ch20

CHAPTER 20

Accounting for Pensions and Postretirement Benefits

ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)

Topics QuestionsBrief

Exercises Exercises Problems

Conceptsfor Analysis

1. Basic definitions and concepts related to pension plans.

1, 2, 3, 4, 5, 6, 7, 8, 9, 12, 24

16 1, 2, 3, 4, 5, 7

2. Alternative measures of valuing the pension obligation.

7

3. Income statement recognition, computation of pension expense.

9, 10, 11, 12, 13, 16, 17

1, 2, 4 1, 2, 3, 4, 6, 10, 11, 13, 14, 15, 16, 17, 18

1, 2, 3, 4, 5,6, 7, 8, 9, 11, 12

4, 5

4. Balance sheet recognition. 15, 19, 20, 22, 23

6, 8, 10 3, 9, 11, 12, 13, 14

1, 2, 3, 4, 5, 6, 7, 8, 9, 11, 12

2, 3, 5, 7

5. Worksheet preparation. 3 3, 4, 7, 10, 14, 18

1, 2, 7, 8, 9, 10, 11, 12

6. Prior service cost. 12, 13, 20 5, 6 1, 2, 3, 5,9, 11, 12,13, 14

1, 2, 3, 4, 6, 7, 8, 9, 11, 12

1, 4

7. Unexpected gains and losses.

14, 17,21, 22, 24

7 8, 9, 13, 14, 16, 17

1, 2, 3, 4, 5, 6, 7, 8, 9, 11, 12

4, 5, 6

8. Corridor calculation. 18 7 8, 13, 14, 16, 17

2, 3, 5, 6, 7, 8, 11, 12

3, 4, 5, 6

9. Reporting and disclosure issues.

15, 19, 20, 22, 23

8, 10 9, 11, 12, 14

9, 11, 12 3, 4

9. Special Issues. 25

*10. Postretirement benefits. 26, 27,28, 29

11, 12 19, 20, 21, 22, 23, 24

13, 14

*This material is dealt with in an Appendix to the chapter.

Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 20-1

ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)

Learning Objectives Brief Exercises Exercises Problems

1. Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

2. Identify types of pension plans and their characteristics.

3. Explain alternative measures for valuing the pension obligation.

4. List the components of pension expense. 1, 2, 4 1, 2, 6, 11, 12, 13, 15

5. Use a worksheet for employer’s pension plan entries.

3 3, 4, 7, 10, 14, 18

1, 2, 4, 7, 8, 9, 10, 11, 12

6. Describe the amortization of prior service costs. 5 1, 2, 5, 7, 12, 13

1, 2, 3, 4, 6, 7, 8, 9, 10, 11, 12

7. Explain the accounting for unexpected gains and losses.

12, 13 1, 2, 3, 4, 5, 6, 7, 8, 9,10, 11, 12

8. Explain the corridor approach to amortizing gains and losses.

7 8, 12, 13, 16, 17, 18

3, 4, 5, 6, 8, 11, 12

9. Describe the requirements for reporting pension plans in financial statements.

6, 8, 9, 10

9, 11,12, 13 1, 2, 3, 4, 8, 11, 12

*10. Identify the differences between pensions and postretirement healthcare benefits.

11, 12 19, 20, 21, 22, 23, 24

13, 14

*11. Contrast accounting for pensions to accounting for other postretirement benefits.

11, 12 19, 20, 21,22, 23, 24

13, 14

20-2 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only)

ASSIGNMENT CHARACTERISTICS TABLE

Item DescriptionLevel ofDifficulty

Time (minutes)

E20-1 Pension expense, journal entries. Simple 15–20E20-2 Computation of pension expense. Simple 10–15E20-3 Preparation of pension worksheet. Moderate 15–25E20-4 Basic pension worksheet. Simple 10–15E20-5 Application of years-of-service method. Moderate 15–25E20-6 Computation of actual return. Simple 10–15E20-7 Basic pension worksheet. Moderate 15–25E20-8 Application of the corridor approach. Moderate 20–25E20-9 Disclosures: Pension expense and other comprehensive income. Moderate 25–35E20-10 Pension worksheet. Moderate 20–25E20-11 Pension expense, journal entries, statement presentation. Moderate 20–30E20-12 Pension expense, journal entries, statement presentation. Moderate 20–30E20-13 Computation of actual return, gains and losses, corridor test, and

pension expense.Complex 35–45

E20-14 Worksheet for E20-13. Complex 40–50E20-15 Pension expense, journal entries. Moderate 15–20E20-16 Amortization of accumulated OCI (G/L), corridor approach,

pension expense computation.Moderate 25–35

E20-17 Amortization of accumulated OCI balances. Moderate 30–40E20-18 Pension worksheet—missing amounts. Moderate 20–25

*E20-19 Postretirement benefit expense computation. Moderate 5–10*E20-20 Postretirement benefit worksheet. Moderate 25–30*E20-21 Postretirement benefit expense computation. Simple 10–12*E20-22 Postretirement benefit expense computation. Simple 10–12*E20-23 Postretirement benefit worksheet. Moderate 15–20*E20-24 Postretirement benefit worksheet—missing amounts. Moderate 25–30

P20-1 2-year worksheet. Moderate 40–50P20-2 3-year worksheet, journal entries, and reporting. Complex 45–55P20-3 Pension expense, journal entries, amortization of loss. Complex 40–50P20-4 Pension expense, journal entries for 2 years. Moderate 30–40P20-5 Computation of pension expense, amortization of net gain or

loss-corridor approach, journal entries for 3 years.Complex 45–55

P20-6 Computation of prior service cost amortization, pension expense, journal entries, and net gain or loss.

Complex 45–60

P20-7 Pension worksheet. Moderate 35–45P20-8 Comprehensive 2-year worksheet. Complex 45–60P20-9 Comprehensive 2-year worksheet. Moderate 40–45P20-10 Pension worksheet—missing amounts. Moderate 25–30P20-11 Pension worksheet. Moderate 35–45P20-12 Pension worksheet. Moderate 35–45

*P20-13 Postretirement benefit worksheet. Moderate 30–35*P20-14 Postretirement benefit worksheet—2 years. Moderate 40–45


ASSIGNMENT CHARACTERISTICS TABLE (Continued)

Item DescriptionLevel ofDifficulty

Time (minutes)

CA20-1 Pension terminology and theory. Moderate 30–35

CA20-2 Pension terminology. Moderate 25–30

CA20-3 Basic terminology. Simple 20–25

CA20-4 Major pension concepts. Moderate 30–35

CA20-5 Implications of GAAP rules on pensions. Complex 50–60

CA20-6 Gains and losses, corridor amortization. Moderate 30–40

CA20-7 Nonvested employees—an ethical dilemma. Moderate 20–30


LEARNING OBJECTIVES

1. Distinguish between accounting for the employer’s pension plan and accounting for the pension fund.

2. Identify types of pension plans and their characteristics.3. Explain alternative measures for valuing the pension obligation.4. List the components of pension expense.5. Use a worksheet for employer’s pension plan entries.6. Describe the amortization of prior service costs.7. Explain the accounting for unexpected gains and losses.8. Explain the corridor approach to amortizing gains and losses.9. Describe the requirements for reporting pension plans in financial statements.

*10. Identify the differences between pensions and postretirement healthcare benefits.*11. Contrast accounting for pensions to accounting for other postretirement benefits.*12. Contrast accounting for pensions under GAAP and IFRS.

*This material is covered in an Appendix to the chapter.


CHAPTER REVIEW

1. Chapter 20 discusses the various aspects of accounting for the cost of pension plans. Accounting for pension costs is somewhat complicated because of the variety of social concepts, legal considerations, actuarial techniques, income tax regulations, and varying business philosophies that affect the development and maintenance of pension plans. This chapter relates these issues to the recommended accounting treatment for the costs associated with a pension plan.

Nature of Pension Plans

2. (L.O. 1) A pension plan is an arrangement whereby an employer provides benefits (payments) to employees after they retire for services they provided while they were working. In accounting for a pension plan, consideration must be given to accounting for the employer and accounting for the pension plan itself. A pension plan is said to be funded when the employer sets funds aside for future pension benefits by making payments to a funding agency that is responsible for accumulating the assets of the pension fund and for making payment to the recipients as the benefits come due. In an insured plan, the funding agency is an insurance company; in a trust fund plan, the funding agency is a trustee.

Types of Pension Plans

3. (L.O. 2) The most common types of pension arrangements are defined contribution plans and defined benefit plans. In a defined contribution plan, the employer agrees to contribute a certain sum each period based on a formula. The employees bear part of the cost of the stated benefits or voluntarily make payments to increase their benefits. The formula might consider such factors as age, length of service, employer’s profits, and compensation level. Accounting for a defined contribution plan is straightforward. The employer’s responsibility is simply to make a contribution each year based on the formula established in the plan. Thus, the employer’s annual cost is the amount it is obligated to contribute to the pension trust. If the contribution is made in full each year, no pension asset or liability is reported on the employer’s balance sheet.

4. A defined benefit plan defines the benefits that the employee will receive at the time of retirement. The employer bears the entire cost. The formula that is typically used provides for the benefits to be a function of the level of compensation near retirement and of the number of years of service. The accounting for a defined benefit plan is complex. Because the benefits are defined in terms of uncertain future variables, an appropriate funding pattern must be established to insure that enough monies will be available at retirement to meet the benefits promised.

Actuaries

5. Because the problems associated with pension plans involve complicated actuarial considera-tions, actuaries are engaged to ensure that the plan is appropriate for all employee groups covered. Actuaries make predictions (actuarial assumptions) of mortality rates, employee turnover, interest and earnings rates, early retirement frequency, future salaries, and other factors necessary to operate a pension plan.


Measures of Liability

6. (L.O. 3) Most accountants agree that an employer’s pension obligation is the deferred compensation obligation it has to its employees for their services under the terms of the pension plan. However, there are three ways to measure this liability. One approach is to base the obligation on the vested benefits to which current employees are entitled. The vested benefits pension obligation is computed using current salary levels and includes only vested benefits. A second approach to the measurement of the pension obligation is to base the computation on all years of service performed by employees under the plan—both vested and nonvestedusing current salary levels. This measurement of the pension obligation is called the accumulated benefit obligation. A third measurement technique bases the computation on both vested and nonvested service using future salaries. Because future salaries are expected to be higher than current salaries, this approach, known as the projected benefit obligation, results in the largest measurement of the pension obligation.

7. Regardless of the approach used, the estimated future benefits to be paid are discounted to present value. The profession has adopted the projected benefit obligation to measure the liability for the pension obligation.

8. Companies must recognize on their balance sheet the full overfunded or underfunded status of their defined benefit pension plan. The overfunded or underfunded status is measured as the difference between the fair value of the plan assets and the projected benefit obligation.

Components of Pension Expense

9. (L.O. 4) Pension cost should be accounted for on the accrual basis. Accounting for pension plans requires measurement of the cost and its identification with the appropriate time periods. The determination of pension cost is very complicated because it is a function of a number of factors. These factors are identified and described below.

Service Cost. The expense caused by the increase in pension benefits payable (the projected benefit obligation) to employees because of their services rendered during the current year. Actuaries compute service cost as the present value of the new benefits earned by employees during the year.

Interest. Because a pension is a deferred compensation arrangement, it is recorded on a discounted basis. Interest expense accrues each year on the projected benefit obligation based on a selected interest rate called the settlement rate.

Actual Return on Plan Assets. Annual expense is adjusted for interest and dividends that accumulate within the fund as well as increases and decreases in the market value of the fund assets. Computation of the actual return on plan assets is illustrated by the following schedule:


Fair value of plan assets at end of the period $2,500,000Deduct: Fair value of plan assets at beginning of period.... 1,800,000Increase/decrease in fair value of plan assets.................... 700,000Deduct: Contributions to plan during period....................... $275,000 Less benefits paid during the period................................ 120,000 155,000Actual return on plan assets................................................ $ 545,000

If the actual return on the plan assets is positive (a gain) during the period, it is subtracted in the computation of pension expense. If the actual return is negative (a loss) during the period, it is added in the computation of pension expense.

Amortization of Prior Service Cost. Because plan amendments are granted with the expectation that the employer will realize economic benefits in future periods, the cost (prior service cost) of providing these retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees.

Gain or Loss. Two items comprise gain or loss: (1) the difference between the actual return and the expected return on plan assets, and (2) amortization of the unrecognized net gain or loss from previous periods.

Pension Worksheet

10. (L.O. 5) The text material makes use of a worksheet approach to illustrate accounting for pensions by the employer. The worksheet is unique to pension accounting and is utilized to record both the formal entries and memo entries that are necessary to keep track of all the employer’s relevant pension plan items and components. The format of the worksheet is as follows:

Pension Worksheet

Items

General Journal Entries Memo Record

Annual

Pension

Expense Cash

Pension

Asset/

Liability

Projected

Benefit

Obligation

Plan

Assets

a. The left side “General Journal Entries” columns of the worksheet determine the entries to be made in the formal general ledger accounts. The right side “Memo Record” columns maintain balances in the projected benefit obligation and the plan assets. The difference between the PBO and the plan assets is the Pension Asset/Liability, which is reported in the balance sheet.


b. On the first line of the worksheet, the beginning balances (if any) are entered. Subsequently, transactions and events related to the pension plan are recorded, using debits and credits using both records for recording the entries. For each transaction or event, the debits must equal the credits. The ending balance in the Pension Asset/Liability column should equal the net balance in the memo record. The worksheet approach to accumulating balances for pension accounting is a most effective means of keeping track of complicated computations.

2014 Entries and Worksheet

11. To illustrate the use of a worksheet, the following facts apply to Oehler Company for the year 2014:

Plan assets, January 1, 2014....................................... $450,000Projected benefit obligation, January 1, 2014.............. 450,000Annual service cost for 2014........................................ 27,000Settlement rate for 2014............................................... 7%Actual return on plan assets for 2014........................... 30,000Contributions (funding) in 2014.................................... 32,000Benefits paid to retirees in 2014................................... 17,000

The worksheet is completed as follows:

Oehler Company

Items

General Journal Entries Memo Record

Annual

Pension

Expense Cash

Pension

Asset/

Liability

Projected

Benefit

Obligation

Plan

Assets

Balance, 1/1/14 450,000 Cr. 450,000 Dr.(a) Service cost 27,000 Dr. 27,000 Cr.

(b) Interest cost *31,500 Dr. 31,500 Cr.

(c) Actual return 30,000 Cr. 30,000 Dr.

(d) Contributions 32,000 Cr. 32,000 Dr.

(e) Benefits Paid 17,000 Dr. 17,000 Cr.

Journal entry for 2014 28,500 Dr. 32,000 Cr. 3,500 Dr.

Balance, 12/31/14 3,500 Dr. 491,500 Cr. 495,000 Dr.

*$450,000 X .07

The journal entry for 2014 is:

Pension expense………………………….. 28,500Cash 32,000Pension Asset/Liability 3,500



12. To illustrate the use of a worksheet with amortization of unrecognized prior service costs, the following facts apply to Oehler Company for the year 2015:

Present value of prior service benefits granted January 1, 2015…. $42,000Annual service cost for 2015........................................................... 28,000Settlement rate for 2015.................................................................. 7%Actual return on plan assets for 2015.............................................. 31,000Contributions (funding) in 2015....................................................... 29,000Benefits paid retirees in 2015.......................................................... 24,000Amortization of prior service costs................................................... 17,500

The journal entry for 2015 is as follows:

Pension Expense......................................................... 51,845Other Comprehensive Income (PSC)........................... 24,500

Cash...................................................................... 29,000Pension Asset/Liability........................................... 47,345

The worksheet would be completed as follows:

Oehler Company

Pension Worksheet—2015

Items

General Journal EntriesMemo Record

Other Comprehensive Income

Annual

Pension

Expense Cash

Prior

Service

Cost

Pension

Asset/

Liability

Projected

Benefit

Obligation

Plan

Assets

Balance, Dec. 31, 2014 3,500 Dr. 491,500 Cr. 495,000 Dr.(f) Prior service cost 42,000 Dr. 42,000 Cr.

Balance, Jan. 1, 2015 533,500 Cr. 495,000 Dr

(g) Service cost 28,000 Dr. 28,000 Cr.

(h) Interest cost *37,345 Dr. 37,345 Cr.

(i) Actual return 31,000 Cr. 31,000 Dr.

(j) Amortization of PSC 17,500 Dr. 17,500 Cr.

(k) Contributions 29,000 Cr. 29,000 Dr.

(l) Benefits 24,000 Dr. 24,000 Cr.

Journal entry for 2015 51,845 Dr. 29,000 Cr. 24,500 Dr. 47,345 Cr.

Accumulated OCI, Dec. 31, 2014 0

Balance, Dec. 31, 2015 24,500 Dr. 43,845 Cr. 574,845 Cr. 531,000 Dr.

*$533,500 X .07


The pension reconciliation schedule is as follows:

Projected benefit obligation (Credit)......................... $(574,845)Plan assets at fair value (Debit)................................ 531,000Pension asset/liability (Credit).................................. $ (43,845)

13. Amortization of Prior Service Costs. When either initiating (adopting) or amending a defined benefit plan, a company often provides benefits to employees for years of service before the date of initiation or amendment. As a result of this prior service cost, the projected benefit obligation is increased to recognize this additional liability. The employer initially records the prior service cost as an adjustment to other comprehensive income. The employer then recognizes the prior service cost as a component of pension expense over the remaining service lives of the employees who are expected to benefit from the change in the plan. The cost of the retroactive benefits (including any benefits provided to existing retirees) is the increase in the projected benefit obligation at the date of the amendment.

Gain or Loss

14. (L.O. 7) Because of the concern to companies that pension plans would have uncontrollable and unexpected swings in pension expense, the profession decided to reduce the volatility by using smoothing techniques. Asset gains (occurring when actual return is greater than expected return) and asset losses (occurring when actual return is less than expected return) are recorded in an other Comprehensive Income (G/L) account and combined with unrecognized gains and losses accumulated in prior years. Liability gains (resulting from unexpected decreases in the liability balance) and liability losses (resulting from unexpected increases) are deferred and combined in the same other Comprehensive Income (G/L) account used for asset gain or losses.

Corridor Approach

15. (L.O. 8) The Accumulated other Comprehensive Income (G/L) account can continue to grow if asset gains and losses are not offset by liability gains and losses. To limit this potential growth, the FASB invented the corridor approach for amortizing the accumulated balance in the Accumulated OCI account when it gets too large. The Accumulated OCI account balance is considered too large and must be amortized when it exceeds the arbitrarily selected FASB criterion of 10% of the larger of the beginning balance of the projected benefit obligation or the market-related value of plan assets. Any systematic method of amortizing the excess may be used, but it cannot be less than the amount computed using straight-line amortization over the average remaining service-life of all active employees. Amortization of the excess unrecognized net gain or loss should be included as a component of pension expense, only if, as of the beginning of the year, the unrecognized net gain or loss exceeds the corridor.


16. To illustrate the amortization of unrecognized gains and losses, assume the following information related to Scott Inc.’s pension plan:

Beginning of the Year 2014 2015 2016

Projected Benefit Obligation $3,600,000 $4,100,000 $4,400,000

Market-Related Asset Value 4,100,000 4,300,000 4,200,000

Accumulated OCI (G/L) –0– 900,000 800,000

If the average remaining service life of all remaining employees is 8 years, the schedule to amortize the unrecognized net loss is as follows:

Corridor Test and Gain/Loss Amortization ScheduleMinimum

Projected AmortizationBenefit Plan Accumulated of Loss

Year Obligation Assets Corridor OCI (G/L) (Current Year)

2014 $3,600,000 $4,100,000 $410,000 $ –0– $ –0–

2015 4,100,000 4,300,000 430,000 900,000 58,750(a)

2016 4,400,000 4,200,000 440,000 1,641,250(b) 150,156(b)

(a) $900,000 – 430,000 = $470,000; $470,000 ÷ 8 = $58,750(b) $900,000 – 58,750 + 800,000 = $1,641,250

$1,641,250 – 440,000 = $1,201,250; $1,201,250 ÷ 8 = $150,156

The loss recognized in 2014 increases pension expense by $58,750. This amount is far less than the $900,000 that would be recognized if the corridor method was not applied. The rationale for the corridor is that gains and losses result from refinements in estimates, as well as real changes in economic value and that, over time, some of these gains and losses will offset one another.


17. Continuing the Oehler Company illustration into 2016, the following facts apply to the pension plan:

Annual service cost for 2016............................................... $29,000

Settlement rate is 7%; expected earnings rate is 7%

Actual return on plan assets for 2016................................. 28,000

Amortization of PSC in 2016............................................... 21,000

Contributions (funding) in 2016........................................... 32,000

Benefits paid to retirees in 2016......................................... 20,000

Changes in actuarial assumptions establish

the end-of-year projected benefit obligation..................... 640,000


The worksheet would be completed as follows:

Oehler Company

Pension Worksheet—2016

Items

General Journal EntriesMemo Record

Other Comprehensive Income

Annual

Pension

Expense Cash

Prior

Service

Cost

Gains/

Losses

Pension

Asset/

Liability

Projected

Benefit

Obligation

Plan

Assets

Balance, Jan. 1, 2016 43,845 Cr. 574,845 Cr. 531,000 Dr.

(m) Service cost 29,000 Dr. 29,000 Cr.

(n) Interest cost *40,239 Dr. 40,239 Cr.

(o) Actual return 28,000 Cr. 28,000 Dr.

(p) Unexpected loss **9,170 Cr. 9,170 Dr.

(q) Amortization of PSC 21,000 Dr. 21,000 Cr.

(r) Contributions 32,000 Cr. 32,000 Dr.

(s) Benefits 20,000 Dr. 20,000 Cr.

(t) Liability increase ***15,916

Dr.

15,916 Cr.

Journal entry for 2016 53,069 Dr. 32,000 Cr. 21,000 Cr. 25,086 Dr. 25,155 Cr.

Accumulated OCI, Dec. 31, 2015 24,500 Dr. 0

Balance Dec. 31, 2016* 3,500 Dr. 25,086 Dr. 69,000 Cr. 640,000 Cr. 571,000 Dr.

*Accumulated OCI (PSC) $ 3,500 Dr.

Accumulated OCI (G/L) 25,086 Dr.

Accumulated OCI, Dec. 31, 2016 $28,586 Dr.

*7% × $574,845 = $40,239

**($531,000 × .07) – $28,000 = $9,170

***$574,845 + $29,000 + $40,239 – $20,000 = $624,084; $640,000 – $624,084 = $15,916

The pension reconciliation schedule is as follows:Projected benefit obligation (Credit).................................... $(640,000)Plan assets at fair value (Debit).......................................... 571,000Pension asset/liability.......................................................... $ (69,000)

Reporting Pension Plans in Financial Statements

18. (L.O. 9) Within the financial statements:

a. Recognition of the net funded status of the pension plan: Measured as the difference between the fair value of the plan assets and the projected benefit obligation.


b. Classification of pension asset or pension liability: No portion of a pension asset is reported as current. A pension liability is reported as noncurrent except for the portion of the liability that represents the amount of benefit payments to be paid in the next 12 months which is classified as current.

c. Aggregation of pension plans: When a company has more than one pension plan, all overfunded plans should be combined and shown as a pension asset, and all underfunded plans should be combined and shown as one net pension liability on the balance sheet.

d. Actuarial gains and losses/prior service cost: Those not recognized as part of pension expense are recognized as an increase or decrease in other comprehensive income.

19. Within the notes to the financial statements (including but not limited to):

a. A schedule showing all the major components of pension expense.

b. A reconciliation showing how the projected benefit obligation and the fair value of the plan assets changed from the beginning to the end of the period.

c. A disclosure of the rates used in measuring the benefit amounts.

d. A table indicating the allocation of pension assets by category and a narrative description of investment policies and strategies.

e. 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.

f. The nature and amount of changes in plan assets and benefit obligations recognized in net income and in other comprehensive income of each period.

g. 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.

Pension Reform Act

20. The Pension Reform Act of 1974 (ERISA) set out specific requirements for companies providing a pension plan for their employees. These requirements are designed to safeguard employees’ pension rights, specifically in the areas of funding, participation, and vesting. The Act also created the Pension Benefit Guaranty Corporation (PBGC) to administer terminated plans and to impose liens on the corporate assets for certain unfunded pension liabilities.


Pension Terminations

21. ERISA prevents companies from recapturing excess assets (pension plan assets in excess of projected benefit obligations) unless they pay participants what is owed to them and then terminate the plan. The accounting issue that arises from these terminations is whether a gain should be recognized by the corporation when these assets revert back to the company. The FASB requires recognition in earnings of a gain or loss when the employer settles a pension obligation either by lump-sum cash payments or by purchasing annuity contracts.

Post-Retirement Benefits

*22. (L.O. 10) Health care and other postretirement benefits (other than pensions) for current and future retirees and their dependents are forms of deferred compensation earned through employee service and subject to accrual during the years an employee is working. The period of time over which the postretirement benefit is accrued, called the attribution period, is the period of service during which the employee earns the benefits under the terms of the plan. The attribution period generally begins when an employee is hired and ends on the date the employee is eligible to receive the benefits and ceases to earn additional benefits by performing service, called the vesting date.

*23. Employers account for post retirement benefits other than pensions on an accrual basis. Like pension accounting, the accrual basis necessitates measurement of the employer’s obligation to provide future benefits and accrual of the cost during the years that the employee provides service.

*24. The components of net periodic postretirement benefit cost are as follows: 1) service cost; 2) interest cost; 3) actual return on plan assets; 4) amortization of prior service costs; and 5) gains and losses.

*25. (L.O. 11) Complete coverage of the requirements for accounting for other postretirement benefits including illustrative accounting entries, is provided in Appendix 20A. The illustration provides a comparison of pension benefits and health care benefits and points out the reasons for differences in accounting for these issues.


LECTURE OUTLINE

The material in this chapter can be covered in four class periods. Accounting for the costs of pension plans is technically complex and conceptually challenging for most students. The use of the pension worksheet illustrated in the textbook is very helpful in organizing and presenting the major components of pension expense.

A. Nature of Pension Plans.

TEACHING TIP

Illustration 20-1 can be used to describe basic features of different types of pension plans.

1. Definition of pension plan. An arrangement whereby an employer provides benefits (payments) to retired employees for services employees provided while employed.

2. (L.O. 1) Employer vs. pension plan accounting. An employer sponsors the plan, incurs the cost, and makes contributions. The plan receives the contributions, administers plan assets, and makes benefit payments to recipients.

a. Funding. Employers make payments to a funding agency.

b. Contributory vs. noncontributory.

(1) Contributory: Employees bear part of the cost of the stated benefits.

(2) Noncontributory: Employer bears entire cost.

c. Qualified pension plans.

(1) Plans that meet federal income tax requirements that permit deductibility of employer’s contributions.

(2) Earnings from fund assets are tax-free.

3. (L.O. 2) Types of pension plans.

a. Defined contribution plans. Employer’s contribution is defined; there is no promise regarding amount of benefits to be paid out.

b. Defined benefit plans. Employer is responsible for payment of defined benefits regardless of what occurs in the trust fund.

4. Companies engage actuaries to compute pension measures such as the pension obligation and the annual cost of servicing the plan.


B. (L.O. 3) The pension obligation is a deferred compensation obligation an employer has to its employees.

1. Vested benefits. Benefits the employee is entitled to even if no further services are rendered.

2. Measurement options. All three options are discounted so that the estimate of future benefits are reported at their present value.

a. Vested benefit obligation. Benefits for vested employees only at current salaries.

b. Accumulated benefit obligation. Benefits for vested and nonvested employees at current salaries.

c. Projected benefit obligation. Benefits for vested and nonvested employees at future salaries. The accounting profession adopted this measure.

C. (L.O. 4) Components of Pension Expense.

TEACHING TIP

Illustration 20-2 can be used to identify and define the basic components that make up pension expense.

1. Service cost. The actuarial present value of benefits attributed by the pension benefit formula to employee service during the period. Increases pension expense.

2. Interest on the liability. The interest for the period on the projected benefit obligation. The discount rate is the settlement rate. Increases pension expense.

3. Actual return on plan assets. The increase in pension funds from interest, dividends, and realized and unrealized changes in the fair value of the plan assets. Generally, decreases pension expense.

4. Amortization of prior service cost. The cost of providing retroactive benefits. Allocated to pension expense according to the remaining service-lives of the affected employees. Generally, increases pension expense.

D. Pension Worksheet

1. The worksheet is merely a device to make it easier to prepare entries and the financial statements.

2. The “General Journal Entries” columns of the worksheet (near the left side) determine the entries to record in the formal general ledger accounts.

3. The “Memo Record” columns (on the right side) maintain balances in the projected benefit obligation and the plan assets.


4. The difference between the projected benefit obligation and the fair value of the plan assets is the pension asset/liability.

TEACHING TIP

Illustration 20-3 provides a numerical example of the amortization of prior service cost by the years-of-service method.

E. Amortization of Prior Service Cost (PSC).

1. PSC occurs due to providing benefits to employees for years of service before the date of initiation or amendment. The projected benefit obligation is increased to recognize the additional liability. The employer initially records the prior service cost as an adjustment to other comprehensive income. The employer then recognizes the prior service cost as a component of pension expense over the remaining service lives of the employees. The cost of the retroactive benefits is the increase in the projected benefit obligation at the date of the amendment.

F. (L.O. 6) Unexpected net gain or loss.

1. The net gain or loss is comprised of the difference between the actual and expected returns on plan assets; less amortization of the unexpected net gain or loss from previous periods. May decrease or increase pension expense.

2. Gains or losses result from unexpected changes in the fair value of plan assets or changes in actuarial assumptions that affect the projected benefit obligation.

G. (L.O. 8) The corridor approach is used to control the volatility of pension expense which may occur because of unexpected gains or losses.

1. If the balance of the Accumulated Other Comprehensive Income account exceeds 10% of the larger of the beginning balances of the PBO or the market-related value of the plan assets (the corridor), amortization is required.

2. Minimum amortization is the difference between the Accumulated OCI account balance and the upper or lower limits of the corridor divided by the average remaining service period of active employees expected to receive benefits.

TEACHING TIP

Illustration 20-4 provides a numerical example of the corridor approach in amortizing unexpected gains or losses.


TEACHING TIP

Illustration 20-5 provides an example of a pension worksheet that appears in the textbook.

H. (L.O. 9) Reporting Pension Plans.

1. Within the financial statements:

a. Recognition of the net funded status of the pension plan: Measured as the difference between the fair value of the plan assets and the projected benefit obligation.

b. Classification of pension asset or pension liability: No portion of the pension asset is reported as current. A pension liability is reported as current or noncurrent depending on the expected payment dates.

c. Aggregation of pension plans: When a company has more than one pension plan, all overfunded plans should be combined and shown as a pension asset, and all underfunded plans should be combined and shown as a pension liability on the balance sheet.

d. Actuarial gains and losses/prior service cost: Those not recognized as part of pension expense are recognized as an increase or decrease in other compre-hensive income.

2. Within the notes to the financial statements (including but not limited to):

a. A schedule showing all the major components of pension expense.

b. A reconciliation showing how the projected benefit obligation and the fair value of the plan assets changed from the beginning to the end of the period.

c. A disclosure of the rates used in measuring the benefit amounts.

d. A table indicating the allocation of pension assets by category and a narrative description of investment policies and strategies.

e. 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.

f. The nature and amount of changes in plan assets and benefit obligations recog-nized in net income and in other comprehensive income of each period.

g. The amount of the 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.


I. Special Issues.

1. The Pension Reform Act of 1974. Mandated many pension plan requirements; including minimum funding, participation, and vesting.

2. Pension terminations.

a. GAAP requires recognition in earnings of a net gain or loss when an employer settles a pension obligation either by lump-sum cash payments or by purchasing nonparticipating annuity contracts.

*J. Appendix 20A. Accounting for Postretirement Benefit.

1. (L.O. 10) Differences between pension benefits and healthcare benefits.

TEACHING TIP

Use Illustration 20-6 to discuss the differences between pension and healthcare benefits.

2. Postretirement benefits accounting provisions.

a. Attribution period. Period of time over which the postretirement benefit cost accrues.

b. Obligation for postretirement benefits.

(1) Expected postretirement benefit obligation (EPBO): The present value as of a particular date of all benefits a company expects to pay after retirement to employees and their dependents.

(a) Not recorded.

(b) Used to measure periodic expense.

(2) Accumulated postretirement benefit obligation (APBO). The present value of future benefits attributed to employees’ services rendered through a particular date.

(a) APBO = EPBO for retirees and active employees fully eligible for benefits.

TEACHING TIP

Use Illustration 20-7 to demonstrate the relationship between EPBO and APBO.

3. Components of postretirement benefit cost:

a. Service cost.


b. Interest cost.

c. Actual return on plan assets.

d. Amortization of prior service cost.

e. Gains and losses.

4. (L.O. 11) Accounting for other postretirement benefits:

a. A worksheet is used to determine the journal entry and memo entry amounts.

b. Footnote disclosure requirements.

(1) All components comprising the postretirement expense for the period.

(2) A schedule showing changes in postretirement benefit obligations and plan assets for the period.

(3) A schedule reconciling the plan’s funded status with amounts reported in the balance sheet, separately identifying the reconciling items.

(4) Assumptions and rates used in computing the EPBO and APBO.

*K. IFRS Insights

1. The accounting for various forms of compensation plans under IFRS is found in IAS 19 (“Employee Benefits”) and IFRS 2 (“Share-Based Payment”). IAS 19 addresses the accounting for a wide range of compensation elements—wages, bonuses, postretirement benefits, and compensated absences.

2. The underlying concepts for the accounting for postretirement benefits are similar between GAAP and IFRS—both GAAP and IFRS view pensions and other postretirement benefits as forms of deferred compensation. At present, there are significant differences in the specific accounting provisions as applied to these plans.

3. Similarities

a. IFRS and GAAP separate pension plans into defined contribution plans and defined benefit plans. The accounting for defined contribution plans is similar.

b. 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.)

c. 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.

4. Differences

a. 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.

b. 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.”

c. 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.


ILLUSTRATION 20-1BASIC FEATURES AND TYPES OF PENSION PLANS


ILLUSTRATION 20-2COMPONENTS OF ANNUAL PENSION EXPENSE


ILLUSTRATION 20-3EXAMPLE: AMORTIZATION OF PRIOR SERVICE COST


ILLUSTRATION 20-4EXAMPLE: AMORTIZATION OF UNEXPECTEDGAINS OR LOSSES


ILLUSTRATION 20-5THE PENSION WORKSHEET


ILLUSTRATION 20-6DIFFERENCES BETWEEN PENSION AND HEALTHCARE BENEFITS


ILLUSTRATION 20-7RELATIONSHIP BETWEEN EPBO AND APBO


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Documents

pension obligation

computation of pension

pension fund

basic pension worksheet

components of pension

simple1015 e20

moderate1525 e20

reporting pension plans