INTERMEDIATE
ACCOUNTING
Sixth Canadian Edition
KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK
Prepared by
Gabriela H. Schneider, CMA; Grant MacEwan College
CHAPTER
20
Pensions and Other Employee
Future Benefits
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. Identify the accounting and disclosure
requirements for defined contribution plans.
4. Explain alternative measures for valuing the
pension obligation.
5. Identify the components of pension expense.
Learning Objectives
6. Identify transactions and events that affect the
projected benefit obligation.
7. Identify transactions and events that affect the
balance of the plan assets.
8. Explain the usefulness of—and be able to
complete—a work sheet to support the
employer’s pension expense entries.
9. Explain the pension accounting treatment of past
service costs.
Learning Objectives
10. Explain the pension accounting treatment of
actuarial gains and losses, including corridor
amortization.
11. Identify the differences between pensions
and post-retirement health care benefits.
12. Identify the financial reporting and
disclosure requirements for defined benefit
plans.
13. Identify the financial accounting and
reporting for defined benefit plans whose
benefits do no vest or accumulate.
Pensions and Other
Employee Future Benefits
Introduction
and
Terminology
Nature of
pension plans
Defined
contribution
plans
Defined benefit
plans
The role of
actuaries
Defined Benefits
Defined Benefits that Vest or
Defined
that Vest or
Benefits that
Accumulate
Accumulate do no Vest or
Complexities
Basics
Accumulate
Alternative
measures of the
liability
Capitalization vs.
non-capitalization
Components of
pension expense
Projected benefit
obligation and
plan assets
Basic Illustration
Past service costs
PostActuarial gains and employment
losses
benefits and
Corridor
compensated
amortization
absences
Other benefits that
vest or accumulate
Comprehensive
illustration
Reporting defined
benefit plans
Plan complexities
Pension Plans
• A pension plan provides benefits to retirees
for services provided during employment
• Employer sponsors and contributes to fund,
and incurs the cost of the pension plan
• Accounting for the employer
• Pension plan receives the contributions,
administers pension assets, and makes
pension payments to the beneficiaries
• Accounting for the pension plan
Pension Terminology
• Contributory
• Employee and employer make contributions to
the plan
• Non-contributory
• Employers bear the full cost of the pension plan
• No contributions made by employee
• Vested
• Amounts in the plan become the legal property
of the employee
• Employee is entitled to receive benefits even after
leaving the employ of the corporation
• Governed by provincial law
Defined Contribution Plans
• Employer contributes a defined sum to a
third party – plan trustee
• Ownership of plan assets assumed by
trustee
• Employee assumes the economic risk
• No guarantee made by employer as to
benefits paid
• Cost of the plan in the current year is
known with certainty
Defined Contribution Plans
• Liability reported if contribution
(funding) is less than required
• Asset reported if the amount contributed
is more than required for the period
• Disclosure requirements:
• Annual pension expense amount
• Nature and effect of matters affecting
comparability
Defined Contribution Plans:
Employers’ Journal Entries
Contribution made
is less than
the pension expense
Contribution made
is more
than pension expense
Pension Expense Dr
Cash
Cr
Prepaid/Accrued Cr
Pension Expense Dr
Prepaid/Accrued Dr
Cash
Cr
Liability
Asset
Types of Pension Plans
• Defined benefit pension plan
• The end benefit is predefined
• Contributions to fund end benefit based on formula
• Employee’s years of service and expected salary level at
retirement
• Actuarial assumptions used extensively in
accounting for defined benefit plans
• Cost of the plan in the current year is not known
with certainty
• The employer remains liable to ensure benefit
payments
• Employer is the trust-beneficiary
Pension Liability Measurement
Vested benefit obligation
Recommended
method -Accumulated
CICA
benefit
Pension obligation Handbook,
obligation (ABO)
Section 3461
Present value of
the estimated
future benefits to
be paid to
employees
Projected benefit obligation
(PBO)
Pro-rated on salaries Pro-rated on service
Pension Liability Measurement
• Projected benefit obligation
• Pension obligation is measured based on the
projected future salaries of the employee at
retirement
• Two methods available
• Pro-rated on salaries
• Annual funding based on percentage of total
estimated compensation earned by the
employee over their career
• Pro-rated on services
• Annual funding based on the total estimated
benefit being allocated evenly over the years
of service of the employee
Pension Fund Stream
TRUST
COMPANY
Pension Expense
Cash paid to pension
plan (funding)
Accrued/prepaid
pension costs
$
Plan
Assets
Projected Benefit
Obligation
Employees (pension benefits)
Components of
Pension Expense
Service Cost for
Current Year
+
Interest on the
Liability
+
Expected return on
Plan Assets

Pension Expense
+
Amortized
Past Service Costs
+ or 
Amortized
Net Actuarial Gain
or Loss
+ or 
Amortized
Transitional
Asset or Obligation
Components of
Pension Expense
• Current service cost
• The amount of pension benefit earned in the
current period
• Expected Interest on PBO
• Consider PBO as a long-term liability (albeit
off-balance sheet) that accrues interest
• Interest rate used is the long-term debt rate
(if none provided)
• Applied to the opening PBO balance
Components of
Pension Expense
• Expected Return on Plan Assets
• The assets in the pension plan earn income and this
income reduces the eventual cost of the pension
• Long-term rate of return applied to fair value of plan
assets
• Amortization of Past Service Costs (PSC)
• PSC are from either the initial adoption of a pension
plan or an amendment to improve the existing plan
• PSC are the present value of those additional future
benefits
• Amortized over the expected average remaining
service life of the employee group
Components of
Pension Expense
• Amortization of Actuarial Gains/Losses
• Change in plan’s actuarial assumptions or
• Plan experiences gains and losses
• Amortized using “corridor approach”
• Amortization of Transitional Asset or Obligation
• Stem from CICA Handbook, Section 3461 (introduced in
2000)
• When Section 3461 is applied prospectively, any
difference in the plan assets and PBO is amortized
• Amortization period is the Expected Average Remaining
Service Life (EARSL)
Notes on EARSL
• EARSL is the expected average
remaining service life of the employee
group
• It is another number determined by the
actuary
• Consider the following example
EARSL
Picture a bus full of employees heading for
retirement. Given an EARSL of 10 years in 2000,
what is a reasonable EARSL in 2001?
Are the same employees on
the bus at retirement as were
on at the beginning?
2000
2001
Some got on the bus, others got off the bus…
Retirement
A reasonable estimate for 2001 might be 10 years.
Summary of Pension Expense
Components and Methods
Pension expense
component
Method used to
determine cost
Effect on pension
expense
1 Service Cost
Present Value
2 Interest Expense
Settlement rate
+
3 Expected Return
Expected Rate of Return
-
4 Prior Service Cost
Straight line (service years)
on Plan Assets
+
+
5 Actuarial Gains
Corridor method
+/-
6 Transition Gains
EARSL
+/-
and Losses
and Losses
PBO Transactions
PBO, beginning of period • The PV of total
benefits due to
+ Current Service Cost
employees
at
+ Interest Cost
retirement
+ PSC during period
• Most information
 Benefits paid to
relating to PBO
retirees
provided by actuaries
+ Actuarial Gains
 Actuarial Losses
= PBO, end of period
Plan Assets Transactions
Plan assets (FV)
beginning of period
+ Employer/employee
funding
+ Expected return
 Actual return
 Benefits paid out
= Plan assets (FV) end
of period
• Funded Status =
PBO less
FV of plan assets
• When PBO  Plan
Assets plan is
underfunded
• When Plan Assets 
PBO plan is
overfunded
Notes on Pension
• The accrued/prepaid pension cost on the
balance sheet represents the difference
between what has been recognized as expense
and the amount that has been funded since
accounting for the defined benefit pension plan
• CICA Handbook, Section 3461 recommends the
noncapitalization approach
• Pension amounts not required to be recorded by
the company
• PBO, Plan Assets, Unrecognized PSC,
Unrecognized Net Actuarial Gains/Losses,
Unrecognized Net Transitional Asset/Liability
The Pension Worksheet
• Used to record both the formal journal
entries and the memo entries to keep
track of the relevant pension plan items
and components
The Pension Worksheet
General Journal Entries
Items
Annual
Pension Cash
Expense
Memo Record
Prepaid/
Accrued
Cost
Projected
Benefit
Obligation
Plan
Assets
Beginning Balances recorded here
An ending credit
balance here is
reported with
Long-term
Liabilities
An ending debit
balance is
reported with
other Deferred
Charges
Pension transactions are recorded through the worksheet,
using debits and credits (all entries must therefore balance)
The Pension Worksheet - Example
General Journal Entries
Annual
Pension
Cash
balance
ItemsCredit
Expense
Memo Record
Prepaid/
Projected
Accrued
Benefit
reported
as
a
Cost
Obligation
Journal
Entries:
Plan
Assets
Long-term Liability
Pension
9,000
Bal. Debit balance reported
100,000 Dr.
as Expense
a 100,000 Cr.
Prepaid/Accrued
9,000
Deferred
Pension
Expense
a)
9,000 Dr.
9,000 Cr.
other
b) with
10,000
Dr. Deferred Charges 10,000 Cr.
Prepaid/Accrued
8,000
c) 10,000 Cr.
10,000 Dr.
8,000
d)
8,000 Cr. Cash
8,000 Dr.
e)
7,000 Dr.
7,000 Cr.
9,000 Dr. 8,000 Cr. 1,000 Cr. 112,000 Cr. 111,000 Dr.
Actuarial Gains and Losses
• Caused by:
• Changes in market value of plan assets
• Changes in actuarial assumptions affecting the
PBO
• If changes large enough, including full
amount of the gains or losses, it results in
substantial fluctuations in reported pension
expense
• Amortization allows for “smoothing” the
impact of these changes
Actuarial Gains and Losses
• Over time, accumulated effect of the changes
(net gains/losses) may even out
• Corridor approach adopted to allow for
circumstances where no accumulating offset
occurs
• Corridor approach used only when the
unrecognized gains/losses are greater than
10% of the larger of the opening balance of
the PBO and the FV of Plan Assets
• Amount calculated under the Corridor
Approach uses Beginning Balances only
Corridor Approach - Example
2001
2002
PBO, January
1
Opening
Balance 2,100,000
$400,0002,600,000
Less:Jan.
Corridor
FV Plan Assets,
1
280,0002,800,000
2,600,000
$120,000
Corridor – 10%
of the over 5.5260,000
280,000
Amortized
years –
larger of theaverage
PBO or PA
remaining service life
Opening
$678,182
Net Actuarial
LossBalance
(current
400,000
300,000
portion)(400,000 – 21,818 + 300,000)
Less: Corridor
Cumulative Net Actuarial
Loss (Beginning of Year)
290,000
0
400,000
$388,182
2003
2,900,000
2,700,000
290,000
-0678,182
Amount to be Amortized
0
120,000
388,182
Current Year Amortization
0
21,818
70,579
Disclosure Requirements –
Defined Benefit Plans
• All enterprises must disclose:
• Amounts recorded in the financial statements
• Off-balance sheet accounts
• Underlying assumptions
• Financial institutions have additional
disclosure requirements
• Reconciliation of PBO and Plan Assets
beginning and ending balance
• Unamortized balances of PSC, Net actuarial
Gains/Losses, Net Transitional amounts; and
amortization amount for each
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