20-1 7.explain the accounting for unexpected gains and losses. 8. explain the corridor approach to...

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Financial Accounting and Accounting StandardsLEARNING OBJECTIVES
Distinguish between accounting for the employer’s pension plan and accounting for the pension fund. (SELF-STUDY)
Identify types of pension plans and their characteristics. (SELF-STUDY)
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.
Accounting for Pensions and Postretirement Benefits
20
20-*
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.
After studying this chapter, you should be able to:
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.
Accounting for Pensions and Postretirement Benefits
20
20-*
An arrangement whereby an employer provides benefits (payments) to retired employees for services they provided in their working years.
Pension Plan
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
Pension Expense
The two most common types of pension plans are defined contribution plans and defined benefit plans.
20-*
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.
After studying this chapter, you should be able to:
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.
Accounting for Pensions and Postretirement Benefits
20
20-*
Risk borne by employees
Benefit determined by plan
Risk borne by employer
Nature of Pension Plans
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.
After studying this chapter, you should be able to:
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.
Accounting for Pensions and Postretirement Benefits
20
20-*
Two questions:
What is the pension obligation that a company should report in the financial statements?
What is the pension expense for the period?
Accounting for Pensions
20-*
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
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.
20-*
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.
After studying this chapter, you should be able to:
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.
Accounting for Pensions and Postretirement Benefits
20
20-*
Components of Pension Expense
Actuarial present value of benefits attributed by the pension benefit formula to employee service during the period
Effect on Expense
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.
Effect on Expense
+-
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
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
+
Effect on Expense
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
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.
After studying this chapter, you should be able to:
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.
Accounting for Pensions and Postretirement Benefits
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
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.
Prepare the pension worksheet for 2014.
Using a Pension Work Sheet
LO 5
Prepare a pension worksheet for 2014.
($100,000 x 10%)
($1,000) net liability
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.
After studying this chapter, you should be able to:
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.
Accounting for Pensions and Postretirement Benefits
20
20-*
Amortization of Prior Service Cost
Company should not recognize the retroactive benefits as pension expense 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.
Prior Service Cost
Employers may use straight-line amortization over the average remaining service life of the employees.
LO 6
20-*
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
grants prior service benefits having a present value of 120,000
Settlement rate 9%
Service cost 58,000
Contributions (funding) 65,000
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
($135,720) liability
Pension Asset/Liability 121,920
E20-7: Pension Journal Entry for 2014.
Dec. 31
LO 6
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.
After studying this chapter, you should be able to:
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.
Accounting for Pensions and Postretirement Benefits
20
20-*
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.
Gains and Losses
20-*
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
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.
Gains and Losses
Companies report liability gains and liability losses in Other Comprehensive Income (G/L).
Companies combine the liability gains and losses in the same Other Comprehensive Income (G/L) account.
They accumulate the asset and liability gains and losses in Accumulated Other Comprehensive Income and report on the balance sheet in the stockholders’ equity section.
Gains and Losses
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.
After studying this chapter, you should be able to:
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.
Accounting for Pensions and Postretirement Benefits
20
20-*
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
20-*
Illustration: Data for Callaway Co.’s projected benefit obligation and plan assets over a period of six years.
Gains and Losses
20-*
BE20-7: Shin Corporation had a projected benefit obligation of $3,100,000 and plan assets of $3,300,000 at January 1, 2014. Shin also had a net actuarial loss of $465,000 in accumulated OCI at January 1, 2014. The average remaining service period of Shin’s employees is 7.5 years.
Instructions: Compute Shin’s minimum amortization of the actuarial loss.
Gains and Losses
Gains and Losses
135,000
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
10%
10%
10%
18,000
22,000
24,000
160,000
54,400
41,600
520,000
P20-2: Pension Work Sheet for 2013
($57,000)
*
P20-2 Pension Journal Entry for 2013
Pension Expense 21,000
OCI – Gain/Loss 2,000
Pension Asset/Liability 7,000
P20-2: Pension Work Sheet for 2014
($217,700) liability
Pension Asset/Liability 160,700
P20-2 Pension Journal Entry for 2014
LO 8
P20-2: Pension Work Sheet for 2015
($203,400) liability
P20-2 Pension Journal Entry for 2013
Pension Expense 89,370
Pension Asset/Liability 14,300
Cash 48,000
Dec. 31
LO 8
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.
After studying this chapter, you should be able to:
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.
Accounting for Pensions and Postretirement Benefits
20
20-*
Classification of pension asset or pension liability
Aggregation of pension plans
LO 9
Reporting Pension Plans in Financial Statements
LO 9
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).
20-*
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.
Within the Notes to the Financial Statements
Reporting Pension Plans in Financial Statements
LO 9
20-*
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.
Within the Notes to the Financial Statements
Reporting Pension Plans in Financial Statements
LO 9
20-*
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.
Within the Notes to the Financial Statements
Reporting Pension Plans in Financial Statements
LO 9
Pension Terminations
Special Issues
LO 9
Accounting Guidance
In December 1990, the FASB issued rules on “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” These rules cover for healthcare and other “welfare benefits” provided to retirees, their spouses, dependents, and beneficiaries.
Other welfare benefits include life insurance offered outside a pension plan; medical, dental, and eye care; legal and tax services; tuition assistance; day care; and housing assistance.
APPENDIX 20A
LO 10 Identify the differences between pensions and postretirement healthcare benefits.
20-*
Illustration 20A-1
APPENDIX 20A
Differences Between Pension Benefits and Healthcare Benefits
Measuring the future payments for healthcare benefit plans is so much more difficult than for pension plans.
Many postretirement plans do not set a limit on healthcare benefits.
The levels of healthcare benefit use and healthcare costs are difficult to predict. Increased longevity, unexpected illnesses (e.g., AIDS, SARS, and avian flu), along with new medical technologies and cures, cause changes in healthcare utilization.
APPENDIX 20A
Postretirement Benefits Accounting Provisions
Attribution Period - period of time over which the postretirement benefit cost accrue.
Illustration 20A-2
APPENDIX 20A
Postretirement Benefits Accounting Provisions
Obligations Under Postretirement Benefits
Expected postretirement benefit obligation (EPBO) is the actuarial present value as of a particular date of all benefits a company expects to pay after retirement to employees and their dependents.
Accumulated postretirement benefit obligation (APBO) is the actuarial present value of future benefits attributed to employees’ services rendered to a particular date.
APPENDIX 20A
Gains and Losses
Illustrative Accounting Entries
LO 11 Contrast accounting for pensions to accounting for other postretirement benefits.
2014 Entries and Worksheet
Illustration: The use of a worksheet in accounting for a postretirement benefits plan, assume that on January 1, 2014, Quest Company adopts a healthcare benefit plan. The following facts apply to the postretirement benefits plan for the year 2014.
Plan assets at fair value on January 1, 2014, are zero.
Actual and expected returns on plan assets are zero.
Accumulated postretirement benefit obligation (APBO), January 1, 2014, is zero.
Service cost is $54,000.
Interest cost on the APBO is zero.
Funding contributions during the year are $38,000.
Benefit payments to employees from plan are $28,000.
APPENDIX 20A
Illustrative Accounting Entries
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
Illustrative Accounting Entries
Illustration: The following facts apply to the postretirement benefits plan for Quest Company for the year 2015.
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.
Benefit payments to employees during the year are $5,000.
Average remaining service to expected retirement: 25 years.
APPENDIX 20A
Illustrative Accounting Entries
20-*
LO 12 Compare the accounting for pensions under GAAP and IFRS.
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.
20-*
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 other comprehensive income. These gains and losses are not “recycled” into income in subsequent periods. GAAP recognizes liability and asset gains and losses in “Accumulated other comprehensive income” and amortizes these amounts to income over remaining service lives, using the “corridor approach.”
LO 12
RELEVANT FACTS - Differences
The accounting for pensions and other postretirement benefit plans is the same under IFRS. GAAP has separate standards for these types of benefits, and significant differences exist in the accounting.
LO 12
ON THE HORIZON
The IASB and the FASB have been working collaboratively on a postretirement benefit project. The recent amendments issued by the IASB moves IFRS closer to GAAP with respect to recognition of the funded status on the statement of financial position. However, as illustrated in the About the Numbers section above, significant differences remain in the components of pension expense. The FASB is expected to begin work on a project that will reexamine expense measurement of postretirement benefit plans. The FASB likely will consider the recent IASB amendments in this area, which could lead to a converged standard.
LO 12
20-*
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?
$5,000.
$90,000.
$85,000.
$20,000.
20-*
At the end of the current year, Kennedy Co. has a defined benefit obligation of $335,000 and pension plan assets with a fair value of $245,000. The amount of the vested benefits for the plan is $225,000. Kennedy has unrecognized past service costs of $24,000 and an unrecognized actuarial gain of $8,300. What account and amount(s) related to its pension plan will be reported on the company’s statement of financial position?
Pension Liability and $74,300.
Pension Liability and $90,000.
Pension Asset and $233,300.
Pension Asset and $110,000.
20-*
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…

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