intermediate financial accounting postretirement benefits other than pensions
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Intermediate Financial Accounting
Postretirement Benefits Other than Pensions
The Financial Statements 2
Accounting for Postretirement Benefits Identify the differences between
pensions and postretirement benefits other than pensions (i.e., health-care benefits).
To learn the accounting for postretirement benefits other than pensions.
The Financial Statements 3
About SFAS No. 106
Postretirement benefits other than pensions include health care benefits and other welfare benefits (i.e., tuition, eye care, legal & tax services, day care, housing assistance) for retirees, their dependents and spouses.
The Financial Statements 4
Accounting Practice of OPEB (Other Post Employment Benefits) Prior to SFAS 106 Only recognizes them when pay - on a
cash basis. Reasons of NOT pre-funding these
benefit plans:
1. The payments to pre-fund health care costs are NOT tax deductible.
The Financial Statements 5
Accounting Practice of OPEB (Other Post Employment Benefits) Prior to SFAS 106
2. These OPEB were once perceived to be low cost employee benefits and could be changed or eliminated at will, and, therefore, Not a legal liability.
The Financial Statements 6
Accounting Practice of OPEB under SFAS 106 The liability of OPEB should be
recognized during the employment of employee, rather than delay to their retirement. OPEB is a form of deferred compensation.
Thus, the accounting treatment of OPEB is on an accrual basis, rather than on a cash basis.
The Financial Statements 7
Accounting Practice of OPEB under SFAS 106 (contd.) When IBM adopted SFAS No. 106 in 3/91,
it resulted in $2.3 billion charge and the first ever quarterly loss in IBM history.
GE disclosed a $2.7 billion liability on 4th quarter of 1993 when adopting SFAS 106.
AT&T charged $2.1 billion when adopting SFAS 106.
The Financial Statements 8
Differences between Pension Benefits & Health Care Benefits Reasons why FASB does not issue one statement for
both pension benefits and OPEB:Item Pension Health Care BenefitsFunding Generally funded NotBenefit Well-defined & level
dollar amountGenerally uncapped & great
variabilityBeneficiary Retiree (may be some
benefits to survivingspouse)
Retiree, spouse, anddependents
Benefit Payable Monthly As needed & usedPredictability Variables are predictable Utilization difficult to predict
Level of Cost variesGeographically & fluctuates
over time Because of the substantial differences, FASB issues
different statements for these two benefits.
The Financial Statements 9
Obligations under Postretirement Benefits Expected postretirement benefits
obligation (EPBO): The actuarial present value as of a
particular date of all benefits expected to be paid to employees and their dependents after retirement.
The EPBO is NOT recorded in the F/S, but it is used in measuring periodic expense.
The Financial Statements 10
Obligations under Postretirement Benefits (contd.) Accumulated postretirement benefits
obligation (APBO): The actuarial present value of future
benefits attributed to employees’ services rendered to a particular date.
The Financial Statements 11
Obligations under Postretirement Benefits (contd.) APBO = EPBO for retirees. APBO = EPBO for active employees
with full date eligibility for benefits (fully eligible for benefits).
APBO < EPBO for active employees NOT fully eligible for benefits.
The Financial Statements 12
Postretirement Expense (recognized on I/S) Postretirement expense (net periodic
postretirement benefit cost): The annual expense that employer
recognized on the income statement. It consists of many similar components used to compute annual pension expense.
The Financial Statements 13
Postretirement Expense (contd.)
The components are:+ 1. Service cost . The portion of
EPBO attributed to employee service during the period.
+ 2. Interest cost. The interest on APBO attributable to
the passage of time.- 3. Actual return on plan assets.
The Financial Statements 14
Postretirement Expense (contd.)
The components are (contd.):+ 4. Amortization of prior service
cost.+ or - 5. Gains and losses.
+ 6. Amortization of transition obligation.
The Financial Statements 15
The Transition Amount
At the adoption of SFAS No. 106, a transition amount is computed as the difference between:
(1). The APBO and (2). The fair value of the plan assets plus any accrued obligation or less and prepaid cost(mostly zero at adoption)
Due to most plans are unfunded, larger transition obligations occur at the adoption of SFAS No. 106.
The Financial Statements 16
The Transition Amount - the Accounting Treatments A. Immediate Recognition (IR Method)
Cumu. Eff. of Acct.Change1 xxxDeferred Tax Assets xxx
Prepaid/Accrued Postret. Benefit Cost
xxx (reported on B/S as
a long-term liability)
1. The tax effect if deferred because only the actual payment for retiree benefits are tax deductible.
The Financial Statements 17
The Transition Amount - the Accounting Treatments (Contd.) The Prepaid/Accrued account can only
be reduced by funding, not by payments of benefits.
Payments of benefits reduce the APBO which is only disclosed in the footnote, not recognized.
The Financial Statements 18
The Transition Amount - the Accounting Treatments (contd.)
B. Deferred recognition:Amortize the transition amount on
a straight-line basis over the average remaining service period to expected retirement of the employees or 20 years if it is longer. Similar entry as for the IR method will be recorded. Once chosen, the method cannot be changed.
The Financial Statements 19
Off Balance Sheet Items Related to Postretirement Benefits1. EPBO
2. APBO
3. Postretirement plan assets
4. Unrecognized transition amount
5. Unrecognized prior service cost
6. Unrecognized net gains or losses
The Financial Statements 20
Example 1
1997 Entries & work sheetAssuming on 1/1/97, Quest adapts
SFAS No. 106 to account for its health care benefit plan. The following facts apply to the post retirement benefits plan for the year of 1997:
1. Plan assets at fair value on 1/1/97: $0
The Financial Statements 21
Example 1 (contd.)
2. Actual & expected returns on plan assets in 1997: $0.
3. APBO, 1/1/97 is $400,000 (Transition obligation at the adoption of 106).
4. Service costs for 1997 is $22,000.5. Prior service cost: $0.6. Discount rate: 8%.
The Financial Statements 22
Example 1 (contd.)
7. Contributions (funding) to plan in 1997 are $38,000.
8. Benefit payments to employees from plan in 97 are $28,000.
9. An average remaining service to full eligibility: 21 years.
10. An average remaining service to retirement: 25 years.
11. Transition amount to be amortized.
The Financial Statements 23
J.E. of Quest memo record
Items
Annual Post-retirement Expense
CashPrepaid/ Accrued
CostAPBO Plan Assets
Unrecognized Transition Amount
Balance 1/1/97 400,000(Cr) 400,000(Dr)
(a) service cost 22,000(Dr) 22,000(Cr)
(b) Interest cost 32,0001(Dr) 32,000(Cr)
(c) Contributions 38,000(Cr) 38,000(Dr)
(d) Benefit payments 28,000(Dr) 28,000(Cr)
(e) Amortization of Transition 16,0002(Dr) 16,000(Cr)
J.E. fr 1997 70,000(Dr) 38,000(Cr) 32,000(Cr) 426,000(Cr) 10,000(Dr) 384,000(Dr)
Balance 12/31/97 32,000(Cr)
1. 400,000 x 8% = 32,000
2. 400,000 / 25 = 16,000
The Financial Statements 24
Example 1 (contd.)
Journal entry recorded on
12/31/97
Postretirement benefit expense 70,000
Cash 38,000
Prepaid/accrued Postreti. Benefit cost 32,000
The Financial Statements 25
Example 1 -Reconciliation Schedule
APBO ($426,000) cr.
Plan Assets 10,000 dr.
Funded Status (416,000) cr.
Unrecognized
Transition Amo. 384,000 dr.
($32,000) cr.
The Financial Statements 26
Recognition of Gains & Losses (G/L)
Gains & losses represent change in APBO or the change in value of plan assets resulting for actual experience difference from expected or from change in actuarial assumptions.
The Financial Statements 27
Amortization of G/L
The corridor approach applies. The corridor is the greater of 10% * APBO
or 10% * market value of plan assets. If the unrecognized G/L is greater than the
corridor, the excess amount needs to be amortized and included in as a component of the postretirement expense.
The Financial Statements 28
Amortization of G/L (contd.)
If the unrecognized G/L is less than the corridor, NO amortization of G/L is needed.
If amortization is required, the minimum amortization amount is the excess gain or loss (beyond the corridor) divided by the average remaining life to expected retirement of all active employees.
The Financial Statements 29
Amortization for G/L (contd.)
Any systematic amortization method can be used as long as:
(a) The amount amortized in any period is greater than the minimum amount calculated above;
(b) the method applied consistently, and
(c ) the method is applied similarly for both gains and losses.
The Financial Statements 30
Example 2
1998 Entries and work sheetContinuing the Quest illustration to
1998, the following facts apply to the plan for the year of 98:
1. Actual return on plan assets: $6002. Expected return on plan assets:
$8003. Discount rate: 8%
The Financial Statements 31
Example 2 (contd.)
4. Increase in APBO due to changes in actuarial assumptions is $60,000.
5. Service cost for 1998 is $26,000.6. Contributions (funding) to plan are
$50,000.7. Benefit payments to employees in
1998 are $35,000.
The Financial Statements 32
Example 2 (contd.)
8. Average remaining service to full eligibility: 21 years.
9. Average remaining service to retirement: 25years.
The Financial Statements 33
J.E. of Quest memo record
Items
Annual Post-retirement Expense
CashPrepaid/ Accrued
CostAPBO
Plan Assets
Unrecognized Transition Amount
Unrecognized Net G/L
Balance 1/1/98 32000(Cr) 426000(Cr) 10000(Dr) 384000(Dr)
(a) service cost 26000(Dr) 26000(Cr)
(b) Interest cost1 34080(Dr) 34080(Cr)
(c) Actual Return 600(Cr) 600(Dr)
(d) Unexpected Loss 200(Cr) 200(Dr)
(e) Contributions 50000(Cr) 50000(Dr)
(f) Benefits 35000(Dr) 35000(Cr)
(g) Amortization: Transaction 16000(Dr) 16000(Cr)(h) Increase in APBO-loss 25280(Cr) 60000(Cr) 60000(Dr)
J.E. fr 1997 75280(Dr) 50000(Cr) 57280(Cr) 511080(Cr) 25600(Dr) 368000(Dr) 60200(Dr)
(d) & (h) are components of gains & losses
1. 426,000 x 8% = 34,080
The following worksheet presents all the postretirement benefit entries and information Recorded by Quest in 98
The Financial Statements 34
Example 2 (contd.)
Journal entry on 12/1998:
Postretirement benefit expense 75,280
Cash 50,000
Prepaid/accrued cost 25,280
The Financial Statements 35
Example 2 -Reconciliation Schedule
APBO ($511,080) cr.
Plan Assets 25,600 dr.
Funded Status (485,480) cr.
Unrecognized
Transition Amo. 368,000 dr.
Unrecog. Gain/loss 602,000 dr.
Accrued cost ($57,280) cr.
The Financial Statements 36
Footnote Disclosures of Postretirement Benefits other than Pensions The disclosures for postretirement benefits other than pensions parallel with those for the pensions. Thus, refer to the disclosure notes for pensions in Chapter 17 for these disclosures.