Pensions and Other
Postretirement Benefits
Sid Glandon, DBA, CPA
Associate Professor of Accounting
University of Texas at El Paso
Qualified Pension Plans





Must cover 70% of employees
Can’t discriminate in favor of highly
compensated employees
Must be funded through contributions to
an irrevocable trust
Benefits must vest within specified period
Compliance with restrictions regarding
timing and amount of contributions and
benefits.
Types of Pension Plans

Defined Contribution



Promise to pay fixed annual contributions to
the pension fund
Employee assumes risk of fund performance
Defined Benefits


Promise to pay fixed retirement benefit
defined by a designated formula
Employer assumes risk of fund performance
Defined Contribution Plans

401(k) Plans

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Permit voluntary contributions by
employees (contributory plan)
Money purchase plans
Thrift plans
Savings plans
Profit-sharing plans
Components of Pension Expense
+ Service cost
+ Interest on pension liability
- Return on plan assets
Amortization of:
+ Prior service cost
+/- Losses/gains resulting from
a) revisions in estimates of pension liability
b) investing plan assets
Pension Obligations

Vested benefits obligation


Accumulated benefit obligation (ABO)


Present value of vested benefits at present pay
levels
Present value of vested and nonvested benefits
at present pay levels
Projected benefit obligation (PBO)

Present value of vested, nonvested and
additional benefits related to projected pay
increases
Projected Benefit Obligation

Earned retirement benefits


Present value of retirement annuity


retirement annuity based on current data
PV of retirement annuity at retirement date
Projected benefit obligation

PV of retirement annuity at current date
Example
Fact Pattern
Employee:
Years of service:
Current annual salary
Pension formula:
Estimated final annual salary
* Percentage
* Years of service to date
Retirement benefit
Spencer
15 years
$40,000
Years of service remaining
Estimated final annual salary
Estimated retirement period
Discount rate
10
$60,000
20 years
6%
$60,000
2%
15
$18,000
Earned Retirement Benefits
Estimated final annual salary
* Factor
* Years of service to date
Earned retirement benefits
$60,000
2%
15
$18,000
Present Value of Retirement Annuity
Estimated earned retirement annuity
$18,000
* PVOA, n = 20, i = 6%
11.46992
PV of retirement annuity at retirement date
$206,459
Pension Benefit Obligation
PV of retirement annuity at retirement date
* PV$1, n = 10, i = 6%
Pension benefit obligation
$206,459
0.55839
$115,284
Components that Cause Changes to
Projected Benefit Obligation

Service cost

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Interest cost

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Result of plan amendments
Gain or loss on the PBO


Beginning PBO * discount rate
Prior service cost


Current year of service
Revision of estimates
Payment of retirement benefits
Pension Plan Assets


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Pension plan assets are managed by
a trustee
Expected return on assets is
included in periodic pension
expense
PBO > Plan Assets


Underfunded pension plan
Plan Assets > PBO

Overfunded pension plan
Pension Expense
+
+
+
+
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
(-) Amortization of net loss or
(gain)
Recording Pension Expense and
Pension Funding
Account
Debit
$XXX
$XXX
Pension expense
Prepaid (accrued) pension cost
Cash
To record pension expense and funding for the current year
Credit
$XXX
Pension Spreadsheet

Informal Records
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PBO
Plan assets
Prior service cost
Net loss (gain)
Formal Records



Pension expense
Cash
Prepaid (accrued) pension cost
Pension Spreadsheet
#
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Description
Beginning balance
Service cost
Interest cost
Actual return on plan assets
Loss (gain) on plan assets
Loss (gain) on PBO
Change in prior service cost
Amortization:
Prior service cost
Net gain (loss)
Contributions to fund
Benefits paid
Minimum liability adjustment
Journal entry
Ending balance
PBO
($8,500)
(750)
(510)
Informal Records
Prior
Plan
Service
Assets
Cost
$7,800
$1,200
780
(80)
Net Loss Pension
(Gain) Expense
$600
$750
510
(780)
(312)
312
80
(120)
85
120
145
(85)
($145)
$912
($9,755)
$8,640
Cash
Formal Records
Prepaid
Intangible
(Accrued) Additional Pension
Cost
Liability
Asset
$1,100
$1,080
$368
($145)
(767)
$333
#1 Reconciliation Between Beginning
Informal and Formal Records
Informal Records
PBO
Plan assets
Prior service cost
Net loss (gain)
Formal Records
Prepaid (accrued) pension cost
($8,500)
7,800
1,200
600
$1,100
$1,100
#2 Service Cost

Given by actuary as $750
#3 Interest Cost
Beginning PBO
Discount/interest rate
Interest cost
$8,500
6%
$510
Pension Spreadsheet
#
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Description
Beginning balance
Service cost
Interest cost
Actual return on plan assets
Loss (gain) on plan assets
Loss (gain) on PBO
Change in prior service cost
Amortization:
Prior service cost
Net gain (loss)
Contributions to fund
Benefits paid
Minimum liability adjustment
Journal entry
Ending balance
PBO
($8,500)
(750)
(510)
Informal Records
Prior
Plan
Service
Assets
Cost
$7,800
$1,200
780
(80)
Net Loss Pension
(Gain) Expense
$600
$750
510
(780)
(312)
312
80
(120)
85
120
145
(85)
($145)
$912
($9,755)
$8,640
Cash
Formal Records
Prepaid
Intangible
(Accrued) Additional Pension
Cost
Liability
Asset
$1,100
$1,080
$368
($145)
(767)
$333
#4 Actual Return on Plan Assets
FV plan assets, end of year
FV plan assets, beginning of year
Increase in FV of plan assets during year
Contributions to fund
Payments to retirees
Excess payments (contributions) during year
Actual return on plan assets
$8,640
7,800
$840
145
85
(60)
$780
#5 Loss (Gain) on Plan Assets
Expected return on plan assets:
FV of plan assets, beginning of year
Expected rate of return
Expected return
Actual return on plan assets
Loss (gain) on plan assets
$7,800
6%
$468
780
($312)
Pension Spreadsheet
#
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Description
Beginning balance
Service cost
Interest cost
Actual return on plan assets
Loss (gain) on plan assets
Loss (gain) on PBO
Change in prior service cost
Amortization:
Prior service cost
Net gain (loss)
Contributions to fund
Benefits paid
Minimum liability adjustment
Journal entry
Ending balance
PBO
($8,500)
(750)
(510)
Informal Records
Prior
Plan
Service
Assets
Cost
$7,800
$1,200
780
(80)
Net Loss Pension
(Gain) Expense
$600
$750
510
(780)
(312)
312
80
(120)
85
120
145
(85)
($145)
$912
($9,755)
$8,640
Cash
Formal Records
Prepaid
Intangible
(Accrued) Additional Pension
Cost
Liability
Asset
$1,100
$1,080
$368
($145)
(767)
$333
#6 Loss (Gain) on PBO
PBO, End of Year (actuarially determined)
PBO, Beginning of Year
Service cost
Interest cost
Benefits paid
Computed PBO, End of Year
Loss (gain) on PBO
$9,755
$8,500
750
510
(85)
9,675
$80
Pension Spreadsheet
#
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Description
Beginning balance
Service cost
Interest cost
Actual return on plan assets
Loss (gain) on plan assets
Loss (gain) on PBO
Change in prior service cost
Amortization:
Prior service cost
Net gain (loss)
Contributions to fund
Benefits paid
Minimum liability adjustment
Journal entry
Ending balance
PBO
($8,500)
(750)
(510)
Informal Records
Prior
Plan
Service
Assets
Cost
$7,800
$1,200
780
(80)
Net Loss Pension
(Gain) Expense
$600
$750
510
(780)
(312)
312
80
(120)
85
120
145
(85)
($145)
$912
($9,755)
$8,640
Cash
Formal Records
Prepaid
Intangible
(Accrued) Additional Pension
Cost
Liability
Asset
$1,100
$1,080
$368
($145)
(767)
$333
#7 Change in Prior Service Cost

In this case there is no change in
prior service cost
#8 Amortization of Prior Service Cost
Prior service cost
Average remaining service life per employee
Amortization of prior service cost
$1,200
10
$120
#9 Amortization of Net Gain (Loss)

In this case there is no net gain
(loss) on which amortization should
be taken
#10 Contributions

The employer made contributions to
the plan in the amount of $145
#11 Benefits Paid

The plan paid benefits to retirees in
the amount of $85.
#12 Minimum Liability Adjustment

None in this case
Accumulated benefit obligation, End of Year
FV of plan assets, End of Year
Minimum liability (ABO > FV of plan assets)
($8,500)
8,640
0
#13 Year-End Journal Entry to
Record Pension Expense and Funding
Account
Pension expense
Accrued pension cost
Cash
To record pension expense and funding for the year
Debit
$912
Credit
767
$145
#14 Reconciliation Between Beginning
Informal and Formal Records
Informal Records
PBO
Plan assets
Prior service cost
Net loss (gain)
Formal Records
Prepaid (accrued) pension cost
($9,755)
8,640
1,080
368
$333
$333
Postretirement Benefit Plans
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Medical insurance
Dental insurance
Life insurance
Other postretirement benefits
Post Retirement Health Benefits


Subject to the same assumptions as
pension plans
Additional assumptions

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

Benefits are unrelated to service
Benefits are based on medical need
Costs are shared between employer and
retiree
Coverage is extended to spouses and qualified
dependents
Net Cost of Benefits
Estimated annual medical costs
Less: Retiree co-payments
Less: Medicare payments
Estimated net cost of annual benefits
Assumptions in addition to those
applied to pension plans

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Estimated current cost of providing
health benefits to retirees
Demographic characteristics of
potential retirees
Benefits provided by Medicare
Expected health care cost trends
Postretirement Benefit Obligation

Expected postretirement benefit
obligation (EPBO)


Actuarial estimate of PV of future
postretirement benefits
Accumulated postretirement benefit
obligation (APBO)

Portion of EPBO attributed to employee
service to date
Example: Measuring the Obligation
Fact Pattern:
EPBO at 12/31/04
Years of service completed
Expected total years of service
Actuarially determined discount rate
$48,000
5
30
5%
APBO at 1/1/05
EPBO
*
Years completed
Total years
$48,000
*
5/30
=
APBO
=
$8,000
APBO at 12/31/05
EPBO at 1/1/05
*
[ 1 + discount rate ]
=
EPBO at 12/31/05
$48,000
*
1.05
=
$50,400
*
Years completed
Total years
=
APBO at 12/31/05
*
6
30
=
$10,080
EPBO at 12/31/05
$50,400
Measuring APBO
APBO at 1/1/05
Interest cost:
Beginning APBO
Discount rate
Interest cost
Service cost:
Ending EPBO
One year of service
Service cost
APBO at 12/31/05
$8,000
$8,000
5%
400
50,400
1/30
1,680
$10,080
Postretirement Benefit Expense

Service cost


Interest cost


Ending EPBO * one year of service
Beginning APBO * discount rate
Amortization



Prior service cost
 Liability resulting from plan amendment
Net loss (Gain)
 Liability resulting in changes in assumptions
Transition amount
 Liability at adoption of plan
Required Disclosures




Changes in APBO
Components of net periodic
postretirement benefit expense
Weighted-average discount rate,
rate of compensation used to
compute postretirement benefit
obligation
Assumed health care cost trends