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Pensions ACCTG 5120 David Plumlee.

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1 Pensions ACCTG 5120 David Plumlee

2 Important fact… Accounting we are talking about is for the company!
The pension fund is actually managed and accounted for separately legal and accounting entity of its own….. We focus on the impact of an asset/liability/expense for payment of the pension obligation from the company’s perspective

3 Pensions: The Big Picture
Funding Payments Employer Pension Fund Trustee Invests funds to earn a return and payout cash to retiree Retiree Benefit Payments

4 Basic questions What is employer’s liability/asset (how should this be reported on the balance sheet)? What is the current year’s expense associated with the plan? We will spend the rest of our class time wresting with the following two issues what is the liability what is the expense? Pretty simple concepts--but lots of ways to measure them and we have to decide the best (or rather (the required amount…..under fas87)

5 Defined Contribution Plan
Employer contracts for an amount to be contributed Example Plan The company will make a contribution under the plan equal to a stated percentage of the employee’s current annual salary. The percentages applied vary according to age (see attached table). All employees are required to make a 5% minimum contribution. Ownership of all contributions is fully vested in the participant. employer sponsored pension plans are either defined contribution plans or defined benefit plans here is an excerpt from a defined contribution plan under the terms of this plan the employer agrees to make a contribution of some % of salary where the specific % depends on the employee’s age the plan requires employees to make a contribution as well equal to 5% of salary if the employee does not make his/her contribution to the plan then the employer does not have to make its contribution to the plan either this is described as a contributory plan a contributory plan is one in which the employee is required to make contributions as well as the employer a non-contributory plan on the other hand does not require the employees to make any contribution to the plan only the employer makes contributions under a non-contributory plan the terms of the plan also allow for full and immediate vesting of the contributions what does that mean? once the contributions have vested they become the property of the employee on whose behalf they we made so if the employee quits the company they can take the contributions plus any accrued income on them with him or her it is not unusual for there to be a waiting period before contributions vest since companies don’t want employees joining the company working for a short period of time and then leaving with entitlement to their pension benefits this is a right that they want employees to earn only after being with the company for a reasonable period of time questions so far?

6 Defined Contribution Plan
Employee Employees Company% Wages < age % $150,000 45 to % $350,000 50 to retirement 11.5 % $200,000 the terms of this particular plan are such that the employers required contribution as a percentage of the employee’s salary varies with the age of the employee so for example, for employees under the age of 45 the employer makes a contribution to the plan of 7% of salary for employees between 45 and 49 the percentage increases to 8.5% of their current year salary and finally at age 50 to retirement it goes up to 11.5%

7 Company contribution =$1,500,000* $3,500,000* $2,000,000*.115 =$335,000

8 Defined Contribution Example
Benefit period Total Employment Period

9 Defined Benefit Plan Employer contracts for future payouts
Example Plan The company agrees to provide to all employees at age 65, an annual pension benefit computed in accordance with the “benefit formula.” Ownership of all benefits becomes fully vested following three years of continuos employment with the company. life is not so simple when we are facing a defined benefit pension plan once again here is an excerpt from a typical defined benefit pension plan please not that these are just examples of defined contribution and defined benefit plans that are representative of plans that you might run into however, each plan is unique in terms of its particular terms and formulas that are applied to determine either the required contribution for a defined contribution plan or the required pension benefit for a defined benefit plan under the terms of this particular plan the employer agrees to pay an annual benefit to employees after age 65 equal to an amount that is determined in accordance with the benefit formula (we will take a look at the benefit formula for this plan in a moment) in this case the benefits become vested in the employee following three years of employment so if the employee leaves before the three years is up they are entitled to no pension benefit but if they stay beyond three years they are entitled to the annual benefit specified by the formula even if they quit or are fired before retirement

10 Defined Benefit Example
Total Employment Period Benefit period

11 Determining Employer Contribution
What does the employer need to do? What is the amount of that liability?

12 Actuarial Assumptions
Assume for an employee who works for this company: Benefits are $4,000 per year in retirement for every year worked Expected # of years at company = 20 yrs Employee will live 15 years beyond retirement Settlement rate is 6%. (The interest rate implicit in the annuity contract at retirement.) Expected rate of return 8%. ( The amount that funding will earn.) so lets say you are an employee of this company and you want to estimate how much your annual pension benefit will be when you retire you want know if you are going to be able to afford the 3 months in Hawaii every year that you’re planning on so you sit down and you estimate how much you expect to be earning on average over the last 3 years of employment with the company - lets say that works out to $100,000 and how long you expect to be employed by the company - say 20 years using this information and the benefit formula how much will your annual pension benefit be? $40,000 so if everything works out just like you plan you will get $40,000 per year 20 years from now for each year you are retired after the age of 65 at todays rates of inflation that should be about enough to keep you in hamburger but thats about it! So--now that we have figured out that you hope SS still exists when you retire--how would the employer account for this??? How much is ‘tchnically’ a liability--when is it earned? All those basic questions….

13 Actuaries Determine Benefits
Current period Retirement Total Employment Period Actuarial Estimate of Retirement Benefits = PV of Settlement Rate

14 Actuaries Determine Benefits
Retirement Benefits = Remaining Employment Period = 20 years Current period Retirement = 15 years

15 Actuaries Determine Funding
So, how much should the company fund this year? What is that amount in this example?

16 Actuaries Determine Funding
Current period Retirement = 15 years Remaining Employment Period = 20 years

17 Defined contribution vs. benefit plans
Employer’s contribution is based on expected payout Contract is for payments to retired employees employer bears risk associated with plan performance Great uncertainty regarding annual pension expense Contribution Employer’s contribution to the plan is defined No promises regarding ultimate pension benefit Employees bear risk associated with plan performance No uncertainty regarding annual pension expense

18 Accounting for Defined Contribution Plans
Assume required contribution under terms of plan for 2003 is $335,000 Employer Funding Contribution Status Case A: $335, fully funded Case B: $300, under funded Case C: $600, over funded say that the company did this and determined that the contribution required of them under the terms of the plan is $335,000 now the company must decide whether it wants to fund the plan by this amount this year or if its short of cash it might decide to pay a little less than this year and owe the plan some amount which it will have to catch up with interest at a later date, or if it has some extra cash this year the company may decide to pay a little extra this year in advance of future required contributions so “funding” a plan is the act of making cash contributions to the plan that will be set aside and invested a funded plan - refers to the status of the plan in terms of how much money has been set aside to date the funding status of the plan can further be described as “fully funded” i.e. case A, “under funded” i.e. Case B and “over funded - Case C” any questions so far then lets look at the accounting for each of these three possible cases

19 Accounting for Defined Contribution Plans
Case A: Case B: Case C: if the company fully funds the plan the entry debits pension expense and credits cash for the required contribution if however, the company is somewhat short of cash and decides to fund only $300,000 this year then the entry still records pension expense based on the required contribution of $500,000 but now the cash leaving the firm is only $300,000 the other $200,000 is a liability of the company to the pension plan i.e. the firm owes the plan $200,000 so we credit this to a liability account called “pension obligation” which will be classified as a current or long-term liability depending on how long we expect to owe the money any questions so far? then what would the entry look like for case C where we pay in $600,000 even though the required contribution is only $500,000

20 Defined BENEFIT Options
Cash basis accounting wait until employees retire expense actual payments to retired employees Modified cash basis accounting fund plan prior to retirement expense funding payments Accrual basis accounting (FAS 87) expense pension related cost of services provided in current year by employees various approaches to accounting for pension expense of defined benefit plans cope with this uncertainty to varying degrees for example the company could wait until the employees retire then when they make actual payments to retirees they could charge these to pension expense at that time PROBLEMS? may not have enough money to meet obligation in the future (economic problem) fail to match the cost of the plan to the period that the employees rendered their service to the company (accounting problem) how useful is Joe to us sitting in his basement making bird houses after he retries? - not very so if we wait until that time to charge his pension benefits to expense we will be expensing something for which we get no benefit we received the benefit of Joe’s service before he retired and so that is when the cost of his plan should be expensed view the pension plan as deferred salary - if we didn’t have a pension plan we would have had to pay Joe a higher annual salary when he was working alternatively we could use a modified cash basis say we recognize that their may be some concern about not having enough money to satisfy the obligation in the future and we recognize that waiting until Joe retires to start expensing his pension is not entirely correct

21 What is the ‘obligation’?
Given we use an accrual method of accounting there arethree measures of pension obligation all require input from actuaries about estimated payments required 2 big differences first is whether we are going to use current salary levels or future salary levels second is whether amounts ‘due’ to employees that are not vested in plans will be considered an obligation prior to vesting what is vesting under ERISA-- must vest fully within 5 years or 20% within three years with another 20% each year until fully vested after 7 years While these are all theoretical measures of pension obligation--the ones we will use are the PBO and the ABO. There are times when the ABO (even though it understates the net liability) is used to compute the MINIMUM liability = ABO - plan assets discuss this more later…. Accumulated benefit obligation (ABO) Estimate of total retirement benefits based on current salary levels Vested benefit obligation Portion of ABO that is vested Projected benefit obligation (PBO) Estimate of total retirement benefits based on future salary levels

22 Major Components of a Pension Plan
PBO actuarial present value of future pension benefits earned to date to be paid to employees in the future Pension plan assets value of assets set aside to satisfy obligation **net pension obligation (asset) =PBO-pension assets** Pension expense amount charged to income for the period so instead the FASB said companies would be required under FAS 87 to account for pension expense using an approach that is consistent with the accrual basis of accounting using certain assumptions and a specified actuarial approach companies are required to determine the pension cost arising from services rendered by employees in a given year and regardless of how much you decide to fund this year that is the amount we want you to expense (so even if you don’t put away enough cash this year to meet your future obligation, you need to accrue the expense…) so under FAS 87 it is very likely that the company will expense an amount which is completely different from the amount that they fund during the period neither the PBO or the pension plan assets are reported on the balance sheet--but they will determine how much outstanding liability is shown !!! over the next few classes we are going to take an in-depth look at how we compute pension expense under FAS 87 AND WHY we compute it the way we do a first step in getting there is to make sure that we are speaking the same language when it comes to the main components of a pension plan - the plan obligation, the plan assets and total pension expense

23 the pension obligation (or more accurately projected benefit obligation) is the actuarial present value of the future pension benefits that the company has promised it will pay to its employees when they retire that have been earned to date--so this is the amount a lot of companies would put into a fund and expense in a given year. the adjective actuarial just means that this is the present value computed by an actuary one of several actuarial valuation methods and taking into consideration a whole host of assumptions with respect to employee turnover, longevity after retirement, interest rates etc. (I will have a lot more to say about this next class) the pension plan assets are just the assets which have been set aside to satisfy this obligation very often the company will make cash contributions to a trustee that will invest and administer the plan assets and make benefit payments to existing retirees out of the plan assets the difference between the total amount we owe and the assets we have set aside to satisfy that obligation is the company’s net pension obligation (or net pension asset if assets exceed the obligation) on the balance sheet of the company we could show plan assets under the assets side of the balance sheet and PBO under the liabilities side of the balance sheet , but we end up netting the two and show only the net amount on the balance sheet so for computation purposes both are important, for disclosure purposes the net under or over funded balance is important any questions on this? before we can introduce how each of these is generally computed we first need to get some important terms out on the table

24 Important Terms Benefit payments Funding payments
pension payments to participants Funding payments payments made to the trustee to fund the plan Transition adjustment “catch-up” adjustment that arose when firms first adopted FAS 87 for example benefit payments are the actual pension benefit payments made to retirees of the company funding payments on the other hand are the payments that the employer makes to the trustee to fund the plan it is out of accumulated funding payments plus interest, dividends and capital gains that benefit payments are made so benefit payments and funding payments are two very different things and should not be confused with one another the transition adjustment is the catch up adjustment that firms had to make when they first adopted FAS 87 in 1986/87

25 Important Terms Current service cost (CSC)
present value of benefits earned during the current period Actual return on plan assets includes dividends, interest income and capital gains and losses Expected return on plan assets anticipated return on plan assets based on the expected long-term rate of return on plan assets current service cost or service cost is the present value of the benefits earned by employees because they worked the current year for the firm this is generally the largest component of pension expense actual return on plan assets is the return generated on the plan assets during the year and includes interest income, dividend income and capital gains less capital losses the actual return should not be confused with the expected return one of the assumptions that the actuary makes is the rate of return that they expect the plan assets to earn over the long-term (and it is very unlikely that the average long tem will be the same as any single year return!!) to the extent that the actual return is greater than the expected return -- then we can say we had good experience this period that is we had an experience gain

26 Important Terms Experience gain or loss Actuarial gain or loss
difference between actual and expected return on plan assets Actuarial gain or loss a change in the value of the PBO resulting from a change in actuarial assumptions Prior service cost (PSC) cost of retroactive benefits granted in a plan amendment on the other hand if we actually earned less than we expected to then we had an experience loss so experience gains and losses are just the difference between the actual and expected return on plan assets actuarial gains and losses on the other hand arise when the actuary changes an assumption in his or her computations of the company’s projected benefit obligation so for example -- say when the actuary last estimated the PBO he/she assumed that on average employees would live until they are 70 but a new study shows that average life expectancy has increased and so he/she decides it is more likely that on average employees will survive until 75 the impact of making that change in assumption in the computation of the projected benefit obligation is going to be to increase the PBO significantly from what we originally computed since now for every employee we are assuming five more years of pension benefits will have to pay changes in assumptions that increase the PBO give rise to actuarial losses and changes in assumptions that reduce the obligation give rise to actuarial gains FINALLY prior service costs prior service costs arise when a company retroactively adopts or amends a pension plan for example say in 1997 wash u adopts a defined benefit pension plan for its faculty when they adopt the plan they may say, faculty, because you are so loyal and hardworking we will give you credit for years 1995 and 1996 when we compute you pension benefits so even though the plan is only adopted in 1997, the number of years used in the benefit formula would be 3 as of the end of 1997 the effect of this decision is to incur a huge pension obligation and a need to catch up on the pension related pension expense for 1995 and 1996 at the time that the plan is adopted we refer to the cost of this obligation as prior service costs

27 Pension Assets opening balance + actual return on plan assets
Pension Fund Trustee Invests funds to earn a return and payout cash to retiree opening balance + actual return on plan assets + funding payments - benefit payments to retirees closing balance we compute the plan assets available at the end of a given year by starting with the opening balance and adding the actual return on the plan assets during year and the funding payments made to the trustee during the year by the company and subtracting any cash payments made to the company’s retirees any questions so far?

28 Projected Benefit Obligation
opening balance + current service cost + prior service cost + interest on obligation - benefit payments to retirees +/- changes in assumptions (i.e. actuarial gains/losses) closing balance Employer it is important that you quickly become familiar with these terms because they are going to pop into the conversation constantly armed with this tool bag of terms we can now take a look at how the pension obligation and plan assets change over time and how pension expense is computed this is just an overview we will come back to each computation in detail next class and on Monday a company’s pension obligation as at the end of a given year is computed by starting with the amount owing at the beginning of the year plus the cost of the pension benefits arising from services provided by employees in the current year - this is called current service cost plus the cost of pension benefits arising from retroactive changes to the plan i.e. prior service cost plus interest on the obligation since the pension obligation is stated at present value we have to accrue interest on the amount owing thereby increasing the obligation the obligation is reduced by any payments actually made to retirees and finally it can be increased or decreased because of changes in the actuaries assumptions

29 Pension Expense + current service cost
+ interest on pension obligation - actual return on plan assets +/- deferral of experience gain/loss +/- amortization of unrecognized gain/loss (including experience and actuarial gains/losses) + amortization of unrecognized prior service cost +/- amortization of transition adjustment pension expense then finally let’s introduce the pension expense computation pension expense is the sum of a whole host of components specifically current service cost plus interest on the pension obligation minus the expected return on plan assets (not the actual return) + amortization of unrecognized prior service cost + amortization of unrecognized gains and losses (arising because we reduced pension expense by expected return not actual return) and amortization of unrecognized changes in assumptions next class we will spend almost the entire class figuring out how to compute each of these items and why they are computed and treated the way they are

30 Current Service Cost Actuarial present value of new benefits earned by employees during current period Current period Retirement Total Employment Period the current service cost is the actuarial present value of the new pension benefits earned by the firms employees during the year based on actuarial assumptions--one more year of service is included in the calculations--this is the main component of pension expense PV of additional retirement benefits

31 Effect of Service Cost Assume a $500,000 increase of PBO due to additional year of service Expense Current service cost increases in first year of plan, same as for PBO PBO Service cost is starting point Current service cost will increase PBO on an annual basis Beg Bal $1,300,000 Current SC , $ 500,000

32 Prior Service Cost Credit given to employees for past service
Initiate or amend a plan Retroactive benefits really retroactive? Expectation of future service…. Increases PBO Amortize PSC for pension expense Years of service method prior service cost = $100,000, 5 year amortization

33 Prior Service Cost Prior service period PV of benefits due to plan amendment or adoption for past periods Plan Amendment Current period Retirement Total Employment Period

34 Effect of PSC PBO Expense Increases by total amount in year of change
amortized into over estimated life of employees effected, beginning with year of change Beg Bal $1,300,000 Current SC , $ 500,000 PSC , ,000

35 Interest on Pension Obligation
Employee is one year closer to retirement, which increase present value of benefits due to the time value of future benefits Interest on the pension obligation (i.e. projected benefit obligation) outstanding during the period = beginning-of-year balance x settlement rate Assume settlement rate = 10% or companies can look to the current return on low risk investments to get an estimate of the settlement rate why low risk investments? because you want to make sure that if you were to buy assets today to settle the future pension obligation that the returns on those assets are pretty much guaranteed so you would not want to use the return on risky assets because there is too much uncertainty regarding the future income stream from risky investments any questions on this?

36 Effect of Interest Increases expense Increases PBO Beg Bal $1,300,000
Current SC , $ 500,000 PSC 100, ,000 Interest 130, ,000

37 Payments and changes in assumptions
Benefit payments reduce PBO Payments have NO EFFECT on pension expense Assume $30,000 funding payment Changes in actuarial assumptions Increase or decrease PBO Amortized in pension expense (when too big!) Assume actuarial assumptions change amount is increase in PBO of $40,000

38 Effect of payments and changes in assumptions
Payments decrease PBO Changes in actuarial assumptions change PBO No effect Changes in actuarial assumptions are amortized into expense using corridor approach Beg Bal $1,300,000 Current SC , $ 500,000 PSC 100, ,000 Interest 130, ,000 Benefit pmt ( 30,000) 00 Actuarial loss , *

39 Return on Plan Assets Actual return =
Pension Fund Trustee Actual return = interest + dividends + cap. gains - cap. losses Expected return = actuary’s expected rate of return x plan assets Difference is the ‘experience gain or loss’ the next item is the return on plan assets which typically reduces pension expense for the period remember that there are two return numbers that are important the actual return on plan assets which is the sum of interest and dividends for the year and capital gains minimum capital losses and the expected return on plan assets which is the amount of the return the actuary expected the plan assets to generate during the period based on a long-run average rate of return can anyone see a problem with including the actual return on plan assets in the computation of pension expense? could result in wild swings in pension expense for example the company might be able to achieve a 40% return in the stock market for a given year or should another black Monday hit they might have a return of -60% in that year the question is whether substantial and perhaps one time events like this should be left in current pension expense actuaries ignore fluctuations like this when they develop a funding plan they make an assumption about what the plan assets will earn over the long-term and use this expected rate of return to compute the expected return on plan assets for a given year the difference between the expected return on plan assets and the actual return on plan assets is called and actuarial gain or loss the FASB concluded that it was not appropriate to include actual return in the computation of pension expense because of concerns over wild swings such as these

40 Details of expected return
Actual return reduces pension expense with ‘experience’ gains/losses deferred Net result is EXPECTED return reduces pension expense Amortize experience gains/losses when they gets too large

41 Return on plan assets Plan assets = $1,000,000
Actual return at 25%= $250,000 Expected return at 11% = $110,000 unexpected gain (i.e. experience gain) = 250, ,000=140,000 Reduce pension expense by $250,000 Defer experience gain of $140,00 (incr. Pension exp.) so for example lets say we have plan assets of $1,000,000 accumulated in the pension plan to satisfy for the future pension benefits lets say we expect that over the long haul we will on average generate a return of 11% let’s also say that this year was a great year for the stock market and in reality we earned a return this year of 25% the actual return on plan assets = $250,000 the expected return on plan assets = $110,000 so in this case the company had an unexpected (or experience) gain of $140,000 continuing on with the example we started earlier pension expense would be computed and disclosed in the financial statement footnotes in the following manner why do we report actual return and then adjusted for the unexpected portion to get back to expected return why not just report the expected amount? there is a lot of important information in the actual amount but the important thing to realize is that on net, pension expense is not reduced by the actual return, but by the expected return

42 Effect of return on plan assets
No effect Reduces expense by expected return Actual return less the deferred ‘experience gain/loss’ Beg Bal $1,300,000 Current SC , $ 500,000 PSC 100, ,000 Interest 130, ,000 Benefit pmt ( 30,000) Actuarial loss , * Actual return (250,000) Deferred exp gain ,000

43 Delayed Recognition Under FAS 87
Impact of following items not fully recognized when they occur experience gains and losses actuarial gains and losses (i.e. impact of changes in assumptions) prior service cost transition adjustment (IGNORE!!) as a result, the experience gain or loss is not recognized in pension expense when it occurs instead it is deferred and ultimately effects pension expense at a later date this is an example of delayed recognition but this is not the only item which is afforded delayed recognition treatment delayed recognition treatment is also applied to actuarial gains and losses, prior service costs and the catch up adjustment from adopting FAS 87, i.e. the transition adjustment this has very significant implications for accounting and reporting of pensions because it is because of the FASB’s decision to require delayed recognition of these amounts that pensions still give rise to very significant off-balance sheet assets or liabilities if you know where to look and how to interpret pension footnotes this will not cause a problem but for the uniformed it can lead to serious problems

44 With Full Recognition:
to see why this is so consider what life would be like without delayed recognition to record CSC we should be debiting pension expense and crediting the pension obligation account to record the effect of prior service costs arising in the current period because of retroactive initiation or amendment of the plan we should again debit pension expense and credit the obligation same with accrued interest on the obligation the entry to record benefit payments would simply debit the pension obligation and credit plan assets and the impact of changes in assumptions, which are like catch up adjustments to pension expense, would be recorded by debit or crediting the pension obligation as the case may be and debiting or crediting pension expense as far as the plan assets go, the entry to record the actual return on plan assets would be recorded by debiting plan assets and crediting pension expense we already talked about how benefit payments would be recorded and finally contributions or funding payments into the plan would be recorded by debiting plan assets and crediting cash so if we used an approach of full and immediate recognition of each of these items the balance sheet would show a pension obligation equal to the ending balance in the first column, a pension asset account equal to the ending balance in the second column and total pension expense equal to the total of third column but FAS 87 does not adopt an approach of full and complete recognition for all items for psc, return on plan assets and the impact of changes in assumptions, FAS 87 adopts a delayed recognition approach

45 Effect of Delayed Recognition
Prepaid (accrued) pension reported on balance sheet may not equal net pension asset (obligation) i.e. frequently companies have significant off-balance sheet pension liabilities or pension assets Total pension expense does not equal the change in the PBO as a result, the amount of prepaid or accrued pension reported on the balance sheet may not be equal to the net pension obligation or asset computed as the difference between the pension obligation and the plan assets instead many if not most companies disclose in the footnotes significant off balance sheet pension assets or liabilities that arise because of delayed recognition in addition,pension expense does not equal the sum of the items shown here but instead includes only an amortized portion of those items that are afforded delayed recognition treatment so let’s continue looking at the remaining components of pension expense bearing in mind that delayed recognition applies in each case let’s start with gains and losses - this category includes both to deferred experience gains and losses and deferred actuarial gains and losses

46 The Corridor Approach Minimum amortization
allow gains less losses to accumulate until net amount deferred exceeds a defined threshold amortization required when beginning-of-year net gain or loss exceeds 10% of maximum opening (PBO or fair value of plan assets) amortization period is Estimated Average Remaining Service Life of the active employees expected to receive benefits amount amortized is the EXCESS over the corridor amount. (beginning net deferred gain/loss - threshold)/EARSL I said earlier that we will defer gains and losses and only begin to amortize them to pension expense when the unamortized balance is viewed as becoming too large this is done to smooth out pension expense since we do not want wild fluctuations in pension expense from one period to the next and if our assumptions are unbiased over time gains and losses should net out such that the net balance is relatively minor but should it get too large then we must reduce it by amortizing the excess to pension expense all that remains then is some approach to assessing when the the net balance has become too large and this is where the corridor approach comes in we keep track of the amounts deferred and we do not begin amortizing them to pension expense until they reach a defined threshold the limits are discussed in the text and they are based on 10% of the PBO or FMV of the plan assets which ever is larger once that limit is passed such that the total amount deferred to date exceeds the defined threshold then the company must amortize the excess so they take the difference between the total amount of the actuarial gains and or losses deferred deduct the threshold and then typically using the SL method amortize the excess over a period not to exceed five years so in any given period in which there are deferred exchange gains and losses there may or may not be an adjustment to pension expense for amortization of previously deferred actuarial gains and losses the computation I just described is the minimum amount of amortization that firm’s must take they can, however, amortize at a faster rate if they want to using straightline amortization the full amount of the net gain or loss at the beginning of the period can be written off

47 Corridor Example Beginning fair value of plan assets = $1,000,000
Beginning of year PBO = $ 1,300,000 Beginning of year deferred gain/loss = $180,000 End of year deferred gain = $320,000 EARSL = 10 years so let’s continue with our previous example we computed earlier that this year we had an experience gain of the question is, does any of that amount have to be amortized this period and if so how much well 10% of the opening balance of the greater of the plan assets or the PBO is 130,000 as far as we know the opening balance of the net deferred gains and losses is zero so this year we have no amortization to take next year may be a different story since we will have an opening deferred gain of at that point in time which may exceed the corridor

48 Corridor Solution Determine 10% threshold Amortization amount
10% of beginning PBO = $130,000 10% of beginning FV plan assets = $100,000 Amortization amount Beginning deferred gain/loss = $180,000 Corridor (10% of PBO) ,000 Total amort. Amount $50,000 (This year’s portion $50,000/10=$5,000)

49 Effect of amortization
No effect Increases expense Beg Bal $1,300,000 Current SC , $ 500,000 PSC 100, ,000 Interest 130, ,000 Benefit pmt ( 30,000) Actuarial loss , * Actual return (250,000) Deferred exp gain ,000 Amortization ,000

50 What do we record? Journal entry to record pension expense
as calculated above Entry to record funding payment Balance to pension asset/liability

51 What is not on the balance sheet?
Unrecognized experience gains/losses Plan assets include actual return not expected return Unrecognized prior service cost PBO includes entire prior service cost not amortized Unrecognized actuarial gains/losses PBO includes all actuarial gains/loss

52 Minimum liability Concerns over underfunded plans with no balance sheet recognition Requires reporting of ‘minimum liability’ Difference between fair value of plan assets and ABO Can only report in a liability, not additional asset…. (when ABO is less than FV of plan assets)

53 Recording Compare minimum liability to balance sheet and adjust for difference Debit contra equity account for amount related to PSC Debit balance to Intangible Asset-Deferred Pension Cost Credit additional pension liability for amount minimum liability exceeds reported liability/asset

54 Minimum Liability Example
Assume no minimum liability attributable to PSC. Intangible Asset - Deferred Pension Cost $XXXX Minimum Liability $XXXX Assume $ 100,000 attributable to PSC. Intangible Asset - Deferred Pension Cost $(XXXX-$100k) Contra Equity Account $100K Minimum Liability $XXXX

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