Chapter 20 Including FASB 158
Accounting for
Postemployment
Benefits
Intermediate Accounting 10th edition
Nikolai Bazley Jones
An electronic presentation
by Norman Sunderman
Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation.
Thomson, the Star logo, and South-Western are trademarks used herein under license.
2
Objectives
1. Understand the characteristics of pension
plans.
2. Explain the historical perspective of
accounting for pension plans.
3. Explain the accounting principles for
defined benefit plans, including
computing pension expense and
recognizing pension liabilities and assets.
4. Account for pensions.
5. Understand disclosures of pensions.
3
Objectives
6. Explain the conceptual issues regarding
pensions.
7. Understand several additional issues
related to pensions.
8. Explain other post-employment benefits.
9. Account for OPEBs.
10. Explain the conceptual issues regarding
OPEBs.
11. Understand present value calculations for
pensions. (Appendix)
4
Defined Contribution Plans
 The employer contributes a defined sum to a third party
plan trust.
 Amounts to be funded are determined by the plan.
 The plan invests the contributed assets, which earn
income, and makes distributions to retirees.
 There is no promise for specific future benefits.
 Market risk is borne by the employee.
 Accounting for the firm is relatively straightforward.
 For profit companies contribute to 401(k) plans and nonprofit organizations contribute to 403(b) plans.
5
Characteristics of a Pension Plan
A pension plan
requires that a
company provide
income to its retired
employees in return
for services they
provided during their
employment.
6
Defined Benefit Plans
The retirement income,
normally paid monthly,
usually is determined on
the basis of the
employees earnings and
length of service with
the company.
$50,000 average salary X 2.5% per year X 30 years
= $37,500 pension per year
Internal Revenue
Qualifications
Most companies design their pension plans to meet
the Internal Revenue Code qualifications, which
state that:
1. Employer contributions are deductible for
income tax purposes when paid.
2. Pension fund earnings are exempt from income
taxes.
3. Employer contributions to the pension fund are
not taxable to the employees until they receive
their pension benefits.
7
8
Pension Relationships
9
Defined Benefit Plans
 The employee is promised a certain amount of benefits
at retirement.
 The amount received is based upon variables such as
-Years of service
-Ending salary or average of best (three) years
-Multiplier, such as 2.5% per year of service
-Age, if retiring early, a deduction will be made
 The employer remains liable for the benefits and bears
the market risk.
 The employer is the trust-beneficiary.
 The accounting by the firm is complex.
10
Projected Benefit Obligation
The projected benefit
obligation is the actuary’s
estimate of the present value of
benefits attributed to date
based on future salary levels.
11
Accumulated Benefit Obligation
The accumulated benefit
obligation is the actuary’s
estimate of the present value of
benefits attributed to date
based on current salary levels.
12
Components of
Pension Expense
1.
2.
3.
4.
5.
+Service cost for the year. Increases pension expense.
+Interest on projected benefit obligation (liability).
Beginning PBO times the discount or settlement rate.
Increases pension expense.
-Expected return on plan assets during the year. Fair
value of plan assets at beginning of year times expected
long-term rate of return on plan assets. Generally
decreases pension expense.
+Amortization of prior service cost = Present value of
additional benefits/modification of the plan amortized
over the remaining service lives of active employees.
Generally increases pension expense.
+Gain or loss = Amortization of the cumulative net gain
or loss from previous periods that has not yet been
included in pension expense, in excess of the corridor.
13
Service Cost
Service cost is the
actuarial present value
of the benefits attributed
by the pension benefit
formula to service
rendered by the
employees during the
current period.
14
Interest Cost
Interest cost is the
increase in the
projected benefit
obligation due to the
passage of time.
15
Expected Return on Assets
The expected return on
plan assets is the
expected increase in plan
assets due to investing
activities.
The expected return on
plan assets, if positive,
will decrease pension
expense.
16
Expected Return on Plan Assets
Projected Benefit Obligation
Projected Benefit Obligations
Grows to Equal Expected
at Beginning of Period =
Retirement Obligation
Present Value of Benefits
Earned to Date
Retirement
Interest = Projected Benefit x Discount
Cost
Obligation
Rate
Expected Return on Plan Assets
During Period
Plan assets at Beginning
of Period at Fair Value
Assets Used to Pay
Retirement Benefits
Assets Grow to Equal
the Amounts Needed to
Pay Retirement Benefits
17
Prior Service Cost
When a defined benefit plan is either
initiated or amended, credit is often given
to employees for years of service
provided before the date of initiation or
amendment.
18
Prior Service Cost
The retroactive benefit Prior service cost is reported
to a pension plan is theas a liability and as a negative
element of Other
prior service cost.
Comprehensive Income for
the year at the date of the
plan amendment.
19
Methods of Amortization
Prior service cost may be amortized to
pension expense over future service
periods of employees active at the time of
the plan amendment using either the
straight-line or years-of-service method.
20
Straight-line Method
The average remaining service life of employees
expected to receive benefits is calculated by
dividing the total future service years by the
number of employees.
Total future service years = average remaining service life
Number of employees expected
to receive benefits
21
Years-of-Service Method
The Board prefers a years-of-service
amortization method where prior
service cost is divided by the number
of future service years to be worked
by participating employees, to
obtain a cost per service-year. This
cost per service-year is multiplied by
the number of service years
consumed each year.
22
Years-of-Service Method
At the beginning of 2007, Watts Company had nine
employees who are expected to receive pension
benefits. One employee (A) is expected to retire after
three years, one (B) after 4, two (C,D) after 5, two
(E,F) after 6 and three (G,H,I) after 7 years.
23
Years-of-Service Method
At that time, the company’s actuary computed the
prior service cost at $400,000.
24
Straight-Line Amortization
The seven employees will provide 50 years of service,
so the average service provided will be 50 / 7 =
5.56 years. The prior service cost of $400,000
divided by 5.56 years equals $71,942 to be
amortized to pension expense each year.
25
Gain or Loss
A gain or loss from previous periods
arises because the actual amount of the
PBO is different from what was
assumed and because of changes in
actuarial assumptions.
26
Gain or Loss
The gain or loss for the year is
recorded as a liability or asset and in
Other Comprehensive Income for the
year.
Accrued/Prepaid Pension Cost
15,300
Other Comprehensive Income (gain)
15,300
27
Gain or Loss
The excess of the accumulated gain or
loss over a “corridor” amount is
amortized over the remaining service
life of active employees expected to
receive benefits under the plan.
28
Amortization of Gain or Loss
The minimum amortization required is computed
by dividing the total accumulated gain or loss
subject to amortization at the beginning of the year
by the average remaining service period of active
employees expected to receive benefits.
The amount subject to amortization is the excess
of 10% of the greater of the beginning balances of
the projected benefit obligation and the fair value
of the assets value. Use absolute values.
29
Amortization of Gain or Loss
1. Amortization of any unrecognized net
loss from previous periods is added to
compute pension expense, or
2. Amortization of any unrecognized net
gain from previous periods is deducted
to compute pension expense.
30
Computation of Net Gain or Loss
Use January 1 cumulative gain or loss for computation.
Jan. 1
Cumulative
Net Loss
Year
(Gain)
Projected
Benefit
Obligation
Actual
Fair
Value
of Plan
Assets
2007
$13,000
$110,000
2008
(2,300)
2009
2010
Corridor
Excess
Net Loss
(Gain)
Amortized
Net Loss
(Gain)
$100,000
$11,000
$2,000
$200
135,000
130,000
13,500
----
----
18,700
168,000
170,000
17,000
1,700
170
27,500
230,000
215,000
23,000
4,500
450
Assume the average
remaining service period
is 10 years.
Divide
By 10 years
Component
of pension
expense
31
Net Gain or Loss
December 31, 2007:
Amortized $200 of January 1 accumulated net loss to
pension expense.
December 31, 2007:
Accrued/Prepaid Pension Cost
Other Comprehensive Income
200
200
(Amount amortized to pension expense during 2007)
32
Net Gain or Loss
December 31, 2007:
Accrued/Prepaid Pension Cost
Other Comprehensive Income
15,300
15,300
(Difference between $13,000 loss on January 1 and $2,300
gain on December 31)
December 31, 2008:
Other Comprehensive Income
Accrued/Prepaid Pension Cost
21,000
21,000
(Difference between $2,300 accumulated gain on January 1
and $18,700 accumulated loss on December 31)
33
Projected Benefit Obligation
Beginning projected benefit obligation
+ Prior service cost added this year
= Adjusted beginning projected benefit obligation
+ Service cost for the period
+ Interest cost on beginning PBO
+ Actuarial losses (or – Actuarial gains)
- Payments to retirees
= Ending projected benefit obligation
34
Plan Assets
Beginning fair value of plan assets
+ Actual return on pension plan assets
+ Contributions by the company
- Payment to retirees
= Ending fair value of plan assets
35
Pension Expense Equal to
Funding
Facts for the Carlisle Company
1. The company adopts a pension plan on
January 1, 2007. No retroactive benefits were
granted to employees.
2. The service cost each year is: 2007, $400,000;
2008, $420,000; 2009, $432,000.
3. The projected benefit obligation at the
beginning of each year is: 2008, $400,000;
and 2009, $840,000.
Continued
36
Pension Expense Equal to
Funding
4. The discount rate is 10%.
5. The expected long-term rate of return on plan
assets is 10%.
6. The company adopts a policy of funding an
amount equal to the pension expense and
makes a payment at the end of each year.
7. Plan assets are based on the amounts
contributed each year, plus a return of 10%,
less $20,000 to retired employees (beginning
2008).
37
Pension Expense Equal to
Funding
December 31, 2007:
Pension Expense
Cash
400,000
400,000
December 31, 2008:
Pension Expense
Cash
Service cost (from actuary)
Interest cost ($400,000 x 10%)
Expected return on plan assets
($400,000 x 10%)
Pension expense
420,000
420,000
$420,000
40,000
(40,000 )
$420,000
38
Balance-Plan Assets
Plan Assets
Cash from 2007
400,000
Return in 2008
40,000
Cash from 2008
420,000
Bal. 1/1/09
840,000
Paid to
retirees
2008
20,000
39
Balance-PBO
Projected Benefit Obligation
400,000 Service cost 2007
420,000 Service cost 2008
40,000 Interest on 1/1/08 PBO
Benefits paid to
retirees in 2008
20,000
840,000 Bal. 1/1/09
40
Pension Expense Equal to
Funding
December 31, 2009:
Pension Expense
Cash
Service cost (from actuary)
Interest cost ($840,000 x 10%)
Expected return on plan assets
($840,000 x 10%)
Pension expense
432,000
432,000
$432,000
84,000
(84,000 )
$432,000
Note that the interest cost and the return on
the plan assets offset each other each year.
41
Funding Greater Than
Pension Expense
Carlisle Company funds $405,000 in 2007,
$425,000 in 2008, and $435,000 in 2009.
December 31, 2007:
Pension Expense
Accrued/Prepaid Pension Cost
Cash
400,000
5,000
405,000
Asset
42
Funding Greater Than
Pension Expense
December 31, 2008:
Pension Expense
Accrued/Prepaid Pension Cost
Cash
419,500
5,500
Service cost (from actuary)
$420,000
Interest cost ($400,000 x 10%)
40,000
Expected return on plan assets
($405,000 x 10%)
(40,500 )
Pension expense
$419,500
Asset balance is now $5,000 + $5,500
425,000
43
Balance-Plan Assets
Plan Assets
Cash from 2007
405,000
Return 2008
40,500
Cash from 2008
425,000
Bal. 1/1/09
850,500
Paid to
retirees
2008
20,000
44
Funding Greater Than
Pension Expense
December 31, 2009:
Pension Expense
Accrued/Prepaid Pension Cost
Cash
Service cost (from actuary)
Interest cost ($840,000 x 10%)
Expected return on plan assets
($850,500 x 10%)
Pension expense
430,950
4,050
435,000
$432,000
84,000
(85,050 )
$430,950
The balance in the asset account is $14,550
($5,000 + $5,500 + $4,050)
Pension Expense Less Than
Pension Funding & Expected
Return Different from Both
Actual Return & Discount Rate
Carlisle Company funds $415,000 in 2007, $425,000
in 2008, and $440,000 in 2009. The expected return
is 11% and the actual return is 12% each year.
December 31, 2007:
Pension Expense
Prepaid/Accrued Pension Cost
Cash
400,000
15,000
415,000
45
Pension Expense Less Than
Pension Funding & Expected
Return Different From Both
Actual Return & Discount Rate
December 31, 2008:
Pension Expense
Prepaid/Accrued Pension Cost
Cash
Service cost (assumed)
Interest cost ($400,000 x 10%)
Expected return on plan assets
($415,000 x 11%)
Pension expense
414,350
10,650
425,000
$420,000
40,000
(45,650 )
$414,350
The balance in the asset account is $25,650
46
47
Balance-Plan Assets
Plan Assets
Cash from 2007
415,000
Return 2008
49,800
Cash from 2008
425,000
Bal. 1/1/09
869,800
Paid to
retirees
2008
20,000
48
Balance-PBO
Projected Benefit Obligation
400,000 Service cost 2007
420,000 Service cost 2008
40,000 Interest on 1/1/08 PBO
Benefits paid to
retirees in 2008
20,000
840,000 Bal. 1/1/09
Pension Expense Less Than
Pension Funding and Expected
Return Different From Both
Actual
Return
&Discount
Rate
December 31, 2009:
Pension Expense
Prepaid/Accrued Pension Cost
Cash
Service cost
Interest cost ($840,000 x 10%)
Expected return on plan assets
($869,800 x 11%)
Pension expense
420,322
19,678
440,000
$432,000
84,000
(95,678 )
$420,332
The balance in the asset account is $49,478
49
50
Difference Between Expected
and Actual Return
Because the 12% actual return is $49,800,
which is $4,150 higher than the $45,650
expected return, a journal entry must be
made to Accrued/ Prepaid Pension Cost and
Other Comprehensive Income for the year.
A gain increases income.
Accrued/ Prepaid Pension Cost
Other Comprehensive Income
4,150
4,150
51
Pension Expense Including
Amortization of Prior Service
Cost
Carlisle Company awarded retroactive benefits
to employees when it adopted the pension plan.
The prior service costs were estimated to be $2
million, which is to be amortized over 20 years.
Carlisle decided to increase its contributions to
$705,000 in 2007, $715,000 in 2008, and
$730,000 in 2009.
52
Pension Expense Including
Amortization of Prior Service
Cost
As required by FAS 158, the prior service costs
of $2 million must be recorded as a liability
and also as a negative element of Other
Comprehensive Income for the year.
Other Comprehensive Income
2,000,000
Accrued/Prepaid Pension Cost
2,000,000
Pension Expense Including
Amortization of Prior Service
Cost
December 31, 2007:
Pension Expense
Accrued/Prepaid Pension Cost
Cash
700,000
5,000
Service cost
$400,000
Interest cost ($2,000,000 x 10%)
200,000
Amortization of prior service cost
($2,000,000/ 20 years)
100,000
Pension expense
$700,000
705,000
53
54
Pension Expense Including
Amortization of Unrecognized
Prior Service Cost
The 2007 pension expense includes $100,000
amortization of prior service cost ($2,000,000/
20 years). Therefore, the company must record
an adjusting entry to increase 2007 Other
Comprehensive Income.
Accrued/Prepaid Pension Cost
100,000
Other Comprehensive Income
100,000
55
Balance-PBO
Projected Benefit Obligation
400,000 Service cost 2007
2,000,000 Prior service cost
200,000 Interest on 1/1/07 PBO
2,600,000 Bal. 1/1/08
Pension Expense Including
Amortization of Prior Service
Cost
December 31, 2008:
Pension Expense
Prepaid/Accrued Pension Cost
Cash
Service cost (assumed)
Interest cost ($2,600,000 x 10%)
Expected return on plan assets
($705,000 x 11%)
Amortization of prior service cost
Pension expense
702,450
12,550
$420,000
260,000
(77,550 )
100,000
$702,450
715,000
56
57
Pension Expense Including
Amortization of Prior Service
Cost
The 2008 pension expense also includes
$100,000 amortization of prior service cost so
the company must record an adjusting entry to
increase 2008 Other Comprehensive Income.
Accrued/Prepaid Pension Cost
100,000
Other Comprehensive Income
100,000
58
Balance-PBO
Projected Benefit Obligation
400,000 Service cost 2007
Benefits paid 2,000,000 Prior service cost
to retirees
200,000 Interest on 1/1/07 PBO
in 2008
420,000 Service cost 2008
20,000 260,000 Interest on 1/1/07 PBO
3,260,000 Bal. 1/1/09
59
Balance-Plan Assets
Plan Assets
Cash from 2007
705,000
Return in 2008
84,600
Cash from 2008
715,000
Bal. 1/1/09
1,484,600
Paid to
retirees
2008
20,000
Pension Expense Including
Amortization of Prior Service
Cost
December 31, 2009:
Pension Expense
Accrued/Prepaid Pension Cost
Cash
Service cost
Interest cost ($3,260,000 x 10%)
Expected return on plan assets
($1,484,600 x 11%)
Amortization of prior service cost
Pension expense
694.694
35,306
730,000
$432,000
326,000
(163,306 )
100,000
$694,694
60
61
Disclosures
According to FASB Statement No.
132R and 158, a company must
disclose specific information about
a defined benefit pension plan,
including the following:
62
Disclosures
1. A reconciliation of
the beginning and
ending balances of
the projected benefit
obligation.
3. The components
and amount of
pension expense.
2. A reconciliation of
the beginning and
ending balances of
the fair value of
the plan assets.
4. The discount rate,
the rate and the
expected long-term
rate of return on the
plan assets.
63
Required Funding
A company must fund its
pension plan each year
at an amount that at
least equals the service
cost for the year plus
the amount needed to
amortize any
underfunding over a
maximum of seven
years.
64
Summary of Journal Entries
1. Pension expense.
Entries to Accrued/Prepaid Pension Cost and Other
Comprehensive Income
2. Record prior service cost.
3. Record difference between expected return and
actual return.
4. Record amortization of prior service cost.
5. Record amortization of cumulative gain or loss.
6. Record changes in PBO (not illustrated in text).
---------------------------------------------------7. Close Other Comprehensive Income to
Accumulated Other Comprehensive Income
65
Termination Benefits Paid to
Employees
FASB Statement No. 88 requires that a
company record a loss and a liability for
termination benefits when the following two
conditions are met:
1. The employee accepts the offer, and
2. The amount can be reasonably
estimated.
66
Other Postemployment Benefits
Many companies offer
additional benefits to former
employees after their
retirement--widely referred to
as OPEB.
What are the major
differences between
postretirement healthcare
benefits and pensions?
67
Other Postemployment Benefits
Item
Pensions
Beneficiary Retired employee (some
residual benefit to
surviving spouse)
Benefits
Defined, fixed dollar
amount, paid monthly
Funding
Healthcare
Retired employee,
spouse, and
dependents
Not limited, paid as
used, varies
geographically
Funding legally required Usually not funded
and tax deductible
because not legally
required and not tax
deductible
68
OPEB Benefits
The net postretirement benefit expense includes the
following components:
1.
2.
3.
4.
5.
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Amortization of net gain or loss
69
Illustration of
Accounting for OPEB
Livingston Company adopts a healthcare plan for
retired employees on January 1, 2007. At that
time the company has two employees and one
retired employee. The discount rate is 10%, all
employees were hired at age 25 and will become
eligible for full benefits at age 55. The retired
employee was paid $1,500 postretirement
healthcare benefits in 2007. The company
determines its accumulated postretirement benefit
obligations to be $100,000.
Continued
70
Illustration of
Accounting for OPEB
Service cost (actuarially determined)
Interest cost ($100,000 x 0.10)
Expected return on plan assets
Amortization of prior service cost
($100,000 ÷ 5)
Gain or loss
Postretirement Benefit Expense
Continued
$ 1,100
10,000
0
20,000
0
$31,100
71
Illustration of
Accounting for OPEB
January 1, 2007
Other Comprehensive Income
100,000
Accrued Postretirement Benefit
Cost
100,000
December 31, 2007
Postretirement Benefit Expense
Accrued Postretirement Benefit
Cost
31,100
31,100
72
Illustration of
Accounting for OPEB
To record the payment of retirement benefits
Accrued Postretirement Benefit Cost
Cash
1,500
1,500
To record amortization of prior service cost
Accrued Postretirement Benefit Cost 20,000
Other Comprehensive Income
20,000
73
Chapter 20
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