1. Accounting for Pensions and Postretirement Benefits
PART II: Corporate Accounting Concepts and Issues
Lecture 23
Accounting for Pensions and Postretirement Benefits
Instructor
Adnan Shoaib

2. Learning Objectives
Distinguish 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 prior service costs.
Explain the accounting procedure for unexpected gains and losses.
Explain the corridor approach to amortizing gains and losses.
Describe the requirements for reporting pension plans in financial statements.

3. Accounting for Pensions and Postretirement Benefits
Nature of Pension Plans
Accounting for Pensions
Using a Pension Worksheet
Reporting Pension Plans in Financial Statements
Defined contribution plan
Defined-benefit plan
Role of actuaries
Alternative measures of liability
Recognition of net funded status
Components of pension expense
2012 entries and worksheet
Amortization of prior service cost
2013 entries and worksheet
Gain or loss
2014 entries and worksheet
Within the financial statements
Within the notes to the financial statements
Pension note disclosure
2015 entries and worksheet—a comprehensive example
Special issues

4. 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 Plan
Administrator
Contributions
Employer
Retired
Employees
Benefit Payments
Assets &
Liabilities
LO 1 Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

5. 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.

6. Nature of Pension Plans 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 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.

7. 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.

8. Accounting for Pensions
Alternative measures of the Liability
Employer’s pension obligation is the deferred compensation obligation it has to its employees for their service under the terms of the pension plan.
FASB’s choice
Illustration 20-3
LO 3 Explain alternative measures for valuing the pension obligation.

9. Accounting for Pensions
LO 4 List the components of pension expense.

10. Accounting for Pensions
Components of Pension Expense
Effect on Expense 1.
Service Costs +
Actuarial present value of new benefits earned by employees during the period.
LO 4 List the components of pension expense.

11. Accounting for Pensions Interest on the Liability
Components of Pension Expense
Effect on Expense 2.
Interest on the Liability +
Interest for the period on the projected benefit obligation outstanding during the period.
Interest rate (settlement rate) should be those based rates of return on high-quality fixed-income investments currently available, whose cash flows match the timing and amount of the expected benefit payments.
LO 4 List the components of pension expense.

12. Accounting for Pensions Actual Return on Plan Assets
Components of Pension Expense
Effect on Expense 3.
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 20-5
LO 4 List the components of pension expense.

13. Accounting for Pensions Amortization of Prior Service Costs
Components of Pension Expense
Effect on Expense 4.
Amortization of Prior Service Costs +
Plan amendments often increase benefits for 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.
LO 4 List the components of pension expense.

14. Accounting for Pensions
Components of Pension Expense
Effect on Expense 5.
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 projected benefit obligation.
LO 4 List the components of pension expense.

15. 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.

16. Using a Pension Work Sheet
At January 1, 2012, Beaty Company had plan assets of $280,000 and a projected benefit obligation of the same amount. During 2012, service cost was $27,500, the settlement 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 Beaty for 2012.
LO 5 Use a worksheet for employer’s pension plan entries.

17. Using a Pension Work Sheet
Prepare a pension worksheet for Beaty for 2012.
($280,000 x 10%)
($10,500) net liability
LO 5 Use a worksheet for employer’s pension plan entries.

18. Using a Pension Work Sheet
Note the following about the Work Sheet:
The balance in the Pension Asset / Liability column should equal the net balance in the memo record – this is the “net funded position” of the pension plan. If a credit balance, Pension liability; if a debit balance, Pension asset.
For each transaction or event, the debits must equal the credits.
LO 5 Use a worksheet for employer’s pension plan entries.

19. Prior Service Cost Amortization of Prior Service Cost
Company should not recognize the retroactive benefits as pension expense entirely in the year of 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.
Amortization Method:
Board prefers a years-of-service method.
SFAS No. 158 allows use of the straight-line method.
LO 6 Describe the amortization of prior service costs.

20. Using a Pension Work Sheet
The following defined pension data of Rydell Corp. apply to the year 2012.
Projected benefit obligation, 1/1/12 (before amendment) $560,000
Plan assets, 1/1/ ,200
Pension liability 13,800
On January 1, 2012, 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 ,000
Instructions: For 2012, prepare a pension work sheet for Rydell Corp. that shows the journal entry for pension expense.
LO 6 Describe the amortization of prior service costs.

21. Using a Pension Work Sheet
($135,720) liability

22. Using a Pension Work Sheet
Pension Journal Entry for 2012.
Dec. 31
Pension Expense ,920
Other Comprehensive Income (PSC) ,000
Pension Asset/Liability ,920
Cash 65,000
LO 6 Describe the amortization of prior service costs.

23. Gains and Losses Gain or Loss
Unexpected swings in pension expense can result from:
Sudden and large changes in the fair value of plan assets, and
Changes in actuarial assumptions that affect the amount of the projected benefit obligation.
LO 7 Explain the accounting for unexpected gains and losses.

24. Gains and Losses Volatility
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.
LO 7 Explain the accounting for unexpected gains and losses.

25. Gains and Losses Answer
Question: What happens to the difference between the expected return and the actual return?
Answer
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.

26. Gains and Losses Answer
Question: What happens with unexpected gains or losses from changes in the Projected Benefit Obligation (PBO)?
Answer
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 Losses 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 (which may equal 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.

28. Gains and Losses
Shin Corporation had a projected benefit obligation of $3,100,000 and plan assets of $3,300,000 at January 1, Shin’s also had a net pension actuarial loss of $465,000 in accumulated OCI at January 1, The average remaining service period of Shin’s employees is 7.5 years.
Instructions: Compute Shin’s minimum amortization of the actuarial loss.
LO 8 Explain the corridor approach to amortizing gains and losses.

29. Gains and Losses ÷ Compute Shin’s amortization of the loss.
LO 8 Explain the corridor approach to amortizing gains and losses.

30. Using a Pension Work Sheet
Jackson Company adopts acceptable accounting for its defined benefit pension plan on January 1, 2011, with the following beginning balances: plan assets $200,000; projected benefit obligation $250,000. Other data are as follows.
LO 8 Explain the corridor approach to amortizing gains and losses.

31. Using a Pension Work Sheet
Pension Work Sheet for 2011 *
* Expected Return on Plan Assets $200,000 x 10% = $20,000
($57,000)
LO 8 Explain the corridor approach to amortizing gains and losses.

32. Using a Pension Work Sheet
Pension Journal Entry for 2011
Dec. 31
Pension Expense 21,000
OCI – Gain/Loss ,000
Pension Asset/Liability ,000
Cash 16,000
LO 8 Explain the corridor approach to amortizing gains and losses.

33. Using a Pension Work Sheet * Actual return = Expected Return
Pension Work Sheet for 2012 *
* Actual return = Expected Return
($217,700) liability
LO 8 Explain the corridor approach to amortizing gains and losses.

34. Using a Pension Work Sheet
Pension Journal Entry for 2012
Dec. 31
Pension Expense ,100
Other Comprehensive Income (PSC) ,600
Pension Asset/Liability ,700
Cash 40,000
LO 8 Explain the corridor approach to amortizing gains and losses.

35. Using a Pension Work Sheet
Pension Work Sheet for 2013 *
* Plug
($203,400) liability
LO 8 Explain the corridor approach to amortizing gains and losses.

36. Using a Pension Work Sheet
Pension Journal Entry for 2013
Dec. 31
Pension Expense ,370
Pension Asset/Liability 14,300
Other Comprehensive Income (G/L) ,070
Other Comprehensive Income (PSC) 41,600
Cash 48,000
LO 8 Explain the corridor approach to amortizing gains and losses.

37. Reporting Pension Plans in Financial Statements
Within the Financial Statements
Pension expense
Pension Asset / Liability
Components of Accumulated Other Comprehensive Income
LO 9 Describe the requirements for reporting pension plans in financial statements.

38. Reporting Pension Plans in Financial Statements
Within the Notes to the Financial Statements
Major components of pension expense.
Reconciliation showing how the projected benefit obligation and the fair value of the plan assets changed.
A disclosure of the rates used in measuring the benefit amounts (discount rate, expected return on plan assets, rate of compensation).
LO 9 Describe the requirements for reporting pension plans in financial statements.

39. Reporting Pension Plans in Financial Statements
Within the Notes to the Financial Statements
A table indicating the allocation of pension plan assets by category (equity securities, debt securities, real estate, and other assets), and showing the percentage of the fair value to total plan assets.
The expected benefit payments to be paid to current plan participants for each of the next five fiscal years and in the aggregate for the five fiscal years thereafter. Also required is disclosure of a company’s best estimate of expected contributions to be paid to the plan during the next year.
LO 9 Describe the requirements for reporting pension plans in financial statements.

40. Reporting Pension Plans in Financial Statements
Within the Notes to the Financial Statements
The nature and amount of changes in plan assets and benefit obligations recognized in net income and in other comprehensive income of each period.
The accumulated amount of changes in plan assets and benefit obligations that have been recognized in other comprehensive income and that will be recycled into net income in future periods.
The amount of estimated net actuarial gains and losses and prior service costs and credits that will be amortized from accumulated other comprehensive income into net income over the next fiscal year.
LO 9 Describe the requirements for reporting pension plans in financial statements.

41. Reporting Pension Plans in Financial Statements
Special Issues
The Pension Reform Act of 1974
Pension Terminations
LO 9 Describe the requirements for reporting pension plans in financial statements.

42. Illustrative Accounting Entries
ACCOUNTING FOR POSTRETIRMENT BENEFITS
2012 Entries and Worksheet
Illustrative Accounting Entries
Illustration: The use of a worksheet in accounting for a postretirement benefits plan, assume that on January 1, 2012, Quest Company adopts a healthcare benefit plan. The following facts apply to the postretirement benefits plan for the year 2012.
Plan assets at fair value on January 1, 2012, are zero.
Actual and expected returns on plan assets are zero.
Accumulated postretirement benefit obligation (APBO), January 1, 2012, is zero.
Service cost is $54,000.
No prior service cost exists.
Interest cost on the APBO is zero.
Funding contributions during the year are $38,000.
Benefit payments to employees from plan are $28,000.
LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.

43. Illustrative Accounting Entries
ACCOUNTING FOR POSTRETIRMENT BENEFITS
2012 Entries and Worksheet
Illustrative Accounting Entries
Illustration 20A-4
Journal Entry

44. Illustrative Accounting Entries
ACCOUNTING FOR POSTRETIRMENT BENEFITS
Illustrative Accounting Entries
Recognition of Gains and Losses
Gains and losses represent changes in the APBO or the value of plan assets. Gains and losses are recorded in other comprehensive income.
The Corridor Approach
Amortization Methods
LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.

45. Illustrative Accounting Entries
ACCOUNTING FOR POSTRETIRMENT BENEFITS
2013 Entries and Worksheet
Illustrative Accounting Entries
Illustration: The following facts apply to the postretirement benefits plan for Quest Company for the year 2013.
Actual return on plan assets is $600.
Expected return on plan assets is $800.
Discount rate is 8 percent.
Increase in APBO due to change in actuarial assumptions is $60,000.
Service cost is $26,000.
Funding contributions during the year are $18,000.
Benefit payments to employees during the year are $5,000.
Average remaining service to expected retirement: 25 years.
LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.

46. Illustrative Accounting Entries
ACCOUNTING FOR POSTRETIRMENT BENEFITS
2013 Entries and Worksheet
Illustrative Accounting Entries
Illustration 20A-6
Journal Entry

47. Illustrative Accounting Entries
ACCOUNTING FOR POSTRETIRMENT BENEFITS
Illustrative Accounting Entries
Amortization of Gains and Losses in 2014
Illustration 20A-8
LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.

48. RELEVANT FACTS
IFRS and GAAP separate pension plans into defined contribution plans and defined benefit plans. The accounting for defined contribution plans is similar.
Both IFRS and GAAP compute unrecognized past service costs (PSC) (referred to as prior service cost in GAAP) in the same manner. However, IFRS recognizes any vested amounts immediately and spreads unvested amounts over the average remaining period to vesting. GAAP amortizes PSC over the remaining service lives of employees.

49. RELEVANT FACTS
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. GAAP does not permit choice; actuarial gains and losses are reported in “Accumulated other comprehensive income” and amortized to income over remaining service lives.
For defined benefit plans, 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.

50. End of Lecture 23