benefits vest immediately or not.LO 4 List the components of pension expense.
15 Accounting for Pensions Components of Pension ExpenseEffect on Expense5.Gain or Loss+-Volatility in pension expense can result from sudden and large changes in the fair value of plan assets and by changes in actuarial assumptions that affect the defined benefit obligation.LO 4 List the components of pension expense.
16 Using a Pension Work Sheet 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.LO 5 Use a worksheet for employer’s pension plan entries.
17 Using a Pension Work Sheet BE20-3: At January 1, 2010, Blue Diamond Company had plan assets of $250,000 and a defined benefit obligation of the same amount. During 2010, 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.Instructions: Prepare a pension worksheet for Blue Diamond for 2010.LO 5 Use a worksheet for employer’s pension plan entries.
18 Using a Pension Work Sheet BE20-3: Prepare a pension worksheet for Blue Diamond for 2010.$250,000 x 10%($7,500) net liabilityLO 5 Use a worksheet for employer’s pension plan entries.
19 Prior Service Cost Amortization of Prior Service Cost If benefits from the amendment to the planVest immediatelyrecognize the expense and related liability at the amendment date.Do not vest immediatelyrecognized as an expense on a straight-line basis over the average remaining period until the benefits become vested.LO 6 Describe the amortization of past service costs.
20 Prior Service CostIllustration: Hitchcock plc amends its defined pension plan on January 1, 2011, resulting in £300,000 of past service cost. There are 300 active employees, of which 60 vest immediately (20%) and 240 (80%) vest in four years. The past service cost applicable to the vested employees is £60,000 and vests immediately. Unrecognized past service cost related to the unvested employees is £240,000 and is amortized over four years.Illustration 20-10LO 6 Describe the amortization of past service costs.
21 Using a Pension Work Sheet E20-7: The following defined pension data of Doreen Corp. apply to the year 2010.Defined benefit obligation, 1/1/10 (before amendment) $560,000Plan assets, 1/1/ ,200Pension liability 13,800On January 1, 2010, Doreen Corp., through plan amendment,grants prior service benefits having a present value of 100,000Discount rate 9%Service cost 58,000Contributions (funding) 55,000Actual (expected) return on plan assets 52,280Benefits paid to retirees 40,000Past service cost amortization for ,000Instructions: For 2010, prepare a pension work sheet for Doreen Corp. that shows the journal entry for pension expense.LO 6 Describe the amortization of past service costs.
22 Using a Pension Work Sheet ($40,920) liabilityLO 6
23 Using a Pension Work Sheet E20-7: Pension Journal Entry for 2010.Dec. 31Pension Expense ,120Pension Liability ,120Cash 55,000LO 6 Describe the amortization of past service costs.
24 Using a Pension Work Sheet Gain or LossUnexpected swings in pension expense can result from:Changes in the fair value of plan assets, andChanges in actuarial assumptions that affect the amount of the defined benefit obligation.LO 7 Explain the accounting for unexpected gains and losses.
25 Gains and Losses Volatility Question: What is the potential negative impact on Net Income of these unexpected swings?VolatilityThe profession decided to reduce the volatility with smoothing techniques.LO 7 Explain the accounting for unexpected gains and losses.
26 Gains and LossesQuestion: What happens to the difference between the expected return and the actual return?Recorded in Net Gain or Loss account.Amortize amount in excess of corridor to pension expense, over the average remaining service period of active employees expected to receive benefits under the plan.LO 7 Explain the accounting for unexpected gains and losses.
27 Gains and LossesQuestion: What happens with unexpected gains or losses from changes in the Defined Benefit Obligation?Recorded in Net Gain or Loss account.Amortize amount in excess of corridor to pension expense, over the average remaining service period of active employees expected to receive benefits under the plan.LO 7 Explain the accounting for unexpected gains and losses.
28 Gains and Losses Corridor Amortization IASB uses 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 defined benefit obligation or the fair value of the plan assets.Any accumulated net gain or loss balance above the 10% must be amortized.LO 8 Explain the corridor approach to amortizing gains and losses.
29 Gains and LossesBE20-7: Hunt Corporation had a defined benefit obligation of $3,100,000 and plan assets of $2,900,000 at January 1, Hunt’s unrecognized net pension loss was $475,000 at that time. The average remaining service period of Hunt’s employees is 7 years.Instructions: Compute Hunt’s minimum amortization of pension loss.LO 8 Explain the corridor approach to amortizing gains and losses.
30 Gains and LossesBE20-7: Compute Hunt’s minimum amortization of pension loss.÷LO 8 Explain the corridor approach to amortizing gains and losses.
31 Gains and Losses Immediate Recognition of Gains and Losses IASB indicates:Corridor approach results in the minimum amount recognized as an actuarial gain and loss.Companies may use any systematic method that is faster provided it is used for both gains and losses and is used consistently from period to period.IASB favors the immediate recognition of actuarial gains and losses.Actuarial gain or loss can either adjust net income or other comprehensive income.LO 8
32 Gains and LossesIllustration: Wentworth Company has the following components of pension expense for 2011.Illustration 20-19If company decides to report the loss in net income.Illustration 20-20LO 8
33 Gains and LossesIllustration: If Wentworth Company decides to report the loss in other comprehensive income.Illustration 20-21Illustration 20-19If company decides to report loss in other comprehensive income.LO 8
34 Using a Pension Work Sheet P20-2: Katie Day Company adopts IAS 19 in accounting for its defined benefit pension plan on January 1, 2000, with the following beginning balances: plan assets $200,000; defined benefit obligation $250,000. Other data are as follows.
40 Using a Pension Work Sheet P20-2: Pension Journal Entry for 2012Dec. 31Pension Expense 83,430Pension Asset/Liability 35,430Cash 48,000
41 Reporting Pension Plans in Financial Statements Within the Financial StatementsPension ExpensePension Asset / LiabilityComponents of Accumulated Other Comprehensive IncomeLO 9 Describe the requirements for reporting pension plans in financial statements.
42 Reporting Pension Plans in Financial Statements Within the Notes to the Financial StatementsDescription of the plan and the accounting policy for recognizing actuarial gains and losses.Schedule showing all the major components of pension expense.Reconciliation showing how the defined benefit obligation and the fair value of the plan assets changed from the beginning to the end of the period.Funded status of the plan and the amounts recognized and not recognized in the financial statements.LO 9 Describe the requirements for reporting pension plans in financial statements.
43 Reporting Pension Plans in Financial Statements Within the Notes to the Financial StatementsDisclosure of the rates used in measuring the benefit amounts (discount rate, expected return on plan assets, rate of compensation).Company’s best estimate of the contributions expected to be made to the plan in the next year. A table indicating the allocation of pension plan assets by category and showing the percentage of or the amount related to the fair value to total plan assets. In addition, the actual return on the plan is disclosed, as well as information on how the expected rate of return is determined.LO 9 Describe the requirements for reporting pension plans in financial statements.
44 Reporting Pension Plans in Financial Statements Special IssuesOther postretirement benefitsCurtailments and settlementsLO 10 Explain special issues related to postretirement benefit plans.
45 IFRS and U.S. GAAP separate pension plans into defined contribution plans and defined benefit plans. The accounting for defined contribution plans is similar.Both IFRS and U.S. GAAP compute unrecognized past service costs (PSC) (referred to as prior service cost in U.S. GAAP) in the same manner. However, IFRS recognizes any vested amounts immediately and spreads unvested amounts over the average remaining period to vesting. U.S. GAAP amortizes PSC over the remaining service lives of employees.
46 Under IFRS, companies have the choice of recognizing actuarial gains and losses in income immediately (either net income or other comprehensive income) or amortizing them over the expected remaining working lives of employees. U.S. GAAP does not permit choice.For defined benefit plans, U.S. GAAP recognizes a pension asset or liability as the funded status of the plan (i.e., defined benefit obligation minus the fair value of plan assets). IFRS recognizes the funded status, net of unrecognized past service cost and unrecognized net gain or loss.The accounting for pensions and other postretirement benefit plans is the same under IFRS. U.S. GAAP has separate standards for these types of benefits, and significant differences exist in the accounting.